Unpublished Disposition, 869 F.2d 1496 (9th Cir. 1988)

MEMORANDUM^* 

Central Pacific Supply (CPS) agreed to purchase the Bretons' leasehold interest in property. The Agreement of Sale included a warranty which provided the premises would be free and clear of all encumbrances. It was later discovered that a building on the property encroached 0.45 feet onto a neighboring lot. The Bretons attempted to obtain an easement to free the property from the encumbrance, but CPS refused to remit final payment. In an amended judgment, the district court ruled that the easement rendered the property merchantable and assessed damages against CPS for breaching the agreement. We find the easement did not render the property merchantable, and reverse.

FACTS

On August 7, 1981, CPS, an Hawaii corporation which is in the business of wholesale and retail sales of ceramic tile and related products, purchased a leasehold interest from the Bretons, as principals of Kaulua-Kaneohe Rental Center, Inc. CPS paid $35,000.00 to the Bretons as a down payment at the time of the execution of the Agreement of Sale and was obligated to make an additional payment of $56,250.00 of principal on March 15, 1982. A final payment of principal in the amount of $56,250.00 was due on March 15, 1983. The Agreement further required CPS to pay interest, taxes, assessments, rent to the fee simple owner, insurance and utilities. CPS made all of the payments under the Agreement except for the final payment of $56,250.00. The final payment was to be made a part of a final closing in which all of the performances due from each of the parties would be required to be made simultaneously.

The Agreement also provided that: (1) the seller would warrant the premises to be free and clear of all encumbrances at the time the premises were conveyed; (2) time was of the essence; (3) failure to make timely payments constituted a default; (4) if CPS vacated or abandoned the premises, such action would constitute a default; and (5) among the Seller's remedies in the event of default by CPS, the Seller, after giving thirty days' notice, could cancel the agreement and retain all payments made, or could foreclose CPS's interest in the premises.

A survey dated December 3, 1982, certified that there was an encroachment of approximately 0.45 feet onto the adjoining property on one side of the building only. Breton informed CPS of this encroachment in late 1982.

On January 26, 1983, CPS reminded the Bretons by letter of their duty to clear the encroachment by March 15, 1983:

"It would appear that the matter can be resolved either by obtaining an appropriate grant of easement from the adjoining owners (the form of which will be subject to CPS' reasonable approval).... There may be other remedies that you wish to propose."

Pursuant to the warranties of the Agreement, CPS stated it would not make final payment until the encroachment problem was resolved.

On March 15, 1983, CPS did not remit the final payment. Instead, in a letter dated April 14, 1983, CPS attempted to rescind the Agreement for Bretons' failure to cure the encroachment problem. The letter provided: "... as a sufficient period of time has elapsed for you to have cured the encroachment on the premises, this is to advise you that CPS hereby rescinds its Agreement of Sale." (Appellant's Excerpt of Record ("ER") at 57.) CPS further acknowledged that an easement document was under consideration and stated that in the event an appropriate easement is fully completed and filed within thirty days (i.e., by May 14, 1983), CPS would be willing to waive the Bretons' delay in providing good title and would remit the final payment in return for conveyance of the premises. (Id.) CPS stated it would remain in occupancy during the interim thirty days if so authorized.

On April 25, 1983, a Grant of Easement for Encroachment of Boundary Wall dated January 11, 1983, for a one foot easement extending along the boundary was duly recorded. The easement was to continue in existence until such time as the buildings upon the subject property were "razed and demolished, for whatever purpose." CPS determined, however, that the easement document did not provide an adequate cure of the encroachment and declined to waive its rescission. In mid-May of 1983, CPS vacated the premises.

CPS filed its complaint on June 30, 1983, in federal district court, claiming it was entitled to rescind the Agreement and recover the damages. On October 17, 1983, the Bretons filed their answer and counterclaim, seeking cancellation of the Agreement for nonpayment by CPS of the March 15, 1983 final payment.

The Bretons filed a Petition to Cancel Agreement of Sale on August 8, 1983 in the Land Court of the State of Hawaii. At the time this petition was filed, the Bretons claim they were unaware that CPS had initiated a suit in federal court. The state court granted Bretons' petition.

Subsequently, the Bretons moved to dismiss CPS's complaint in federal court. Because the state court action had involved the same issues, this motion was granted on April 12, 1985. Following this dismissal, the parties stipulated to a voluntary dismissal with prejudice of the counterclaim.

Meanwhile, the state court judgment was appealed to the Hawaii Supreme Court. The supreme court held that the state land court's judgment was void for lack of jurisdiction.

On June 12, 1986, an order setting aside the order dismissing CPS's complaint was granted on the basis that the state court decision had been invalidated by the Hawaii Supreme Court. The Bretons filed a motion to reinstate the counterclaim on the ground that it entered into the Stipulation for Dismissal of the counterclaim on the basis of the court's dismissal of CPS's complaint. The motion to reinstate the counterclaim was granted on October 14, 1986.

After the entry of a judgment in favor of CPS in the amount of $30,230.00 the Bretons filed a motion for reconsideration. The court entered amended findings and conclusions, and entered an amended judgment denying recovery to CPS and awarding damages to the Bretons on February 12, 1988. CPS appeals this judgment.

