A new opinion of our Court of Appeals further shows how old real property conventions continue to erode in the face of modern contract law principles, especially when equitable outcomes hang in the balance. In United Insurance Company of America v. Lutz (June 16, 2011), the Court of Appeals reversed summary judgment entered against the landlord in a case where a tenant’s guarantors tried to evade their obligations.

The Lutzes formed a company to purchase a building, and then flipped it to United. The Lutzes company, WKL, had signed a lease, and WKL owned the building for a few minutes before conveying it to United. The Lutzes contended that WKL’s lease with that company’s seller terminated at the moment WKL acquired fee title, and, thus, there was no lease subject to Lutzes guarantee when rent payments stopped four years later. The Lutzes relied on the old real property rule that a tenancy merges by operation of law if the same person holds the landlord’s interest and the tenant’s interest under a lease at a single moment. The Lutzes do not appear to have explained to any court why United would have agreed to allow WKL to stay in the building for four years after the acquisition and flip, if there was no lease in effect.

Nonetheless, the Court of Appeals states that the common law merger rule is no longer viable because it ignores the intentions of the parties to the agreement that is merged. Therefore, says the Court of Appeals, no matter what the nature is of the property estate, including leases, evidence of contrary intentions of one party, or “other equitable considerations,” may bar finding the existence of merger in particular circumstances.

This sounds like another incursion of “good faith and fair dealing,” a contract doctrine, into the ancient, hoary realm of real property common law. The reasonable expectation of the landlord party here likely was not that the tenant had entered into a month to month lease arrangement when the flip was completed, and that the guarantors had been discharged from their obligations. A “Resale Agreement,” indeed, indicated the contrary intention. That document stated that the parties’ intentions were quite the contrary – that no merger would occur at the time of WKL’s ownership of the building, but that the lease would continue in effect. (More than likely, this was the precise consideration for United’s promise to acquire the building from WKL – a built-in rent stream was available to the new owner.

The Court of Appeals thought that the “non merger” of the leasehold estate language in the Resale Agreement sufficiently raised a question of material fact barring summary judgment for the Lutzes on the guaranty claim brought by United, and remanded the matter to the Superior Court for the appropriate fixing of the guarantors’ obligations. The opinion is 1 CA-CV 10-0464.