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Avalon Pacific - Santa Ana, L.P v. Hd Supply Repair & Remodel

February 22, 2011

AVALON PACIFIC - SANTA ANA, L.P., PLAINTIFF AND RESPONDENT,
v.
HD SUPPLY REPAIR & REMODEL, LLC, ET AL., DEFENDANTS AND APPELLANTS.



Appeal from a judgment of the Superior Court of Orange County, Josephine Staton Tucker, Judge. (Super. Ct. No. 30-2008-00105887)

The opinion of the court was delivered by: Fybel, J.

CERTIFIED FOR PUBLICATION

OPINION

Reversed and remanded with directions.

INTRODUCTION

Avalon Pacific - Santa Ana, L.P. (Avalon), leased a parcel of real property in Santa Ana to HD Supply Repair & Remodel, LLC (HD Supply), which intended to convert the property from vacant warehouses and office space into a retail facility. After demolishing the office space, HD Supply halted renovations due to economic conditions and allowed the property to fall into disrepair. Avalon sued HD Supply and the guarantor of the lease, The Home Depot, Inc. (Home Depot), for breach of the maintenance and repair obligations of the lease and for waste. (HD Supply and Home Depot are collectively called Defendants.) However, Avalon did not terminate the lease, the initial term of which runs into 2017. HD Supply continues to pay, and Avalon continues to receive, about $50,000 a month in rent.

The jury found in favor of Avalon, and awarded it $677,000 in damages for breach of lease against Defendants and $561,000 in damages for waste against HD Supply, both damage awards based on the cost of repairs. The trial court trebled the waste damages based on the jury's finding that HD Supply acted willfully or maliciously. Defendants appeal from the judgment in Avalon's favor.

We reverse. The most significant facts, indeed the facts driving our decision, are that Avalon has not terminated the lease, the lease has not expired, HD Supply continues to pay Avalon monthly rent of about $50,000, and, contrary to Avalon's assertion, HD Supply has not abandoned the lease. HD Supply, which remains the lessee, has the possessory interest in the leased property into at least 2017, while Avalon has a reversion interest.

Those salient facts mean that Avalon's measure of damages for breach of the maintenance and repair covenants and for waste is the diminution in value of its reversion interest. Yet Avalon sought, and the jury awarded it, cost of repair damages, the measure of damages applicable when the lease has expired or been terminated and the lessor has regained possession. By obtaining cost of repair damages without terminating the lease, while continuing to receive monthly rent, Avalon has been unjustly rewarded. Avalon is having and eating the proverbial cake.

As we explain, under the terms of the lease, California case law, and prevailing law across the nation, a lessor may not recover cost of repair damages for breach of a lease's maintenance and repair obligations when the lease has neither expired nor been terminated. A lessor is limited to damages it actually suffered: injury to the reversion interest--the interest the lessor has in the leased property. Similarly, to recover for waste while a lease remains in effect, a lessor must prove the acts of waste caused damage that was sufficiently substantial and permanent to injure the lessor's reversion interest. The trial court erred by instructing the jury that waste need only cause substantial or permanent depreciation in market value.

Avalon did not present evidence of injury to its reversion interest. It had full and fair opportunity to do so at trial but opted instead to present evidence of cost of repairs. Accordingly, we reverse the judgment and remand with directions to the trial court to enter judgment for Defendants.

SUMMARY OF LANDLORD/TENANT LAW

We deviate from the usual practice by first providing a brief review of some fundamentals of landlord/tenant law to provide a legal framework for understanding the facts and discussion sections of the opinion.

A lease is both a conveyance of an estate in real property and a contract between the lessor and the lessee for the possession and use of the property in consideration of rent. (12 Witkin, Summary of Cal. Law (10th ed. 2005) Real Property, § 517, p. 593.) "'[T]he lease has two sets of rights and obligations--one comprising those growing out of the relation of landlord and tenant, and said to be based on the "privity of estate," and the other comprising those growing out of the express stipulations of the lease, and so said to be based on "privity of contract."'" (Samuels v. Ottinger (1915) 169 Cal. 209, 211.)

