Leasehold Options and the Rule Against Perpetuities

Although a number of jurisdictions across the country have abolished the Rule Against Perpetuities altogether, the Rule remains very much alive in New York. Just this year, the Rule has reared its head in two appellate cases involving lease renewal options. In the first, Double C Realty Corp. v. Craps, LLC, 58 NY2d 480, the First Department upheld the leasehold option. In the second and more recent case, Bleecker Street Tenants Corp. v. Bleeker Jones, LLC, NYLJ 6/26/09, p. 25., col. 3., the same court held the leasehold option invalid, drawing a distinction that has no relationship to the purposes behind the Rule.

Background

EPTL 9-1.1(b), New York's codification of the common law rule against perpetuities, provides that “[n]o estate in property shall be valid unless it must vest, if at all, not later than twenty-one years after one or more lives in being at the creation of the estate.” The common law rule was designed, first, to promote alienability of land, and second, to prevent “remote vesting,” which could promote dynastic control of wealth. Commercial options, of course, do not operate as a significant impediment to alienation of land; the holder of the option and the holder of the fee interest can always agree to transfer a fee interest to any interested party.

For that reason, New York had developed little case law concerning application of the Rule to options before the statute took its current form in a series of amendments from 1959 through 1965. Until that time, New York's prohibition on remote vesting departed substantially from the common law rule, and applied only to a narrow set of cases that did not include lease options. With the 1965 amendment that restored a version of the common law rule, New York courts had to confront the applicability of the Rule to options.

In Buffalo Seminary v. McCarthy, 58 NY2d 867, the Court of Appeals affirmed an Appellate Division determination holding that the Rule Against Perpetuities applies to options in gross. In that case, a landowner gave his neighbor an option, unlimited in time, to purchase a 20-foot strip of land along the boundary line of the property at market value, to be set by appraisers if the parties failed to agree. The option was expressly binding on heirs and assigns. In an exhaustive opinion, the Appellate Division concluded that the New York statute was designed to adopt the common law rule against perpetuities, and that the weight of authority established that options were subject to the common law rule. The court expressly noted, however, that options appendant to leases were not subject to the common law rule. The Court of Appeals affirmed on the basis of the Appellate Division opinion.

Symphony Space v. Pergola Properties, Inc.

The status of leasehold options reached the Court of Appeals in 1996, in the Symphony Space v. Pergola Properties, Inc. 88 NY2d 466, a case that, because of its perversity, has become a staple of law school casebooks. The owner of Manhattan property including a theater and commercial space sought to reduce its real estate taxes. The owner sold the entire property, for a below-market price, to a not-for-profit that wanted to use the theater. The erstwhile owner than leased back the remainder of the commercial space, and simultaneously executed an option agreement entitling the owner to buy back the entire parcel at specified prices during specified periods that extended beyond 21 years from the execution of the option agreement. Later, when the value of the property increased substantially, the not-for-profit challenged the validity of the option, relying on the Rule Against Perpetuities. The Court of Appeals, while acknowledging that commentators had questioned the wisdom of applying the Rule to commercial options, nevertheless held that the option was subject to the Rule, and was invalid under the Rule ' providing an enormous windfall to the not-for-profit.

However, in its opinion, the Court of Appeals acknowledged that the Rule does not apply to options “appurtenant” to a lease. 88 NY2d at 480. But the court held that the Symphony Space option was not appurtenant because the option itself was contained in a separate agreement, not in the lease itself, and because by the terms of the option, it could be exercised after the expiration of the lease. (The lease expired on May 31, 2003, but by its terms, the option could be exercised until Dec. 31 of that year).

Resulting Litigation

Symphony Space has now spawned considerable litigation about when an option is appurtenant to a lease, and therefore exempt from the Rule Against Perpetuities. The courts could have focused on the Symphony Space language noting that the option in that case was contained in a separate agreement, but they have not. Instead, the First Department has asked whether the option could be exercised after the expiration of the lease, leading to results that have little to commend themselves, and nothing to do with the purposes behind the Rule Against Perpetuities.

Thus, in Double C, supra, the court upheld a lease renewal option that might vest beyond the perpetuities period because by the terms of the lease, the tenant was required to exercise the option before the expiration of the lease term. By contrast, in Bleecker Street Tenants Corp., the court invalidated the lease renewal option even though it, too, provided that the tenant was required to exercise the renewal option at least six months before expiration of the prior lease term. Unfortunately for the tenant, the lease also required the landlord to serve the tenant with a reminder notice if the tenant had not exercised the option withing seven months of the expiration of the lease term, and provided that the renewal option would remain in effect until the landlord served the reminder notice. The court relying on an earlier First Department case, Warren St. Assoc v. City Hall Tower Corp., 202 AD2d 200, seized upon this language, and noted that if landlord did not serve the notice, the renewal option might remain in effect past the expiration of the lease term. As a result, the court held the renewal option invalid under the Rule Against Perpetuities. The effort by the tenant's lawyer to assure that the option did not expire due to the tenant's inadvertence led to invalidity of the option under the Rule Against Perpetuities ' a result that advances none of the policies behind the rule, and a result surely not contemplated by the parties.

