Options: Two Wrong Ways To Write It Right

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Weekly, Ruminations looks for a topic. Now, two short of 250 blog postings [who’d a thunk?], finding unique ones is a challenge. Don’t worry, we’ve got a few lined up. But, today, we’re returning to a central theme: the failure to write what you mean. This isn’t theoretical. It that regard, we respectfully disagree with the late, great Judge Benjamin N. Cardozo, in particular when he wrote:

The law has outgrown its primitive stage of formalism when the precise word was the sovereign talisman, and every slip was fatal. It takes a broader view to-day. A promise may be lacking, and yet the whole writing may be “instinct with an obligation,” imperfectly expressed. If that is so, there is a contract. [Wood v. Lucy, Lady Duff-Gordon, 118 N.E. 214 (N.Y. 1917)].

Well, we don’t “exactly” disagree with those words. After all, he was talking about contract formation. In fact, in that regard, he is right. [As if he needed our endorsement.] What makes us uncomfortable is that our colleagues act as if it is OK to ignore precision, and don’t realize that doing so can be fatal. It isn’t a problem about choosing the “precise word.” It is a problem with not thinking through the possible issues before choosing “words that work.” Today, we’ve got a story about a fatal slip and it comes from a Connecticut Supreme Court decision released this past March. It is in the case of Howard-Arnold, Inc. v. T.N.T. Realty, Inc. and can be seen by clicking HERE.

The subject of the parties’ dispute was a purchase option within a lease. It manifested itself in two places, one in the lease’s text and the other in the way the tenant tried to exercise the option. The dispute came before all of Connecticut’s three court tiers and probably paid for nice, new vacation homes for the litigators.

Let’s start with a quiz. Look at the lease’s option provision:

“During the term of the [l]ease of the [p]remises, [the tenant] and/or [g]uarantor shall each have the right to purchase the [p]remises . . . upon the payment of [$223,500] plus the then unpaid balance of the [m]ortgage which [the landlord] may then have on the [p]remises, provided that such balance shall not exceed [$350,000]. . . . Notwithstanding the foregoing, effective on April 14, 2010, [the tenant] and/or [g]uarantor shall each be permitted to purchase the [premises] upon the payment of the sum of [$223,500] to [the landlord].”

So, what must the tenant do in order to exercise the option? Must a notice be sent or can the tenant just show up one morning with a bag of cash? If a notice must be sent, is there a “time” element to the notice? If a notice is required (as contrasted with just being a “good idea”), does it need magic words or must anything be included with the notice?

Only one of those questions was addressed by the three courts that resolved a dispute between the landlord and tenant about whether the tenant properly exercised the option. That had to do with “must anything be included with the notice?” We’re puzzled by how those courts came to their conclusion, but can’t really blame them because the real problem was with how the lease’s provision was written. The courts ruled that the purchase price had to be tendered with the tenant’s notice of exercise. Ruminations doesn’t read the provision that way, perhaps because that’s not the way it works in the real world. But, look at the text again. Is it the option that is exercised “upon the payment” or is it the purchase that is made “upon the payment”?

The way the provision was written certainly gave license to the courts to reach the conclusion that the entire purchase price had to be enclosed with the notice of exercise. But, the two court opinions we read were devoid of any analysis of the parties’ intent. Apparently, the lowest court ruled that the exercise notice was invalid without an enclosed payment. The two appellate courts just parroted the outcome without their own analysis.

Look at the provision again. What if the purchase price wasn’t determinable at the time the tenant wanted to send its notice? We’ll grant that, in this case, after receiving some sort of exercise notice, the landlord sent its mortgage amortization table to the tenant and the tenant, if it knew what the courts would later think, could then have sent the full purchase price. That is, “could have” if it had the money. More about that later.

So, did the parties intend that the tenant pay the full purchase price to its landlord without getting a property deed in return? It seems that troubled the court as well. So, having decided that the payment went with the exercise notice rather than being made at a closing, the courts decided that the payment could have been made into escrow. How or with whom weren’t details covered by the courts, but since, in our view, the courts were running off on their own, why not allow them to add lease provisions without any help from the contracting parties? It makes us wonder.

