Scott E. Mollen

Foreclosures—Second Department Case of First Impression—Statute of Limitations—Reinstatement Provision Was Not a Condition Precedent to Acceleration of the Mortgage And Did Not Prevent Acceleration—Statute of Limitations Commenced When Lender Accelerated the Mortgage—Complaint Dismissed

The Appellate Division, Second Department (court), stated that this decision involved an issue of “first impression for this court.” A plaintiff lender (lender) commenced a mortgage foreclosure action. The lender argued that could not have previously accelerated the mortgage because it “lacked the authority to exercise its contractual option to accelerate the maturity of the entire balance of the loan it seeks to recover.” The lender contended that it was “prevented from validly accelerating the debt by virtue of a reinstatement provision in the…mortgage which gives the borrower the option, under certain circumstances, to effectively de-accelerate the maturity of the debt.” The lender further contended that the statute of limitations (SOL) did not “begin to run until the borrower's rights under the reinstatement provision in the…mortgage were extinguished.”

The mortgage was a “uniform instrument issued by Fannie Mae and Freddie Mac for use in New York.” Based on the “prevalence of the language used in this uniform instrument, and in light of the divergent conclusions reached in the trial-level decisions interpreting that language,” the court deemed it “appropriate to clarify the legal principles that are relevant to this issue and to set forth the appropriate construction of the language used in these uniform instruments.” The court held that the “reinstatement provision contained in the…mortgage was not a condition precedent to the acceleration of the mortgage and did not prevent the plaintiff from validly exercising its option to accelerate.” Thus, the court held that the SOL “started to run when the plaintiff exercised its option to accelerate.”

In October 2016, the lender had commenced a foreclosure action against the borrower (borrower). The borrower moved to dismiss the action as time-barred. The borrower reasoned that the “entire debt was accelerated in June 2010, when a prior action was commenced to foreclose the same mortgage.” The trial court granted the borrower's motion to dismiss and the lender appealed.

The court explained that “[w]here, as here, the claim is for payment of a sum of money allegedly owed pursuant to a contract, the cause of action accrues when the plaintiff possesses a legal right to demand payment….” Further, generally “an action, to foreclose a mortgage may be brought to recover unpaid sums which are due within the 6-year period immediately preceding… the action….”

Even when a mortgage is payable in installments, “the terms of the mortgage may contain an acceleration clause that gives the lender the option to demand due the entire balance of principal and interest upon the occurrence of certain events delineated in the mortgage….” When the mortgage terms provide that “the acceleration of the maturity of a mortgage debt on default is made optional with the holder of the note and the mortgage, some affirmative action must be taken evidencing the holder's election to take advantage of the accelerating provision, and until such action has been taken the provision has no operation….”

Moreover, “[o]nce a mortgage has been…accelerated in accordance with the terms of the mortgage, 'the entire amount is due and (SOL) begins to run on the entire debt….'” Additionally, a “borrower generally must be provided with notice of the lender's decision to exercise an option to accelerate the maturity of a loan… and such notice must be 'clear and unequivocal'.”

Here, the mortgage gave the lender the right “to require the defendant to immediately pay 'the entire amount then remaining unpaid under the Note and [Mortgage]' if the plaintiff first satisfied certain conditions….” The borrower demonstrated that the lender had complied with those conditions and then “validly exercised its option to accelerate the entire remaining balance under the note by filing the summons and complaint in the first foreclosure action in June 2010….”

Since the subject action had not been commenced until October 2016, the borrower established, prima facie that when the lender commenced the action, the SOL had expired. The lender failed to raise an issue of fact since the reinstatement provision of the mortgage “did not prevent it from validly accelerating the mortgage debt.” That provision gave the borrower “the contractual option to de-accelerate the mortgage when certain conditions are met.”

The lender argued that since its right to accelerate the “debt was subject to the defendant's right, under certain circumstances, to de-accelerate that portion of debt, the plaintiff's right to accelerate the debt was subject to a condition precedent and the (SOL) did not begin until the defendant's right to de-accelerate was extinguished in accordance with the terms of the mortgage….”

The court explained that the mortgage “unequivocally set forth the conditions that had to be satisfied before the plaintiff was contractually entitled to exercise its option to accelerate the entire outstanding debt.” The mortgage language “makes clear that the lender is entitled to exercise its option to accelerate 'if all of those conditions… are met.'” The reinstatement language “was not referenced in, or included among, those conditions” listed in provisions setting forth the conditions that had to be met before the lender could exercise its option to accelerate the entire debt.

The reinstatement provision also did not have any language “indicating that it serves as a condition precedent to the plaintiff's right to accelerate the outstanding debt.” Rather, the lender's right to the accelerate the entire debt “may be exercised before the defendant's rights under the reinstatement provision… are exercised or extinguished.”

