Pacific First Bank v. New Morgan Park Corp.

876 P.2d 761, 319 Or. 342, 1994 Ore. LEXIS 65

• Court: Oregon Supreme Court
• Decided: July 21, 1994
• Docket: CC 9010-06729; CA A71494; SC S40692
• Status: Published

Opinions

GRABER, J.

This case involves a commercial lease and presents the following questions: (1) Under a lease agreement providing that the tenant “shall not assign, sell, mortgage, pledge or in any manner transfer the Lease or interest herein whether voluntary or involuntary or by operation of law * * * without the prior written consent of the Landlord,” was the tenant required to obtain the landlord’s consent when the tenant merged into its wholly owned subsidiary? (2) If the tenant was required to obtain the landlord’s consent, was the landlord entitled to withhold its consent at its sole discretion, or was it permitted to do so only reasonably, because of a duty of good faith?¹

We answer those questions as follows: (1) The tenant’s merger into its wholly owned subsidiary effected a transfer of the lease “by operation of law,” requiring the landlord’s consent. (2) A duty of good faith applies to lease agreements; here, however, the landlord’s refusal to consent did not contravene that duty, because the landlord’s refusal did not contravene the “reasonable expectations” of the parties as manifested in the express terms of the lease agreement at issue.

Pacific First Federal Savings Bank (Tenant) was a tenant in a building owned by The New Morgan Park Corporation (Landlord). Article 18 of the lease agreement between the parties² provided in part:

“ARTICLE 18. ASSIGNMENT, SUBLEASE AND HYPOTHECATION.

“Section 18.1 Definitions. The cumulative (i.e., in one or more sales or transfers by operation of law or otherwise) transfer of an aggregate of 50% or more of the voting stock, including by creation of or issuance of new stock, of the corporation which is Tenant, or of any corporate assignee of Tenant, by which an aggregate of 50% or more of such stock shall be vested in a party or parties who are not stockholders as of the date hereof, shall he deemed an assignment of this Lease. * * * This Section 18.1, however, shall not apply to Pacific First Federal Savings and Loan Association so long as it is the Tenant hereunder.

“Section 18.2 Assignment etc. Except as provided in Section 18.3, Tenant shall not assign, sell, mortgage, pledge, or in any maimer transfer the Lease or any interest herein whether voluntary or involuntary or by operation of law * * * without the prior written consent of Landlord. If consent is once given by Landlord to assignment * * * of this Lease or any interest therein, Landlord shall not be barred to refuse to consent to any further assignment * * *.

“Section 18.3 Permitted Subleases. Landlord will not unreasonably withhold its consent to a sublease to a subtenant in the opinion of Landlord (i) with the financial worth and business background and experience necessary to enable it to perform its obligations under its sublease consistent with this Lease and (ii) whose personal identity and use of the subleased premises shall be compatible with the overall character, use and purposes of the Improvements as a whole as established by Landlord at the time of the sublease.”

On July 30, 1990, Tenant notified Landlord that it intended to merge on the following day into Tenant’s wholly owned subsidiary, Pacific First Bank (Bank). Tenant asked that Landlord consent to transfer of the lease.³ Landlord did not consent. The merger proceeded on July 31.

Landlord notified Bank, the post-merger corporate entity, that the merger was an “assignment’ ’ without consent constituting a breach of the lease agreement. Bank filed this action seeking a declaration that it became the tenant of the property in compliance with the lease. Landlord counterclaimed to recover possession of the property.

The trial court concluded that “the merger in this case did not require consent of the Landlord.” As pertinent here, the trial court reasoned that, like an “upstream” merger,⁴ this “downstream” merger⁵ resulted only in a change of form, including a change in the name of the post-merger entity, and that there was evidence that the post-merger entity, Bank, was stronger financially than Tenant, its predecessor. The trial court also stated that Section 18.1 of the lease agreement “indicates an understanding on the part of Landlord that Tenant might, during the term of the lease, deem it appropriate to change or alter its structure and/or ownership and that this would not constitute an assignment.” The trial court also held that, even if the merger constituted a breach of the agreement, in this case the breach was “technical and immaterial,” because Landlord did not show any substantive change in its tenant’s financial condition that increased Landlord’s risk that it would not receive the benefit of its bargain. The trial court entered a judgment in favor of Bank. Landlord appealed.

