Daily Development for Thursday, September 29, 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

LANDLORD/TENANT; EXTENSIONS AND RENEWAL; EXERCISE; LATE EXERCISE: Maryland continues to demand exact compliance with time requirements for exercise of lease extension option, even if form requirements might slip.

Chesapeake Bank of Maryland v. Monroe Muffler/Brake, Inc., 891 A. 2d 384 (Md. App. 2006), cert. denied 898 A.2d 1005

The lease provided that tenant had both options to extend its lease and an options to purchase. The option to purchase provided that, in the event that tenant exercised its option to purchase, possession under the lease would be extended until “settlement” at a pro rate lease rate.  The option to renew required that tenant send notice of exercise of the extension option 90 days prior to the end of the original term “or the then current extension.”  The option to purchase had no specific time requirement for exercise

Near the end of the first 20 year term, Monroe acquired the tenant, and sent the landlord a nice letter to the effect that “[w]e welcome a long and prosperous relationship with you.”  A few months later, Monroe  sent notice exercising its option to extend for an additional five year term.  It send the notice 27 days late.  Ooops!!

Landlord responded that it would not extend the lease due to the late notice.  There was no showing that the landlord did this because it had leased to another tenant.  It just didn’t want to extend the lease on the option terms, so far as we know.  Tenant then gave notice that it intended to exercise its option to acquire the premises, and the parties entered into negotiations concerning the purchase option.  Appraisals were made.  But Monroe discovered that it would have had to acquire an adjacent lot as well in order to satisfy county zoning regulations.  Apparently the resolution of the discussions of the option to purchase did not occur until more than ninety days after the original option to extend was sent.  (You can see where this is going.)

Monroe refused to vacate, and the issue of the validity of the renewal option went to trial.  The trial court found for Monroe on two bases: (1) The informal letter from Monroe discussing the “long and prosperous” future relationship amounted to an exercise of the extension option.  (2) In any event, principles of equity ought to control, since loss of the valuable option was a forfeiture harmful to Monroe and granting the option, in light of the relatively short delay in notice, did not unduly injure the landlord.

On appeal: Held: Reversed.

The intermediate appeals court rules that the informal “exercise” claimed by the tenant was not in fact an exercise of the option at all, as it did not unequivocally commit the tenant to extend the lease.  Of course, the tenant would have been arguing the same thing if the shoe had been on the other foot, and it would have been right.  So enough of that.

The more interesting discussion has to do with the second basis relied upon by the trial court and a third argument made by Monroe, foreshadowed above.

Many courts, in fact, do permit equity to intervene to forgive a tenant for a late exercise of an extension option.  Perhaps the leading proponent of this view is New York.  A recent New York case, also involving an acquisition of tenant’s business shortly before lease renewal time,  proclaimed the established rule that the court will set aside the effect of tenant’s late renewal where: (a) the tenant’s failure or delay was the result of inadvertance or an honest mistake, (b) the nonrenewal would result in a substantial loss to the tenant , and ( c) the landlord would not be prejudiced by the delay in notice. That case cited a long chain of New York cases supporting this view, and in fact permitted the tenant’s testimony that its failure to renew timely as “inadvertant” to stand because the landlord had no way to controvert it.  Popyork, LLC, v. 80 Court St. Copr., 806 NYS 2d 606 (App. Div. 2nd Dept. 2005)

Maryland doesn’t see things the same way as New York.  The Chesapeake case noted that the option was nothing more than a contract right subject to a condition.  The court said that case in Maryland setting aside lease forfeitures even though rent was paid slightly later than required are inapposite.  There, a real estate interest had been created, and equity will protect it from unfair forfeiture.  Here, there is no real estate right to the extended term unless and until the condition precedent is satisfied - timely notice.

Interestingly, the Chesapeake court went on to distinguish, earlier Maryland high court authority that had permitted an extension option to take effect where the option notice was timely, but did not meet various technical requirements set forth in the lease.  In the prior case, the tenant had not included a statement of net worth, as the lease required, and sent the letter on the wrong stationery, thus suggesting that it was not a valid corporate act of the tenant.  The court had concluded that the notice of intent to renew was unequivocally communicated and that the requirement for a statement of net worth was “merely a covenant,” not a condition..

The court then turned to Monroe’s final, creative, argument that the notice in fact was timely because it had been provided more than 90 days before the actual end of the term, extended, as it had been, by negotiations over the purchase option.  There appeared to be no argument that Monroe’s attempt to exercise the option was a pure sham.  Nevertheless, the court concluded that the intent of the drafters necessarily was that the notice be sent before the end of the original term.  The language providing that notice had to be ninety days before the end of the term “or the then current extension” dealt necessarily only with the three five year extension periods that were part of the lease.

Comment 1: Friedman on Leases, Randolph Edition deals with this issue comprehensively, albeit in a somewhat disorganized fashion, in Section 14.2, at note 190 et seq.  There clearly is a split in the case law, but there are so many special fact variations that it is difficult to generalize.  Prior to this case, it would have been difficult to categorize Maryland, in light of the prior authority crediting equitable considerations for nonconforming but timely notices of exercise of an extension option, but not for late exercises.  (The editor is citing Friedman a lot because he is about to go to press with the latest supplement.)

Comment 2: In fact, the editor likes the hardball rule here.  It is often an easy matter for the tenant to invent some equitable case to support setting aside a late renewal.  So any time there is a late exercise, one can expect a dispute, especially when there is money at stake.  All this does is cost both parties a lot of money litigating the issue.  They both have an incentive to do so, since either side has a “fighting chance” to win on the equities, since the rule isn’t clear.  A clearer rule brings discipline to the negotiations and in the long run provides the commercial certainty that benefits everyone, even the careless tenant in the particular case (albeit more remotely and less visibly.)

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