A leasehold estate gives the lessee the exclusive possession of the premises against all the world, including the owner, for the term of the lease. (Howard v. County of Amador (1990) 220 Cal.App.3d 962, 972.) While the lessee has a present possessory interest in the premises, the lessor has a future reversionary interest and retains fee title. (Kolstad v. Ghidotty (1963) 212 Cal.App.2d 228, 231; see also 6 Cal. Real Estate Law & Practice (2010) Landlord & Tenant, ch. 150, § 150.02, p. 150-5 (rel. 46-3/95).) "A reversion is the residue of an estate left by operation of law in the grantor or his successors . . . commencing in possession on the determination of a particular estate granted or devised." (Civ. Code, § 768.) "A future interest entitles the owner to the possession of the property only at a future period." (Id., § 690.)

Thus, the lessee has the right during the term of the lease to the full use and enjoyment of the leased property limited only by a restriction not to commit waste and by the terms of the lease. (Eastman v. Peterson (1968) 268 Cal.App.2d 169, 174-175.) Every lease includes an implied covenant of quiet enjoyment protecting the lessee from any act or omission by the lessor, which interferes with the lessee's right to use and enjoy the premises for the purposes contemplated by the lease. (Petroleum Collections Inc. v. Swords (1975) 48 Cal.App.3d 841, 846.)

FACTS

In December 2006, HD Supply's predecessor, as tenant, and Avalon's predecessor, as landlord, entered into a long-term lease (the Lease) of the premises located at 1044 E. Fourth Street in Santa Ana (the Premises). The Premises included two vacant warehouses, one of which had some interior office space. HD Supply leased the Premises with a plan to conduct major renovations to convert the warehouses into a retail facility selling building supplies to contractors. HD Supply's parent company, Home Depot, executed a written guaranty, guaranteeing HD Supply's performance under the Lease.

The term of the Lease initially was a little over 10 years, concluding in 2017, and the Lease included three five-year options to extend the term into 2032. Base monthly rent was $47,508 for the first three years, with increases to $51,783.72 for the following three years, and continual base rent increases throughout the remainder of the lease term.

Section 6 of the Lease limited HD Supply's use of the Premises to "general office, warehousing, distribution, fabrication, retail and wholesale sales and rental of building materials, construction supplies, tools, hardware, equipment and related materials, and any other legal use which is reasonably comparable thereto." Section 6 of the Lease also provided that HD Supply "shall not use or permit the use of the Premises in a manner that is unlawful, creates damage, waste or a nuisance."

The Lease stated that before its effective date, Avalon and HD Supply agreed on conceptual plans for conversion of the Premises into a retail facility. The conceptual plans included removal of a two-story office space on the north end of building A to provide a turnaround area for trucks, reconstruction of a portion of another building, and construction of a new loading dock. In addition, the Lease required HD Supply to slurry seal the parking lot and repair any damage to the asphalt. Section 4.7 of the Lease provided that HD Supply may not make material changes to the conceptual plans without Avalon's prior approval unless the changes were required by the City of Santa Ana.

Section 9.1 of the Lease sets forth HD Supply's obligations to maintain and repair the Premises. It states: "Except as otherwise provided in this Lease, from and after the Possession Date, [HD Supply] shall repair as necessary and maintain in good condition all parts of the Premises not [Avalon]'s responsibility in this Lease . . . , including all interior building systems, and [HD Supply] shall warrant to [Avalon] for a period of three (3) years after [HD Supply]'s completion of the Proposed Removal and the Proposed Addition, as applicable, that each of the Proposed Removal and the Proposed Addition, as applicable, is free from material defects, and [HD Supply] agrees to repair or cause to be repaired any such defects of which [HD Supply] receives notice within such three (3) year warranty period."