DISCUSSION

The Hawaii Supreme Court has noted: "It is a well recognized rule, sustained by ample authority, that a contract to convey property, free and clear of encumbrances, is not complied with, where there exists an easement upon the land which precluded the full enjoyment of the premises." Clarke v. Title Guaranty Co. of Hawaii, 44 Haw. 261, 353 P.2d 1002, 1006 (1960). Even though it may be considered a comparatively slight hindrance, an easement constitutes such a burden and impediment against the full enjoyment of the land as to affect merchantability and the purchaser is not obligated to accept the conveyance. Id. In addition to this, the court referred to its awareness of cases in which very slight structural encroachments, ranging from a fraction of an inch to about two inches, have been held not to render title unmarketable. Id. at 1007. The court continued by quoting from one such case where it was held that a slight encroachment was not noticeable enough to affect merchantability, however:

A marketable title is a title which is free from encumbrances and any reasonable doubt as to its validity, and such as a reasonably intelligent person, who is well informed as to the facts and their legal bearings, and ready and willing to perform his contract, would be willing to accept in the exercise of ordinary business prudence. Accordingly a marketable title must be so far free from defects as to enable the purchaser not only to hold the land in peace but also, if he wishes to sell it, to be reasonably sure that no flaw will appear to disturb its market value.

Id. (quoting Sinclair v. Weber, 204 Md. 324, 104 A.2d 561, 565 (1954). Thus, even in cases dealing with slight encroachments, the effect of the defect on a buyers willingness to perform must be considered.

In the instant case, the wall of the building encroaches approximately six inches onto the adjoining property for a length of 103.3 feet. The wall, which forms the side of a one-story building, is of substantial construction. The district court found that the encroachment of the building onto the adjoining lot was substantial and constitutes an encumbrance. We agree.

What must be determined is whether the grant of easement effectively cured the encumbrance so as to render the title marketable.¹ 

The Subdivision Rules and Regulations of the City and County of Honolulu state: "no person shall designate an easement unless it conforms to the provisions of these rules and regulations and receives approval." (Sec. 1-103(b)). The Bretons failed to comply in a timely fashion with this requirement. Lack of compliance with the subdivision requirement carries criminal penalties of fine and/or imprisonment. (Revised Ordinances of the City and County of Honolulu. Sec. 22-3.12.).

The district court, however, found the lack of subdivision approval did not create a significant risk of litigation. The court noted that prior to 1986 the Department of Land Utilization (DLU) technically required subdivision approval for an easement for a wall. However, adjacent property owners could agree to have a building straddle their common boundaries without violating the law. Accordingly, the court concluded the encroachment of the building wall did not violate state or county law or regulations, and could remain.

CPS argues this holding was erroneous because of the illegality of the Easement Document. City and County regulations were not followed. The testimony of Arthur Muraoka, Chief of the Department of Land Utilization of the City and County of Honolulu, confirmed that subdivision approval had not been requested in this case. Criminal penalties of fine and/or imprisonment can be imposed for noncompliance. Mr. Muraoka further testified, however, that he could not recall an instance where litigation was instituted by the City and County due to failure to obtain subdivision approval. He indicated the only sanction that would arise due to DLU enforcement would be to disallow future building permits until approval had been obtained. He also noted the procedure to obtain approval was an administrative process requiring the submission of plat maps, a completed application, and the requisite fee.

The fact that the two neighbors in this case agreed to allow the wall to straddle their adjoining property does not negate the fact that an easement with subdivision approval was not recorded. The encroachment at issue is an encumbrance. We find that it would be eminently reasonable to expect that a controversy could later arise as a result of the illegal easement. We therefore find the district court erred in ruling the easement cured the encroachment and rendered the property to be marketable. This defect goes to the "root of the contract" since the encroachment that needed to be cured was substantial. As such, it "defeated the objectives of the parties" in making the Agreement and justifies CPS's refusal to remit final payment. See Schaffer v. Earl Thacker Co., Ltd., 3 Haw.App. 81, 641 P.2d 983 (1982). A reasonable vendor exercising ordinary business prudence would not accept title until subdivision approval was obtained. Moreover, although it is true that the defect in title may have been easily cured, time was of the essence according to the terms of the Agreement. Marketable title was not proffered. Accordingly, CPS was justified in refusing to remit final payment on the basis of lack of subdivision approval for the easement.

Because we find the district court's decision on marketability is in error, we need not determine the remaining issues raised on appeal. The district court is REVERSED and we REMAND for a determination of damages, if any, due to CPS.

REVERSED and REMANDED.

O'SCANNLAIN, Circuit Judge, Dissenting:

I would affirm Judge Kay in his decision that the easement dated January 11, 1983, recorded April 25, 1983, rendered the premises free and clear of all encumbrances. I am not persuaded that failure to obtain subdivision approval rendered the easement nugatory. See Henmi Apartments, Inc. v. Sawyer, 3 Haw.App. 555, 655 P.2d 881 (1982) (although unregistered, easement may still be valid under certain circumstances). While I agree that the willingness of the title insurer to issue title insurance may not be controlling, I do not read Hawaii case law to require rejection of such evidence in ascertaining marketability. See Kipahulu Inv. Co. v. Seltzer Partnership, 4 Haw.App. 625, 675 P.2d 778, 781 (1983).

Because the easement from the landowner on whose property the wall had encroached was given for the express benefit of the adjoining property, Judge Kay properly found that "there was no significant risk of litigation." That conclusion was corroborated by testimony of Mr. Muraoka of the Hawaii Department of Land Utilization ("DLU") (majority at page 8). In any event, Judge Kay's sound prediction came true when the DLU granted subdivision approval of the easement in February 1984.

Because I conclude that the trial judge correctly ruled that the seller had performed his obligations pursuant to the agreement of sale, I respectfully dissent.