Real Property Law

Duty to Inquire

Philippine American Lace Corp. v. 236 West 40^th Street Corp.

NYLJ 9/28/06, p. 47, col. 2

AppDiv, First Dept.

(memorandum opinion)

In an action by holder of a right of first refusal for a declaration that holder is the owner of the disputed premises, purchaser of the premises appealed from Supreme Court's determination that holder of the first refusal right owned the premises. The Appellate Division reversed, holding that there was no reason for purchaser to know that plaintiff held an unrecorded right of first refusal.

Plaintiff had leased the premises for several years, and held an unrecorded right of first refusal in the leased premises. When purchaser first considered purchasing the premises from plaintiff's landlord, purchaser conducted a title search, which did not and could not have revealed the existence of the unrecorded right. Purchaser also obtained a sworn affidavit from the prior owner stating that there were no options to purchase or rights of first refusal in any existing leases or agreements affecting the premises. Purchaser also asked prior power for copies of plaintiff's prior leases, and received copies of the leases, none of which included a right of first refusal. Purchaser then bought the premises. Purchaser then served plaintiff-tenant with a three-day notice demanding payment of rent. The notice listed purchaser as landlord. Nevertheless, plaintiff holder of the first refusal right did not challenge that ownership or assert its right of first refusal for 18 months. When plaintiff did seek declaratory relief, Supreme Court enforced the right of first refusal, holding that plaintiff owned the disputed premises, and ordering that plaintiff reimburse purchaser for the purchase price it had paid to prior owner. Purchaser appealed.

In reversing, the Appellate Division acknowledged that because plaintiff was a tenant in possession of the premises at the time of purchase, purchaser had an obligation to go beyond conducting a title search, and had a duty to inquire about plaintiff-tenant's rights to the premises. The court noted, however, that the prior owner had deliberately interfered with tenant's right of first refusal (by offering tenant terms of sale he knew tenant would not accept), and concluded that under the circumstances purchaser 'did as much as reasonably expected in order to ascertain whether plaintiff had a right of first refusal.' Moreover, the court also concluded that plaintiff's delay in asserting the right of first refusal required application of the laches doctrine as a bar to plaintiff assertion of its right of first refusal. In particular, the court noted that during the 18-month period of delay, purchaser had made improvements, paid insurance, taxes and operating expenses, so that even payment of the purchase price would not fully compensate purchaser for its investment in the building.

COMMENT

A purchaser has a duty to inquire about the rights of a person in actual, visible, and open occupation at the time of purchase. In Phelan v. Brady, 119 N.Y. 587 (1890), the Court of Appeals held that tenant's act of residing on the premises constituted actual possession giving rise to a duty to inquire on purchaser's part. In that case, purchaser claimed ownership after seller had transferred a mortgage of the premises as collateral for a loan. Tenant demonstrated that she owned the premises although her title was unrecorded and seller's name appeared on the title. In rejecting purchaser's argument that he acquired the property in good faith because he could not have ascertained tenant's un-recorded interest, the court determined that tenant's actual and open occupation of the premises imposes on purchaser a duty to inquire and serves as notice to purchaser of tenant's rights in the property. Persons working on the premises as laborers are not 'in possession' within the meaning of the Phelan rule. The Court of Appeals in Brown v. Volkening, 64 N.Y. 76 (1876), held that tenant's proof of occupation consisting of laborers and mechanics working on an unfinished house in which tenant had an unrecorded conveyance did not constitute actual occupation and was therefore insufficient to amount to knowledge of possession on the part of the prospective purchaser.

Possession by a sublessee creates a duty on the part of the purchaser to inquire of the sublessee but does not create a duty to inquire of the lessee. In Van Dyck Foods v. Dime Sav. Bank of Brooklyn, 253 A.D. 347 , the court held that the purchaser's inquiry of a sublessee was sufficient to protect him from a subsequent challenge by lessee who had an unrecorded interest in the property. In that case, lessee had subleased the premises to a third party and obtained a chattel mortgage, both of which were unrecorded. The owner of the property subsequently assigned collection of the rent to the purchaser. After purchaser evicted the sublessee, the lessee brought suit seeking damages for the eviction of his sublessee from the subleased premises. In holding that the purchase was bona fide, the court emphasized that the sublessee had informed purchaser that the lessee was no longer on the premises, that the sublessee was paying rent directly to the purchaser, and that the purchaser had received a letter from the owner stating that the original lease had been assigned to the sublessee, thereby extinguishing original lessee's interest in the premises.

A seller's representation that the property is free from encumbrances is not in and of itself enough to protect purchaser from subsequent challenges brought against him. In XAR Corp. v. Di Donato, 76 A.D.2d 972, the Appellate Division, Third Department held that purchaser's sole reliance on the seller's representation in the purchase agreement that there were no liens or encumbrances other than those set forth in the purchase agreement was insufficient to protect purchaser from a subsequent challenge by a lessee who had a previous unrecorded lease arrangement with the seller for a sign on the premises. The court held that purchaser was required to inquire directly of the lessee about the status of the sign.