Section 9.3 of the Lease, which concerns HD Supply's obligations on lease termination, provides in relevant part: "[HD Supply] shall surrender the Premises by the Expiration Date or any earlier termination date, with all of the improvements, parts and surfaces, except for those which [Avalon] is obligated to maintain, broom clean and free of debris, and in good operating order, condition and state of repair, ordinary wear and tear excepted. . . . [HD Supply] shall repair any damage caused by the installation, maintenance or removal of structures, trade fixtures, furniture, equipment, systems and other personal property. . . , and [HD Supply] owned furnishings."

From December 2006 to May 2007, representatives of HD Supply and Avalon met with the City of Santa Ana Planning and Building Agency, police department, and city council to obtain necessary approvals to implement the conceptual plans. On March 26, 2007, the City of Santa Ana Planning Commission approved a variance for the Premises. However, no construction permits were obtained for the renovation project. On May 18, 2007, HD Supply prepared a notice of intent for the State Water Resources Control Board with a project completion date of December 25, 2007.

Avalon delivered possession of the Premises to HD Supply on May 15, 2007. Sometime thereafter, HD Supply commenced the renovations by removing part of the interior office space on the north end of building A. By the summer of 2007, the demand for home building and construction materials was declining and HD Supply was experiencing a significant downturn in sales at other locations. In August 2007, HD Supply suspended the renovations and notified its design and development firm it was "not going forward with construction." At the same time, HD Supply stopped construction on several other sites being developed into retail facilities.

HD Supply continued paying rent and property taxes on the Premises, and has tried unsuccessfully to sublease them.

After HD Supply ceased renovations, the Premises were vandalized and burglarized. The alarm and sprinkler systems were disabled, some skylights were removed, fencing had been cut or separated, and copper wiring, electrical systems, and bathroom fixtures were stolen. The exterior was marked with extensive graffiti. Vagrants camped inside the buildings and set fires, and Avalon was concerned the Premises would burn to the ground.

Avalon notified HD Supply of the property damage to the Premises and the presence of vagrants and sent HD Supply pictures of the Premises taken in late August 2007 showing the damage. According to Avalon, the demolition, property damage, and vandalism made the Premises unsellable and unleasable to others. Avalon did not seek to terminate the Lease.

On August 24, 2007, HD Supply executed an estoppel certificate for its lender that acknowledged: "There are broken windows that need to be repaired or boarded up as a result of continued vandalism at the property. The air conditioning parts and copper piping/wiring on the second floor of the property have been removed by vandals."

On October 24, 2007, a representative of Avalon sent an e-mail to HD Supply, stating: "As a courtesy, I am offering to speak to you by phone so I can explain more of the details behind these default issues v. what will likely be included in the formal Notice of Default. . . . [W]e do not typically resort to a Notice of Default at such an initial stage of a Lease, but we have been unable to get any response or action out of our other [HD Supply] contacts for some time regarding what we contend are plainly [HD Supply]'s Lease obligations regarding the condition of the Premises, and the very large and increasing dollar amounts at issue clearly mean time is even more of the essence for [HD Supply] remedial action."

On November 7, 2007, Avalon served HD Supply with a notice of lease default asserting (1) "[HD Supply] has demolished a substantial and valuable portion of the Premises"; (2) "[HD Supply] has not conducted much, if any, maintenance or repair of the Premises after the Premises were delivered by [Avalon] to [HD Supply]"; (3) "[i]n the past 40 days the Premises were broken into and resulting extensive vandalism and theft occurred at the Premises, which in part caused great damage, destruction and removal of almost all electrical and other related power systems at the Premises for which [HD Supply] is obligated to restore the Premises"; and (4) "[u]nder the Lease and law [HD Supply] is obligated, but has failed, to properly secure and safeguard the Premises since the Premises were turned over to [HD Supply] by [Avalon] earlier this year."

On November 21, 2007, HD Supply provided notice that it had commenced a cure of the breaches asserted in the notice of lease default.

In December 2007, Avalon's contractors inspected the Premises and evaluated the damages from the demolition, vandalism, and theft. Repair costs were estimated at around $1.4 million, which included the cost of rebuilding the office space.

