Losing And Not Losing Option Rights – What’s The Scoop?

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This week, we’re steering away from a “survey” approach to the topic of options. Rather than present an entire meal, we’re dishing out a few items from our tasting menu. The theme of this meal is “options.” First, we’ll look a court opinion about the “words” used in a notice of exercise. Then, we’ll look at a late exercise notice case.

Here are two “You Be The Judge” scenarios:

Scenario 1.* A tenant had a right to renew its lease “for another five years” for a stated renewal rent. The tenant timely sends the following notice:

“This is notification that Tenant is exercising the Option to Renew at the above referenced location. Tenant would like to propose a reduced term from five (5) years to three (3) years. Term shall commence on 4/01/2008 and expire 03/31/2011.”

The cover letter accompanying the facsimile copy of this notice (and, seemingly not with the overnight courier copy) requested that the landlord advise “if ownership is agreeable to the three (3) year term.”

A week later, the landlord responded:

“We are unwilling to do this and will accept … your renewal notice … whereby you exercised the five (5) year option.”

The tenant vacated 17 months later.

Fellow Ruminators – what result? Renewal? No Renewal? Five years? Three Years?

Scenario 2.** A tenant had a purchase option. It timely sent the following notice:

“Therefore, it is our intent to proceed with plans to exercise the purchase-option… .” This will serve as the required notice of the lessee’s intention to exercise the option … as provided in the lease.

It is understood, however, that we remain open to any precise and complete offer of a renegotiated lease which will be at least as beneficial to the [tenant] as ownership.”

Fellow Ruminators – what result? Purchase? No Purchase? Lease?

Have you had enough time? Have you re-read the notices carefully?

Here are the answers: (1) no exercise of the renewal option; and (2) no exercise of the purchase option. In the first case, it worked out in the tenant’s favor; in the second case, in the landlord’s favor.

What the two scenarios have in common is whether the exercise of the option right was “unconditional.” As to the lease renewal, would the tenant have “lost” the renewal had it argued that it sent an unconditional renewal notice accompanied by a mere invitation for an offer from its landlord of a lease amendment to change the five year term to a three year term? In the actual case, the tenant didn’t want a five year renewal and was willing to vacate the premises if it couldn’t get a three year renewal. So, it didn’t make that argument. Nonetheless, what would the court have decided?

In the second hypothetical, had the landlord accepted the purchase option exercise notice, would the tenant have been able to renege because its landlord did not offer a lease alternative? What do you think?

Actually, it doesn’t matter what you or Ruminations think, because (in the first scenario), a U.S. District Court Judge said: “no renewal.” In the second scenario, a New Jersey Appellate Court panel said: “no sale.” There are only about 680 U.S. District Court Judges, making that a pretty rarefied group. At 33, New Jersey’s Appellate Court Judges number even fewer. So, regardless of the inevitable jokes, these people have been culled from over a million and a quarter attorneys in the United States, and their opinions count more than ours and yours.

You might think that each court thought its decision was a close call. You’d be wrong because in the purchase option situation, the court concluded that it could not “see how this letter could be said to represent an unqualified exercise of the purchase option.” In the lease renewal situation, the judge opined that in the renewal letter and in SUBSEQUENT conversations with the landlord, “[the tenant] unambiguously indicated its intention to change the lease duration from five years, as stated in the option, to three years.”

We’re not too concerned that we don’t see the ambiguities that each court saw, allowing each court to “interpret” the notices. That’s because the lesson for today is simple: Don’t mix messages in any contractual notice, and especially when an option is on the line. Don’t give the recipient or a court any opportunity to find your notice to be ambiguous or unambiguous (against your interest). If you receive a notice that has a mixed message, insist on an immediate clarification and confirmation.

We think the landlord in scenario one would have had the benefit of a five year lease had it responded with an acceptance and a demand that the tenant assert otherwise by a given date. At least, it would have known whether its tenant was holding over without permission. What difference would that have made to this particular landlord? Wouldn’t that have brought about the same result – no renewal? Maybe yes, and maybe no, but it wouldn’t have incurred the legal expenses to have reached the same result. Moreover, when the court said: “no renewal,” the landlord argued that once the lease expired, its tenant became “one at sufferance.” A tenant at sufferance is one that remains wrongfully on the property and, under New Jersey law, would be liable for rent at double the fair market rent. In this lease, by contract, had the tenant continued as a “tenant at sufferance,” it would have been required to pay 150% of the rent previously payable. As it was, the landlord, insisting that the lease had renewed, continued to accept rent without objection. This made its tenant into a month-to-month tenant, and not a “wrongful” one. So, no 150 percent.

Either tenant could have begun discussions “ahead of the deadline” for giving notices. The tenant with the purchase right could have clearly said that it would be buying the property even if no lease deal could be worked out. That would have been unequivocal.

When we wrote “ahead of the deadline”, we created a segue to the issue of late “notices” for the exercise of one’s option rights.

