Exercising a Renewal Option or SNDA When In Default – Why Not?

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This will not be politically correct, and you can throw this back to me when you see me on the landlord’s side of a lease or the lender’s side of an SNDA. I’ll take that risk because I live by the overriding principle that everything is “bargaining power, everything is priced into the rent or into the deal.” Therefore, fairness is not the deciding factor. Ethical behavior, moral behavior, lawful behavior, politeness – yes, these are all overriding factors, but leases and SNDAs allocate “risk” between the parties, and the topic of this blog entry is a particular kind of risk.

Those caveats having been expressed, I going to pretend that I’ve been hired to fill the role of King Solomon, but there is no baby to be found. I’m being asked to decide what is right or wrong. I take comfort that if the parties to a lease or SNDA decide to do what I think is “wrong,” they’ve “priced” it into the lease or the loan. That’s a convoluted way of saying that parties can accept lease or loan or SNDA provisions that are “wrong” or “unfair” if the overall deal is advantageous. Ralph Waldo Emerson is said to have written: “For everything you have missed, you have gained something else, and for everything you gain, you lose something else.”

Now, to the subject matter of this blog entry. I’m using lease examples, but the final paragraph will extend those examples to SNDAs.

Why do landlord-prepared leases and off-the-shelf leases say that a tenant cannot be in default of the lease’s provisions if the tenant wants to exercise a bargained-for option? Why are many drafted to say that the tenant has to be default-free both at the time of exercising an option and the time it takes effect. Doesn’t that expose a tenant, thinking it has the right to stay another five or so years, to the loss of that right at midnight just before the start of the option period?

Why do I ask “why”? Because, where the parties have negotiated specific remedies for a default and for notice and cure periods, this kind of option language seems to be treated as entirely unrelated to those negotiations. If there are procedural safeguards against a landlord exercising a remedy upon its tenant’s alleged default, are they also there when the tenant wants to renew a lease or exercise an expansion right? Are the cure periods available? Notice rights?

If a tenant has bargained for only court-ordered remedies, such as for judicial eviction and not for landlord self-help eviction, does the same principle carry over to an option clause that begins, “provided Tenant is not in default of… “? What about minor defaults for which no court would evict a tenant. After all, eviction is an equitable remedy. Making the absence of a default into a condition precedent to the right to exercise an option is a matter of contract and, theoretically, a court should not be using its inherent equitable powers so readily when a contractual provision is up for review.

Here’s the circuit breaker for me. If the tenant is in default before, at the time of, or after the exercise of its option, and the landlord wants to do something about it, let the landlord seek eviction or whatever other remedy it has bargained for. If the lease is eligible for termination by reason of a tenant’s default and the landlord wants the tenant out – evict it (or use whatever self-help or conditional limitation remedy the lease allows). Don’t use the back door of cutting-off a bargained-for option right using a lesser standard of “badness.”

What about other in agreements, such as SNDAs? Just rewrite the foregoing by changing leases to SNDAs and changing landlords to lenders, and so on.

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Comments

  1. Lowell Berg says:

    A more balanced approach would subject the limitation on exercise of the option to the tenant’s right to receive notice of default and tenant’s right to cure the default within the stated time frames, as expressed elsewhere in the lease.

    While I agree in theory that the option and the LL’s rights on default are separately bargained for, in practice, I suspect it would be hard to convince LL’s counsel to completely dispense with the limitation on the right to exercise the option. A compromise seems more promising.

    Best regards,

    Lowell
    berg.lowell@gmail.com

  2. Our Courts have held that where an extension option is subject to the Tenant not having been in default, & the Tenant subsequently cures that default, then that cured default will not prevent the Tenant from exercising its option. It’s called a “spent breach”.

    • That’s pretty interesting. Is that the “law” throughout Canada or just in your Province? Is it universally applied by the courts? We, South of the Border, may have a lot to learn from those on the top.

