Are Lease Renewal Options Exempt from Rule Against Perpetuities?

Q I'm thinking of renting space in the first floor of the mixed-use building I own to a successful retailer. I'd like to offer the tenant a long-term lease because I think it will bring substantial foot traffic to the other stores in the building. I'm planning on offering the tenant a 15-year lease with 10 options to renew for consecutive 10-year periods. However, I'm concerned that if the tenant wants to get out of the lease later, it will claim that such a large number of options invalidates the lease. Because the options continue the lease for more than 100 years if the tenant exercises all of them, are they void under the rule against perpetuities (RAP)?

A It depends on the state in which your building is located. Under RAP, an “interest in land—such as a lease for commercial space—must “vest—that is, be completed—within a certain period of time. In other words, the length of a lease term and all the consecutive options to renew it must not exceed that number of years. And that number is state-specific.

Wide Reach of RAP

The purpose of RAP is to limit the right of an owner to control title to property indefinitely—even after the owner has died. RAP frees property for “productive use.” However, RAP has been abolished in Alaska, Idaho, New Jersey, Pennsylvania, and South Dakota. Twenty-eight other states have adopted the Uniform Statutory Rule Against Perpetuities (USRAP), which validates “non-vested” interests, such as options to renew that have not yet been exercised, that would otherwise be void under the common law RAP—if that interest actually vests “within 90 years of its creation.” The remaining states follow the common law rule that the interest must vest “not more than 21 years after one or more lives in being” that were involved when the options were given to the tenant.

If your state follows USRAP or the common law, the options you want to offer to your new tenant might not be valid because there is a possibility (if it exercises each one consecutively) that its lease would not vest until 115 years from now—significantly more years than allowable under either rule. However, for options to renew leases, some states allow a loophole in their common law RAP or USRAP. For example, the New York Court of Appeals decided recently that the state's long-standing RAP does not apply to options to renew commercial leases there. While this is encouraging for owners and tenants that would benefit from very long-term leases, check with your attorney about the rules that apply to the terms you want to offer, before spending time and money negotiating a lease that might not work out.

Overview of Landmark Decision

In a landmark New York case, an owner unsuccessfully tried to void its retail tenant's lease renewal options, claiming that they were prohibited under the state's codified version of RAP—EPTL 9-1.1(b). The lease provided for an initial term of 14 years, with nine consecutive options to renew for a 10-year period.

A new tenant took over the lease during the original term and, after the initial 14-year term expired, did not exercise any lease option. Instead, it became a month-to-month tenant until the owner sued to evict it.

A lower court ruled that the lease's renewal options clause was void under EPTL 9-1.1(b), but the New York State Court of Appeals disagreed. It ruled that RAP does not apply to options to renew leases. The appeals court pointed out that under American common law, agreements for perpetual options to renew leases had always been held valid. (Traditionally, options to purchase property had not.) Therefore, because EPTL 9-1.1(b) simply codified the common law, it followed that options to renew leases “fell outside of the scope of the law,” the appeals court said.

Reasoning Behind Exemption

The controversial case dealt with the owner of a six-story Manhattan apartment building, which was converted to cooperative ownership in September 1983 and contained some first-floor commercial space. The owner rented that space to a real estate company, which was later replaced on the lease by the new tenant. Each term of the nine consecutive options to renew for a 10-year period was to “commence on the first day of the calendar month immediately following the expiration of the immediate preceding term of this lease.”

The tenant could exercise the renewal options together or successively, and by giving written notice to the owner at least six months “prior to the expiration date of the preceding term.” If the tenant did not exercise a timely renewal option and the owner did not provide notice of the existence of an option seven months before the date of each expiration, then each renewal option remained in effect until the owner notified the tenant in writing of its right to exercise it. The tenant then had 60 days to exercise that renewal option.

The lease also provided: “If the term shall have expired, tenant shall remain in possession as a month-to-month tenant until owner complies with the notice requirements.” Both the tenant and owner agreed that, under these provisions, a renewal option could be exercised even after the original lease term had expired, during the month-to-month tenancy resulting from the absence of written notice.

When the initial 14-year lease term expired, the tenant did not exercise any lease option thereafter, but it remained as a month-to-month tenant until the owner sued it, seeking to void the lease renewal options under EPTL 9-1.1(b) and the common law rule.

When it ruled in favor of the tenant, the trial court concluded that “the renewal options were appurtenant to the lease, exercisable during the lease term and, therefore, valid.” But the appeals court reversed the decision, declaring that the renewal options clause was void under EPTL 9-1.1(b). It determined that the lease term had expired prior to any renewal option having been exercised and, thus, concluded that the option could not be “appurtenant—that is, connected—to the lease, a requirement for validity.

The tenant then appealed to New York's highest court—the Court of Appeals—which said that EPTL 9-1.1(b) did not apply to options to renew leases. That was because, under the common law, “it [was] well settled that agreements for perpetual options to renew leases have always been held valid.” Therefore, because the rule of perpetuities has not applied to options to renew leases under the common law and EPTL 9-1.1(b) codifies the common law, it follows that options to renew leases also fall outside of the scope of EPTL 9-1.1(b).

Consistency with RAP

In this case, the lease renewal options were valid, according to the New York State Court of Appeals, which noted that the owner and tenant expressly agreed upon nine consecutive renewal options to the 14-year lease term, exercisable according to particular notice requirements. The court pointed out that the lease's option provision was not inconsistent with the purpose of RAP, because the options would continue the tenant's possession of the space without interruption, “thus encouraging the efficient use of the property.”

The court said: “It's clear from the lease that, so long as the renewal options existed, the tenant would remain a tenant, lawfully in possession of the property, at least on a month to month basis. There is no sound reason of policy to invalidate such a tenant's option to renew.”

RAP Defense Prohibition

In addition to exempting commercial lease renewal options from RAP, the court's ruling—at least in New York—protects both owners and tenants that are part of a commercial lease with numerous options to renew. It eliminates any thoughts that one side might have about invoking RAP to void the lease [Bleecker Street Tenants Corp. v. Bleeker Jones LLC, et al., February 2011].