Daily Development for Thursday, August 19, 2004
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu

LANDLORD/TENANT; EXTENSIONS AND RENEWALS; RULE AGAINST PERPETUITIES: Symphony Space distinguished; extension options that remain valid unless landlord provides notice of pending expiration do not violate the Rule Against Perpetuities where terms of lease provide that lease continues until option expires or is exercised.

Deer Cross v. Stop & Shop Supermarket, 773 N.Y.S.2d 211 (Sup. 2003).

Almost ten years ago, New York real estate lawyers were stunned when the Court of Appeals decided, in Symphony Space, Inc. v. Pergola Properties, Inc., 646 N.Y.S.2d 641 (Ct. App. 1996) (the DIRT DD for 3/28/97), that a purchase option that was a critical piece of a carefully structured financing arrangement was void because of the Rule Against Perpetuities. The decision left a property worth tens of millions of dollars in the hands of a nonprofit, even though the plan was that the party paying off the financing package could acquire the property for an option price of about $10,000.

The New York Court of Appeals identified a critical defect in the scheme - a “free floating option” feature that protected the optionee against inadvertant failure to exercise the option by requiring that the optionor give notice of pending expiration to the optionee before the option could be deemed expired. As a consequence, even though the parties fully expected that the whole financing would work out within the period of an underlying lease, the option potentially could not expire within the term of the lease and potentially might later be exercised beyond the measuring period of the rule. This potential, of course, rendered the option void from the outset under the traditional Rule Against Perpetuities recognized in New York.

The editor isn’t aware of whether this method of drafting options is still in favor, but he saw a number of versions of it during the years prior to the Symphony Space decision, and at least once saw it used in a way the violated the Rule in a financing of over $100 million. (The option was exercised in the editor’s deal without the parties ever raising the Rule - whew!!) The instant case involved a 1974 lease of a grocery store for a twenty five year term with three ten year options to extend. Although the case involved options to extend, rather than options to purchase, the court noted that New York authority applies the Rule to all kinds of options that might vest an interest at time outside the measuring period of the Rule, and the vesting of a leasehold interest is an interest covered by the Rule.

But although the creation of a new leasehold interest is subject to the Rule, the Rule does not apply to estates that are presently effected at the time of grant. So any interest that is in fact part of a continuing lease, even if the lease lasts (including with contractual extensions) beyond the period, is not affected by the Rule, even if that interest is subject to a contingency that might be satisfied outside what would otherwise be the measuring period. The measuring period never starts to run in this case, since the contingent interest is “sheltered” by the existing lease.

The parties in the instant case had used a “free floating option” device to protect the tenant from loss of the extension option. (The court refers to the options indiscriminately as “extension options” and “renewal options” - not unusual these days.) The lease provided that if the landlord failed to provide a timely notice that the tenant had failed to exercise one of the options, then the term of the lease was extended past the “expiration date” of the lease to a date which was 60 days after the date that such notice was eventually given. Looks bad, heh?

The court noted, however, that the term “expiration date” as used in this section did not, in the context of the lease, mean the time that the rights of the tenant actually expired, but simply the end of the original twenty five year term. It concluded, rather, that the tenant’s lease right in fact continued in effect until such time as the lease was either extended under the option or the option terminated. This reading permitted the lease to “shelter” the option. The lease remained in effect until the option was exercised or rejected by the tenant, and therefore never became subject to the measuring period under the Rule.

Nice try, landlord, but the ancient doctrines don’t help you here.

Comment: The court apparently assumes (perhaps because the option language so stated) that the option could not be exercised after the tenant’s lease had terminated, such as if the tenant had defaulted or the lease was terminated for some other reason. This is understandable in the case of a lease extension option. How could one “extend,” or for that matter “renew” a lease that was no longer in existence? It wouldn't be impossible to have the option to extend become an option for a new lease, and thus to trigger concerns about the Rule, but it seems an unlikely scenario. With options to purchase, however, this may not be so unusual. Sometimes these “free floating options” are deemed exercisable even after the lease containing them terminates, since the idea is to protect a significant up front investment by the optionee.

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