  3. Amen, Ira!

    What puzzles me: If I am a tenant and am in default, then the landlord usually has damages equal to the economic benefit of its bargain (i.e stated rent minus mitigating rent). So, if I am in default with six months to go, I should be able to exercise my renewal right, regardless. If I chose to extend landlord’s economic damages for another 5 years’ worth by exercising my renewal, why is that a problem? The landlord had 6 months of rent damages before, and now has 66 months. Landlords object saying that this analysis only works if the lease rents are at or above market. Otherwise, a defaulting tenant could tie up the property with below-market rents, they say. Oh, horrors! If the tenant cures the default and pays the extended term rents, isn’t that exactly what the landlord bargained-for in the beginning? How is it harmed? Conversely, if the default is not cured, then, evict the tenant for default and re-let the space for more cash. Again, whether a default is contemplated, exists, is noticed, is cured, is not cured is simply beside the point of whether a tenant should have the right to exercise a renewal that it bargained-for. More likely, the lease language is a back-door tool to make a tenant roll over on defending an aggressive billing of pass-through charges from prior periods. That’s how I’ve had to deal with “the so long as tenant is not in default” trap. Just my $0.02.
    David

    • Thanks for your insight. I think you are putting your finger on the crux of the issue. These kinds of provisions are usable as an in terrorem means to extract a concession. There’s nothing morally wrong about that in our society because we respect “bargaining power.” There is another comment posted describing a compromise solution if a Landlord is stuck on this and the parties want to make a deal. You can allow the exercise subject to a condition subsequent wherein the landlord can send a notice to tenant rejecting the exercise and allowing the tenant to cure the alleged breach. Failing a cure, the exercise would be invalidated, retroactively. Also, in our experience, tenants are more willing to accept a “no monetary default” condition with a right to do a subsequent cure. No thinking tenant would extent the “no default” condition to the eve of a new renewal term.

  4. Ira, an excellent post and touches one of my hot buttons. Re options to extend, I am Ok with the tenant being free from (i) monetary defaults, and (ii) material non-monetary defaults, at the time of the exercise of the option in order to validate the exercise. “Free of default” includes a situation where there may be a failure of performance outstanding but whose cure period had not yet expired. Then the tenant must get himself out of that purgatory status within the cure period or its option exercise becomes retroactively invalid. However, once the option is validly exercised, then the tenant has committed to the additional term. When time for the onset of the option period arrives, if the tenant is in full default (cure period has expired with no cure), then still the option cannot simply drop off like a dead limb from a tree without the landlord doing something. The landlord must take affirmative action to evict the tenant and terminate any remaining (i.e. extended) term just as in any other situation. With respect to SNDA’s, I don’t think the tenant is disqualified pre-foreclosure from getting an SNDA after a cure period has expired without the landlord doing something to evict, as the lender has no direct lease relationship with the tenant yet. The problem may be fixed later and before (or during) foreclosure. At foreclosure time, practically all SNDA’s provide that they are invalidated if the tenant is in default beyond the cure period at that time. The lender will still have to pursue ejectment remedies even if there is no longer a lease with the tenant upon foreclosure. Seems little difference from the option question with the landlord above. So as King Solomon did with respect to the natural mother, I rule for the tenant in the cause of “right” and political incorrectness. I don’t think contra provisions would have been factored into the rent nor do I think that the tenant’s lust for a location should outweigh its vigorous pursuit of a fair nondisturbance agreement.

  5. Sandy Cameron says:

    I totally agree with you, but have had a hard time convincing landlord’s of same. I had one instance recently where the tenant’s right to receive the $500,000.00 tenant improvement allowance after completion of construction was contingent upon tenant’s not being in default. I had trouble convincing the landlord of the absurdity of that position, but was able to get the landlord to modify the language to an extent. My preference would have been to be able to receive the TI allowance minus the amount (or even double) required to cure any default.

  6. I’m not a lawyer but a landlord’s rep. While your thoughts make a good argument some things are missing in my mind. First an option is always asked for by the tenant, not the landlord, so it is beneficial only to the tenant. Second, eviction is not the only recourse to be used (though some tenants will tell the landlord that is their ultimate solution) and removing clauses beneficial to the tenant as a result of a default of the terms agreed to by the tenant is a reasonable outcome. Third, as another person noted, default came come in all forms and certain major defaults should warrant the tenant not receiving the ability to arbitrarily continue the relationship.

