What does an owner-landlord do when a tenant has a $300,000 purchase option for a property worth more than 20 million dollars? That question could be the end of today’s posting if we treated that as a rhetorical question. Other bloggers might do that, but not the erstwhile Ruminator.
When the spread is over 20 million dollars, legal costs mean little. For students of the “expected value” approach, the breakeven point for a 1% chance of picking up those millions is $200,000. If you think there is a 5% chance, then spending a million dollars is fair value for such a lottery ticket. Hence, a case decided about a week ago by the United States Court of Appeals for the Ninth Circuit makes sense to us economically, but doesn’t help us with our abiding belief that a deal should be a deal.
The parties are the Postal Service as the tenant and, after what appears to be at least 7 transfers, descendants of the family that bought the lease from the original developer-landlord, as the landlord. The lease had a 20 year term followed by one 10-year extension option and then by four 5-year options. For the math challenged, that’s 50 years. Critically, the Postal Service had a purchase option available at the end of each of the term segments. More critically, as time went on, the option price went down, ultimately to $300,000 at the end of the 50 years.
The Postal Service sent timely extension notices each time an option period approached, some quite early. The lease continued for 50 years with the Postal Service paying its rent and each of the landlords along the way cashing the check (figuratively) and loving the money. [Well, we’re not sure about the loving part, but it clearly appears that no rent was ever refused or returned.]
About five years before the end of the 50- year lease term, and well ahead of the last allowable day to do so, the Postal Service exercised its purchase option. Just before the one-year notice deadline it even sent a reminder of its option exercise of four years earlier.
To sum up, the Postal Service had been in possession of the leased space for 49 years inclusive of the initial term and five renewal terms. It gave notice, way ahead of time, of its exercise of the purchase option. What was the landlord’s response? This one may not be hard to guess. It rejected the purchase option renewal asserting that none of the Postal Service’s five renewal term exercise notices had been properly given. By extension, if not properly given, then the lease was not in effect when, four years before the landlord’s rejection letter was sent, the Postal Service tried to buy a 20 million dollar property for $300,000.
To gild refined gold, to paint the lily [credit Shakespeare in King John], the landlord also claimed that the extension option notices sent in 1983 and in 1992, 30 and 20 years earlier, were signed by Postal Service employees who lacked authority to bind the Postal Service. We won’t address those alleged grounds for rejection except to pull some words out of the court’s decision (which, in turn, came from a different court’s decision in an unrelated case): “[The landlord had to] do more than simply show that there is some metaphysical doubt as to the material facts. … [It can’t simply speculate that the signing officers] might not have had the requisite authority [by noting] that unauthorized transactions by federal authorities do exist.”
So, on what slender thread did the landlord argue [we assume, with a straight face] that the five extension options had never been properly exercised? Well, that’s a story by itself, one that we are going to try to navigate more simply than did the court.
This was a 1963 lease from the property’s developer. In 1964, the property was sold to two married couples as four tenants in common. Curiously, after that transfer took place, the developer gave an assignment of rents to an insurance company, one that was in the mortgage lending business. More curiously, the insurance company then made two of the four owners, the husbands, its “attorney in fact” to collect the rents. So, at this point, the Postal Service began to pay rent to those two individuals.
Then, in 1968, the four individual owners (constituting the two married couples) amended the lease with the Postal Service. That amendment redefined the “landlord” as couple one and couple two.
In 1978, couple one transferred their half ownership interest to four separate trusts (for four grandchildren). If your head is spinning, here is where the ownership stood at that point in 1978. There were six owners: husband of couple two, 25%; wife of couple two, 25%; and four grandchild trusts each owning 12-1/2%.
In 1982, three months ahead of the one year extension notice deadline for the first option period, the Postal Service sent a lease extension notice. It went to the same two individuals who remained authorized to collect the rent and who, in fact, had been collecting the rent – the husband of couple one and the husband of couple two, both still the attorneys in fact. The notice requested a response as to any changes in address or ownership. The notice was actually received, no response was sent in return, no notice was ever sent that there were now six owners, and the parties proceeded as if everything was hunky dory [origin: unknown].
In 1989, the trusts were terminated and each grandchild took direct ownership of her or his 12-1/2% interest in the property. No notice of that ownership change was ever sent to the Postal Service.
Ahead of the deadline for exercising the second extension option, the Postal Service sent an extension notice. It was addressed to the actual six owners. There is no clue how the Postal Service came to know their identities, but it did. Only one copy of the notice was sent, that going to the husband of couple two, an owner of a 25% interest in the property. It was actually received. As with the previous extension, no objection was raised and the owner-landlords and the Postal Service proceeded as if everything was in order – the Postal Service paid the rent and the six owners kept the money.
At the beginning of 1993, the four grandchildren transferred their interests to couple two. As a result, the property was now 50% owned by the husband of couple two and 50% by his wife. As with each of the earlier transfers, no notice of the ownership change was sent to the Postal Service.
Near the end of that same year, the husband died and his estate, controlled by his wife, succeeded to his 50% interest.
When the third extension term approached, the Postal Service again exercised its option. Its notice was addressed to the estate, the wife, and to the four grandchildren (even though those four were no longer owners). A single copy the notice was sent to the wife’s address and she signed for its receipt. As before, the lease continued to be treated as if all was in order.
In 1999, the husband’s estates interest was transferred to a trust for his surviving wife’s benefit. She was the trustee of that trust, so she now controlled the entire property interest, 50% by reason of her direct ownership and the other 50% as trustee of the trust. Seemingly, the Postal Service was not notified of this change.
In 2001, notice of the Postal Service’s exercise of its fourth lease option was timely sent, this time to the wife as personal representative of her late husband’s estate (but not in her individual capacity) and to the four former owners, the grandchildren. It was mailed to the wife’s address and her daughter-in-law signed the delivery receipt.
