Kendall v. Ernest Pestana, Inc.

Supreme Court of California
40 Cal.3d 488, 709 P.2d 837, 220 Cal. Rptr. 818 (1985)

ELI5:

Rule of Law:

Where a commercial lease contains a clause requiring the lessor's consent for an assignment or sublease, the lessor may not unreasonably and arbitrarily withhold consent, even if the lease does not contain a provision prohibiting the unreasonable withholding of consent. Such refusal must be based on commercially reasonable objections.

Facts:

The City of San Jose leased hangar space to Irving and Janice Perlitch, who later assigned their interest to Ernest Pestaña, Inc.
The Perlitches entered into a 25-year sublease for the hangar space with Robert Bixler for the purpose of conducting an airplane maintenance business.
The sublease provided that the lessee could not assign the lease without the lessor's prior written consent, and that an assignment without consent would be void and could terminate the lease.
In 1981, Bixler agreed to sell his business, including the leasehold interest, to Jack Kendall, Grady O’Hara, and Vicki O’Hara.
The proposed assignees (Kendall et al.) had a stronger financial statement and greater net worth than the current lessee, Bixler, and were willing to be bound by the existing lease terms.
Bixler requested consent for the assignment from the lessor, Ernest Pestaña, Inc.
Ernest Pestaña, Inc. refused to consent to the assignment, maintaining it had an absolute right to refuse arbitrarily.
Ernest Pestaña, Inc. demanded increased rent and other more onerous terms as a condition for its consent to the assignment.

Procedural Posture:

The proposed assignees, Jack Kendall et al., filed a suit against the lessor, Ernest Pestaña, Inc., in the trial court for declaratory relief, injunctive relief, and damages.
The trial court sustained the lessor's demurrer to the complaint without leave to amend, effectively dismissing the case.
The proposed assignees appealed the trial court's order of dismissal to the Court of Appeal.
The California Supreme Court granted review to resolve a conflict among the Courts of Appeal.

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Issue:

In a commercial lease that requires the lessor's consent for assignment but contains no standard governing the exercise of that consent, may the lessor arbitrarily and unreasonably withhold consent to an assignment?

Opinions:

Majority - Broussard, J.

No. Where a commercial lease provides for assignment only with the prior consent of the lessor, such consent may be withheld only where the lessor has a commercially reasonable objection to the assignment. The court's reasoning rests on two legal principles: the policy against unreasonable restraints on the alienation of property and the implied covenant of good faith and fair dealing inherent in every contract. A lease is both a conveyance of a leasehold interest and a contract. As a conveyance, an arbitrary refusal to consent is an unreasonable restraint on alienation. As a contract, it includes an implied covenant of good faith and fair dealing, which requires a party with discretionary power, such as the power to approve an assignment, to exercise that power in accordance with commercially reasonable standards. Denying consent solely to charge a higher rent is not commercially reasonable because it is an attempt to get a better bargain than originally contracted for.

Dissenting - Lucas, J.

Yes. A commercial lessor should be allowed to withhold consent to an assignment arbitrarily or without reasonable cause. The plain language of the lease, which does not require reasonableness, should be enforced as written. The parties were free to contract as they saw fit, and the court should not rewrite an unambiguous contract to add terms the parties did not negotiate for, especially when competent counsel likely prepared the lease in reliance on the long-standing majority rule. Furthermore, the California Legislature has implicitly recognized the existence of the right to arbitrarily withhold consent by creating a statutory incentive (in Civil Code § 1951.4) for lessors to include a reasonableness clause in their leases. Changing this established common law rule judicially will only create mischief and encourage needless litigation.

Analysis:

This decision marked a significant shift in California commercial real estate law, moving away from the traditional common law majority rule that favored the landlord's absolute discretion. By imposing a 'commercially reasonable' standard on the landlord's consent, the court aligned lease law with modern contract principles, specifically the implied covenant of good faith and fair dealing. This precedent limits a landlord's ability to use an assignment clause as leverage to extract higher rent or other concessions not contemplated in the original lease, thereby promoting the free alienability of commercial leaseholds and protecting tenants' contractual expectations. The ruling has prompted more explicit drafting in commercial leases regarding the standards for consent to assignments.

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