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DemQuarter Healthcare Investors, L.P. v. OP Chattanooga, LLC

Court of Appeals of Tennessee, Knoxville

December 29, 2016


          Session October 19, 2016

         Appeal from the Chancery Court for Hamilton County No. 13-0521 Jeffrey M. Atherton, Chancellor

         This case involves the lease of a skilled nursing facility. The lessee assigned the lease, and the assignee then subleased the nursing facility. While the appeal raises multiple issues, we have determined that the lessor prevails and that the judgment of the trial court must be reversed and the case remanded.

         Tenn. R. App. P. 3 Appeal as of Right; Judgment of the Chancery Court Reversed

          Barry Goheen, Atlanta, Georgia, and Scott M. Shaw, Chattanooga, Tennessee, for the appellant, DemQuarter Healthcare Investors, L.P.

          Joshua A. Powers, Chattanooga, Tennessee, for the appellees, OP Chattanooga, LLC, and FC-THC Leasing, LLC.

          Andy D. Bennett, J., delivered the opinion of the court, in which D. Michael Swiney, C.J., and John W. McLarty, J., joined.



         Factual and Procedural Background

         The facts in this case are voluminous and complex. We will begin with a bare-bones summary to provide a context for a discussion of the issues on appeal and will then add details in the analysis sections as necessary for an understanding of the questions under consideration.

         DemQuarter Healthcare Investors, L.P. ("DemQuarter") owns the Stratford House, a skilled nursing facility in Chattanooga, Tennessee. Douglas Mittleider is the president of DemQuarter's general partner. DemQuarter's purchase of Stratford House was originally financed by GMAC Commercial Mortgage Corporation ("GMAC"); the loan was later converted into a mortgage-backed security, with LaSalle National Bank ("LaSalle") acting as trustee of DemQuarter's loan on the Stratford House for the benefit of holders of GMAC securities.

         DemQuarter leased Stratford House to OP Chattanooga, LLC ("OPC") pursuant to an agreement executed in May 2003. At the time of the original lease in May 2003, OPC was wholly owned by Tandem Health Care, LLC ("Tandem"). Also in May 2003, another Tandem entity, OP Whites Creek, leased a long-term care facility in Whites Creek, Tennessee, called the Windsor House.

         Key Provisions of Stratford House Lease

         The following summary serves to highlight key provisions of the lease between DemQuarter and OPC that will be discussed in detail in the analysis section of the opinion.

         The lease ran for five years with an option to renew for two additional five-year periods. Under section 9.1 of the lease, the term "Event of Default" includes an event of default under the lease agreement between Brookside Healthcare Investors, L.P. and OP Whites Creek, Inc., regarding Windsor House. Under section 10.1, if DemQuarter "proposes to sell or otherwise transfer the Facilities to any party . . . [OPC] or one or more of its Affiliates as Lessee may designate shall have the right of first refusal to purchase the Facilities prior to Facilities being offered for sale or sold to any other Person." The right of first refusal ("ROFR") provision provides a formula for calculating the purchase price.

         Pursuant to section 11.20, OPC "shall not assign this Lease or sublet the entire Facilities or any portion thereof, without the prior written consent of [DemQuarter], which consent shall not be unreasonably withheld or delayed." This section also states, however, that OPC may assign or sublet the facilities without DemQuarter's consent "to an Affiliate of Lessee" and to certain other persons. "Affiliate" is a defined term under the lease.

         Corporate Restructuring

         In 2006, Tandem's principal shareholders sold Tandem's stock to Formation Capital, LLC ("Formation Capital") and JER Partners. Two of Tandem's former senior executives, Joseph Conte and Gene Conte, thereafter created Consulate Health Care ("Consulate"). In 2011, an investor group led by Formation Capital purchased 100% of the stock of LaVie Health Care, LLC. In July 2012, Consulate merged into LaVie, and LaVie adopted the Consulate Health Care corporate name.

         OPC Assignment of the Lease

         In 2007, OPC entered into an agreement to assign the Stratford House lease to FC-THC Leasing, LLC ("FC-THC"). Consulate Facility Leasing, LLC ("Consulate Facility") subleased Stratford House from FC-THC in 2007. Stratford Facility Operations, LLC ("SFO") sub-subleased Stratford House from Consulate Facility that same year. All of these agreements were placed in escrow and then released in August 2007. On August 29, 2007, DemQuarter sent a default letter to OPC stating that, pursuant to the terms of the lease, the lease could not be assigned without the lessor's prior written consent.