Accordingly, the court held that “the extinguishment of the defendant's contractual right to de-accelerate the maturity of the debt pursuant to the reinstatement provision… was not a condition precedent to the plaintiff's acceleration of the mortgage….” The court further stated that “[t]o the extent that decisional law interpreting the same contractual language holds otherwise, it should not be followed….” Thus, the court affirmed the trial court's dismissal of the complaint as time-barred.

Bank of New York Mellon v. Dieudonne, Appellate Division, 2d Dept., Case No. 2017-08956, decided March 13, 2019, Dillon, J.P., Austin, Miller, Duffy, JJ. (Opinion by J. Miller)

Commercial Landlord-Tenant—Successor Liability—De Facto Merger—Dunkin Donuts Store Closed and Reopened 100 Feet Away

A landlord had commenced an action for nonpayment of rent based upon a commercial lease. The landlord had moved, inter alia, for summary judgment on several causes of action and to quash third party subpoenas. Two individual defendants (guarantors) had cross-moved for summary judgment.

The subject building (building) included a store (premises), which had been leased for use as a Dunkin Donuts store. On or about Oct. 3, 2008, the defendant tenant had acquired a Dunkin Donuts franchise. The lease had been extended through March 31, 2020 (lease).

The guarantors had signed a guaranty that provided: “This guaranty is limited to obligations accruing prior to (a) Tenant's surrender of possession of the premises to Owner at any time during the term of this lease consisting of (i) delivery of vacant possession, free of all occupancies and tenancies, with all rent and additional rent paid in full to such date; (ii) execution by tenant and delivery of an instrument of surrender and release; and (iii) delivery of the keys to the premises….”

The landlord alleged that the tenant violated the lease by vacating the premises and ceasing to pay rent, without the landlord's consent. The landlord sought to recover the outstanding rent from the tenant and an alleged “successor entity” to the tenant, under the “de facto merger doctrine.” The landlord alleged that the alleged successor tenant is an entity that “wholly owns and that mirrors the management, employees, assets, and general business operation” of tenant 'to a tee'….”

Although the lease authorized the landlord to send a written notice to the tenant terminating the lease, the landlord had never sent such notice to the tenant. On or about June 1, 2016, the tenant sent the landlord a letter stating that it intended to vacate the premises on June 30, 2016. The tenant's letter stated that it would surrender the premises as of June 30, 2016, or before, and would pay all rent and additional rent due through such date. The letter stated that the guarantors would have no further obligations as guarantors, but was silent as to why the tenant was vacating.

After the guarantors received no objection to its surrender from the landlord, the tenant vacated the premises on June 30, 2016, and surrendered possession and delivered the keys to the landlord by letter dated July 8, 2016. However, by letter dated July 15, 2016, the landlord objected to the guarantors' position that they were released from their guaranty. The landlord noted that in order for the guarantors to have been released from their obligations, they had to deliver the keys by June 30, 2016, the date by when the tenant had advised the landlord that it would return the keys. Since the keys were not returned until July 8, 2016, the landlord asserted that “the tendered surrender documents were null and void.”

Following some negotiation, the landlord sent the tenant a letter on or about August 19, 2016, enclosing a release for guarantors. The release stated that “the parties…agree that notwithstanding that (landlord) has agreed to the…release as and against guarantors in consideration…of the settlement amount, nothing herein is intended to, or should be construed as, a release of any kind in favor of (tenant) and (landlord) expressly reserves any and all claims against (tenant).”

Thereafter, the guarantors closed the Dunkin Donuts at the premises and, “[w]ithin days, re-opened it 100 feet down the block….” The landlord argued that the guarantors had formed a new entity (new entity) and the new entity had acquired all of the tenant's assets and had hired “the majority, if not the entirety,” of the tenant's staff, “and took over all of (tenant's) vendor relationships….” The premises had not been leased to a new tenant. The guarantors had cross moved to dismiss the complaint based upon the release.

The defendants argued that the landlord had “deliberately keep the premises vacate” and that they had vacated the premises only after they learned that the Building had a new owner (owner) and they had received information that “led them to believe that the Building was going to be torn down.” The guarantors testified that an employee of the owner “gave them the impression that the Building was going to be torn down and they would lose the store.” The owner of the Building was a well known developer.

The defendants argued that they invoked the “good guy” guaranty based on their belief that the Building would be demolished and that they had surrendered possession and delivered the keys on July 8, 2016 and sold all of the store assets for $92,000 to the new entity. The defendants noted that the landlord had not objected to the surrender until July 15, 2016, one week after receiving the keys. They claimed that the landlord had objected because the keys were delivered on July 8, 2016 rather than June 30, 2016, that in order to resolve that dispute, a guarantor had paid the landlord $22,841.32 and the landlord had released the guarantors.

