By: Aaron B. Bloom

A version of this article was originally published in the September 2005 issue of
Real Estate Southern California.

A tenant defaults but expresses an interest in curing the default over time.  The landlord is faced with a decision:  (1) enter into an arrangement to help the defaulting tenant “work it out” or (2) immediately serve a three day notice to pay or quit followed by an unlawful detainer lawsuit. 

In making accommodations, landlords must be careful not to jeopardize their ability to receive a quick and full recovery in the event the tenant continues to default.

Preventing Multiple Lawsuits

One common accommodation made by landlords is to allow defaulting tenants to pay past-due rent over time in addition to their ongoing rental payments.  Most landlords attempt to accomplish this by entering into promissory notes whereby the outstanding rent is amortized along with interest as monthly payments (“note payments”).  However, this practice can cause problems down the road if the tenant defaults on note payments.

In an expedited unlawful detainer lawsuit, the landlord may recover possession of the premises and the “amount of any rent due.”  Cal. Civ. Proc. Code § 1174(b).  The statute's language raises the question of whether past-due note payments could be recovered in an unlawful detainer suit as “rent” or whether the landlord would have to file a separate, non-preference lawsuit to recover the outstanding Note Payments and thus achieve a full recovery.

Some landlords seek to avoid this issue by including a provision in the lease which states that “all monetary obligations of the lessee to lessor shall be deemed to be rent.”  While such provisions are helpful, a court might nonetheless rule that outstanding note payments are a separate obligation and not properly considered “rent” under the statute.

In order to best protect their interests, landlords who are willing to accept past due-rent over time should have defaulting tenants sign a Confession of Judgment with a payment plan pursuant to C.C.P. §§ 1132, et seq.  Then, if the tenant defaults on those payments, the landlord can have a judgment immediately entered without the need to litigate that entire issue.

Proper Application of Tenant Payments

The creation of a separate payment plan (by promissory note or Confession of Judgment) on top of ongoing rental obligations creates another issue for the landlord.  If a landlord has misapplied tenant payments, then the landlord's three day notices to pay or quit (upon which an unlawful detainer lawsuit is based) may overstate the amount of outstanding rent and thus allow the tenant to prevail at trial.  See, e.g. Valov v. Tank, 168 Cal.App.3d 867, 872 (1985).

Under California law, if a tenant owes “several obligations,” then a payment must be applied to a “particular obligation” only if “the intention or desire of the [tenant] . . . be manifested to the [landlord]” “at the time of performance.”  Cal. Civ. Code § 1479.  If, at the time of a payment, the tenant does not specify the purpose of the payment, the landlord “may apply it toward the extinction of any obligation” then due.

The statute also provides that, if the landlord does not apply a tenant's payment to a particular obligation “within a reasonable time,” then the payment must be applied in the following order: (1) interest due at the time of performance, (2) principal due, (3) obligation earliest in date of maturity, (4) an obligation unsecured by a lien or collateral undertaking, and (5) a secured obligation.

I recently handled an unlawful detainer case on behalf of a commercial landlord wherein the tenant owed several obligations and the amount and timing of the tenant's checks rarely had any correlation to any of the tenant's obligations then due.  Nothing written on, or accompanying, the tenant's checks indicated to which of the multiple obligations the checks should be applied. 

The landlord issued apparently conflicting balance statements at the tenant's request (e.g., “What would I owe if I replaced my last bounced check and you applied my last two payments toward the promissory note?”), but the landlord failed to create a paper trail indicating that those statements did not reflect how Landlord was, in fact, applying the tenant's payments.  The landlord also occasionally applied the tenant's payments to obligations not yet due.

Some landlords include a provision in the lease which states that “lessor may apply any funds received by lessee to any obligations owed by lessee in lessor's absolute and sole discretion.”  This practice in conjunction with respecting a tenant's wishes with respect to which obligation the payment should be applied and otherwise following the statute will best protect the landlord's rights.  In addition, landlords should avoid issuing conflicting balance statements or at least create an appropriate paper trail regarding the purpose of the alternative balance statements.

Conclusion

These are just a few of the many potential pitfalls which face a well-intentioned landlord.  There is nothing wrong with trying to help out a defaulting tenant, but landlords should first consult with competent counsel to ensure that they are proceeding in a manner that does not jeopardize their ability to receive a quick and full recovery in the event the tenant continues to default.