Application of Covenant of Good Faith and Fair Dealing to Commercial Lease Obligation
A lease is both a contract and a conveyance of property. As a general rule, contract law provides the parties with wide latitude to customize their respective rights and duties under their mutual agreement. The California legislature, enacting §1995.270 of the Civil Code, expressly acknowledged the strong public policy “to enable and facilitate freedom of contract by the parties to commercial real property leases.”
Contract rules inform the interpretation of covenants in leases, including the independent covenants of tenant to pay rent and of landlord to provide quiet enjoyment. Even where landlord fails to provide tenant with quiet enjoyment of the leased premises, so long a tenant remains in possession it is obligated to pay the landlord rent. Landlord’s breach of the covenant of quiet enjoyment may give the tenant the right to terminate the lease, but the rental obligation remains until possession is relinquished.
As in most contracts in California, the covenant of good faith and fair dealing has been consistently implied in commercial leases. The covenant has been interpreted to require a party to a lease with discretionary power over the rights of another party to exercise that power in good faith. The California Supreme Court has noted that the implied covenant must be read specifically in the context of the agreement, as it is intended “to protect the express covenants or promises of the contract, not to protect some general public policy interest not directly related to the contract’s purpose.”[1] Such covenant requires actions to be taken with subjective good faith and objective fair dealing.[2]
In a recent appellate case[3], a retail tenant sought damages for the destruction of its business, against a landlord for losses suffered by tenant as a result of landlord’s renovation of its retail center, asserting that landlord’s conduct breached the express covenant of quiet enjoyment and the implied covenant of good faith and fair dealing. The lease included an express covenant of quiet enjoyment, but also granted the landlord the right to remodel the center. The provision authorizing renovation included a limitation of liability for damages resulting from any renovation, but included the right of tenant to abate rent to the extent its use of the premises was impaired. In addition, the lease included an express exemption of landlord for liability for certain damages, including damages arising from the condition of the premises or the buildings, and injury to tenant’s business or loss of income or profits, whether such damages resulted from landlord’s negligence or breach of lease. The express damage remedy provided the tenant was a claim under tenant’s insurance policies that it was obligated to maintain under the lease.
The court acknowledged that public policy, as articulated by California courts, disfavored contractual provisions purporting to exempt a party from liability from such party’s fraud or willful or negligent actions which caused injury to persons or property. As a result, the court determined that the lease provisions limiting landlord’s liability could not apply to gross negligence, and any exemption for ordinary negligence would be strictly scrutinized, with the focus on the intent of parties as expressed in the lease.
The broad language exempting landlord from liability specifically included the following language: “Notwithstanding the negligence or breach of this lease by Lessor or its agents, neither Lessor nor its agents shall be liable under any circumstances for” personal injury or property damage, including tenant’s merchandise and other property, injury to tenant’s business and loss of income and profits.[4] This language, along with the specific exemption of liability included in the provision entitling landlord to remodel the center, were deemed by the court to evidence the parties’ intent to limit landlord’s liability for the damages sought in the tenant’s complaint. Fundamental to its decision was the court’s acknowledgement that parties to a lease may expressly agree to limit the express or implied covenants of good faith and fair dealing and quiet enjoyment.
This case illustrates the principal that the covenant of good faith and fair dealing cannot be applied to prohibit the conduct of a party which is expressly permitted in the lease. As previously noted by the California Supreme Court “The general rule [regarding the covenant of good faith] is plainly subject to the exception that the parties may, by express provision of the contract, grant the right to engage in the very acts and conduct which would otherwise have been forbidden by an implied covenant of good faith and fair dealing.”[5]
The covenant of good faith and fair dealing implied in all leases must be considered in the context of the exercise of a party’s discretionary power. Such power must be exercised by a party believing in the validity of its actions, and such conduct must be objectively reasonable. While often critical in gauging parties’ conduct under a lease, it is important to recognize that the implied covenant of good faith and fair dealing will be reviewed with specific reference to the rights and obligations of the parties to the lease, and can be limited by the express agreements of the parties included in the lease.
Alfred M. Clark, III is a partner in the Los Angeles office and a member of the national Board of Directors of Locke Lord, LLP. His principal practice area involves representing institutional lenders and private investors in mortgage financing transactions, including the exercise of creditor’s rights in troubled projects. In addition, Mr. Clark represents investors, landowners and commercial users in a wide variety of real estate transactions.
VIEWS EXPRESSED ARE THE PERSONAL VIEWS OF THE AUTHOR AND DO NOT REPRESENT THE VIEWS OF ROBERT THORNBURGH, KIDDER MATHEWS, LOCKE LORD LLP, ITS PARTNERS, EMPLOYEES OR ITS CLIENTS. FURTHERMORE, THE INFORMATION PROVIDED BY THE AUTHOR IS NOT INTENDED TO BE LEGAL ADVICE AND DOES NOT CREATE AN ATTORNEY-CLIENT RELATIONSHIP.
[1] Foley v. Interactive Data Corp. (1988), 47 Cal. 3d 654, 690.
[2] Carma Developers (California), Inc. v. Marathon Development California, Inc., (1920) 2 Cal. 4th 342, 372
[3] Frittelli, Inc. v. 350 North Canon Drive, LP, (2011), 202 Cal. App. 4th 35.
[4] Id. at 45.
[5] Carma Developers, supra 2 Cal. 4th at 374 [citations omitted].