Now, we really don’t want to beat up the courts. The judges were doing the best they could with the little the warring parties gave them to work with. There is a lesson here. If you “don’t write it right,” then a court is empowered and entitled to “get it wrong.” Courts can only do the best they can. Often said is that it isn’t a court’s job to make a better deal for a party than it made for itself. The corollary isn’t necessarily correct. Perhaps a court is permitted to make a worse deal for a party than it made for itself.

Whatever the judicial principle might be, even if this particular tenant had sent an otherwise effective exercise notice, the failure to include a check made it fatally defective. Yes, the slip was fatal and the coroner attributed the death to “poor drafting.”

So, would the exercise have been effective if the money had been in the envelope? Well, no, it wouldn’t have been. To know why, you’ll need to know more of the story.

Under the lease, the landlord was required to perform certain environmental remediation (having to do with a specific underground storage tank) and to make a particular roof repair (where a building addition met the original building). We’ll explain.

The tank “story” is the simpler of the two. A tank had been removed, leaving what was called a “grave.” That’s the first time we’ve seen that word used in this context, but we guess that the hole into which a tank is buried is its grave. An environmental company took care of the “grave” and after its testing showed lawful levels (or less) of contaminants, it issued a certification that the remediation was complete. When the tenant sought financing to buy the property, a second company did some testing and the results weren’t so happy. According to the second round of testing, more remediation was required. We’ll jump ahead. The court found that the landlord had not satisfied its obligation to remediate the underground tank problem.

The roof story and legal outcome was (to us) is a little peculiar. We’ll start with the lease’s applicable provision wherein the landlord was required to:

“repair the entire roof on the rear section of the [p]remises (i.e. the addition made … during 1969), as necessary, such that the leak will be completely fixed during the term of the [l]ease … [and to] repair the leaning walls and correct the structural deficiencies (i.e. footings, steelbeams, wall, roof … as determined by a licensed engineer selected by [the lessor]) in the rear addition….”

There was no disagreement that the roof leaked in the area where the building addition and the original building were joined. At hard as roofers worked, and as often as they came, the leaks persisted. So, an engineer was called in and opined that expansion joints were needed to bridge the gap between the two parts of the total building.

This lawsuit was a request by the tenant for orders of specific performance to require the landlord to honor the option exercise, remediate the “grave,” and fix the roof and structure.

Surprisingly (to us), the lower court “found that the doctrine of impossibility excused the [landlord’s] performance of those obligations and, accordingly, declined to order specific performance.” Without adding any additional information, the two appellate courts just accepted that conclusion. So, the landlord was excused from its obligation to fix the roof and the tenant was either without remedy or (possibly) could sue for damages, if any.

Now, why are a “grave” and a leaking roof part of this story about a defective purchase option exercise? The answer allows us to drone on about how not to write an agreement or a notice.

Here, in essence, is the gist of the exercise notice sent by the tenant’s attorney to the landlord’s attorney. It said the tenant:

“[had] elected to exercise [the] option to purchase the premises” and requested that the landlord provide to it “a written copy of [the] outstanding balance on [the] mortgage.” The letter further explained that “before [the tenant and its guarantor] can close, two issues must be resolved by [the landlord], namely [the landlord’s] failure to satisfy [its] obligations under [article nine of the lease covering the “grave” and the roof].” The letter concluded by making the following request: “Please speak with your client to determine when [it] will fulfill [its] obligations as called for by the lease so we can prepare to close the transaction.”

Note, that the courts all accepted this as the “exercise notice,” defective as they also eventually ruled. That it was sent by the tenant’s attorney to the landlord’s attorney, and not from the tenant to the landlord, wasn’t a defect. It seems that the court “read” the lease’s provision governing the purchase option to require a notice that included payment of the purchase price (that could be put in some kind of unspecified escrow account with some unknown escrow agent), and also found in it “invisible” guidelines for sending such a notice. Well, the tenant had it coming: it negotiated and signed the lease.

