Ysiem Corp. v. Commercial Net Lease Realty, Inc.

United States Court of Appeals
For the First Circuit

No. 02-1625

YSIEM CORPORATION,

Plaintiff, Appellant,

v.

COMMERCIAL NET LEASE REALTY, INC.,

Defendant, Appellee.
__________

OFFICEMAX, INC.,

Defendant.

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF PUERTO RICO

[Hon. Jay A. García-Gregory, U.S. District Judge]

Before

Boudin, Chief Judge,

Selya and Lipez, Circuit Judges.

Eugenio C. Romero with whom Eugenio C. Romero Law Offices was
on brief for appellant.
Verónica Ferraiuoli-Hornedo with whom Néstor Durán and
McConnell Valdés were on brief for appellee.

May 1, 2003
 BOUDIN, Chief Judge. Ysiem Corporation ("Ysiem") is a

Puerto Rico corporation that owns a parcel of land in Rio Piedras,

Puerto Rico. In late 1997, Ysiem inquired through a broker whether

the office supply chain OfficeMax would be interested in building

a store on a portion of the site. OfficeMax replied that it does

not acquire or develop property itself; it will only lease (or

sublease) sites that are fully developed. The broker put Ysiem in

contact with Commercial Net Lease Realty, Inc. ("Commercial Net"),

a company that develops commercial properties that are then leased

to major retail businesses under long-term leases. Commercial Net

had developed sites for OfficeMax in the past.

Commercial Net and Ysiem began to negotiate a ground

lease agreement in February 1998. During these negotiations,

Commercial Net had no assurance from OfficeMax that the latter

would be interested in subleasing the site from Commercial Net:

OfficeMax usually does not negotiate with the developer at all

until it has received a pro forma budget, for the developer will

ordinarily first need at least a tentative agreement with the

landowner as to the ground rent.

Representatives from Ysiem and Commercial Net met in

March 1998. Ysiem understood that Commercial Net hoped to lease

the land from Ysiem and build a retail store to OfficeMax

specifications that OfficeMax would then sublease from Commercial

Net. On March 26, 1998, Commercial Net and Ysiem signed a letter

-2-
of intent specifying the lease term, annual ground rent, and other

contemplated provisions including a statement that the effective

date of the ground lease would be the date that OfficeMax opened

its doors or six months after the start of construction, whichever

came later. The letter also stated: "The parties shall enter into

negotiations for the completion of documentation incorporating the

above. This transaction shall not be binding until final execution

and delivery of such mutually agreeable documentation."

After signing the letter of intent, Commercial Net and

Ysiem began to negotiate the ground lease agreement and, in May

1998, the parties settled upon final language incorporating many of

the terms laid out in the letter of intent. But unlike the

deferred effective date for the lease contemplated in the letter of

intent, the ground lease stated (conventionally) that the lease was

"made, entered into and effective as of" a specific date--which was

left blank in the draft. Section 7.6 of the ground lease gave

Commercial Net the right to terminate the agreement if it was not

able to enter into a sublease agreement with OfficeMax within 60

days:

Within sixty (60) days of the Effective Date,
Tenant shall have obtained a sublease with
OfficeMax, Inc., an Ohio corporation
("OfficeMax"), in a form satisfactory to
Tenant in its sole and absolute discretion. If
Tenant does not obtain the sublease within
such 60-day period, Tenant, at Tenant's
option, by written notice to Landlord within
five (5) days after the expiration of such 60-
day period, may terminate this Lease. If

-3-
 Tenant does not give the aforesaid notice to
Landlord prior to the expiration of the
applicable 5-day period, Tenant shall be
deemed to have waived this condition. If
Tenant terminates this Lease under this
Section 7.6, this Lease shall become null and
void, and neither party shall have any further
obligations hereunder.

On May 6, 1998, Commercial Net sent Ysiem four copies of

the ground lease agreement for execution. The accompanying letter

instructed Ysiem's representative to execute the four copies and

return them to Commercial Net for Commercial Net's execution.

Ysiem signed the copies, leaving the execution date blank, and

returned them to Commercial Net on May 12. In early June,

Commercial Net asked Ysiem for a resolution from Ysiem's board of

directors stating that the Ysiem employee who had signed the ground

lease had authority to do so; Commercial Net said this was

necessary for the ground lease "to be effective and binding against

the landlord and in order to record the Lease." Ysiem's board

quickly passed this resolution.

