Federal Court: Lease Options Are To Be Strictly Exercised
Written by: Alan Nochumson
Most commercial tenants who invest, at their cost, significant sums of money in improving their leased premises often insist on including options for them to extend the lease agreement beyond the initial lease term. What most of these tenants fail to realize is that such an option must be properly exercised in strict accordance with the terms of the lease agreement, and, if they fail to do so, they risk forever losing their right to so extend the lease agreement.
In Warminster Equities LLC v. Warminster Commerce, the U.S. District Court for the Eastern District of Pennsylvania taught such a devastating lesson to a commercial tenant that failed to properly exercise their option to extend, for all intents and purposes, a 97-year lease agreement.
According to the opinion, the tenant in Warminster Equities LLC took over the lease agreement, which had an initial term of 27 years and seven consecutive 10-year options. Under the lease agreement, the tenant could exercise an option by providing the landlord with written notice, via first class mail, of such election to exercise the option no later than 12 months prior to the expiration of the basic term or the then-current extended term.
Prior to the expiration of the initial term, the tenant’s predecessor-in-interest properly exercised the first 10-year option. After that happened, the tenant was assigned the leasehold. The tenant financed the purchase of the lease agreement with a loan and subleased the leased premises.
Prior to the expiration of the first lease option, the landlord informed the tenant that it had not received written notice of the tenant’s intent to extend the lease agreement for the second 10-year term in accordance with the terms of the lease agreement and that the leasehold would, therefore, expire upon its own terms, the opinion said.
The tenant then claimed it informed the landlord of its intent to renew prior to the option deadline set forth in the lease agreement, but the landlord maintained its position that the lease agreement had been terminated, the opinion said. According to the opinion, the landlord sent a letter to the bank that financed the tenant’s purchase of the lease agreement, explaining that, since the tenant would no longer have an interest in the leased premises upon the expiration of the first option term, the mortgage between the bank and the tenant would expire on that date, and that the bank should satisfy the mortgage immediately after the expiration of the lease agreement.
That same day, the landlord also informed the subtenant that the lease agreement was expiring and that thereafter it should send all rental payments directly to the landlord, the opinion said.
The tenant eventually filed a complaint in federal court seeking, among other things, a declaratory judgment that the lease agreement remained in full force and effect.
The federal court entered summary judgment in favor of the landlord and against the tenant because of what was deemed the tenant’s failure to properly extend the leasehold as a result of the tenant’s own negligence in not exercising the second option in accordance with the terms of the lease agreement.
According to the federal court, “A lease is a contract and ‘is to be interpreted according to contract principles,'” and, with “an option contract, time is always of the essence.” The federal court emphasized that “when an option is not exercised until after the prescribed deadline, and the only reason for the delay is the optionee’s own negligence, ‘equity will not aid the tardy optionee,'” which “is true even when the option or suffers no prejudice as a result of the delay.”
The federal court then noted that the lease agreement required the tenant to exercise the option, in writing, at least 12 months prior to the end of the current term, and by mailing such written notice to the landlord.
Unlike the tenant, the federal court pointed out that the tenant’s predecessor-in-interest strictly complied with the lease agreement when exercising the first option.
The tenant did not dispute that it failed to comply with the technical terms of the lease agreement, but rather believed that the written notice requirement should be excused.
First, the tenant argued that the lease agreement was extended by the conduct of the parties. In opposing the summary judgment motion, the tenant claimed that one of its members had multiple conversations with the landlord’s manager in which the manager was advised of the tenant’s intention to extend the lease agreement.
In rejecting this argument, the federal court stated that the lease agreement unambiguously provided that options could only be exercised by written notice.
Moreover, the federal court discounted the tenant’s reliance upon the Supreme Court of Pennsylvania’s ruling in McClelland v. Rush and Matter of Opus One Inc. The tenant argued that “where a lessee gives oral notice to renew, and the lessor does not timely object to the form thereof, the lessor may be deemed to have waived the right to written notice.”
