Guest Column: Renewal Options in Commercial Real Estate Leases

By Louis Pashman

An option in a contract is considered to be a “time of the essence” provision. Thus, the parameters for exercise of the option must be strictly met. Because the property owner cannot unilaterally withdraw the offer contained in the option, courts will require the holder to adhere strictly to its terms. As is often the case, however, courts have carved out exceptions based on fairness or equitable principles.

Every party to a contract is bound by an implied duty of good faith and fair dealing. A prime example of that involved a tenant who had an option to purchase a 99-year lease on the property he was leasing. The tenant notified the property owner 19 months before the deadline that he intended to exercise the option. The owner responded that he had forwarded the letter to his attorney and would hear in a couple of weeks. Much time passed with no substantive action by the owner, notwithstanding the tenant’s repeated efforts to get a response. Two years after the tenant first notified the owner of his intention to exercise, and after the deadline to exercise had passed, the owner notified the tenant that he had not properly exercised. The court held that the owner had violated his duty of good faith and fair dealing and granted the tenant specific performance of the option.

Another general area where courts have carved out an exception is if the property owner has taken steps that effectively repudiate his obligations under the option. Under those circumstances, a tenant does not have to do a “vain or useless thing” in order to be refused, which would otherwise be required.

In another case, 39 days after the deadline for exercise, the tenant had not notified the landlord. The landlord wrote to the tenant informing him that he had to vacate because the landlord was planning to expand into the tenant’s space. Within a day or two of receiving that notice, the tenant wrote to the landlord notifying him that he intended to exercise the option. The tenant had been there for 10 years and argued that it would be unjust and inequitable to forfeit his lease. The court agreed. Finding that the tenant would suffer substantial harm if forced to relocate and that the landlord had not changed his position based on the non-exercise of the option, the court held that this “special circumstance” justified renewal of the option.

A decade later, another court reached the same conclusion in a case where the tenant had exercised the option prematurely, which was not in strict accordance with its terms.

In addition to requiring good faith and fair dealing on the part of a property owner, we know from these cases that a technically non-compliant exercise of the option will not be considered forfeiture when:

• Substantial harm would result to the tenant if forced to relocate;
• The landlord did not change his position based on the delay;
• The failure by the tenant to give notice was based on an “honest mistake of fact”;
• The delay was “slight”;
• The loss to the landlord, if any, was “insignificant.”

Clearly, courts will not allow landlords to use “tactics” to avoid the option. A landlord can, however, diminish the equitable argument a tenant might otherwise have if he reminds the tenant in advance of the approaching deadline or if he sends no notice and takes significant action in reliance on his belief that he has no tenant. For these reasons, tenants should be sure to comply completely with all requirements of the option and should not rely on exceptions to the general rule.

Louis Pashman is the co-founder of Pashman Stein P.C., a business law firm located in Hackensack, N.J. He has extensive experience in many law disciplines including commercial transactions, corporate law, and estate planning, among others. He can be reached at [email protected].