Leases: Avoid Unnecessary Headaches With Precise Drafting

Charter v. Kearney (In re Colen), 516 B.R. 618 (Bankr. D. Or. 2014) –

A chapter 7 trustee sued the tenants’ landlord to recover payment of a fee that he contended was illegal under state law.  The issue turned on whether a “move in” fee paid at the beginning of the lease term was illegal under a statutory provision applicable to residential leases.

The debtors leased a manufactured home pursuant to a lease with a 10-year term (Lease), and had an option to purchase at the end of the lease term pursuant to a separate “Lease to Purchase Option Agreement” (Option).

Under state law applicable to residential leases:

A landlord may not charge a fee at the beginning of the tenancy for an anticipated landlord expense and may not require the payment of any fee except as provided in this section.  A fee must be described in the written rental agreement.

The Lease provided in a section titled “Rent” as follows (emphasis in original):

The total lease due for the term hereof in the sum of 120 consecutive monthly timely lease installments of $200 DOLLARS ($24,000) plus a 5,000.000 [sic] nonrefundable move in fee payable on signing for a total lease amount of ($29,000) payable on the 1st day of each month of the term after receiving the nonrefundable move in fee of $5,000, [i]n equal consecutive monthly lease installments of $200 DOLLARS per month, first installments [sic] to be paid upon execution of this Agreement, the second installment to be paid on May [ ]1st, 2012.

The integration clause referenced several other documents including the Option. Under the Option, the debtors could purchase the manufactured home at the end of the Lease term for $12,500 (emphasis in original):

The consideration for the option to purchase was described as “a non-refundable fee of $5,000”… If Debtors’ timely exercised the option, they would be entitled to a credit of $62.50 for every timely lease payment ($120 x $52.50 equals $7,500) plus the $5,000 move in fee, against the $12,500 purchase price.

Upon a default, the landlord could terminate the Option.  In that case the debtors would not be entitled to any refund of the monthly installments or the nonrefundable move in fee.

When the debtors paid $5,000 at the beginning of the Lease term, the check noted that it was for “move in fee” on the memo line.  It was clear that a “move in” fee was not a fee authorized by the state statute.

After filing bankruptcy the debtors listed the Lease in their schedules as a “10-year lease with option to buy,” that they intended to assume.  They also listed a “deposit” with the landlord with a value of $5,000.  They claimed the $5,000 was exempt as a “security deposit” under a state homestead exemption.

The trustee contended that the $5,000 move in fee could be recovered from the landlord because it was illegal under state law.  The landlord’s first defense was that the trustee did not have standing because the $5,000 was no longer a part of the bankruptcy estate property due to the debtors’ claim of a homestead exemption.  However, the state statute distinguished between the mutually exclusive categories of a security deposit and fees.  Since the Lease did not contain any reference to a security deposit, the exemption claimed in a $5,000 security deposit did not preclude the trustee from recovering a $5,000 fee.

Next, the landlord argued that it was clear that the $5,000 was consideration for the purchase option, as opposed to a landlord’s fee.  As an initial point, the court determined that the Lease and Option should be considered a single document.  Although they did not incorporate each other by reference, (1) the documents were made by the same parties, (2) they were executed at about the same time, and (3) they were part of the same transaction.

The court reviewed the text and context of the documents to determine the character of the $5,000 payment:

  • The Lease included a reference to a “nonrefundable move in fee” which was part of the “total lease amount of ($29,000).”
  • Similarly, the Option referred to a “nonrefundable fee,” and a “nonrefundable move in fee” and included it in the “total lease of $29,000.”

Notwithstanding these characterizations, there was a statement in the Option:  “As consideration for this Option to Purchase Agreement, the Buyer/Tenant/Grantee shall pay the Seller/Landlord/Grantor a nonrefundable fee of $5,000.” The court viewed this as unambiguously establishing that the $5,000 was consideration for the purchase option.  And even if there was a conflict between the Lease and the Option, the documents provided that in the event of a conflict the Option would control.  The court also determined that the parties intended the $5,000 to be consideration for the Option.

Given this conclusion, the court determined that the “move in” fee was not an illegal fee under state law since it was not being charged by a “landlord” pursuant to a “rental agreement,” but rather was received by the seller as an optionor under an option contract.  If the Option didn’t exist, the $5,000 fee also would not exist.

The landlord/seller could have avoided a year of litigation if it had kept in mind the consumer protection provisions applicable to residential leases and been more precise it its description of the $5,000 fee.  It probably should consider itself lucky that the court did not accept the description as a “move in” fee under the Lease at face value – which likely would have resulted in a finding that the fee was illegal.

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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