Unlike the landlord in McCelland, however, the federal court concluded that the landlord did not “expressly agree” that the tenant may have the leased premises for the second option period.
In Matter of Opus One Inc., a federal court in the Western District during bankruptcy proceedings dealt with a tenant that had notified the landlord in unequivocal language of his intent to extend the lease upon multiple occasions, but the landlord failed to provide the tenant with information such as rental figures under the renewed lease prior to the option deadline.
The federal court in Matter of Opus One, Inc. held that enforcing the written notice requirement “would be manifestly unfair, particularly in light of the lessor’s repeated refusal to supply information necessary for the lessee’s exercise of its option.”
In this case, however, the federal court found no evidence that the landlord was responsible in any way for the tenant’s failure to provide written notice. Rather, according to the federal court, the only such evidence appears to be the fact that, prior to the option deadline, the landlord’s manager failed to remind the tenant of the written notice requirement. Since the lease agreement did not place any obligation upon the landlord to provide such a reminder, the federal court held that the tenant’s failure to comply with the technical terms of the lease agreement could not be attributed to any fault on the part of the landlord.
The federal court next summarily rejected the tenant’s reliance upon Land v. Cloister Pure-Spring Water Co. for the proposition that “where a lessee orally indicates its intent to renew a lease in time, equity may prevent a landlord from rejecting a late written notice where a landlord has not been prejudiced and bears some responsibility for the lateness of the written notice” because the landlord did nothing to cause the tenant’s delay in providing written notice under the terms of the lease agreement.
The federal court next addressed whether the landlord waived the written notice requirement as contained in the lease agreement.
“In Pennsylvania, waiver of a legal right requires a clear, unequivocal and decisive act of the party with knowledge of such right and an evident purpose to surrender it. Waiver may be express or implied. Implied waiver applies only to situations involving circumstances equivalent to an estoppel, and the person claiming the waiver to prevail must show that he was misled and prejudiced thereby.”
As part of its argument, the tenant pointed to conversations between the tenant and the landlord’s manager, during which the tenant communicated the tenant’s interest in buying the property, as evidence that the landlord waived its contractual right to written notice of the tenant’s intent to extend the lease agreement.
During one of these conversations, the tenant claimed it had a lease agreement for a significant period of time, which included the duration of the remaining options.
The federal court believed that this evidence was insufficient to establish waiver because the conversations occurred in the context of the tenant attempting to purchase the property, not to exercise the second option.
Moreover, the federal court noted that, even assuming the landlord’s manager inferred from the tenant’s reference to the potentially long duration of the lease agreement that the tenant intended to renew the lease agreement, the landlord’s manager did not respond with any “clear, unequivocal and decisive act” to indicate that this notice was sufficient and that the landlord would surrender its right to written notice.
Furthermore, the federal court pointed out that the tenant failed to demonstrate that it was misled by the landlord, as is required for a claim of implied waiver.
The federal court also held that the Statute of Frauds prevented the parties from modifying the requirement that notice of renewal be in writing.
In Pennsylvania, the Statute of Frauds requires that any lease longer than three years must be in writing and “its terms cannot be subsequently orally modified.”
As such, even if the conversations between the tenant’s member and the landlord’s manager demonstrated intent to modify the written notice requirement, which the federal court believed was not the case, the federal court concluded that the tenant’s claim that the lease agreement was orally modified is barred by the Statute of Frauds.
LESSONS LEARNED
The federal court’s ruling in Warminster Equities LLC speaks volumes about the necessity of just following the terms of the contract. All the tenant in Warminster Equities, LLC had to do was notify the landlord in advance, in writing, and via first class mail of its election to exercise the second option under the lease agreement. By not complying with these technical requirements of the lease agreement, the tenant lost the ability to continue to lease the property to a subtenant, and, worse, had its loan that financed its purchase of the lease agreement to be called.
When a tenant possesses a lease option, the tenant, thus, must fully understand how to properly exercise the option or risk forever losing that right to extend the lease term.
Reprinted with permission from the May 16, 2011 edition of The Legal Intelligencer © 2011 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.