The defendants also argued that the landlord kept the premises vacant and was “warehousing” space as a “part of a redevelopment for (landlord's) own benefit is not consistent with the landlord-tenant relationship, creating a surrender by operation of law as of July 1, 2016” and that terminated the tenant's “obligation to pay rent and additional rent thereafter.” They further contended that the landlord had failed to establish its rent ledger.

The court explained that “[u]nder New York law, as distinguished from an express surrender, a lease is surrendered by operational law 'when the parties to release both do some act so inconsistent with the landlord-tenant relationship that it indicates their intent to deem the lease terminated… [and can be] inferred from the conduct of the parties….'”

The lease vested the landlord with the right to terminate the lease if the landlord intended to “demolish or substantially alter the building,” provided that the landlord gives similar notices to other tenants whose leases contain similar rights to terminate. Nothing in the lease gave the tenant a unilateral right to terminate the lease. Accordingly, the court found that when the tenant vacated the premises “unilaterally and without the (landlord's) consent, in contravention of the Lease terms, they did not surrender by operation of law.”

Since the tenant continued to be liable under the lease, the court granted summary judgment to the landlord as against the tenant, with the amount of rent due to be determined at trial. The landlord was also entitled to attorney's fees pursuant to an attorney's fee provision contained in the lease.

The landlord had further alleged that the guarantors were the sole members of both the tenant and the new entity and that the new entity is the successor of the tenant. The landlord claimed that the guarantors had “fraudulently transferred” the tenant's “franchise right, employees, stock and inventory, and equipment” to the new entity, without “fair and adequate consideration” and that the new entity had opened up a Dunkin Donuts store 100 feet away. The landlord asserted that since the tenant and the new entity shared “a commonality of the ownership, assets, personnel, and goodwill, (the new entity) is responsible for the liabilities of (tenant).”

The defendants countered that the tenant received fair consideration for the sale of its assets. Of the $92,000 paid for the assets, $82,000 was allocated to the franchise agreement. The members of the tenant had purchased a 20 year franchise term in 2014, at the rate of $4,500 a year, for a sum of $90,000. They argued that $82,000 represents the balance of the franchise term pursuant to the asset sale in 2016. They also noted that the equipment was “used, and an upgrade or replacement of the equipment was imminent pursuant to the franchise agreement,” i.e., the equipment was of “little value.” They also argued that the “goodwill was of little value” to tenant since the goodwill “inures to the benefit of the franchisor” and the $5,000 for the goodwill was an overvaluation.

The court explained:

As a general rule, a corporation that purchases the assets of another corporation is not responsible for the torts of the seller corporation. However, '[a] corporation may be held liable for the torts of its predecessor if (1) it expressly or impliedly assumed the predecessor's tort liability, (2) there was a consolidation or merger of seller and purchaser, (3) the purchasing corporation was a mere continuation of the selling corporation, or (4) the transaction is entered into fraudulently to escape such obligations…. Plaintiff grounds its successor liability claim in at least the first of these exceptions. Plaintiff argues that the sale present: (1) continuity of ownership, (2) cessation of ordinary business operations and the dissolution of the selling corporations as soon as possible after the transaction, (3) the buyer's assumption of the liabilities ordinarily necessary for the uninterrupted continuation of the seller's business, and (4) continuity of management, personnel, physical location, assets and general business operations…. In other words, the question for the court is whether (new entity) is a 'mere continuation' of (tenant)….

The defendants contended that the landlord's de facto merger argument cannot prevail where “the seller corporation is never dissolved and 'remains in existence in a meaningful way since the subject transaction closed…,'” i.e., the tenant remained “an active limited liability company, and continued to exist after the asset sale to pay certain expenses.” Courts have looked to “whether the buyer assumed the seller's existing contracts, royalty obligations, or outstanding debts….” The landlord emphasized that the new entity succeeded to the same Dunkin Donuts franchise and that it utilized the same “vendors…the same utilities, the same garbage collector, the same window cleaner, and the same uniforms” and most of the employees had become employees of the new entity.

The court found that the guarantee was limited to obligations related to the lease and to obligations which accrued prior to the tenant's surrender of the premises and an assignment of the lease with landlord's prior written consent. Thus, the court held that the release did not encompass the landlord's Debtor and Creditor Law claims and thus, the court denied the guarantors cross motion for summary judgment.

The court also quashed subpoenas for two executives related to the landlord. The depositions were allegedly needed to investigate the purpose of the landlord's purchase of the Building. Since the landlord did not invoke the demolition or termination clauses in the lease, the depositions were unnecessary. Accordingly, the court granted the landlord's motion for summary judgment against the tenant and the new entity, as well as for attorney's fees.

14th St. Owner LLC v. Westside Donut 6th Ave. Ventures LLC, Supreme Court, New York Co., Case No. 650473/2017, decided March 1, 2019, Lebovits, J.

Scott E. Mollen is a partner at Herrick, Feinstein.