In 2005, the Postal Service exercised its final option, with a timely notice addressed in the same way as was the notice for the fourth lease extension.
Now, here’s the reason why Ruminations selected this fact-laden court decision for this week’s blog posting. Almost every reader, if not every reader, already has figured out who won, landlord or tenant. There will be no cliff hanger here. We wanted to touch on an aspect of “notices” that keeps coming up. Whenever someone wants to reject a notice as being invalid, such as when a 20 million dollar property would be sold for less than 7% of its value, it argues, “read the law, enforce every word in the most literal sense.”
Again, we will drag out a fundamental concept of contract interpretation, one that losing parties continue to challenge. It can be stated in many different ways. Today, we’ll use words chosen by this particular Ninth Federal Circuit panel: “A written contract must be read as a whole and every part interpreted with reference to the whole, with preference given to reasonable interpretations.” So, even though an option must be exercised “strictly in accordance with its terms,” common sense will override strained rigidity. The court said this much better. We kind of like this formulation. In fact, Ruminations is a bit envious of its wordcrafting. What it wrote was that even though the Postal Service must be held to the exact terms of the lease (and has no special advantage as a federal entity), “[T]his standard of exactitude [i.e., strict compliance when it comes to exercising an option] is calibrated to what the contract actually requires, not an indefinite standard of scrupulous paperwork or best practices.” [The bracketed words are ours, not the court’s.] Said differently, “[A]n option, like any contract, is circumscribed by its terms.”
The lease required that notice be given in writing to the landlord. The landlord (at the time the purchase option was sent) argued that the notice sent almost 30 years earlier to the two husbands as “attorneys in fact” was not to the actual landlords (the two couples and the four grandchildren trusts). It also contended that the notices that were sent to only one of the multiple owners but should have been sent to each of the six owners. It argued that naming the grandchildren in notices sent after they were no longer owner served to invalidate those notices. Lastly, it asserted that naming the surviving wife in her capacity as executor and not also in her direct ownership capacity was a fatal flaw. You get the gist of its approach.
In sum, the landlord asserted that “each and every one of the ‘attempted’ exercises of an option to extend the term of the lease was fatal to the continuing viability of the lease, because none of those notices were “given in writing to the Lessor.”
So, even though we haven’t told you so, you already know that the court rejected each of these arguments and upheld the purchase option’s validity. What we will do is to tell you why it did. First, though this might come as surprise to some, according to this court, because the terms of the options did not require multiple notices to be specifically delivered to each and every landlord, one notice to all was adequate.
It held that a reasonable interpretation of the word “given” did not “require the degree of punctiliousness” the landlord insisted was required. All that “to give” called for was “to put into the possession of another for his use” or “to convey by physical action.” In every instance, the Postal Service “‘gave’ written notice via certified mail of its intention to exercise its option to at least one person who was a Lessor at the time of the renewal.” There was no evidence put forth by the landlord that the notice had not been put into the possession of all of the separate landlords.
An independent reason to reject the landlord’s arguments was an obvious one – everyone treated the lease as valid for the entire thirty years after the first ease extension notice had been sent. In fact, in 1987 when the Postal Service asked the then-landlord for consent to have the building repainted, the landlord’s refusal suggested that if the Postal Service was unhappy with the rejection, it could terminate the lease, implying that the lease was in effect. Those same owners twice offered to pay the Postal Service one million dollars to strike the purchase option from the “lease.” Those “facts” allow Ruminations to drag out another principal, again from words cited by the court: “[T]he practical interpretation of a contract, as shown by the parties, is of great weight in interpreting the contract.”
What a strange set of facts. Not really! Some variation of them comes up quite often. Landlords or tenants move and don’t advise the other of the new address for notices. It is not unoften that a landlord will notify its tenant that the rent should be sent to a new address and not say that notices should go there (or elsewhere) as well. So, what happens when one or the other wants to send a notice? Perhaps the notice goes to where the sender actually knows the other will be found. Perhaps it is sent only to the last “official” address for notices even if that one was written into a lease 30 years, and three moves, earlier. Wisely, it is sent everywhere.
In most cases (we speculate) the notices actually wind up in the right hands. Though not sent strictly in accordance with the lease, actual notice has been accomplished. When the stakes are high, a relative term and not always a 20 million dollar property for less than 7% of its value, the parties battle it out. We think actual receipt win out every time, but are also sure that there are aberrational exceptions to what we think. The tougher battles are when the notice is sent only to the “official” one in the lease even though the sender knows that address to be stale and maybe even gets it back as “undeliverable.” For that reason, notices, certainly critical ones, should be sent “everywhere.” Ruminations has another thought, one never seen in practice. Perhaps, at least when it comes to a landlord’s address for the purpose of sending notices, the lease should require that notices also be sent to the address to which rent is sent (when there is such an address) if that address differs from the “official” notice address in the lease.
Another lesson from this purchase option dispute is one that probably doesn’t need to be presented. A lease should have a notice provision in the first place, one that defines “official” notice. Seemingly, the Postal Service’s did not. Had it contained such a provision, then there could be no viable argument that notice had to go to each individual owner. The lease’s provision would have given the address or addresses that, if used, would constitute proper (and complete) notice.
So, what do you think the odds for success on the landlord’s part were? If 1%, then the breakeven cost to pursue this case was $200,000. Perhaps taking it thorough discovery, a trial in the United States District Court, and an appeal to the Circuit Court came in below that. If you think it was 5%, then a million dollars would have been a good investment. So, even if you concluded, early on, that the landlord’s case was a loser, was $200,000 well spent? $400,000? $1,000,000?
For those who want to read the court’s own words, that can be done by clicking: HERE.