Can Buyer of Building with Regulated Unit Back Out of Deal After HSTPA?

Legal blogs are "agog" with speculation as to the viability, during the pandemic, of force majeure and impossibility/frustration-of-performance defenses to obligations under leases, mortgages, and other real property contracts. A recent case examines the viability of those defenses in another context—a change in law.

On April 19, 2019, Malachite Servs., LLC agreed to purchase a building in Midtown Manhattan from 148-150 E. 28th St LLC for $6.668 million, with a down payment of $668,000 but no mortgage contingency clause.

In June 2019, New York passed the Housing Stability and Tenant Protection Act of 2019 (HSTPA). According to Malachite, that caused the appraisal value of the premises to fall to $5.7 million.

Malachite claimed that it would not have entered into the agreement had it known about HSTPA and that the concept of "force majeure" applied. Malachite sought a declaratory judgment that it was entitled to rescind the contract and get its down payment back.

E. 28th moved for summary judgment dismissing the action on the ground that the concept of force majeure did not apply. There was no force majeure clause in the contract, and the passage of a new law was not a basis to terminate. And it asserted that, if the court were to accept Malachite’s argument, then any time a new law is passed a buyer could get out of a contract affected by the new law.

Malachite contended that its sole purpose in buying the premises was the ultimate ability to vacate the under-market rent-stabilized unit and change the use and occupancy of the premises—and that this was known to E. 28th. Malachite offered a frustration-of-purpose claim and contended that the unexpected event (the passing of HSTPA) rendered its performance of the contract valueless.

E. 28th emphasized that it was Malachite that stated that it was no longer going to close and instead wanted rescission of the contract. E. 28th maintained that it was ready and willing to close under the terms of the contract, and pointed out that Malachite had abandoned its force majeure arguments and instead raised the frustration-of-purpose claim.

Counsel for Malachite spoke personally with a real estate broker involved, and he apparently said he was aware of the goal of eventually destabilizing the unit (although counsel was unable to get an affidavit from the broker).

The doctrine of frustration of purpose is a narrow one which does not apply unless the frustration is substantial. In order to invoke the defense, the frustrated purpose must so completely be the basis of the contract that, as both parties understood, without it, the transaction would have made little sense.

The court granted E. 28th’s motion and denied Malachite's cross-motion. Malachite failed to state a cause of action for either frustration of purpose or under a force majeure. Simply put, there was no basis to find that the agreement should be terminated based on the passage of HSPTA.

Furthermore, a closer examination of the contract revealed that Malachite's concerns about possibly destabilizing one of the units was irrelevant. The contract stated that "This Agreement embodies and constitutes the entire understanding between the parties with respect to the transaction contemplated herein." Nowhere in the contract was there any mention that Malachite entered into the contract with the express purpose to destabilize a unit. So Malachite could not rely on oral representations it may have made in connection with buying the building because the value later dropped.

In fact, it appeared from the contract that there were many units in the building, both commercial and residential, and only one of the units was rent stabilized. The court did not see how the fact that one of the nine units in the building would remain stabilized under the terms of HSTPA frustrated the purpose of buying the building such that the contract could be terminated. And even if HSTPA had not been passed, the rent for the unit ($725.08) was significantly below the former high-rent deregulation threshold—such that it would have been quite a while before that unit could possibly have been taken out of rent stabilization, something Malachite surely knew if that was its goal in buying the building.

To the extent Malachite asserted a force majeure claim (apparently abandoned in its cross-motion), that was also without merit. Passing legislation was not an act so unforeseeable that it could justify terminating the contract. Malachite agreed to buy a building, and that building still existed. A change in how much rent could be collected from a single unit was not a basis to rip up this agreement.

The court recognized that Malachite was unhappy that the passage of HSTPA, which apparently caused the value of the building it was buying to decrease. But that was not a basis to terminate a contract or order the return of a down payment under a force majeure or frustration-of-purpose theory. Those doctrines are reserved for situations in which the entire point of a contract is eliminated. The fact that, under current law, Malachite would not be able to destabilize one unit in a nine-unit building did not come close to the situation those legal theories envisioned. Values of buildings change all the time; sometimes neighborhoods become more or less popular or pandemics can force lucrative long-term tenants to permanently close.

Malachite's alleged purpose was not found anywhere in the contract, which also contained a clause stating it constituted the entire agreement between the parties. And the passage of legislation could not form the basis for ripping up the contract. Otherwise, every time legislation was passed, it would permit an unhappy party to get out of an affected contract. The court declined to embrace such an expansive view of the doctrines of force majeure or frustration of purpose [Malachite Servs., LLC v. 148-150 E. 28th St LLC, 2020 NY Slip Op 33037(U), 9/15/20].