The Court of Appeals held that the merger was an “assignment” requiring the consent of Landlord and that failure to obtain that consent was a material breach of the lease agreement. Pacific First Bank v. New Morgan Park Corp., 122 Or App 401, 405, 857 P2d 895 (1993). The Court of Appeals first noted that “the lease did not present an obstacle to an upstream merger” because, in such a merger, Tenant would have continued as the tenant and because Section 18.1 expressly stated that a transfer of 50 percent or more of Tenant’s stock to another entity or entities would not constitute an assignment of the lease “so long as [Tenant] is the Tenant [under the lease].” Id. at 404. The court concluded, however, that the downstream merger that occurred in this case was “distinguishable,” ibid., because, in “transferring] [Tenant’s] stock and its interest in the lease’ ’ to Bank, Tenant ceased to exist and Bank became Landlord’s tenant, id. at 405. The Court of Appeals also noted that, although Section 18.3 provides that Landlord “will not unreasonably -withhold its consent to a sublease to a subtenant” under certain specified conditions, Section 18.2 places no conditions on the Landlord’s right to withhold consent. Id. at 406.

The Court of Appeals also referred to this court’s statement in Abrahamson v. Brett, 143 Or 14, 22, 21 P2d 229 (1933), that,

“[w]here a subletting or assignment of the leased premises without the consent of [the landlord] is prohibited, [the landlord] may arbitrarily withhold [its consent] without giving any reasons, and in granting [its consent] may impose such conditions as [it] sees fit.”

The Court of Appeals concluded that, consistent with this court’s quoted statement in Abrahamson, Landlord’s right to consent to the assignment of the lease was not constrained by a duty of good faith. 122 Or App at 406-07. The court reversed and remanded the case to the circuit court. Id. at 408.

Bank sought review in this court, arguing that the merger did not require Landlord’s consent, because the quoted statement in Abrahamson v. Brett, supra, was merely dictum-, because, under other decisions of this and other courts, every contract contains a duty of good faith; and because lease provisions relating to consent to assignments carry an implied obligation of reasonableness.⁶ We allowed review of Bank’s petition and now affirm the decision of the Court of Appeals on different grounds.

In answering the questions presented, we employ general principles of contract construction. Unambiguous contracts must be enforced according to their terms; whether the terms of a contract are ambiguous is, in the first instance, a question of law. OSEA v. Rainier School Dist. No. 13, 311 Or 188, 194, 808 P2d 83 (1991). If a contract is ambiguous, the trier of fact -will ascertain the intent of the parties and construe the contract consistent with the intent of the parties. Ibid.; see also ORS 42.240 (in the construction óf a written instrument the intention of the parties is to be pursued if possible). Words or terms of a contract are ambiguous when they reasonably can, in context, be given more than one meaning. Shadbolt v. Farmers Insur. Exch., 275 Or 407, 411, 557 P2d 478 (1976).

We first consider whether the lease agreement was ambiguous as to whether, by merging with its wholly owned subsidiary, Tenant “transfer[red]” the lease “in any manner,” within the meaning of Section 18.2 of the lease agreement, so as to require Tenant to obtain the consent of Landlord. Section 18.2 does not expressly state whether a merger of Tenant with another corporation effects a “transfer” of the lease for which Tenant must obtain the consent of Landlord. It does, however, expressly provide that a “transfer” of the lease “in any manner,” “whether voluntary or involuntary or by operation of law,” is an event requiring the consent of Landlord.

We conclude that there is no ambiguity on that point in Section 18.2.⁷ The terms of Section 18.2 are broad and all-encompassing, including transfers “in any manner.” The word “transfer” — even without the extra expansiveness of the phrase “in any manner” — covers all forms of passing of rights and obligations. To “transfer” means “to cause to pass from one person or thing to another”; ‘ ‘to make over * * * the possession or control of’; “CONVEY.” Webster’s Third New Int’l Dictionary 2426-27 (unabridged ed 1993). See also Black’s Law Dictionary 1497 (6th ed 1990) (“Transfer means eveiy mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property”). Section 18.2 expressly includes transfers “by operation of law,” and Section 18.1 expressly contemplates that certain transfers of stock are deemed to be assignments of the lease. That being so, Section 18.2 contemplates that the type of merger that occurred in this case was a “transfer” within the meaning of that section.

Bank argues that the nonassignment clause of the lease agreement (Section 18.2) does not apply, because it does not refer expressly to mergers. More pertinently, however, Section 18.2, which is worded in a broad and all-encompassing manner, does not exclude mergers. A downstream merger is one way in which the rights and obligations under a lease pass — that is, transfer — from one corporate entity to another.

