Arizona Court Ruling Could Weaken the Centuries-Old Merger Doctrine

August 14, 2011 Stephen Aron Benson Real Estate Law

Strict application of the common law merger rule may no longer be viable; in Arizona, courts may look instead to the intentions of the parties

Unless you spent the summer reading Ken Follett’s World Without End, you probably have relatively little interest in the legal system (particularly the real estate rules) that was established in the Middle Ages. However, as any first-year law student can tell you, many of the legal principles that began in the Middle Ages became firm English common law and remain alive and well in many situations and circumstances in America.

A good example of that is the “merger” doctrine. While “merger” can be applied to a number of real estate circumstances, it most commonly applies in lease/ownership situations. The general rule, straight out of the 13th century, is that when the same party holds both a tenancy and ownership on the same property – even if only for an instant – the tenancy “merges into the deed,” and the tenancy or lease disappears. This “trap” can apply to various situations, and courts around the country tend to apply it pretty strictly, even when the intention of the parties might seem to be otherwise.

However, perhaps things are changing. In the recent case of United Insurance Co. of America v. Lutz, the Arizona Court of Appeals reversed a summary judgment entered against the landlord in a case where the tenant’s guarantors took the position that, because of the merger concept, there was no lease to guarantee.

The facts are as follows: The defendants, Mr. & Mrs. Lutz, were the sole members of WKL, LLC. WKL had entered into a purchase agreement with North Scottsdale Gateway, LLC (“Gateway”) for a building in north Scottsdale. Before completing the purchase, WKL agreed to lease office space in the building from Gateway. The Lutzes personally guarantied WKL’s obligations under the Gateway lease.

WKL and United Insurance Co. of America (“United”) entered into an agreement whereby, after WKL acquired the building from Gateway, WKL would sell it to United. In conjunction with the agreement for sale, WKL and Gateway amended the Gateway lease, with the Lutzes extending their personal guaranty. WKL eventually purchased the building from Gateway and conveyed it to United later that same day.

Four years later, United sued WKL for a breach of the Gateway lease and the Lutzes on their personal guaranty. The Lutzes moved for and were granted, summary judgment on the grounds that the merger doctrine terminated the Gateway lease, and therefore, the lease guaranty was no longer in effect (because there was no lease to guarantee).

The Court of Appeals reversed. Concluding that an inflexible application of the merger doctrine is now “practically extinct,” the Court adopted a modern approach, which examines the parties’ intentions and equitable considerations in order to determine whether merger is applicable. Finding that the Lutzes and United intended for the Gateway lease and the associated guaranties to survive the transfer from WKL to United, the Court reversed the decision of the trial court.

The United Insurance ruling is strong evidence that strict application of the common law merger rule may no longer be viable. Arizona courts will perhaps look instead to the intentions of the parties.

To non-attorneys, that may sound like a sensible result; however, English common law has a strong hold on real estate principles. We do not yet know whether this ruling will be appealed to the Arizona Supreme Court, but, if it stands, United Insurance represents an important change in the direction of real estate law.