Lease Interpretation: “Clear and Unambiguous” Is In the Eye of the Beholder?

Woodhollow Loft, Inc. v. Sisters of St. Francis Health Services Inc., 472 B.R. 494 (N.D. Ind. 2010) –

The results can be unpredictable if a lease does not precisely document the parties’ intent, leaving matters up to a court’s imagination.

The Sisters of St. Francis Health Services bought a fitness center with a sports bar through a subsidiary (SMMHC) in January 1998.  As a matter of policy, they decided against direct ownership of the liquor license.  Instead SMMHC entered into a three-year Consulting and Non-Competition Agreement  with the seller (Et Al) to continue to operate the sports bar and maintain the liquor license.

SMMHC then decided to convert the sports bar into an upscale restaurant and bar to be operated by a new group.   The new group formed The Sunshine Boys, Inc. (TSB), which leased the bar under a five year lease, and Woodhollow Lofts, Inc. (Woodhollow), which operated the bar.  The two entities had the same three shareholders.

The lease provided that “Landlord shall transfer a liquor license to Tenant [TSB] upon execution of this Lease Agreement.  Upon expiration or termination of this Lease Agreement Tenant shall work with Landlord to transfer the liquor license back to Landlord.”  In fact, the liquor license was transferred by Et Al (SMMHC’s seller) to Woodhollow.  Woodhollow did not pay any consideration for the transfer of the license.

Woodhollow occupied and operated the bar from October 1999 through July 31, 2007.  It was never a formal party to the lease.  In 2001 SMMHC sought to evict Woodhollow.  The parties entered into a stipulated order that required TSB and Woodhollow to make certain rent payments, and provided for the return of the leased premises and the liquor license if TSB and Woodhollow defaulted.

Woodhollow filed a Chapter 11 petition in February 2007.  (TSB was administratively dissolved by the State of Indiana in August 2002.)  The landlord sought relief from the automatic stay to recover the leased premises, and Woodhollow sought to assume its tenancy.  This was resolved by an agreement that Woodhollow would vacate the premises at the end of July 2007.

The landlord also commenced a proceeding to determine ownership of the liquor license.  After initially determining that Woodhollow was entitled to transfer the liquor license, the bankruptcy court ultimately determined that (i) Woodhollow had no right to continue to use the liquor license after it vacated the leased premises, and (ii) the landlord did not have an allowable claim against Woodhollow.

Woodhollow appealed contending that it was entitled to retain the liquor license.  The landlord filed a cross-appeal asking for a determination that its amended proof of claim was timely filed, either because it was a claim for rejection of the lease (which was not subject to the claims bar date) or because its motion for relief from the automatic stay constituted a timely informal proof of claim.

On appeal, the district court went out of its way to lay out the contract construction principle that where a contract is “clear and unambiguous,” it should be enforced as written, and it is ambiguous only if there is more than one interpretation so that “reasonably intelligent” people could come to different conclusions – citing more than a half dozen cases.

However, this principle seems to have disappeared as soon as it was stated.  Instead the court relied on the “pivotal factual finding … that an agreement existed among all of the parties” that the liquor license should remain with the leased premises – citing various supporting facts, as opposed to contractual provisions.

The district court also rejected the landlord’s argument that it had a timely filed claim.  (The landlord was claiming almost $800,000 in unpaid rent and expenses.)  The court determined that the claim was not a rejection claim since Woodhollow was not a party to the lease and there was no rejection of an occupancy agreement because Woodhollow vacated under the automatic stay settlement agreement.  The court also rejected the argument that the automatic stay motion was an informal proof of claim, applying a relatively strict test.

This case illustrates that it is generally a good idea to draft contracts so that they clearly document the actual agreement of the parties, and if circumstances change through a course of dealing it is probably worth documenting the new relationships.  Otherwise if things do not proceed as anticipated, the parties may face extended litigation with uncertain results, as turned out to be the case in Woodhollow.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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