Bank also argues that the nonassignment clause should not apply, because its purpose would not be furthered. Specifically, Bank asserts that it is stronger financially than Tenant, its predecessor. That may be so, but Section 18.2 contains no hint whatever that it applies only to situations involving financially equal or weaker transferees. The plain words of Section 18.2 make the provisions therein applicable to every “transfer” of the lease “in any manner,” “whether voluntary or involuntary or by operation of law.” Only in the situation of a sublease covered by Section 18.3 is the financial condition of an entity made relevant under the terms of the agreement; by implication, in the situations covered by Section 18.2, financial condition is not relevant. In addition, the exception provided in Section 18.1 relates to the continued existence of the original tenant as the leasing entity — not the financial condition of that entity. Although there is “meager authority” addressing the effect on a nonassignment clause of mergers by corporate tenants, where such clauses prohibit transfers “by operation of law,” such mergers are a breach of the nonassignment clause ‘ ‘if the effect is to transfer the lease to an entity other than that of the original tenant” even though no interest in property is impaired by the merger. Milton R. Friedman, 1 Friedman on Leases § 7.303e2 (3d ed 1990). See also R. Schoshinski, American Law of Landlord and Tenant § 8.16 (1980 & March 1994 Supp) (if a covenant not to assign a lease expressly prohibits transfers by operation of law, then transfers by operation of law breach the covenant not to assign).

As a result of the merger that occurred in this case, Tenant ceased to exist as a corporate entity, and Bank — a legally separate corporate entity — succeeded to all the rights and liabilities of Tenant with respect to the lease. For federal savings banks, see 12 CFR § 552.13(b)(6) (providing that a federal savings bank whose corporate existence does not continue after a merger is a “disappearing” association); 12 CFR § 552.13(k) (providing that a charter of a “disappearing” association is deemed to be canceled on the effective date of a merger); 12 CFR § 546.3 (providing in part that, on the effective date of a merger in which the resulting entity is a federal savings bank, the resulting association “succeeds to" all the rights and obligations of the merging association (emphasis added)). For state banks, see ORS 711.040 (when a bank merger becomes effective, the separate existence of every bank, except the resulting bank, ends; “[a]ll property, all debts, all choses in action and every other interest of each merging * * * bank is transferred to and vested in the resulting bank without any further act or deed of any party to the merger” (emphasis added)); see also ORS 60.497 (when a merger of corporations takes effect, the separate existence of every corporation except the surviving corporation ceases, and the surviving corporation has all the property and liabilities of each party to the merger). In other words, whichever law relating to the effect of mergers — federal, state, or both — applied here, that law “operated” to give the rights and liabilities of Tenant (one entity) to Bank (another entity), with respect to the lease. Accordingly, the merger of Tenant into its wholly owned subsidiary effected a “transfer” of the lease “by operation of law” that, under the express and unambiguous terms of Section 18.2, required the consent of Landlord.

Bank next argues that, even if the merger of Tenant into its wholly owned subsidiary effected a transfer of the lease requiring the consent of Landlord, Landlord could not withhold that consent unreasonably. Bank contends that, in cases of this court decided after Abrahamson v. Brett, supra, this court recognized the principle that every contract contains a duty of good faith. See Best v. U.S. National Bank, 303 Or 557, 561, 739 P2d 554 (1987) (stating that principle); Perkins v. Standard Oil Co., 235 Or 7, 16, 383 P2d 107, 383 P2d 1002 (1963) (same); see also Restatement (Second) of Contracts § 205 (1981) (stating principle).

In Best v. U.S. National Bank, supra, this court considered whether a bank’s fees for processing certain types of checks were excessive, in violation of the bank’s duty of good faith in the performance of its account agreements with depositors. This court noted that that duty

“limited the Bank’s apparently unlimited authority to set [the challenged] fees, and the [Bank’s] depositors [could] recover for the breach of this obligation just as they could for the breach of any other contractual obligation.” 303 Or at 561.

This court proceeded to consider the meaning of the term “good faith” in that context. The court discussed the purpose of the good faith doctrine and the definitions of “good faith” proposed in the Restatement (Second) of Contracts § 205. Id. at 562-63. The court explained that, in its previous decisions, it

“has not attempted to set forth a comprehensive definition of good faith. But in line with the Restatement and traditional principles of contract law, [this] court has sought through the good faith doctrine to effectuate the reasonable contractual expectations of the parties. When one party to a contract is given discretion in the performance of some aspect of the contract, the parties ordinarily contemplate that that discretion will be exercised for particular purposes. If the discretion is exercised for purposes not contemplated by the parties, the party exercising the discretion has performed in bad faith.” Id. at 563 (citations omitted).