         Purchase Negotiations and Attempted Lease Renewals

         In April 2007, DemQuarter informed OPC that a third party was interested in purchasing both the Stratford House and Windsor House facilities, thus triggering OPC's ROFR. Under section 10.1 of the lease, the purchase price is defined as follows: "the EBITDARM of the Facilities for the immediately preceding four calendar quarters ended March 31, June 30, September 30 and December 31, multiplied by 5.38; provided, however, that the purchase price shall not be less than Six Million Seven Hundred Thousand and 00/100 Dollars ($6, 700, 000.00)." "EBITDARM" is a defined term under the lease.[1] Negotiations broke down because the parties could not agree on a purchase price; they differed in their calculation of EBITDARM.

         By letter dated January 25, 2008, FC-THC informed DemQuarter of its intent to renew the lease for Stratford House for another five years. In March 2008, counsel for DemQuarter responded that the lease was in default and the notice of renewal was therefore ineffective. At the same time, the parties were again discussing a purchase agreement. They ultimately agreed on a purchase price and entered into an asset purchase agreement. The sale never went through, however, because FC-THC was unable to secure financing due to the crisis in the debt markets. Meanwhile, FC-THC continued to pay and DemQuarter continued to accept the rent for Stratford House.

         By letter dated January 29, 2013, FC-THC informed DemQuarter of its intent to renew the lease for Stratford House for another five years. In a letter dated February 8, 2013 confirming an earlier telephone conversation, DemQuarter stated that the lease was in default and, therefore, FC-THC could not make a valid exercise of renewal of the lease term.


         DemQuarter filed its complaint against OPC and FC-THC (collectively, "the defendants") on July 19, 2013, alleging causes of action for breach of contract and declaratory judgment. The defendants filed an answer and counterclaim for breach of contract and declaratory relief. On September 30, 2014, DemQuarter filed a motion for declaratory judgment. A hearing on the motion was held on October 13, 2014, and the defendants' attorney did not appear at the hearing. The trial court granted DemQuarter's motion and decreed that its October 21, 2014 order was a final order pursuant to Tenn. R. Civ. P. 54.02.

         The defendants filed a motion to set aside the trial court's October 21, 2014 order. Counsel for the defendants submitted an affidavit in support of the motion to explain his absence at the earlier hearing. The trial court granted the defendants' motion to set aside. DemQuarter's motion for declaratory judgment was subsequently heard again and denied by the trial court.

         The matter proceeded to trial, which began on April 28, 2015. DemQuarter presented extensive testimony from Mr. Mittleider, and the defendants cross-examined the witness.[2] At that point, the trial court, sua sponte, raised the issue of section 11.14 of the lease, which states that any disputes not resolved within thirty days of notice of the dispute "shall be submitted to arbitration as set forth in Section 11.15, below."[3] The trial court specifically inquired whether the defendants had waived the right to arbitration. The defendants asserted that they had not waived arbitration and made an oral motion for arbitration, which the trial court granted, over the objections of DemQuarter. The trial court entered an order compelling arbitration. Two weeks later, before arbitration had taken place, the trial court entered an agreed order setting aside its order compelling arbitration and setting the case for trial.

         When the trial resumed, DemQuarter read into evidence portions of the deposition of Christina Firth, chief compliance officer and senior vice president for Formation Capital. At the end of the plaintiff's proof, the defendants made a motion for involuntary dismissal, which was denied by the trial court.

         The defendants' proof consisted of the testimony of the following witnesses: Gene Curcio, who was a chief financial officer at Tandem when the lease was signed, as well as an officer of OPC, an officer of Consulate, an officer of Consulate Facility Leasing, and an officer of Stratford Facility Operations; and Ms. Firth. Mr. Mittleider testified again on rebuttal.

         On December 8, 2015, the trial court entered a detailed memorandum opinion and order. The court held that OPC did not breach the lease; that DemQuarter was not at fault for the defendants' failure to exercise the ROFR in 2007; that the ROFR was not extinguished in 2007 and, even if it was, it would have been renewed if the defendants had been permitted to exercise the second renewal of the lease; and that neither party was entitled to attorney fees. DemQuarter appealed.

         Issues ...

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