HOW TO LOSE YOUR ASSETS –
A CASE STUDY IN WHAT NOT TO DO AS A COMMERCIAL TENANT
The recent decision in Pima County Superior Court case, LCL Heritage LLC v. Brass Maze Pizza #794 LLC, et al. dramatically exemplifies what commercial tenants should not do if they want to protect their business and personal assets. Prior to entering into its lease, Brass Maze Pizza, LLC (“Tenant”) spent approximately $30,000 to acquire equipment and trade fixtures to use in its pizza business. The Commercial Lease Agreement granted LCL Heritage, LLC (“Landlord”) a security interest and an express contractual lien on any personal property belonging to the Tenant and used at, in or upon the leased property (the “Assets”). The Lease also provided that, after notice of default, the lien was enforceable without further notice or demand. This contractual lien was in addition to the lien under A.R.S. Section 33-362, which provides a landlord a lien on all “property of his tenant” located or used on the premises. Both liens expressly granted the Landlord the right to take possession of and sell the Assets in the event the Tenant failed to pay rent.
A few years into the Lease, the Tenant began to miss payments. The Landlord sent the required written default notices, of which the Tenant acknowledged receipt. In an effort to assist the Tenant, the Landlord made rent concessions. Unfortunately, even with the concessions, the Tenant continued to miss payments. In response, the Landlord gave notice of the additional defaults, reminded the Tenant of the Landlord’s rights to the Assets under the liens, and offered to make further rent reductions.
Thereafter, using a cover story that the business was closing for one day to repair a broken cooler, the members/managers of the Tenant instructed its employees to remove the Assets from the premises. The Landlord’s property manager happened by and was told by one of the managers/members of the Tenant and by the employees that the business was closing only for a day. The employees further stated to the property manager that the Assets were “being cleaned” not removed. The property manager didn’t buy the story and immediately contacted the Tenant to assert the liens; instructed the employees not to remove any of the Assets; and posted notice of the liens on the premises. Later that day, with full knowledge of the liens, the Tenant removed all of the Assets and closed the business. The Tenant then transferred the Assets to various third parties (entities in which, coincidentally, one or both of the Tenant’s managers/members had financial and/or ownership interests in) or placed them in storage. The Court took particular notice of the fact that the truck used to remove the Assets was rented by one manager/member of the Tenant, driven to the premises by his wife, and then driven away by the other manager/member.
The Landlord filed suit against the Tenant and each manager/member individually alleging Breach of Contract, Conversion (the act of wrongfully taking control over the Assets inconsistent with the rights of the Landlord) and Breach of Fiduciary Duty. Since the Tenant no longer had any assets, the Landlord specifically sought an award of damages against the individual managers and members of the Tenant.
The managers/members of the Tenant argued that under Arizona’s Limited Liability Company Act, Brass Maze Pizza, LLC’s “corporate veil” protected them personally from liability for the tort of conversion. Notwithstanding the Act, the Court determined to “pierce the corporate veil” since each manager/member of the Tenant directly participated in the conversion. Consequently, they were each held personally liable for the conversion.
The Court went on to find that, at the time of the conversion, the business was obviously in the “zone of insolvency,” therefore each manager/member owed a fiduciary duty to the Landlord. That duty included the duty to protect the rights of the Landlord in the Assets. Again, each manager/member was held personally liable since the facts showed that they purposefully put their own interests before the rights of the Landlord.
The Court also ruled that the Tenant breached the Lease and was responsible for the full amount of rent due for the entire term of the Lease (over $400,000.) In addition, the Court ruled that Landlord’s liens on the Assets (which the Court valued at over $57,000) could be enforced up to the amount of the rent due. In setting the value of the liens the Court pointedly noted the lack of credibility and convoluted reasoning of the manager/member who attempted to argue that the Assets were only worth $5,000.00.
Finally, since the action arose out of contract, the Court awarded the Landlord its attorney’s fees. The Tenant and its managers/members lost on every count.
If you are a commercial tenant and want to avoid losing assets, do the opposite of what was done in this case. In short:
- Know and follow the terms of your Lease;
- Pay your rent;
- Work with your Landlord (especially when they offer to reduce your rent);
- Tell the truth;
- Do not instruct your employees to lie;
- Do not remove liened property from the premises;
- Do not devise schemes to try to get around the law;
- Maintain your integrity and credibility;
- Do not go to Court when the facts and law are against you; and
- Do not tick off the Judge!