Is Oral Promise for Long-Term Extension Binding on Owner?

Q I signed a short-term lease with a “merger” clause for retail space in my strip mall. The tenant's business was profitable there, and about halfway through the short-term lease, the tenant and I discussed the possibility of extending the lease by five years when the term was up. However, we never actually signed an extension of the lease.

Since that discussion, the tenant made expensive improvements to the space to better accommodate her business. At the end of the tenant's short-term lease, I decided to rent the space to someone else, and I notified the tenant that she would have to leave.

The tenant now claims that my “promise” to her for a long-term extension when her short term was up is binding even though it was made orally. Since she has spent thousands of dollars customizing the space, she thinks that she should be able to hold me to my oral agreement. I disagree. Who is right?

A You are. You aren't bound to an oral agreement to extend the tenant's short-term lease after it expires. That's because the “parol evidence rule” applies to leases for commercial space, such as yours. The rule prohibits oral agreements made outside of a written and executed agreement—here, the short-term lease—to be used as evidence. In other words, if you didn't formally—and in writing—agree to extend the short-term lease with the tenant to a longer term, any promises you made about such an extension can't be relied on by the tenant.

And you aren't responsible for reimbursing the tenant for the costs of the improvements she made in reliance on the oral agreement for an extension. That's because the improvements were made while she was already operating her business in the space, so you could argue that she made them to further her current business, not solely for a future long-term lease that didn't work out.

Case in Point

A New York district court ruled in favor of the owner of a strip mall in a case similar to yours, where a tenant claimed that an oral agreement should be construed in its favor. There, a shopping mall owner sued its tenant, a spa, for possession of the space after the tenant's license agreement expired and the tenant refused to vacate the space. The owner and the tenant had entered into a license agreement for the tenant to rent space for its spa business from July 2010 to October 2010. The license agreement gave the tenant permission to use the space on a “temporary basis.”

Like your short-term lease, the license agreement had a merger clause stating that the agreement constituted “the entire agreement between the parties and all representations relating to the License Area and to this Agreement contained herein.”

The license agreement also provided that if the tenant didn't surrender the premises upon expiration of the license agreement, the tenant would be considered a month-to-month licensee. It stated:

In the event the Licensee does not surrender the Licensed Area upon the expiration or other termination of this Agreement pursuant to Section 9, Licensee shall be deemed in holdover of this Agreement. Such holding over shall be construed as a month-to-month license arrangement, subject to all of the provisions, conditions, and obligations of this Agreement, except that Licensor, at its sole option and at any time during the month-to-month arrangement, may increase the monthly License Fee to twice the monthly installment of Licensee Fee payable for the last month of the License Period, and the Percentage Fee shall be payable monthly by the tenth (10) day of the following month (based on the amount that monthly Gross Sales exceed 1/12 of the Breakpoint).

Under the license agreement, the owner also had the right to double the monthly charge if the tenant held over.

The owner and tenant later entered into a further license agreement in November 2010, which extended the license agreement from November 2010 to the end of December 2010. At the end of the term, the tenant refused to move out of the space, asserting that the owner had orally promised it a five-year lease. The tenant said that the owner had promised to give it an extended five-year lease for the same commercial space if it “performed faithfully under the initial license agreement and any renewals thereafter.”

Moreover, the tenant contended that all negotiations for the five-year agreement were finalized, but the agreement was never executed because a former mall tenant offered the owner higher rent for the space. The tenant claimed that it had relied upon the owner's promises and invested approximately $85,000 to improve the space so that it was fit for a spa business.

The owner sued the tenant and asked a New York district court for a judgment in its favor without a trial. The tenant argued that the owner was not entitled to a judgment in its favor without a trial because questions of fact in the case should be determined by a jury. The court ruled in favor of the owner. It said that the oral lease was not valid.

The court found that the purported oral agreement concerning the five-year lease was barred by the merger clauses contained in the license agreements. The court noted that the purpose of a general merger provision specifying that the agreement represents “the entire understanding between the parties” is to require the parol evidence rule to be applied. In other words, it barred the introduction of extrinsic evidence to vary or contradict the terms of the agreement.

In this case, said the court, there was no mention of any five-year lease in the license agreements. In fact, the license agreements stated that the tenant became a holdover licensee if it failed to vacate in a timely manner and would be subject to a doubling of the monthly license fee being charged.

Aside from the parol evidence rule that applied to the purported oral agreement through the merger clause, the oral agreement was also barred by the statutory parol evidence rule. Under the statute, “a contract for the leasing for a longer period than one year, or for the sale, of any real property, or an interest therein, is void unless the contract or some note or memorandum thereof, expressing the consideration, is in writing, subscribed by the party to be charged, or by his lawful agent thereunto authorized by writing.”

The court also pointed out that the tenant's $85,000 in improvement costs could be seen as having been made for the tenant's benefit during the two license agreements. Because it was already operating a business that immediately benefitted from those improvements, those costs could not have been made for only the purported five-year term that never came to fruition. Therefore, the tenant could not claim that it had spent the money in reliance on the owner's promise and hold it responsible when that lease never materialized.

The court also stressed that in cases where an oral agreement for a future lease hadn't been executed but tenants were currently operating in that space, the tenants could not claim that improvements they had already made had been done solely in anticipation of a future tenancy that didn't pan out [Green Acres Mall, L.L.C. v. Sevenfold Enterprises, LLC d/b/a Dunn's River Day Spa, et al., August 2011].