Commercial Net did not execute the lease after it

received notice of this resolution; instead it began negotiating

the sublease agreement with OfficeMax. At the end of June,

Commercial Net submitted to OfficeMax a pro forma budget stating

that OfficeMax's rent would be $23.09 per square foot. OfficeMax

said this figure was too high, so Commercial Net asked Ysiem for a

reduction in the rent, explaining OfficeMax's position. Ysiem

refused. Commercial Net attempted to salvage the deal by lowering

-4-
its own return rate and reducing the annual rent increases, thereby

reducing OfficeMax's annual rent to $22.42 per square foot.

OfficeMax still found the rent too high.

Ysiem's own broker then sent a letter to an OfficeMax

representative justifying the ground lease rent as comparable to

other rents in the area. Mentioning various possible tenants, the

letter also said that Ysiem had instructed the broker for the

property to find an alternate lessee but to hold off doing so until

Ysiem reached a final resolution with Commercial Net and OfficeMax.

In late July 1998, Commercial Net made one last effort to make a

deal with OfficeMax, which the latter rejected because it still

found the rent too high.

At the end of August, Ysiem requested from Commercial Net

an executed copy of the ground lease. Ysiem's letter, plainly a

predicate to litigation, stated that "[a]lthough such formal

requirement is not strictly necessary under Puerto Rico contract

law, it would seem compelling to have an original copy of the

Agreement available in our files." The letter ended by noting,

"[i]n view of the foregoing, we hereby reiterate YSIEM's emphatic

position that the Ground Lease Agreement is a valid, effective, and

enforceable contract with [Commercial Net]." Commercial Net

responded that there was no contract because Commercial Net had

never executed the ground lease agreement. It also returned the

original four copies without its own signature.

-5-
 Ysiem filed this diversity action against Commercial Net

and OfficeMax in federal district court in Puerto Rico in December

1998, seeking specific performance or damages. Ysiem alleged that

the defendants had breached the ground lease agreement and that

their actions had been wrongful. After discovery, Ysiem

voluntarily dismissed the claims against OfficeMax. The remaining

parties then cross-moved for summary judgment. After receiving a

recommendation from the magistrate judge, the district court

dismissed the remaining claims, and Ysiem has appealed. We review

a grant of summary judgment de novo, construing the record in the

light most favorable to the non-moving party. Motorsport Eng'g,

Inc. v. Maserati S.p.A., 316 F.3d 26, 28 (1st Cir. 2002).

The district court gave two bases for rejecting Ysiem's

contract claim that the ground lease between it and Commercial Net

is binding. Its first reason was that the ground lease agreement

was not binding because Commercial Net never signed a sublease

agreement with OfficeMax. The court stated that OfficeMax was "the

linchpin of the proposed transaction" and "without OfficeMax's

execution and sub-lease documentation, the proposed transaction was

not binding." This effectively reads the final version as if it

retained the effective date language proposed in the letter of

intent.

Under this line of reasoning, the ground lease agreement

would not be an enforceable contract at the outset even if both

-6-
parties had signed and dated the final copies unless and until

OfficeMax executed a sublease. Yet this would be contrary to the

explicit effective date language in the final version of the ground

lease agreement, and it would make redundant the 60-day back-out

clause quoted above. To us, the change from the letter of intent

language to the final ground lease language was self-evidently

meant to give Ysiem a measure of limited protection once the ground

lease agreement was executed by both sides.

The district court's second reason was that the ground

lease agreement never became an enforceable contract because it was

never executed by Commercial Net. Ysiem answers that under Puerto

Rico law an agreement can be binding without executed documentation

if, inter alia, the parties have a "meeting of the minds expressed

through the offer and the acceptance."1 There is nothing wrong

with this abstract proposition; and (statute of frauds or like

requirements aside) the proposition might apply if the parties had

merely agreed to a set of final terms without any understanding

that executed documentation was essential to the formation of the

ground lease agreement. See Consarc Corp., 996 F.2d at 570.

However, in the present case, the framework for the

negotiations was created by the letter of intent which specified

1
Producciones Tommy Muniz, Inc. v. Comite Organizador de los
VIII Juegos Panamericanos, 13 P.R. Offic. Trans. 666, 670 (1982);
see also Consarc Corp. v. Marine Midland Bank, N.A., 996 F.2d 568,
570 (2d Cir. 1993).

-7-
that the negotiations were to be conducted for "the completion of

documentation" and said that the transaction was not "binding"--

that is, did not create an effective contract--"until final

execution and delivery of such mutually agreeable documentation."

Although the parties were still free to alter the final terms and

omit this requirement, the ground lease agreement itself explicitly

provided that it would be effective only when executed, and, in

context, this obviously means by both sides.