Setting the exercise mechanics aside, we’ll look at the substance. Basically, Connecticut law mirrors the general law:

“An option is a continuing offer to sell, irrevocable until the expiration of the time period fixed by agreement of the parties, which creates in the option holder the power to form a binding contract by accepting the offer…. To be effective, an acceptance of an offer under an option contract must be unequivocal, unconditional, and in exact accord with the terms of the option…. If an option contract provides for payment of all or a portion of the purchase price in order to exercise the option, the optionee … must not only accept the offer but pay or tender the agreed amount within the prescribed time.”

Well, readers, what think you? Was the purported exercise, “unequivocal, unconditional, and in exact accord with the terms of the option”? For reasons that should be obvious by now, we don’t know how to respond when it comes to the “in exact accord with the terms of the option” part of the test. But, it certainly wasn’t unequivocal. And, that made it defective. We’ve Ruminated on this before. If you are curious about that, click HERE.

We understand the problem. The tenant needed to borrow the money and couldn’t get a loan with the polluted filled-in grave and the landlord’s response to the exercise notice was to deliver the mortgage information but deny that it was in violation of its environmental remediation obligation. It didn’t matter that the courts agreed with the tenant that the landlord had failed to properly remediate the old “grave” and, in fact, ordered specific performance. That’s because this failure on the landlord’s part was unrelated to the purchase option exercise. The landlord wasn’t obligated to deliver a remediated, leak-free property at closing.

That’s true for two reasons. First, the lease didn’t make one dependent on the other. The second reason goes back to how the purchase option was written. Note that it could have been exercised on the day after the lease was signed, at a time when no one could have expected the remediation to have been completed or the roof fixed. In fact, the hole in the ground was backfilled about a year after the lease was signed. So, as the courts saw it, the tenant could exercise the option whenever it wanted, whether the remediation was complete or not. If the tenant didn’t want to inherit the tank problem, it could have waited. This was a 2000 lease and the tenant had at least 10 years to try to get its landlord to get the work done. The tenant knew, in 2001, that the “grave” was still contaminated. It should have, and could have, acted then.

There is a little mystery here, something the courts’ rulings don’t illuminate. The attempted exercise was in 2007, with at least three years to go in the lease’s term. Had the tenant obtained the order of specific performance for remediation then, it might have been able to get financing while the purchase option was still available to it. We’re not going to criticize whatever counseling the tenant got or didn’t get, we weren’t there. We’re just going to wonder.

Now, a little color commentary in the form of another part of the story: we don’t think the landlord and tenant sat down together with a stationery store lease in hand, adding these specific provisions. They had been partners in a restaurant supply business and owned the building used by that business. After a falling out, they settled their differences with one (the tenant) keeping the business, and the other (the landlord) keeping the building. They clearly had help in “writing that up.” As we see it, that help fell a little short. Was the lease written by excellent litigators? What agreement crafting principle was overlooked?

Before anyone writes anything, she or he need to think. Yes, thinking should precede writing. Nothing about our story should come as a surprise to readers. No crystal ball was needed to see that if the roof wasn’t fixed or the tank removal properly completed, the value of the property would be diminished. It should have come as no surprise that financing would be a problem if the property remained contaminated. If one just thought about that, the lease would have covered those issues.

Now, judging from how the purchase option was described, we grant that the roof and tank removal issues might not have been handled with precision or clarity, but had those who negotiated the lease given some clue as to what they had in mind, a court would have had some guidance.

The other aspect of “thinking” involves reviewing what has been written. Walk through the text and ask, “does this work; what else or what different language might be needed”? Option provisions (and others as well) need to be like recipes or formulas. They need to lay out the ingredients and the steps that follow. The parties need “rules” for getting the work done – step by step.

On the other hand, we want to thank those actors who brought us this story. It allowed us to write our 249th blog posting.

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