The Oregon Court of Appeals determined on July 21, 2021, that a commercial landlord had no obligation to remedy latent construction defects under a "build to suit" lease, since the lease did not contain a "special agreement"—or an explicit agreement—obligating the landlord to do so.1
Cryo-Tech, Inc. (Tenant) owned a Dairy Queen® franchise in Redmond, Ore., and wanted to relocate the store to a former bank building. Tenant entered into a "build to suit" lease with JKC Bend, LLC (Landlord) pursuant to which Landlord would purchase the bank building, enter into a construction contract with a builder chosen by Tenant to convert the building for use as a fast food restaurant, and then lease it to Tenant for 20 years or more.2
After execution of the lease, Landlord entered into a contract with a builder chosen by Tenant to perform the improvements. The construction contract included a warranty to Landlord that the "[w]ork will be free from defects" and "will conform to the requirements of the Contract Documents."
Shortly after occupancy, Tenant discovered latent construction defects in the improvements. Tenant sought the Landlord's help to remedy the defects, but the Landlord declined, contending that the lease made no warranties as to the improvements and that Landlord had no obligation under the lease to assist with repairs.3
In response, Tenant brought a legal action against Landlord for breach of contract and unjust enrichment and sought a declaration from the trial court that, among other things, (1) the lease required Landlord to deliver tenant premises that were free of construction defects and that complied with the plans and specifications of the construction contract, and (2) Landlord has an obligation to repair the defects. The trial court ruled in favor of Tenant.4
The Court of Appeals disagreed with the trial court, reversed the decision in favor of Tenant, and found that the Landlord was entitled to summary judgment on its motion seeking a declaration that the lease did not impose an obligation on Landlord to repair the defects.5 In reaching its decision, the appeals court cited the common law rule that absent a "special agreement," a commercial landlord has no duty to make repairs to the leased premises.6
The Appeals Court's Decision
In the appeals court's view, a "special agreement" in such a lease "would seem to connote an explicit agreement."7 The appeals court explained that in light of that rule, Landlord "is responsible for repairs of construction defects only if the lease assigns responsibility to landlord to make the repairs or otherwise warrants the construction."8
The appeals court focused on Section 17 of the lease that stated, in relevant part: "Except as set forth in Section 18 and except regarding the initial construction of the Landlord Improvements, Landlord shall be under no obligation to … make repairs of any nature … during the term of this Lease …"9 Section 18 of the lease, which is referenced in Section 17, provides in relevant part that "If Premises is damaged and the nature and extent of the damages or cause thereof is covered under the insurance policies then in effect, Landlord … shall repair the damage …."10
Tenant contended that Section 17 excluded the Landlord's improvements from Tenant's repair obligation, with the inference being that the obligation to repair the improvements falls on landlord. The appeals court agreed that Section 17 is "susceptible to an inference that the landlord has responsibility for the repair of defects in the Landlord Improvements." However, the appeals court concluded that for "several reasons" the "possible inference does not plausibly support a construction that landlord bears responsibility for repairs."
First, the appeals court found that there was not an "explicit agreement" in the lease that imposed that responsibility. Second, while the lease did not define "initial construction," the appeals court determined that in the context of the agreement as a whole "initial construction is the construction of the improvements that resulted in the certificate of occupancy and did not extend to repairs of latent defects in the initial construction."11
As for the other exception in Section 17 relating to repairs "as set forth in Section 18," the appeals court summarily dismissed its application, stating that "Section 18 describes the landlord's limited repair obligation in the event of 'damage' to the premises covered by insurance" and it makes "no mention of repair specifically with respect to damage caused by defective construction."12
The appeals court concluded by stating the lease did not "impose on landlord an affirmative obligation to repair construction defects" and that "in the absence of provisions either placing on landlord an obligation to make repairs or warranting the condition of the Landlord Improvements, there was no such obligation."13
In an opinion dissenting in part, Judge Aoyagi disagreed that the Landlord was entitled to summary judgment, found that the lease is ambiguous as it pertains to the exception in Section 17 for the "initial construction of Landlord Improvements," and determined that it was "plausible to read the lease as making landlord responsible for the initial construction of the Landlord in accordance with the plans and specifications, including any latent defects in the initial construction[.]"
In addition, Judge Aoyagi raised the question as to why the Landlord declined to pursue a remedy against the contractor (who had warranted to the Landlord that the work would be free of defects) or the contractor's insurer, instead of telling Tenant that is was not Landlord's problem.
Beyond the issues raised in Judge Aoyagi's dissent, we could not help but wonder whether there was an argument that the part of Section 17 relating to repairs "as set forth in Section 18" applied and, if it did, whether the Landlord would have been obligated to make the repairs. Section 18 stated that, "[i]f Premises is damaged and the nature and extent of the damages or cause thereof is covered under the insurance policies then in effect, Landlord … shall repair the damage …."
Assuming the construction defects resulted in damage to the leased premises, then under what insurance policies would the damage have to be "covered" (Landlord's, builder's, or other) and was there any attempt to trigger coverage? Moreover, if any insurance policies may have covered such damage, would the Landlord have been obligated to repair that damage?
If you ever encounter issues relating to "build to suit" leases, whether as a landlord, tenant, or contractor, please contact us for assistance.
1 Cryo-Tech, Inc. v. JKC Bend, LLC, 313 Or App 413, 427-28 (2021).
2 313 Or App at 415-16.
3 313 Or App at 418-19.
4 313 Or App at 419-22.
5 313 Or App at 427-28.
6 Id. at 420, 424 (citing McWilliam v. Phillips Petroleum, Inc., 269 Or 526, 528, 525 P2d 1011 (1974)).
7 313 Or App at 427.
8 Id. at 424.
9 313 Or App at 427.
10 Id. at 420, n. 5.
11 313 Or App at 427.
12 313 Or App at 426.
13 Id. at 428.