When Affirmative Defenses Fail, Guarantors May Prevail On the Question of Lease Enforceability

This difference becomes important when three parties enter into two related contracts. Each contract represents a distinct set of obligations: a lease calls for the landlord to continue performing for so long as it continues to receive a benefit from the tenant; a guaranty, however, requires only contingent performance by the guarantor, and nothing further from the landlord after the lease has been signed. Though clear on the page, in practice the parties' respective obligations tend to blur when the tenant and the guarantor are effectively the same person fighting a battle on two fronts.

This was the case in I Bldg, which arose from a scenario that is doubtless familiar to anyone in leasing practice. In 2004, I Bldg, Inc. (the landlord) signed a lease agreement with Artisan Spa, Inc. (the tenant) for commercial space at 137 Fourth Avenue in Manhattan. As an inducement to the landlord, the spa's owner, Hong Mei Cheung (the guarantor), signed a so-called “good-guy guaranty” that read, in part:

The undersigned Guarantor ' guarantees to Landlord, Landlord's successor and assigns, the full performance and observance of all agreements to be performed and observed by Tenant in the Lease ' Notwithstanding the foregoing, this Guaranty shall bind Guarantor only for performance and observance of the agreement to be performed and observed under the Lease that accrue while Tenant is in possession of the premises. This Guaranty shall not apply to any performance or observance after Tenant surrenders possession of its premises in the condition required by the terms of the Lease.

The tenant thereafter defaulted under the lease by failing to make timely payment on the rent and additional rent, a fact not disputed by the guarantor. Likely in financial distress and seeking to extricate itself, the tenant requested the landlord's consent to assign its interest in the lease. That request was denied. The landlord reclaimed possession of the premises by summary proceeding and, on Sept. 22, 2009, lawfully evicted the tenant. After obtaining a money judgment from the tenant for unpaid rent and additional rent, the landlord commenced a similar action against the guarantor (see 2014 N.Y. Slip Op. 32231(U)).

This sequence is consistent with the principles mentioned above: Landlord and tenant made obligations to each other under the lease, so they can sue each other under the lease. The same is true under the guaranty, as between the landlord and the guarantor. But the tenant and landlord promised each other nothing in the guaranty, just as the guarantor and landlord made no promises to each other in the lease, so no basis for breach exists in this configuration.

The Guarantor's Argument

When the I Bldg guarantor responded to the landlord's suit, it did so by arguing that the landlord had defaulted under the lease and therefore should not stand to profit by collecting on the guaranty. The default, according to the guarantor, occurred when the landlord unreasonably withheld its consent to the tenant's requested lease assignment.

This argument confused the contractual relationships of the parties: The landlord never promised anything to the guarantor under the lease, so the landlord's decision to withhold consent, however unreasonable, was ultimately not relevant to the guarantor's affirmative defense. It may well be true that the landlord promised to act reasonably under the lease, but if that's the case, the landlord made that promise to tenant alone, so the tenant alone may claim damage from the broken promise.

Indeed the court found the guarantor's defense to be precluded by basic principles of contract law. The trial court reasoned that the guarantor “cannot assert such defenses or counterclaims in this action as it was not in privity with [Landlord] under the Lease. Such defenses and/or counterclaims are only available to the Tenant and should have been raised” as an affirmative defense by the tenant in response to the landlord's collection action.

A Better Argument

The trial court's decision was affirmed on appeal, in an opinion that not only highlighted the failure of the guarantor's argument under basic principles of contract law, but also held up for the guarantor the more persuasive argument it had failed to make: “When a guarantor is sued on the guaranty, as is the case here, he or she cannot raise a claim or defense which is personal to the principal debtor, such as breach of principal contract, unless it extends to a failure of consideration for the principal contract, and therefore for the guarantor's contract.” [emphasis added]

This is the path forward for future litigants. An affirmative defense based on a landlord's default under the lease is not a colorable argument for anyone but the tenant. Where a guarantor does, and will always, have standing is on the question of underlying consideration. The guarantor's argument should focus on the exchange of promises that bind the parties to the lease as a contract.

The I Bldg court's answer made clear that the guarantor had been asking the wrong question throughout. Were the court to find a breach of the lease by the landlord, the remedy would likely also be prescribed by the lease, and in any event would be personal to tenant. Were the court instead to find a failure of consideration, “neither the principal nor the guarantor is accountable for anything which has not been received.” Walcutt v. Clevite Corp., 13 N.Y.2d 48 (1963). The Guarantor in I Bldg erred in asking whether the guaranty should be enforced when the lease has been breached, instead of asking whether the guaranty even could be enforced when the lease has been vitiated.

This raises, of course, the question of what constitutes failure of consideration in the commercial leasing context. Courts in New York have written abundantly on the topic in relation to loan guaranties, where the consideration is clearly identifiable. They have been more circumspect, however, when considering failure of consideration in the context of a lease guaranty.

The limited guidance in New York is notable mainly for what it excludes. Courts have found, for instance, that failure of consideration does not encompass several of the typical grounds for contract rescission, such as frustration of purpose, breach of the covenant of good faith and fair dealing, and fraudulent inducement. See, e.g., Hotel 71 Mezz Lender LLC v. Mitchell, 63 A.D.3d 447 (2009). These are treated as causes of action under the lease, but it is not clear which are limited to their facts and precluded only in deference to a principal asserting the same defense, and which are excluded categorically. Lawyers have argued, unsuccessfully, that a landlord's illegal eviction of a tenant “represented a partial failure of consideration because [the landlord] did not perform its obligations under the Lease.” Moon 170 Mercer, Inc. v. Vella, Brief for Defendant-Appellant dated July 2, 2014. Interestingly, in Moon 170 Mercer, 122 A.D.3d 544 (2014), the same First Department Appellate Division that decided I Bldg held, based on Walcutt, that the guarantor “cannot avail himself of the ' fraud claims asserted by the tenant ' because there are independent causes of action that may only be asserted by the tenant.”

Conclusion

Perhaps the foregoing are the inevitable outcome of looking at a lease agreement through a broad, commercial contracts lens. Doing so fails to account for the differences between personal property and real property as each factors into the underlying bargain. For instance, payment of rent is the primary consideration offered by the tenant in a lease contract, but what consideration does the landlord provide? Is it more accurately classified as a good (i.e., the leasehold property interest) or a service (i.e., delivery of the premises)? If the latter, then the lease perhaps can be understood as a contract for landlord services. Under such an interpretation, could a tenant plausibly claim that a landlord's failure to perform services deprived the tenant of the benefit of the bargain; or is a landlord's failure an eventuality under the lease for which contractual remedies are available?

As the courts and those in the leasing field work through and around these issues, it is worth considering that in trying to understand where the law is heading, there is insight to be found in seemingly modest opinions of the lower courts.

Gregory Voigt is an associate in the Real Estate department of Seyfarth Shaw LLP, where he represents investment funds, institutional investors and other owners and operators of commercial real estate in a variety of matters throughout the United States.