Common Sense Optional

It’s not my role to substitute my judgment for that of a state’s supreme court (the highest rung of its appellate ladder, except when that phrase is used in New York, where the “Supreme Court” is really the trial court, which itself perhaps explains why I always feel a little lost when I tour that city). But I got a “start”—and this topic for a post--when I serendipitously ran across an opinion of the Rhode Island Supreme Court from 2001 whilst researching an unrelated commercial lease issue. This opinion deals with the enforceability of an option to renew a lease. (Mind you, renewals and extensions of a lease are not technically the same thing, but for the purposes of this post, I’m going to pretend they are, since the modern trend for people in a hurry is to imbed the option to lengthen the term in the body of the lease and, so long as there is timely notice of the tenant’s intention to stay longer, the parties go forward without signing a new lease document. But, I digress.)

For contrast to what’s below, Arizona published two appellate opinions on enforceability of lease renewal options from the mid-1980s, with nothing reported since. In 1984, the Court of Appeals laid down the basic rule that to be enforceable, text in a lease pertaining to renewal must be certain and definite, and a term that the rental rate is “to be subject to negotiation and mutual agreement” does not pass muster. There are some brokerage and stationery-store preprinted forms circulating around Arizona where the parties dutifully fill in the blank about renewal options with such precision as this: “Lessee shall have the right to renew for a 5-year term with 90 days notice, upon renegotiated rental rates.” The temptation to remain loosey-goosey with phrases like “subject to negotiation and mutual agreement” must be resisted if a tenant truly wants to preserve its right to extend the lease term; and it should be promoted, if the landlord wants option rights to be void from their inception. Actually, all such phrases about future negotiation ensure is that the landlord and tenant must confer with a modicum of good faith—surely not that an agreement on renewal rent must be reached.

The Court of Appeals in 1985 ruled in McCutchin v. SCA Services of Arizona Inc. that an option was enforceable when the lease text provided that all the terms of the lease (including the rent price) were incorporated by reference in the event tenant extended; this allowed the court to hold that nothing remained to agree on. Utah’s appellate courts find the same principle to be true: That all terms, including rent, must be specified to permit enforceability; but the rent does not have to be written down as a hard number, if “some mechanism for determining the amount of rent is specified in the lease.” Brown’s Shoe Fit Co. v. Olch, 955 P.2d 357, 363, 366 (Utah App. 1998). The common-sense proposition that such a mechanism cannot be interposed by the court finds this simple expression: “Indeed, the application of the covenant of good faith and fair dealing to the parties’ agreement to agree in this case underscores the reason why open-ended price terms under certain agreements are unenforceable: the parties could negotiate in good faith indefinitely and never agree upon the price term.” After all, if sophisticated landlords and tenants have irreconcilable views of value, how can a judge know what a rent stream is worth?
And yet, it seems that in other jurisdictions, Four Corners states’ jurists may be regarded as wimps, where lease enforcement is concerned.

Now (after first mentioning it 500 words ago) consider the opinion in Saunders Real Estate Corporation v. Landry, 769 A.2d 1277 (Rhode Island Supreme Court, April 27, 2001). The lease contained the following provision concerning a renewal term:

“(b) For any extended term of the lease, the Tenant shall pay a monthly
rent which shall be the fair market rental value for the Premises as of the
date of the commencement of such additional five (5) year period(s) as
determined solely by the Landlord in its bona fide business judgment
and in good faith taking into account all relevant factors bearing upon
such rental value for comparable space within the central business
district of Providence, Rhode Island, including, without limitation, size of
premises, location, and visibility and exposure; however, in no event will
the minimum monthly rent be less than the minimum monthly rent in
Section 1.2 and as adjusted by Section 3.1.” (Emphasis added)

In 1964, this same court had held unenforceable a renewal clause in a commercial lease, when the rent for the extension term was to be determined solely by the landlord (oddly there, the State of Rhode Island was one party to the lease—hmm, I forget which side?). But here, the court said that while (i) sole determination by the Landlord, even using “bona fide business judgment” was not enforceable, nonetheless (ii) the minimum rent that had been agreed to for the initial term’s last 12 months was definite, so, being objectively ascertainable, it would be enforced as the renewal rent. Wow--hitting the floor smarts! (To be fair to the court, I cannot tell if it held “upward adjustment clause” was to be incorporated during the renewal term, which was a CPI adjustment provision with specifics omitted from the opinion text. I wonder how inflation or deflation, one of which is en route, would affect these Rhode-nt litigants in the present economic times.)

If Rhode Island’s “initiative” seems modest, contrast it with the temerity of Alaska’s appellate bench some years before Landry was decided:

“With respect to the second point, that the lease was not renewed because the parties failed to agree to a rental amount, it is our view that the trial court committed an error of law.

Courts are no longer reluctant to supply lease terms when parties who, at the time of contracting agreed to set or renegotiate particular terms in the future, are unable to reach agreement. This is particularly true when the amount of rental is the term left to future agreement. City of Kenai v. Ferguson, 732 P.2d 184, 187 (Alaska 1987). Agreement on the rental amount was not a condition precedent to renewal. If the parties could not agree on rental terms, and could not agree on a method to resolve this question, the court could have resolved the issue for the parties, or as our court said in Kenai, ‘The courts will declare the terms upon which the parties fail to agree.’” Berrey v. Jeffcoat, 785 P.2d 20 (Alaska App. 1990).

Leasing parties, eschew stirring the judicial imagination in the Last Frontier, unless you hunger for valuation by fiat! This jurisprudence summarizes the so-called “minority rule”—that since the agreement to permit a renewal is consideration for making of the lease in the first place, it should be enforced by intervention of the court to establish what the future rent rate will be. In this same vein is Cassinari v. Mapes, 91 Nev. 778, 542 P.2d 1069 (1975), which upheld a renewal provision even though the monthly rental would not be certain at the date of renewal; the Nevada court said it was appropriate for it to establish the amount if the parties cannot agree, “since economic conditions are ascertainable with sufficient certainty to make the [renewal] clause capable of enforcement.”

This concept of “complete the blank” for the rent figure appears a spillover from the Uniform Commercial Code Sales article, where if one studies the current price of gizmos in comparable marketplaces for a few hours, one can infer the final price, per gizmo unit, that commercially reasonable parties would expect to pay and receive for the goods on the delivery date. But the time for ordering, manufacturing and delivering most gizmos is relatively circumscribed. Contrast that, please, with a lease renewal period that (being measured in years) can span the peak[s] and trough[s] of an entire real estate cycle. Improved properties and brake linings—never shall the twain meet. The thought that rental property is fungible, coupled with a fondness for judicial determination of rental value, seems hubristic indeed.

Ah, savor our Wild West! Mr. President Obama, search no more for a Commerce Secretary—select one among our appellate bench activists! For the rest of us facing 2009 with some angst, draft your lease renewal option provision so any reasonable person may ascertain the benchmarks, indices or other formulaic approach undergirding renewal term rent computation. Further, make an experienced, neutral appraiser’s valuation of fair market rent the “default solution” in the event the parties cannot reach an agreement on price—unless you’d prefer a judge (who never protests, methinks, his or her personal residence’s ad valorem valuation) calculating rent for the extension period of your commercial lease.

-MNW