Lease Option Provides Future Rent
Shall Be Determined By Mutual Agreement!
Is The Option Enforceable?
In
an action arising out of San Francisco, California, a tenant entered into a
written lease with a landlord for a term of five years. The lease contained an option provision which
provided as follows:
“Providing the Lessee has faithfully
performed all of the terms, covenants and conditions contained herein during
the term of this lease, Lessor grants the Lessee to extend the within lease for
an additional period of five (5) years under the same terms and conditions
except for the rent which shall be determined by mutual agreement at that time. Should the Lessee wish to avail herself of
this privilege, she must give Lessor notice in writing at least ninety (90)
days prior to the termination of this lease.”
The
lease, executed in 1976, provided for monthly rental of $880 per month for the
first two years, with annual increases of $25 thereafter up to $955 for the
fifth and last year of the lease term.
When
the lessee gave timely notice of her interest in renewing the lease, the
parties were unable to agree upon the rental for the extended term. To borrow a line from Claude Rains in
Casablanca, “I’m shocked!”
The
Lessor contended, not surprisingly, that rent should be between $2,500 and
$3,000 per month, whereas the Lessee contended rent should be no more than
$1,100 per month.
A
complaint was filed by the Lessor seeking a declaratory judgment that the
option provision on the lease is not enforceable and that since the parties
were unable to agree upon a rental, there is no lease in effect. The complaint alternatively requested the
court to declare the fair rental value of the property in the event the court
determined that the option provision was enforceable.
The
trial court entered a judgment providing that the Lessee was entitled to
continue to lease the property for the additional five years at a monthly
rental of $1,276 with an annual increase based upon a San Francisco Bay area
consumer index. An appeal by the Lessor
thereafter followed.
In
reviewing the case, the appellate court reviewed various cases around the
country on this subject. It was noted
that some jurisdictions provide that a renewal provision is valid “if the
contract shows the parties’ mutual consent to meet in the future to negotiate
further provisions for rent, even though no method for determining future rent
has been set forth.” The courts adopting
this rule “reason that the contract implies a mutual agreement to provide for a
future ‘reasonable’ rent, which can be determined by a court under the
particular circumstances of the case when parties fail to agree, and that the
rule effectuates the intent of the parties.”
Most
jurisdictions reject this point of view, however, and hold that provisions must
specify some guidelines or method for determining future rent. The court noted examples of valid provisions
as “requiring . . . arbitration or appraisal, or . . . reference to fair market rents for similar
properties at the time of establishment of the future rent.”
The
traditional view, and California’s position, has been that a provision to
extend a lease at a rental to be fixed by mutual agreement is “invalid and
unenforceable for uncertainty, at least where the provision does not specify
any guidelines or method for the fixing of the rent.”
Thus,
a lease which simply provides that rent shall be determined by “the agreement
of the parties” is an illusory obligation since either party may simply refuse
to agree to anything to which the other party might agree.
The
appellate court, in reversing the trial court and holding the option
unenforceable, concluded that:
“a provision for renewal of a lease at a rent
to be determined in the future is enforceable . . . only if the
lease agreement contains an ascertainable standard for the determination
of such rent.”
In
another situation involving a lease, a lessee was given an option to purchase
the property “for the total sum of $85,000, payable as mutually agreed by both
parties.” Sound familiar? The court noted that “unexpressed provisions
of the contract may be inferred from the writing or external facts” but
concluded that “an agreement to agree
upon a material term of a contract . . . renders the instrument unenforceable
in any form of action because it is a mere nullity.”
The
court went on to observe the absence of agreement as to how the purchase price
would be paid, whether in monthly, quarterly, semi-annual or annual
installments, or at the end of a specified number of years. The absence of any rate of interest on such
payments was also noted. The court
continued: “They had simply agreed to
agree upon terms in the future. In such
circumstances there was no binding obligation upon the buyer to accept and pay
for the land.”
The
moral of the story? Before you sign a
lease, or an addendum containing provisions which you have handcrafted, albeit
with the best intentions, retain a knowledgeable attorney to review the
document. The cost will undoubtedly be
less than a trial and possible appeal to interpret your handy work!
[This column is intended to provide general information only and
is not intended to provide specific legal advice; if you have a
specific question regarding the law, you should contact an
attorney of your choice. Suggestions for topics to be discussed
in this column are welcome.]
Reprinted from The Journal
Myles M. Mattenson © 2007
