The commercial real estate business might seem fairly straightforward; a landlord has a building with office, factory, or retail space, and a tenant pays an agreed-upon rent to lease that space.

In fact, however, commercial leases are often complex documents that specify detailed obligations by both landlord and tenant, as well as financial guarantees, letters of credit, environmental standards, and much more – all of which may be subject to interpretation, as demonstrated by a case recently brought before the California Court of Appeal (Rreef America v Samsara).

In March of 2019, Samsara Inc., a technology company serving the transportation industry, signed a 10-year lease for office space in San Francisco, at just over $840,000 per month.

The lease required Samsara to provide the landlord, Rreef America, with a letter of credit, or LOC, of almost $11.4 million as collateral for Samsara’s obligations under the lease.

Rreef was obliged to make the premises available in “delivery condition” by November 1 of that year or provide Samsara with a rent abatement of over $52,000 for every day it was late.

Things did not go as planned. In September of 2021, Samsara sued Rreef, alleging that the premises were contaminated with lead and asbestos. In retribution, Samsara claimed, Rreef accused Samsara of breaching the lease and cut off its access to the property for months.

According to its complaint, Samsara had the premises retested in January of 2021, found that the lead contamination had not been fully abated, and terminated the lease in March of 2021. It demanded a rent abatement of over $56,000 per day for every day since July 15, 2019.

Rreef served Samsara with a 5-day notice to pay rent or quit for the months of August and September 2021, totaling over $1.8 million. Two weeks later, after Samsara had not paid the amount demanded, Rreef filed an unlawful detainer complaint, seeking to evict Samsara. It said its environmental consultant had found only minimal lead contamination, and Samsara had continued to use the premises.

Samsara responded by claiming Rreef was trying to evict it in retaliation for its environmental complaints. It also asserted other legal defenses.

In October of 2021, Rreef asked the court to allow it to “attach” or seize assets of Samara in the amount of nearly $3.8 million, to cover the unpaid rent.

In its reply, Samsara argued that Rreef was not entitled to seek attachment because its claim was fully secured by the $11 million LOC.

Rreef said it had no obligation to draw on the LOC when Samsara had committed an “incurable event of default” under the lease by failing to pay rent.

After a hearing, the San Francisco County Superior Court granted Rreef’s attachment application. Samsara then appealed.

It took the appellate justices more than 35 pages of careful analysis to untangle the legal issues underlying the dispute.

Both tenants and landlords involved in substantial commercial leases may want to pay attention to how the justices said the courts should treat the letters of credit that are often a part of these agreements.

Under California law, Samsara pointed out in its appeal, an attachment must be for an amount “greater than zero.”

It said the $1.9 million Rreef sought to secure by attachment should be reduced by “the value of any security interest” Rreef held in the property. According to Samsara, that included the more than $8 million amount available under its LOC. So, the amount available for Rreef to attach was not “greater than zero,” Samsara said.

If funds were drawn down from its LOC, Samsara pointed out, it would have to reimburse the bank that issued it, so in effect Rreef would be receiving Samsara’s money.

Rreef contended that its interest in the LOC was not an interest in Samsara’s property but in the property of the bank that issued it.

The appellate justices agreed with Rreef. They noted that three relationships exist in a letter of credit: one between the bank and its customer that purchased the LOC; another between the bank and the beneficiary to whom it makes a promise to pay in the event the bank’s customer fails to pay; and a third between the bank’s customer and the beneficiary.

The LOC should not be treated as Samsara’s property for purposes of considering Rreef’s attachment request, the justices said.

They agreed that a customer who obtains a letter of credit has an obligation to reimburse the issuer for any payments made to a beneficiary of the letter. But a bank would have to pay a beneficiary even if its customer went bankrupt, repudiated the contract, or simply failed to pay.

For that reason, the justices said. the LOC Samsara gave to Rreef has to be treated differently from property owned directly by Samsara and cannot be used to reduce the amount subject to attachment.

They reversed the attachment order issued by the trial court, and remanded the case for reconsideration of other issues, ordering the parties to bear their own costs on appeal.

By Laurie Murphy