Ysiem has an alternative claim for relief that does not

depend on the existence of a binding ground lease agreement. This

argument rests on the civil law doctrine of culpa in contrahendo,

which requires parties to negotiate in good faith. Kessler & Fine,

Culpa in Contrahendo, Bargaining in Good Faith, and Freedom of

Contract: A Comparative Study, 77 Harv. L. Rev. 401 (1964) The

argument was not well-developed in the district court, but after

reviewing the complaint and motion papers, we think the argument

was just barely presented and preserved for this appeal, where

somewhat more emphasis is placed upon it.

At common law, liability for bad faith bargaining, in the

absence of a final contract, is fairly limited although claims

based on fraud or estoppel are possible; and depending upon

language and inclination, courts sometimes construe letters of

intent as themselves creating a contractual or quasi-contractual

obligation to negotiate in good faith toward a final contract.

-8-
See, e.g., Venture Assocs. Corp. v. Zenith Data Sys. Corp., 96 F.3d

275, 277-78 (7th Cir. 1996); Farnsworth, Contracts § 3.26 (2d ed.

2001). But the governing law in this case is that of Puerto Rico

where the somewhat broader doctrine of culpa in contrahendo

governs.2

Under this doctrine, negotiations toward an agreement

can--even without a letter of intent--readily give rise to mutual

expectations that the parties will bargain in good faith and

refrain from misconduct. The doctrine looks to common law eyes

closer to a tort than a contract claim and is designed primarily to

protect reliance rather than expectation interests. Satellite

Broad., 807 F. Supp. at 219-22. The culpa in contrahendo test is

not very precise and the courts appear reasonably cautious in

applying a doctrine that could, if applied too freely, chill

negotiations rather than facilitate them. Satellite Broad., 807 F.

Supp. at 222; Farnsworth, supra, § 3.26.

The leading case in Puerto Rico is the Tommy Muniz

decision already cited. There, the plaintiff was the highest

bidder to broadcast the Pan American games in Puerto Rico, and the

committee awarding the contract told the plaintiff that its bid had

2
See generally Tommy Muniz, 13 P.R. Offic. Trans. at 676;
Torres v. Gracia, 19 P.R. Offic. Trans 742, 746-49 & n.2 (1987);
Velazquez Casillas v. Forest Labs., Inc., 90 F. Supp. 2d 161, 166-
70 (D.P.R. 2000); Prime Retail, L.P. v. Caribbean Airport
Facilities, Inc., 975 F. Supp. 148, 151-53 (D.P.R. 1997); Satellite
Broad. Cable, Inc. v. Telefonica de Espana, S.A., 807 F. Supp. 218
(D.P.R. 1992).

-9-
been accepted subject to negotiation of the detailed contract.

Tommy Muniz, 13 P.R. Offic. Trans. at 666-67. In the midst of

negotiations, the committee decided to broadcast the games over

government stations and ended its negotiations with the plaintiff.

Id. at 668-69. Holding that the committee had violated its duty of

good faith, the court adopted a rather general test dependent upon

the circumstances, including conduct, reasonable expectations and

virtually any other relevant circumstance. Id. at 680.

It is possible to criticize Commercial Net's action in

sitting on the ground lease agreement signed by Ysiem instead of

executing and returning the lease promptly or, in the alternative,

saying forthrightly that it was not prepared to sign until its own

negotiations with OfficeMax began to bear fruit. On this record we

cannot know whether this was a deliberate effort to mislead, or an

oversight, or neither: obviously Ysiem knew that it had not

received in return a signed copy of the lease. How much scienter

matters to culpa in contrahendo doctrine under Puerto Rico law is

also unclear.

By contrast to the Tommy Muniz case, Commercial Net's

delay in signing the ground lease was part of an effort to achieve

a sublease with OfficeMax in the interest of both Commercial Net

and Ysiem. The negotiations with OfficeMax were protracted because

of disagreement as to rent; Ysiem was aware of the problem and the

delay: it itself urged OfficeMax to reconsider. Accordingly, even

-10-
if Commercial Net were treated as modestly blameworthy, the fault

was a limited one and occurred in the course of an effort to save

the project as a whole.

In all events, Ysiem would not have been any better off

if the ground lease agreement had been signed by Commercial Net and

returned to Ysiem in early June. Had this occurred, Commercial

Net--as the end of the 60-day period approached without a sublease

from OfficeMax--would surely have exercised the option clause to

terminate the agreement unless Ysiem extended the 60-day period.

Ysiem, in failing to press for return of a signed copy more

quickly, may well have understood the situation.

Affirmed.

-11-