Stephen B. Fainsbert, Esq.
The case of Kelly McClain v. Octagon Plaza, LLC (“McClain vs. Octagon”) decided by a California Appellate Court on January 31, 2008, involves a dispute over the total square feet in a shopping center (“Shopping Center”) and the specific square feet in the property leased in the shopping center (“Leased Space”) by McClain (“Tenant”) from Octagon (“Landlord”). The lease was on the American Industrial Real Estate Association “Standard Industrial/Commercial Multi-Tenant Lease – Net” (“Lease”) form. The Lease provided that the square footage of the Leased Space was “approximately 2,624 square feet”. The Lease went on to say that “Unless otherwise provided herein, any statement of size set forth in this Lease, or that may have been used in calculating Rent, is an approximation which the Parties agree is reasonable and any payments based thereon are not subject to revision whether or not the actual size is more or less.”
The amount of square feet was important since the Lease provided that: (1) the common area expenses (“Common Area Expenses”) paid by the Tenant were to be calculated as a percentage of the square feet in the Tenant’s property in relation to the total square feet in the Shopping Center, which percentage was stated to be 23%, and; (2) the rent was calculated on the basis of $1.45 per square foot per month.
A dispute arose concerning the calculation both of the Tenant’s Leased Space and the total space in the Shopping Center, which ended up in litigation. It turns out that in January 2003 when Tenant investigated leasing in the Shopping Center, Octagon informed her that the Leased Space she was interested in renting was exactly 2,624 square feet. Perhaps not quite trusting Octagon, Tenant attempted to confirm the size of the Leased Space. The principal owners of Octagon, Ted and Wanda Charanian, acted like they were offended by Tenant’s inquiries concerning the total square feet in the Leased Space and contended that measuring of the area would be unreasonably costly due to the unusual angles in the Leased Space. The Charanians insisted that they had “intimate knowledge of every detail of the shopping center,” and that McClain should rely on their representations regarding the size of the Leased Space and the Shopping Center. SOUND FAMILIAR? — LIKE THAT OLD NEGOTIATING TACTIC: “YOU CAN TRUST ME.”
Needless to say, Landlord defended the legal action brought by Tenant on the basis that the Lease stated that the square footage of the Leased Space and the Shopping Center was an agreed-to, fixed number. Among many different claims Tenant made in the lawsuit was “fraud in the inducement” by Landlord. Fraud in the inducement is when a misrepresentation is made, followed by a contract (in this case, a lease) in which “the promisor knows what he or she is signing but the consent is induced by fraud.”
As the dispute became more intense, Tenant obtained a copy of Landlord’s application for earthquake insurance, which interestingly disclosed that the correct size of the Shopping Center actually was 12,800 square feet, rather than 11,835 square feet, as represented by Landlord in the Lease. Further investigation showed that Leased Space was 2,438 square feet, rather than the 2,624 square feet, as represented; therefore resulting in the fact that Tenant should have been allocated 19% of the common area expenses as opposed to 23% and should have been paying $3,535.10 per month rather than $3,804.00. These errors in the calculation of both the Leased Space and in the Shopping Center Space would have obligated Tenant to pay more than $90,000.00 over the term of the Lease.
It should be noted that the Appellate Court received this case after the Trial Court dismissed the lawsuit because of the language in the Lease stating that the calculations of square feet set forth in the Lease were accepted as a given, whether accurate or not. The issue raised in this case on appeal is whether you can get away with exculpatory language or disclaimers in a lease, or in any agreement, including a real estate purchase and sale agreement, if the representations are inaccurate. Of course, it did not help that the Charanians became indignant when the accuracy of their representations of the amount of space in the Leased Space was questioned. The Appellate Court determined that exculpatory language or disclaimers in the Lease did not insulate Landlord from liability for fraud or prevent Tenant from demonstrating justified reliance based on representations of Landlord. What the Appellate Court did in this case was to send this case back to the Trial Court for a judge or jury to make a factual determination if there was fraud in the inducement and to enter a Judgment for the Tenant if there was a finding of fraud in the inducement notwithstanding the exculpatory language and disclaimers in the Lease.
This case is most instructive in giving examples of other instances where prior courts have held that you cannot understate something or say something is approximate or “As Is” and thereby insulate yourself from liability. There must be reasonable belief in the estimates or statements made. In another case cited by the Appellate Court, it was asserted by tenant that, when he leased space in the commercial center, landlord’s agent told him that other units in the shopping center would be “occupied by businesses likely to attract heavy ‘foot traffic’”. That lease also provided landlord the exclusive right to select tenants. The Appellate Court in that case said that if tenant could provide that he reasonably relied on the statements of landlord’s agent and could prove that the landlord did not attempt to obtain the type of tenants who would induce heavy foot traffic, then tenant could prevail in his lawsuit and collect damages from landlord.
In essence this comes down to making “a positive assertion of fact” which allows the basis for suing for fraud in the inducement. In this particular case, as stated above, Tenant claimed the Charanians “exaggerated the size of her unit by 186 feet, or 7.6% of its actual size, and increased her share of the common expenses by 4%, through a calculation that understated the size of the Shopping Center by 965 square feet, or 8.1% of its actual size.” While these discrepancies do not seem large, they still involve a $90,000.00 increase over the 5 years of the Lease term – not exactly pocket change!
What does this case tell us? It sends out a message that you cannot be ‘cute’. You cannot give limited disclosure or make limited statements and then expect to be insulated from any claim. Such a claim could be in a house sale, for example, where sellers say that they think there may be some construction in which no permits were obtained, but that, nonetheless, the construction complied with building code requirements. In this situation, if the sellers had clear knowledge that no permits were obtained and/or never investigated thoroughly to find out whether there was, in fact, compliance with the building codes, the sellers would be liable. You cannot make a limited or general statement and hope that you get away with stating something like the property is sold “As Is” and, expect to not be liable.
The “As Is” clause has always been both questionable and difficult issue. Currently the law is that, if you say “As Is,” you have to make that statement holding reasonable belief, having investigated whether or not it is true. This is why “As Is “ provisions drafted by sophisticated attorneys are often very detailed and will contain language that states the property is sold “As Is” without a duty of inquiry and will include other limiting, carefully drafted language.
Stephen B. Fainsbert is a partner in the West Los Angeles law firm of Fainsbert Mase & Snyder, LLP. Mr. Fainsbert has practiced law in the real estate and real estate exchange area for over forty years and has extensively written and lectured on these subjects both for the real estate industry and for attorneys through the California Continuing Education of the Bar program. Mr. Fainsbert is co-author of Real Property Exchanges, Second Edition, Continuing Education of the Bar, June 1994, which was published by the University of California Press and is recognized as the leading book on this subject. Mr. Fainsbert has been designated one of Southern California’s “Real Estate Super Lawyers” in both Los Angeles Magazine and Southern California Super Lawyers magazine every year since 2004. If you have any questions concerning this article or any other related matter, Mr. Fainsbert may be contacted at (310) 473-6400, by fax at (310) 473-8702