In January 2008, HD Supply entered into an agreement with a contractor to repair the Premises, clean the interior, restore the fire protection system, install fire extinguishers, board up windows, and stucco-finish the exterior surface. Representatives of Avalon and HD Supply met at the Premises to review the damage. No promises were made, but HD Supply's representatives gave assurances "that things were going to change, that things would eventually get worked out and the building would get fixed up."

By April 2008, HD Supply had not secured the Premises or commenced repairs. The fire alarm and sprinkler systems remained inoperable, lighting had not been restored, and the Premises were covered in graffiti. HD Supply contended it had submitted repair plans to the City of Santa Ana. Avalon requested a copy of the plans, but HD Supply never provided one. Avalon filed this lawsuit in April 2008.

Between August 2007 and the time of trial, Avalon received about 15 notices from the City of Santa Ana to clean the premises and was fined. In July 2008, Avalon sent to HD Supply cleanup invoices from the City of Santa Ana. HD Supply refused to pay them, stating, "[l]instigation precludes paying your bills."

In a letter to HD Supply, dated July 15, 2008, the Santa Ana city manager wrote: "For a number of months we have observed the growing deterioration of the building occupied by your company at 1044 E. Fourth Street, Santa Ana, California. The property is currently in a state of disrepair and presents a growing nuisance in our community. Graffiti covers several large walls, windows are boarded up, asphalt is beginning to degrade and landscaping is overgrown. There are several City codes for which the building is in violation."

Ultimately, HD Supply rewired the Premises with an upgraded electrical system, restored the fire alarm system and lighting, repaired the roof parking lot lights, installed circuits for exhaust fans, replaced fixtures, repainted to cover the graffiti, installed new metal doors, and cleaned the site.*fn1 In November 2008, HD Supply started to provide 24-hour security patrol services on the Premises. HD Supply did not attempt to restore the demolished office space or otherwise restore the Premises to the precise condition it had been in when renovation started because HD Supply was trying to sublease the Premises and did not know of a prospective subtenant's needs. The cost to restore the Premises to its condition at the time the Lease was signed is over $1 million.

Avalon has not terminated the Lease, which remains in effect. HD Supply continues to pay monthly rent of about $50,000.

PROCEDURAL HISTORY

Avalon filed this lawsuit in April 2008. The operative pleading, the first amended complaint, asserted causes of action for breach of lease against HD Supply, waste and declaratory relief against Defendants, and breach of guaranty against Home Depot. The first amended complaint alleged HD Supply breached the Lease by, among other things, "demolishing a portion of the Premises, without either completing the demolition job or concluding the refurbishment of the Premises," failing to "return the Premises to their pre-existing condition or finishing the improvements contemplated when the demolition commenced," abandoning the renovation and construction work on the Premises, failing to maintain the Premises in good condition of repair, allowing the Premises to become damaged from theft and vandalism, and failing to repair damage from theft and vandalism. The first amended complaint alleged Defendants committed waste by "failing to properly secure the premises and abandoning the work of improvement midway through the job, . . . le[aving] the [P]remises available for intruders and others."

A jury trial commenced in September 2009. At the close of Avalon's case-in-chief, Defendants moved for a non-suit. The trial court denied the motion except in one respect: The court found, "there is not an issue for the jury with regard to whether [HD Supply] had an obligation to complete the proposed renovation" because the Lease imposed no such obligation on HD Supply. The court found that HD Supply had a right, but not an obligation, to construct the proposed renovations, and concluded HD Supply had an ongoing duty to repair and maintain the Premises and Avalon could recover damages for costs of repair and waste before the Lease expired or was terminated.

The jury awarded Avalon $677,000 in damages for breach of the Lease against HD Supply, $677,000 for breach of guaranty against Home Depot, and $561,000 in damages for waste against HD Supply. On the waste cause of action, the jury found that HD Supply acted "willfully or maliciously" and, based on that finding, the trial court trebled the damages for waste, resulting in a damages award totaling $2.36 million.

After entry of judgment, Defendants filed motions for a judgment notwithstanding the verdict (JNOV) and for a new trial. The trial court denied the motions, and ...


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