The court discussed its previous decisions illustrating the operation of the principle. Id. at 563-64. The court noted that, in Comini v. Union Oil Co., 277 Or 753, 756, 562 P2d 175 (1977), it had concluded that, where an oil company had the contractual right to disapprove its distributor’s transfer of its distributorship, the company could disapprove a transfer to an inexperienced party. Best v. U.S. National Bank, supra, 303 Or at 564. The Best court stated, however, that, consistent with the principle, the company could not have disapproved a transfer “in order to retaliate against the distributor for some reason.” Ibid.

Applying those principles to the case before us, this court concluded in Best v. U.S. National Bank, supra, that the bank was obligated to exercise its discretion as to the amount of the fees “within the confines of the expectations of the depositors.” Id. at 564. When depositors entered into account agreements, they reasonably could have expected that the challenged fees would be similar in amount to other service fees and would reflect the bank’s actual costs in providing the relevant services. Id. at 565-66. There was evidence that the bank set the challenged fees at amounts greatly in excess of such reasonably expected amounts, partly in order to “reap the large profits” obtainable from such fees. Id. at 566. Thus, a trier of fact could have found that the bank’s purposes “were contrary to the reasonable expectations of the depositors when they agreed to pay” the challenged fees. As a result, the court held, the trial court erred in granting summary judgment to the Bank. Ibid.

This court later applied those principles to a similar claim by bank depositors in Tolbert v. First National Bank, 312 Or 485, 823 P2d 965 (1991). In that case, however, there was undisputed evidence that the depositors agreed to the specific fees charged by the bank and agreed to the right of the bank to change the amount of the fees at its discretion. Id. at 490-91. This court concluded:

“The contract in this case * * * granted one party the right to exercise its discretion regarding one aspect of the performance and enforcement of the contract. In changing the amount of the [challenged] fees, [the bank] enforced a right specifically granted to it under the contract. Because the exercise of that right was pursuant to [the bank’s] discretion, the good faith obligation discussed in Best[ v. U. S. National Bank, supra,] applies. Whether any changes in the [challenged] fees were determined in good faith, therefore, should be decided by the reasonable contractual expectations of the parties.

“We emphasize that it is only the objectively reasonable expectations of the parties that will be examined in determining whether the obligation of good faith has been met. In the context of this case — when (1) the parties agree to (and their contract provides for) a unilateral exercise of discretion regarding * * * one of the contract terms, and (2) the discretion is exercised after prior notice — we hold as a matter of law that the parties’ reasonable expectations have been met.” Id. at 493-94 (internal quotation marks omitted; citation omitted; footnote omitted; emphasis in original).

This court has emphasized that

“[t]he obligation of good faith does not vary the substantive terms of the bargain * * *, nor does it provide a remedy for an unpleasantly motivated act that is expressly permitted by contract * * *.”

U.S. National Bank v. Boge, 311 Or 550, 567, 814 P2d 1082 (1991).

We conclude that the principles enunciated in this state’s common-law good faith cases are applicable here. That is, we conclude that, as a general proposition, a duty of good faith applies to lease agreements as it does to other contracts. In so holding, we join the jurisdictions referred to by one commentator as a “rapidly growing minority” that recognize this principle. See Friedman, supra, at § 7.304a (noting that “there is a rapidly growing minority to the effect that if [a] lease states ‘tenant may assign only with landlord’s consent’ or ‘tenant may not assign without landlord’s consent’ there is engrafted on this language by implication the phrase ‘which consent shall not be unreasonably withheld’ ”).

We emphasize, however, that the doctrine of good faith is to be applied in a manner that will “effectuate the reasonable contractual expectations of the parties.” See Best v. U.S. National Bank, supra, 303 Or at 563 (stating that as the purpose of the good faith doctrine); see also Tolbert v. First National Bank, supra, 312 Or at 493-94 (where parties’ contract provides for unilateral exercise of discretion, reasonable expectations are met when that discretion is exercised after notice); Restatement (Second) of Property § 15.2(2) (1977 & 1993 Supp) (“[a] restraint on alienation without the consent of the landlord of the tenant’s interest in the leased property is valid, but the landlord’s consent * * * cannot be withheld unreasonably, unless a freely negotiated provision in the lease gives the landlord an absolute right to withhold consent” (emphasis added)).