We don’t think we could have written the following any better than did the New York Supreme Court, Appellate Division in a 2011 case dealing with a late notice situation***:

“The law generally exacts a high price for failure to comply with the exact language of a contract. … But, in some situations, principles of equity have softened the harsh results of common-law rules of strict contract construction. These equitable principles, such as the doctrine of substantial performance, import the concept of fundamental fairness to the context of contract-dispute litigation. One equitable construct that has been used to protect parties from the harsh results of strict contract construction is the principle that equity will intervene to avoid forfeiture.”

Boy, do wish we could write like that!

The reason options are generally construed narrowly is because the law doesn’t see them as “vested rights.” Essentially, until exercised, they aren’t taken to be “property rights,” a category more protected than “contract rights.”

We’ll return to legal principles after we tell the following story:

A tenant with a five year renewal option had until January 31 to send notice of its exercise of that right. It emailed and faxed the notice on February 4; the landlord rejected the exercise on February 5.

“A deal is a deal,” screamed the landlord. Generally, when a contract has an expressed condition, courts are obliged to treat any failure of that condition as “material.” The rules for treating “implied” conditions are considerable more lax. This tenant’s option right was expressly conditioned on the giving of notice by January 31.

OK, you say, Ruminations has already told us about how notions of equity can trump contractual rights, so — where is this going? Fair enough – we’ll tell you.

The equitable right is not unfettered. For example, in New York, where this story took place, the requirements are as follows:

“Equity will relieve a tenant from a failure to timely exercise an option in a lease to renew or purchase if (1) the tenant in good faith made substantial improvements to the premises and would otherwise suffer a forfeiture, (2) the tenant’s delay was the result of an excusable default, and (3) the landlord was not prejudiced by the delay.”

As you see, at least in New York (and really, most everywhere), the test isn’t just that it was an innocent error and there was no prejudice. The third factor [numbered here as “(1)”] is that the tenant would be losing some valuable “property interest.” Here, the tenant had not put “real” money into the space (as clearly would have been the case had it constructed its own building on leased land). So, what was the “property interest”? Answer – the good will it created for its own business at the location. Yes, the address itself. Wasn’t that the landlord’s good will, not its tenant’s? It doesn’t appear that this argument was raised or, in the alternative, the court gave it so little importance that it didn’t even use its opinion to dismiss it.

Here, the tenant’s store had been at this location for 15 years; the store was one of its top producing locations; it would take a year to find another nearby location, if one could be found at all; and, most of the store’s 114 employees would be out on the street. It didn’t matter to this court that this particular tenant had significant name recognition, separate and apart from this particular location, and could have transferred its name recognition “down the block.”

Suppose the notice had been 40 days late, and not four days? We’re not going there because, as this court repeated from an earlier case, “[b]y its nature, equitable relief must always depend on the facts of the particular case and not on hypotheticals.”

Various jurisdictions have greater or lesser tolerance for late notices, but we think all apply equitable principles when looking at similar situations. We think all “abhor forfeitures.” There is no guaranty, however, that any given jurisdiction, let alone, any given judge, will view “good will” as a property right to be protected against forfeiture.

Argue, as you may, that a “contract” is a “contract,” and that courts shouldn’t go around and rewrite one for the benefit of a careless party, but don’t expect to change the law. It is the “law” that enforces contracts, and the law says: “we have some overriding principles,” one of which brings about this tolerance for SOME late notices.

When a court downplays a provision in a contract, allowing the court to circumscribe its meaning, it is saying that the provision was not a “material” one, i.e., it didn’t go to the heart of the parties’ agreement: “it can’t be a big deal whether the cut-off was January 31 or February 4.” The optionor (that’s the one who receives the notice) can insist that the contract (lease) expressly make the notice’s deadline: “Time of the Essence.” Those few words, in all but the most horrible set of circumstances, will tell a court that when it strives to balance the equities: “the parties agreed this date was an important one – one that each should be able to rely upon.”

Looking from the other side of the “deal,” an optionee (that’s the one who holds the right and gives the notice) should insist that the deadline be the later of a given date or “X” days after it receives an “option exercise reminder notice” from the optionor, with such option reminder notice not being sent sooner than “X” days before the given date, time being of the essence. Why isn’t that fair? After all, the optionor (the one who receives the notice) has agreed to accept a lease renewal or to sell the property or “whatever,” and if a cut-off date is important, it can make it into a “time of the essence” date that a court will respect.

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* From: The Great Atlantic & Pacific Tea Company, Inc. v. Gamestop, Inc., (U.S. Dist. Ct. D.NJ, 2012) [August 1, 2012, Unpublished]. Click HERE.

** From: Robert & Richard Associates v. Division of Purchase and Property, 202 N.J. Super. 352 (App. Div. 1985). Click HERE

*** From: 135 East 57th Street LLC v. Daffy’s Inc., 2011 WL 5839575 (N.Y.A.D. 1st Dept., 2011). Click HERE

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Comments

  1. Ira, regarding the first scenario: Just reading the quoted lease language on its face, and without any knowledge of additional facts, I would have ruled for the tenant. I think the second sentence was an invitation to discuss only, and did not weaken the unconditional exercise of the option. However, as you say later, the court found additional facts that of the tenant’s true intent and ruled for the landlord.

    I agree that putting extraneous messages in the exercise notice is dangerous and could have unpleasant results.

    And it does matter what we Ruminators think – what does a federal judge know?

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