On appeal from the Superior Court of New Jersey, Chancery Division, Monmouth County.
Morton I. Greenberg, O'Brien and Gaynor. The opinion of the court was delivered by O'Brien, J.A.D.
At issue in this appeal is the effect of the exercise, by a lessee, of an option to purchase real estate upon the security interest of the owner-lessor, who had sold a business operated on the real estate to the lessee and had received an assignment of the lease as partial security for the balance of the purchase price. The trial judge, in a summary proceeding, ruled that the leasehold interest merged into the fee and ordered the owner-lessor to give a deed to the premises unencumbered by any limitation to protect its security. We reverse and remand the matter to the trial court for a plenary hearing to ascertain the intention of the parties.
Plaintiff-appellant Anthony L. Petters Diner, Inc. (Petters) owned certain real estate upon which it conducted a restaurant and cocktail lounge business. On February 28, 1979, it executed a written contract to sell the business to defendants Dennis Stellakis, Chris Stellakis and Jacques Verdi (defendants) for $600,000, to be paid by a $10,000 deposit, $90,000 cash at closing and a $500,000 promissory note payable monthly over 20 years. Everything connected with the business was sold, including the plenary retail consumption license, but not the real estate. In the contract, defendants agreed to secure the promissory note by a security agreement with a financing statement covering all of the existing and after acquired fixtures, equipment, and stock in trade. Petters agreed to lease the real estate to defendants for a 25-year term, and they agreed to assign the lease to Petters, in escrow, together with the retail consumption license, as additional security for payment of the promissory note.
In accordance with a right given in the contract, defendants formed two separate corporations to which they assigned their
rights under the contract. Both corporations are wholly owned by defendants who are to remain personally liable on all obligations as guarantors. The corporation known as Stellverdi, Inc. operates the business as tenant under the lease, and the corporation known as Denjachris, Inc. holds the liquor license.*fn1 As further security to Petters for payment of the promissory note, all stock certificates of both corporations, with assignments fully executed, are held in escrow by Petters' attorney until the promissory note is paid in full. Upon default in any monthly payment on the note or rent for 10 days and after giving the requisite notice, the escrow agent is authorized to turn the stock certificates, the lease and the liquor license over to Petters who would then become owner of the corporations.*fn2 Significantly, the following language appears in the contract:
Purchasers further agree that in the event there is a default . . . within the time set forth above, the seller shall have the right to enter upon the property and assume operation of the business in addition to any other rights and remedies as provided herein. [Emphasis supplied.]
The contract granted an option to defendants to purchase the real estate upon which the business is located. The initial option purchase price was $350,000 and could be acted upon any time within five years of the closing. The contract provided that this option be contained in the lease between the parties. The lease was executed on February 28, 1979 and contained the option to purchase, as required.
Title to the business closed on May 21, 1979, and all of the documents called for by the contract were executed by the parties. In addition, a document labeled "Statement of Agreement" was executed by the parties. It is dated May 21, 1979 and was recorded in the Monmouth County Clerk's Office on
May 24, 1979. This instrument provides that the lease agreement, dated February 28, 1979, survives the closing of title, that "both the contract and lease cover the property known as Block 12, Lots 1-9 on the Tax Map of the Borough of Keyport" and that "[i]t is further understood and agreed by and between the parties herein that the said property is subject to all of the terms and conditions of the aforementioned contract and lease agreement . . ." It then quotes the subordination clause*fn3 and the option clause in the lease. The parties disagree as to the purpose of this document but agree it was recorded to give notice that the real estate was subject to the terms and conditions of the contract and lease.
By letter of June 13, 1983 the attorney for defendants notified Petters that "the lessees do herewith exercise their option to purchase the premises."*fn4 Petters' attorney responded by letter dated June 29, 1983 in which, after referring to the fact that the lease was held in escrow as additional security for repayment of the note, he said: "I am of the opinion that upon transfer of the deed to the purchasers, the lease would merge
therein and be extinguished, thus eliminating the intended security of the lease." He then stated:
In order to carry out the intent and purpose of this provision an equal substitute for this security must be provided for. I suggest that whoever takes title to this property immediately enter into a lease arrangement with the seller, which lease shall be held in escrow by me as security for the payment of the notes. The terms and conditions would be exactly the same as those provided for in the original lease agreement between the seller and purchaser.
This suit was instituted to construe the terms of the contract and other documents, and to declare a notice from defendants making time for the real estate closing of the essence invalid. The deed proffered by Petters was attached to the complaint. It was a standard form bargain and sale deed, covenant against grantor's acts, but contained the following conditions:
SUBJECT to a contract of sale dated February 28, 1979 between grantor and grantees herein for the sale of the business of "Town & Country Inn."
SUBJECT to a lease agreement dated February 28, 1979 between grantor and grantees herein for the premises being conveyed herein, which lease shall not merge in this deed.
SUBJECT to an agreement between grantor and grantees herein, known as an assignment of lessee's interest in lease, dated May 21, 1979.
Grantees herein shall not be permitted to give any mortgage to be recorded as a lien on the premises being conveyed herein, which shall exceed the purchase price for said premises, as provided for in the contract of sale dated February 28, 1979.
After hearing oral argument without taking any testimony, the trial judge concluded that Petters was obliged "to convey marketable title"*fn5 to defendants by deed which was to "contain no reference to a leasehold interest or a contractual interest nor any other form of security interest to be retained by [Petters] in the property" and entered a judgment to that effect. The judge further ruled that upon delivery of the deed to defendants the leasehold interest will merge by operation of law into the fee interest. As a result, Petters now argues the assignment of the lease will be meaningless and no longer serve as
security and as a method of reentry upon the property in the event of default in payment of the business purchase ...