[DIRT] DD 10/12/06 Dueling Lease Options

Daily Development for Thursday, October 12, 2006
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

OPTIONS; PRIORITY: Where a lessee has a purchase option in property subject to a prior lease, that also contains a purchase option, the second purchase option loses its rights when the first purchase option is exercised. 

Startex v. Aelina Enterprises, 2006 Westlaw 952390 (Ark. App.  4/14/06)

Startex was the successor in interest to a lessee’s interest in a gas station on a lot that also contained a convenience store.  The Startex lease contained a right of first refusal that gave the tenant a seven day right to respond to any offer.  The right also provided that if the tenant did not exercise its option, its right of first refusal remained intact and any sale would be subject to the lease.

In fact, the landlord’s interest transferred several times, and the tenants under the gas station lease did not exercise the right of first refusal.  Then the landlord leased the convenience store property to Aelina, giving Aelina a purchase option in the same property covered in the gas station right of refusal.  Then the tenant assigned to Startex.

Aelina entered into a purchase agreement with the landlord to acquire the property for less than the option price, and landlord tendered this contract to Startex.  Startex elected to purchase the property.  Then Aelina notified Startex that it was exercising the option contained in its lease to purchase the property from Startex.  Startex refused to sell, and this lawsuit ensued.

Indicating that the dispute here was a matter of first impression, the court of appeals found that Startex exercise of its purchase option (right of refusal) was prior, and terminated the Aelina purchase option.  The court didn’t say whether the Startex purchase also terminated the Aelina lease.  It quoted Friedman on Leases (Third Edition)  to the effect that a “lease and option can be cut off by a paramount interest . . . Accordingly, the tenant cannot rely on the option for any serious purpose unless he satisfies himself with the condition of the landlord’s title before entering the lease and then records a memorandum of  the lease with the option included.” 

Comment Although this is not quite a case of first impression it certainly is a rare case, and prior courts have addressed the overall situation differently.  If the court had an up to date Friedman on Leases (Randolph - 5th - Edition), it would have found, at Section 15.5.1, notes 221 and 222, that cases in other jurisdictions have dealt differently with the situation of competing leases where one of the lessees exercises its lease option.  In Durfee House Furnishing Co. V. Great Atl. & Pac. Tea Co., 136 A.2d 379 (1927), a tenant exercising a lease option was held to take subject to a lease granted subsequent to the tenant’s lease, on the notion that no contract came into effect until the option was exercised.  The editor disagrees with this analysis, and prefers that used in this case and in Cwiakala v Guinta, 92 A. 2d 849 (N.J. App. 1952), where the exercise of the option permitted the optionee to avoid a lease entered into subsequent to the lease containing the optionee’s righ

t.  The option was deemed to relate back to the date of the lease.

As that section also indicates, there is some confusion arising from the fact that many states do not regard an option as a real estate interest, leaving a situation where the optionee may be bound by the existing lease on the proprty, albeit junior to his option, but may have a damages claim against the optionor.

Comment 2: Of course, proper notice is always essential to the first optionor’s rights.  Here, it appears that the parties did have notice of one another.

Comment 3: Note also that there is no mention in the instant case about the survival of Aelina’s lease, only its option.  But the editor assumes that if one falls, both falls.  But what if the optionee under the first option begins to accept rent from the existing tenant and a lease relationship forms.  Under that circumstance, would the option contained in that lease also be valid?  Hmmm. 

Readers are encouraged to respond to or criticize this posting.

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