March  2019

Rights of First Refusal and Holdover Tenants

Right of first refusal was not essential term that carried forward into holdover commercial tenancy and parties did not indicate otherwise.


Smyth v Berman (2019) 31 CA5th 183

Commercial Tenant filed suit against Landlord and others after Landlord rejected Tenant’s offer to purchase the building Tenant rented for his audio recording business. Landlord ultimately sold the building to Purchaser, whose offer was for considerably more money. At that time, Tenant was holding over on a month-to-month basis after the lease had expired. The lease contained a right of first refusal for Tenant to purchase the property. The trial court granted Landlord’s and Purchaser’s demurrer without leave to amend. On appeal, the court of appeal affirmed.

A landlord and tenant are left in a new position once the lease expires and the tenant remains in possession. Although the holdover tenancy is presumed to continue under the old lease terms, the only binding lease terms are essential terms, such as the rental amount and when it is due. A right of first refusal is not an essential term because it “is a conditional option that entitles the holder, if the seller decides to sell property and has obtained an acceptable, bona fide offer from a third party buyer, to make an offer that meets or beats the third party’s offer.” 31 CA5th at 192 (emphasis in original). Notably, the parties may contract to make the right of first refusal an essential term, but that was not done here. The interpretation that a right of first refusal is not an essential lease term preserves the public policy of encouraging stable commercial tenancies. A holdover commercial tenancy does encourage stability, but if a landlord would be facing a presumptive right of first refusal from a holdover tenant, the landlord could simply evict the tenant and sell the property immediately after the eviction. That undercuts stability. Although there is a state court split on this issue, the court of appeal held a right of first refusal was not an essential term that carried forward into a holdover tenancy unless the parties so indicate.

Tenant’s alternative theories for enforcing the right of first refusal lacked merit, including an argument that the parties intended to make the terms essential. Under the sham pleading doctrine, there was no oral extension of the lease. Tenant acknowledged that when it alleged in the complaint that the lease had ended. Nor was a later contract made, composed of four e-mails between the parties, because the essential contract terms were not clearly identified and the statute of frauds was not satisfied.

THE EDITOR’S TAKE:  It is impossible to argue with this decision, which is so clearly based on the supreme court’s opinion in Spaulding v Yovino-Young (1947) 30 C2d 138 (a decision that is old but still authoritative). However, supervising attorneys had better make sure that anyone doing lease transactions in their office is aware of this somewhat counterintuitive decision. Since an option to purchase or a right of first refusal (RFR) can but does not automatically survive a holdover tenancy, express language somewhere is required to deal with this issue when the parties want that result. That language should be in the original lease, whether there is a holdover clause in it or not, and should provide that if the tenant holds over and subsequent rent payments are accepted, it still has an option (to purchase, or whatever). On the other hand, if that is not the desired outcome, the lease should say that the option does not continue, even if the landlord allows the tenant to hold over (although that provision is hardly as necessary, since that is the result dictated by Spaulding and Smyth anyway). There are many variables involved in this issue and it is much safer to address them explicitly rather than to have a judge decide which ones are appropriate. Don’t be clever and expect that you can get around this rule of nonsurvival by having the provision about the lease being renewed or extended or read as if it applies to holdover situations—that may or may not work. The lease should explicitly state that the RFR or option is exercisable after the natural termination of the lease.

Then, the relevant variables should also be addressed. Must the tenant be current in the rent it owes? Or must the landlord have accepted the rent checks tendered by the tenant for the option to survive? Does the option price increase as the holdover continues? Does the timing of the notice of exercise change? It is always preferable for the parties to agree on such matters, and clearly state them in the lease, than to find out how the judge will fill in the gaps.—Roger Bernhardt

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