In the present case, the reasonable contractual expectations of the parties are shown, by the unambiguous terms of Article 18 of the lease to which the parties agreed, to encompass Landlord’s right to withhold consent, at its discretion, to a “transfer” of the lease.⁸ Section 18.2 of the lease agreement prohibited Tenant from transferring the lease “without the prior written consent of Landlord.” Under that provision, the parties expressly agreed to a unilateral, unrestricted exercise of discretion by Landlord. By contrast, Section 18.3 in the same article of the lease agreement provides that “Landlord will not unreasonably withhold its consent to a sublease to a tenant” in certain described circumstances. (Emphasis added.) Taken together, those provisions show that the parties freely bargained for, and agreed on, certain conditions related to transfer of the lease and that their bargain did not include other conditions. Considering the terms of all the lease provisions pertaining to transfer, we conclude that Tenant could not have had an objectively reasonable expectation that Landlord’s right to grant or withhold consent to the transfer of the lease, provided in Section 18.2, was constrained in the manner suggested by Bank.

Bank asserts that its reasonable expectations also included the law that was applicable at the time the lease agreement was made and that that law itself imposed a duty of good faith. There are two flaws in that reasoning. First, with respect to leases, the applicable law at the time the lease agreement was signed (1982) was stated in Abrahamson v. Brett, supra, 143 Or at 22: when a lease prohibits assignment without the landlord’s consent, the landlord “may arbitrarily withhold [its consent] without giving any reasons, and in granting [its consent] may impose such conditions as [it] sees ñt.” As stated above, we are announcing a different principle today: that a duty of good faith applies to lease agreements as it does to other contracts. Second, also as discussed above, the duty of good faith operates to effectuate the reasonable expectations of the parties as determined under the terms of their contract. Here, those terms demonstrate that the parties agreed to — that is, reasonably expected — a unilateral, unrestricted exercise of discretion by Landlord under Section 18.2 of the lease agreement.

In summary, Tenant’s merger with its wholly owned subsidiary effected a transfer “by operation of law” of. the lease, requiring Landlord’s consent. Landlord’s refusal to consent did not contravene the “reasonable expectations” of the parties as to Landlord’s right to withhold that consent, as those expectations were manifested in the express terms of Article 18 of the lease agreement. Bank is not entitled, therefore, to a declaration that it became the tenant of the property in compliance with the lease agreement.

The decision of the Court of Appeals is affirmed on different grounds. The judgment of the circuit court is reversed, and the case is remanded to the circuit court for further proceedings.

1 In Tolbert v. First National Bank, 312 Or 485, 488, 823 P2d 965 (1991), this court stated the general rule that the law imposes “an obligation of good faith in the performance and enforcement of every contract.” Similarly, in Sheets v. Knight, 308 Or 220, 233, 779 P2d 1000 (1989), this court stated “that the law imposes a duty of good faith and fair dealing in the performance of every contract.” For the sake of consistency, in this opinion we will refer to the foregoing “obligation” or “duty” as a “duty of good faith.”

2 The lease agreement was executed in 1982 between Winmar Pacific, Inc., as lessor, and Pacific First Federal Savings & Loan Association, as lessee. Winmar assigned its interest in the lease to Morgan Park in 1986. That assignment created no issue that is pertinent to the present dispute.

3 Tenant sent the following communication to Landlord:

“[Tenant] has entered into an agreement with its indirect, wholly-owned subsidiary, [Bank], pursuant to which [Tenant] will merge with and into [Bank], with [Bank] as the surviving corporation (the ‘Merger’). * * *

"* * * * *

“Section 18.2 of the Lease requires that [Tenant] obtain the written consent of [Landlord] prior to any change of control. Accordingly, as counsel to [Tenant] and on its behalf, we have prepared this letter to provide you with notice of the Merger and, by signing in the space provided below and returning this letter to me, to obtain your consent to the Merger.”

4 An “upstream” merger occurs when a subsidiary corporation merges into its parent corporation. See Henn and Alexander, Laws of Corporations 981 (3d ed 1983) (so stating).

5 A “downstream” merger occurs when a parent corporation merges into its subsidiary corporation. See Henn and Alexander, supra note 4 (so stating).

6 Additional claims of error were argued to the Court of Appeals. Neither party seeks review of the Court of Appeals’ disposition of those claims of error, and we do not consider them.

7 Even if there were ambiguity on that point in Section 18.2, Tenant’s request for consent to the transfer of the lease, quoted in note 3, supra, constituted a practical construction of the lease by Tenant, which is entitled to great weight. See Stark Street Properties v. Teufel, 277 Or 649, 659-60, 562 P2d 531 (1977) (concluding that the parties’ communications regarding the lease in that case “constituted a practical construction of the lease by the parties and is entitled to great weight”).

8 In its argument, Bank also points to certain provisions of the lease agreement outside Article 18. None of the cited provisions relates in any way to assignments or transfers. Article 18 is a self-contained and complete section of the lease agreement with respect to the topic of assignments and transfers of the lease.