    • You make some valid arguments from the landlord’s point of view, and there are others that I’m sure you could add. I’m hoping that you or others will do so because this is a discussion, not Fox vs. MSNBC. So, thanks.

      Yes, renewal options are almost always for a tenant’s benefit, but aren’t those a material part of the “deal”? If a tenant agrees, when making the deal, that a renewal (or other option) is to be conditioned on the absence of a default (or a material default, or a monetary default, etc.), that’s the “deal.” But, when that isn’t expressed in the LOI or term sheet, was it understood that the option was “conditional”? There are arguments either way.

      What some suspect, however, is that it is not the “badness” of the default, but the gap between the renewal rent and the market rent that motivates a landlord to assert the “no default” condition.

      Now, a question for readers – suppose the effectiveness of a renewal is conditioned on the absence of a default at both the time of exercise and at the time the renewal term would start and the tenant exercises the option when it was default-free, but then changes its mind. Can it just hold back the rent and thereby lose the option, leaving its landlord with an empty space and no prospective replacement tenant?

      • Interesting discussion! I am usually on the landlord’s side of the issue. One way to deal with the “intentional default to get out of a renewal” situation is to provide that voiding of the renewal is at landlord’s option, similar to the way other remedies for default are usually treated. Extending this line of reasoning, maybe voiding of the renewal should be listed as one of the possible consequences of an Event of Default in the remedies section.

        Ira’s argument makes more sense in the current leasing market. When replacement tenants are few and far between, it may make more economic sense for the landlord to have the defaulting tenant on the hook for the renewal term.

        • In true Socratic fashion, I now extend the hypothetical: In addition, the Event of Default is defined as failure to make a payment of Base Rent or Additional Rent within 10 days after Landlord sends Tenant notice that such payment is due and unpaid. And, the Lanlord decides not to send the notice.

  7. Ira, your last question is interesting. Under your facts the landlord would have placed itself at quite a disadvantage if the option automatically drops off at the end off the original term. Nor do I think the landlord should have the choice of (i) letting the option drop off , or (ii) treating the option as in effect. In the case of (i), there would be no damages or holdover rent unless the tenant remained in possession – all within the tenant’s control. And landlord now has an empty space to deal with. If he is required to to honor the option, then he has a more substantial rental claim as David suggests. Under your possible facts, and since we don’t know what the tenant will do after the option is exercised, the landlord would be better off in treating the option as still in effect and then evict and pursue rent and other damages.

  8. Of coure the unfairness if unexercised rights to cure exist are apparent, or if the default is non-monetary, and the point is well-taken that these provisions are far too broad. But the landlord should not have to allow a tenant truly in default in payment of rent ot renew so the landlord can have the thrill of eviction! I like the idea of limiting the restriction perhaps to monetary defaults, or maybe if the tenant has been late in paying rent for more than a specified number of months.

  9. Paula McDermott says:

    I am not an attorney, so forgive me for speaking plainly. A tenant’s option to extend benefits the tenant, not the landlord. It allows the tenant the right to tie up the space, so that the landlord is unable to make plans for the space until the tenant decides whether or not to extend. The property may be in need of an overhaul, including the tenant mix; or the market may have changed so greatly that the landlord would be able to get considerably more rent than the lease’s option rent. Under those (and other) conditions, the landlord might prefer that the tenant would not be able to extend the lease term. Requiring the tenant to be free of default gives the landlord a little bit more control of the space.

  10. Ira:
    To me it is a mere matter of leverage. The landlord wants every opportunity to gain leverage and power and the “free from default” language in an option is just another way of getting some leverage, particular as it relates to a provision that rarely provides any benefit to the landlord. If I were a landlord, I really wouldn’t even want to give an option and when I do, I would want to put as much language in the provision to make it as valueless to the tenant as possible.. In a way, I would be saying, “If I am going to give this option to you, then you better tow the line and make me not regret giving it to you in the first place.”

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