By Andrea J. Lawrence
Partner, LeClairRyan
Concepts of equity are important in commercial real estate because the courts will, on occasion, rely on those concepts to avoid loss of a tenant’s interests in a lease. This scenario comes into play in situations where tenants haven’t properly exercised a renewal option, but may potentially have offset that shortcoming with major improvements to the premises or otherwise generated “goodwill” at the property.
For example, the case of 135 East 57th Street LLC v Daffy’s, Inc. saw the New York Appellate Division rely on equitable principles to protect a tenant that didn’t exercise a timely option to renew. Specifically, the Court decided that based on goodwill generated by the tenant, equity would intervene to prevent the loss of its leasehold interests.
More recently, however, the New York Court of Appeals addressed a similar case in Baygold Assoc., Inc. v. Congregation Yetev Lev of Monsey, Inc. This time, equity didn’t counteract what the Court decided was the improper exercise of a renewal option.
In this case, the landlord signed a commercial lease with Baygold Associates to operate a nursing home. The terms included an option for Baygold to extend its lease for four 10-year periods, provided that notice was given to the landlord by certified mail, return receipt requested, no later than 270 days before each lease term was set to expire. The tenant subsequently subleased the premises to an affiliate, who continued to operate the nursing home between 1976 and 1985. During that time, the subtenant made $1 million of improvements to the property.
In 1985, the subtenant sub-subleased the site to a non-affiliate, who continued to operate the nursing home and made additional improvements. In July 2005, Baygold sought to renew for two more 10-year terms. In 2007, however, the building was sold and Baygold was told its lease would expire on September 30, 2007 based on a failure to renew its lease. Although Baygold’s attorney had provided the new owner with a copy of the renewal letter, he couldn’t produce either a certified or return mail receipt.
Baygold sought action against the landlord, seeking a declaration of its rights under the lease. After a bench trial, the lower court decided that Baygold didn’t properly renew its lease because the renewal notice had not complied with the terms of the lease. The Appellate Division upheld the lower court, further concluding that Baygold wasn’t entitled to equitable relief because it didn’t demonstrate that it had made substantial improvements to the premises in anticipation of renewing the lease. That decision was appealed to the Court of Appeals.
The only issue raised on appeal was whether the non-renewal would result in forfeiture by Baygold. The Court did recognize that a forfeiture results where a tenant has made good faith improvements to a commercial space, or has generated goodwill at the premises, in a way that the tenant would experience a significant loss if the lease wasn’t renewed.
With the facts presented, the Court of Appeals decided that Baygold wasn’t entitled to equitable relief for several reasons. First, Baygold hadn’t made any improvements to the premises since it had sublet it 20 years earlier (improvements made by the sub-subtenant didn’t count). Second, the improvements made 20 years earlier when Baygold was the actual tenant weren’t done with the intention of renewing the lease, such that Baygold’s equitable interest in renewal had to be protected.
The Court also rejected Baygold’s argument that litigation expenses incurred because of the alleged default by the sublessor for entering into an illegal sub-sub-tenancy didn’t constitute “substantial improvements.” In other words, because Baygold didn’t make any improvements in anticipation of renewing its lease, and simultaneously didn’t possess any goodwill tied to the location, the Court affirmed the earlier decision.
What this decision means is that commercial tenants shouldn’t necessarily rely on equitable relief to salvage an untimely or improper lease renewal, and that all attempts to exercise a renewal option should strictly conform to the terms and provisions of the lease. To avoid Baygold’s predicament, a commercial tenant should carefully scrutinize the renewal provision in its lease and be fully aware of the date by which it must exercise its option, how the renewal notice is to be delivered, and to whom it should be addressed.
At the same time, the renewal notice should be very clear, leaving no doubt that the tenant is exercising its option. Often, a renewal option is contingent on the tenant’s compliance with the lease—a tenant may not be able to exercise its renewal if it is in default of any of the lease provisions.
The bottom line is that commercial real estate tenants should make sure they are fully in compliance with all terms and conditions of a lease when in comes time to renew. If a tenant fails to properly exercise its option, the lease will expire and the tenancy will, at best, be put on a month-to-month basis.
