A recent California case illustrates how important it is to clearly document changes to lease terms and not simply rely on an oral "gentlemen's agreement". In Gambord v. Galli Produce Company (Cal. Ct. App., May 26, 2015, H039760) 2015 WL 3381728, a commercial landlord verbally agreed to let its longtime tenant make reduced rental payments because the tenant's business had declined. Over two years, from August 2008 through July 2010, the rent reductions exceeded $200,000.
The landlord understood the agreement to simply be a deferment of rent due under the lease until the tenant's business recovered and later testified, "there was no agreement or even a discussion about a specific time of repayment. [¶] It was one of those gentleman handshake kind of deals . . . and the unspoken word was that when things get better we'll pay this money back." The tenant, however, understood the agreement to be a true reduction in rent, meaning that the landlord would forgive the difference between the reduced rental payments and the full amount due under the lease.
As discussed below, because the landlord accepted the reduced rent and never clarified that rent was only being deferred, not forgiven, both the trial court and the court of appeal held that the landlord waived the right to recover the over $200,000 in unpaid rent original scheduled under the lease -- even though the parties only had an oral agreement and the lease required all modifications to be in writing.
The problem with an oral "gentleman's agreement".
To follow from the facts above, in late 2008, a tenant leasing a warehouse space asked its landlord to reduce its rent because business had declined significantly. The tenant had leased the space for over 15 years and was on very good terms with the landlord. The landlord agreed to a $2,000 per month reduction in rent for August - December 2008, which reduced rent to $13,225 per month. Then, for the next several months, the tenant requested additional reductions, and each time the landlord agreed: In December 2008, rent was reduced to $11,500, in March 2009 to $10,000, in June 2009 to $8,500, and finally in August 2009 rent was reduced further to $7,500 and stayed at that level until July 2010.
Each time rent was reduced, the agreement was oral. The tenant would generally call the landlord and ask for a reduction, and the landlord would respond "if that's what you need, you've got it," and then accept the lower payments without objection.
The parties never directly discussed whether the difference between the rent due under the lease and the reduced rent being paid was being forgiven or simply deferred. Although the landlord's property manager did say at the outset that "any unpaid rent would be an issue that would be dealt with later," and the tenant recalled saying that when business improved it would pay more rent, but it never said that when business improved it would pay back the full amount of rent originally scheduled under the lease.
In July 2010, the landlord asked the tenant to start increasing rent $500 a month until rent was back to the scheduled amount, and then followed up with an email:
"At the end of December, your rent will still be 30% below the Lease, which difference we will continue to defer. At the end of the year, if you find this rate difficult for you to maintain, please call me personally so we can discuss. You know I will work with you in every way I can — we've had a great relationship with you for a lot of years."
The tenant responded, agreeing to increase rent, but questioning the landlord's reference to deferred rent:
"I am glad to be able to progressively increase our rent towards a more suitable number for both of us. I must say though, I am taken aback by the use of the word `defer' in your email. Does this mean that you feel that the reduced amount [of rent] is accumulating?"
The landlord responded:
"I'm surprised and a little saddened by your reaction to my mention of the word `defer.' [¶] I'm really sorry if you misinterpreted my willingness to temporarily defer a part of your monthly rent, a significant portion of it at that, until such time as business conditions improve for you. . . . [¶] . . . But this continued forbearance is only done with the understanding that the unpaid rent each month will continue to be deferred, not forgiven . . . "At no time, have I inferred or implied that the deferred rent would be forgiven. As a Trustee, I have no authority to give away assets of the trust for no reason. Additionally, any such basic change in the Lease, as a change of rent would entail, can only be accomplished by written agreement signed by both parties. This has not taken place."
That was the beginning of the dispute that soon led to court. In December 2010, the landlord sent a formal demand letter requesting payment of deferred rent and property tax payments in the total amount of $203,939. The tenant of course refused to pay that amount, and in January 2011, the landlord filed a complaint against the tenant and the guarantors under the lease to recover.
At trial, the judge "found both gentlemen entirely credible" and stated they were "both decent, honorable, credible. They were working under different assumptions. . . . There never was a meeting of the minds . . . as to whether the rent would be forgiven or simply deferred."
And that is largely the problem with an oral "gentleman's agreement" -- there is rarely a meeting of the minds. Rarely does an oral agreement cover all of the material terms and even if it did (in which case, why not put it in writing?) when a dispute arises, each side naturally remembers its own version of things.
A landlord who accepts reduced rent payments without objection waives its right to recover the full amount.
Because the parties had not agreed on whether unpaid rent was being deferred or forgiven, the trial court held that the landlord had waived the right to recover the full amount of the rent required under the lease. On appeal, the judgement was affirmed.
The trial court stated the applicable law as follows: "Where the parties agree to an oral modification, if the landlord accepts the tenant's payment without objection or clarification, i.e., without expressing the landlord's intention that there are strings attached to the arrangement, such as later repayment of the deficiencies, the landlord is precluded from later seeking such deficiencies."
The court of appeal explained further that although "there was no express oral agreement that the reduced rent payments would be accepted as payment in full under the written lease, the lessor's recovery of the unpaid rent may be precluded under section 2076." Civil Code Section 2076 provides that:
"The person to whom a tender is made must, at the time, specify any objection he may have to the money . . . or he must be deemed to have waived it; and if the objection be to the amount of money . . . he must specify the amount . . . which he requires, or be precluded from objecting afterwards."
Here, the landlord agreed to accept reduced rent and by failing to specify (ideally in writing!) that the full amount remained payable, the landlord waived its right to recover the full amount.
What about the provision in the lease stating that all modifications must be in writing?
You may recall that the landlord thought that, notwithstanding its agreement to accept reduced rent, the original lease terms would continue because the parties had never entered into a written amendment or modification and told the tenant "any such basic change in the Lease, as a change of rent would entail, can only be accomplished by written agreement signed by both parties. This has not taken place." The actual lease agreement provided the same and stated: "This Lease may be modified in writing only, signed by the parties in interest at the time of the modification."
However, as both the trial court and court of appeal explained, even where an agreement expressly bars oral modifications, California Civil Code section 1698 will enforce an oral modification to the extent "executed" or fully performed. See Civil Code § 1661 ("An executed contract is one, the object of which is fully performed."); and Julian v. Gold (1931) 214 Cal. 74, 76 ("an executed oral agreement will serve as a modification or release of a written agreement").
Here, the landlord was free to revoke its oral agreement to accept reduced rent at anytime, but so long as the agreement was in place, each payment of rent by the tenant at the lower rate was the tenant's full performance or "execution" of the agreement and was enforceable.
Simply put, there was no way to turn back time, and that is another problem with oral agreements -- parties often have a false sense of security and think that because they have a written agreement, they can temporarily and informally agree to something outside of the agreement orally but continue to rely on the written agreement's enforceability. That was certainly the landlord's intent here. The landlord accepted reduced rent on a temporary basis but believed it would continue to be entitled to the full amount under the lease. However, even if a lease or other agreement prohibits oral modifications, an oral modification will be enforced to the extent performed.
Take time to clarify the terms of your agreements and put them in writing.
The take away here is not just to "get it in writing" but more importantly, take time to clarify the terms of your agreement. In this case, even if the parties' agreement had been in writing, the result would have been the same because the only thing they agreed on was that rent would be reduced. The problem was that the parties never clarified and agreed on all of the other issues related to reducing rent. For example, was the rent being deferred or forgiven, and for how long? If deferred, when would the deferred rent be repaid, would interest accrue, and how would payments that were made be applied?