Duty to Inquire

Philippine American Lace Corp. v. 236 West 40^th Street Corp.

NYLJ 9/28/06, p. 47, col. 2

AppDiv, First Dept.

(memorandum opinion)

In an action by holder of a right of first refusal for a declaration that holder is the owner of the disputed premises, purchaser of the premises appealed from Supreme Court's determination that holder of the first refusal right owned the premises. The Appellate Division reversed, holding that there was no reason for purchaser to know that plaintiff held an unrecorded right of first refusal.

Plaintiff had leased the premises for several years, and held an unrecorded right of first refusal in the leased premises. When purchaser first considered purchasing the premises from plaintiff's landlord, purchaser conducted a title search, which did not and could not have revealed the existence of the unrecorded right. Purchaser also obtained a sworn affidavit from the prior owner stating that there were no options to purchase or rights of first refusal in any existing leases or agreements affecting the premises. Purchaser also asked prior power for copies of plaintiff's prior leases, and received copies of the leases, none of which included a right of first refusal. Purchaser then bought the premises. Purchaser then served plaintiff-tenant with a three-day notice demanding payment of rent. The notice listed purchaser as landlord. Nevertheless, plaintiff holder of the first refusal right did not challenge that ownership or assert its right of first refusal for 18 months. When plaintiff did seek declaratory relief, Supreme Court enforced the right of first refusal, holding that plaintiff owned the disputed premises, and ordering that plaintiff reimburse purchaser for the purchase price it had paid to prior owner. Purchaser appealed.

In reversing, the Appellate Division acknowledged that because plaintiff was a tenant in possession of the premises at the time of purchase, purchaser had an obligation to go beyond conducting a title search, and had a duty to inquire about plaintiff-tenant's rights to the premises. The court noted, however, that the prior owner had deliberately interfered with tenant's right of first refusal (by offering tenant terms of sale he knew tenant would not accept), and concluded that under the circumstances purchaser 'did as much as reasonably expected in order to ascertain whether plaintiff had a right of first refusal.' Moreover, the court also concluded that plaintiff's delay in asserting the right of first refusal required application of the laches doctrine as a bar to plaintiff assertion of its right of first refusal. In particular, the court noted that during the 18-month period of delay, purchaser had made improvements, paid insurance, taxes and operating expenses, so that even payment of the purchase price would not fully compensate purchaser for its investment in the building.

COMMENT

A purchaser has a duty to inquire about the rights of a person in actual, visible, and open occupation at the time of purchase. In Phelan v. Brady, 119 N.Y. 587 (1890), the Court of Appeals held that tenant's act of residing on the premises constituted actual possession giving rise to a duty to inquire on purchaser's part. In that case, purchaser claimed ownership after seller had transferred a mortgage of the premises as collateral for a loan. Tenant demonstrated that she owned the premises although her title was unrecorded and seller's name appeared on the title. In rejecting purchaser's argument that he acquired the property in good faith because he could not have ascertained tenant's un-recorded interest, the court determined that tenant's actual and open occupation of the premises imposes on purchaser a duty to inquire and serves as notice to purchaser of tenant's rights in the property. Persons working on the premises as laborers are not 'in possession' within the meaning of the Phelan rule. The Court of Appeals in Brown v. Volkening , 64 N.Y. 76 (1876), held that tenant's proof of occupation consisting of laborers and mechanics working on an unfinished house in which tenant had an unrecorded conveyance did not constitute actual occupation and was therefore insufficient to amount to knowledge of possession on the part of the prospective purchaser.

Possession by a sublessee creates a duty on the part of the purchaser to inquire of the sublessee but does not create a duty to inquire of the lessee. In Van Dyck Foods v. Dime Sav. Bank of Brooklyn, 253 A.D. 347 , the court held that the purchaser's inquiry of a sublessee was sufficient to protect him from a subsequent challenge by lessee who had an unrecorded interest in the property. In that case, lessee had subleased the premises to a third party and obtained a chattel mortgage, both of which were unrecorded. The owner of the property subsequently assigned collection of the rent to the purchaser. After purchaser evicted the sublessee, the lessee brought suit seeking damages for the eviction of his sublessee from the subleased premises. In holding that the purchase was bona fide, the court emphasized that the sublessee had informed purchaser that the lessee was no longer on the premises, that the sublessee was paying rent directly to the purchaser, and that the purchaser had received a letter from the owner stating that the original lease had been assigned to the sublessee, thereby extinguishing original lessee's interest in the premises.

A seller's representation that the property is free from encumbrances is not in and of itself enough to protect purchaser from subsequent challenges brought against him. In XAR Corp. v. Di Donato, 76 A.D.2d 972, the Appellate Division, Third Department held that purchaser's sole reliance on the seller's representation in the purchase agreement that there were no liens or encumbrances other than those set forth in the purchase agreement was insufficient to protect purchaser from a subsequent challenge by a lessee who had a previous unrecorded lease arrangement with the seller for a sign on the premises. The court held that purchaser was required to inquire directly of the lessee about the status of the sign.