Conclusion

One can only hope that either the legislature or the Court of Appeals cleans up this mess, which leads
to results that provide nearly random windfalls, while subjecting earnest lawyers to potential malpractice claims.

Stewart E. Sterk is Editor-in-Chief of this newsletter.

Although a number of jurisdictions across the country have abolished the Rule Against Perpetuities altogether, the Rule remains very much alive in New York. Just this year, the Rule has reared its head in two appellate cases involving lease renewal options. In the first, Double C Realty Corp. v. Craps, LLC , 58 NY2d 480, the First Department upheld the leasehold option. In the second and more recent case, Bleecker Street Tenants Corp. v. Bleeker Jones, LLC, NYLJ 6/26/09, p. 25., col. 3., the same court held the leasehold option invalid, drawing a distinction that has no relationship to the purposes behind the Rule.

Background

EPTL 9-1.1(b), New York's codification of the common law rule against perpetuities, provides that “[n]o estate in property shall be valid unless it must vest, if at all, not later than twenty-one years after one or more lives in being at the creation of the estate.” The common law rule was designed, first, to promote alienability of land, and second, to prevent “remote vesting,” which could promote dynastic control of wealth. Commercial options, of course, do not operate as a significant impediment to alienation of land; the holder of the option and the holder of the fee interest can always agree to transfer a fee interest to any interested party.

For that reason, New York had developed little case law concerning application of the Rule to options before the statute took its current form in a series of amendments from 1959 through 1965. Until that time, New York's prohibition on remote vesting departed substantially from the common law rule, and applied only to a narrow set of cases that did not include lease options. With the 1965 amendment that restored a version of the common law rule, New York courts had to confront the applicability of the Rule to options.

In Buffalo Seminary v. McCarthy , 58 NY2d 867, the Court of Appeals affirmed an Appellate Division determination holding that the Rule Against Perpetuities applies to options in gross. In that case, a landowner gave his neighbor an option, unlimited in time, to purchase a 20-foot strip of land along the boundary line of the property at market value, to be set by appraisers if the parties failed to agree. The option was expressly binding on heirs and assigns. In an exhaustive opinion, the Appellate Division concluded that the New York statute was designed to adopt the common law rule against perpetuities, and that the weight of authority established that options were subject to the common law rule. The court expressly noted, however, that options appendant to leases were not subject to the common law rule. The Court of Appeals affirmed on the basis of the Appellate Division opinion.

Symphony Space v. Pergola Properties, Inc.

The status of leasehold options reached the Court of Appeals in 1996, in the Symphony Space v. Pergola Properties, Inc. 88 NY2d 466, a case that, because of its perversity, has become a staple of law school casebooks. The owner of Manhattan property including a theater and commercial space sought to reduce its real estate taxes. The owner sold the entire property, for a below-market price, to a not-for-profit that wanted to use the theater. The erstwhile owner than leased back the remainder of the commercial space, and simultaneously executed an option agreement entitling the owner to buy back the entire parcel at specified prices during specified periods that extended beyond 21 years from the execution of the option agreement. Later, when the value of the property increased substantially, the not-for-profit challenged the validity of the option, relying on the Rule Against Perpetuities. The Court of Appeals, while acknowledging that commentators had questioned the wisdom of applying the Rule to commercial options, nevertheless held that the option was subject to the Rule, and was invalid under the Rule ' providing an enormous windfall to the not-for-profit.

However, in its opinion, the Court of Appeals acknowledged that the Rule does not apply to options “appurtenant” to a lease. 88 NY2d at 480. But the court held that the Symphony Space option was not appurtenant because the option itself was contained in a separate agreement, not in the lease itself, and because by the terms of the option, it could be exercised after the expiration of the lease. (The lease expired on May 31, 2003, but by its terms, the option could be exercised until Dec. 31 of that year).

Resulting Litigation

Symphony Space has now spawned considerable litigation about when an option is appurtenant to a lease, and therefore exempt from the Rule Against Perpetuities. The courts could have focused on the Symphony Space language noting that the option in that case was contained in a separate agreement, but they have not. Instead, the First Department has asked whether the option could be exercised after the expiration of the lease, leading to results that have little to commend themselves, and nothing to do with the purposes behind the Rule Against Perpetuities.

Thus, in Double C, supra, the court upheld a lease renewal option that might vest beyond the perpetuities period because by the terms of the lease, the tenant was required to exercise the option before the expiration of the lease term. By contrast, in Bleecker Street Tenants Corp., the court invalidated the lease renewal option even though it, too, provided that the tenant was required to exercise the renewal option at least six months before expiration of the prior lease term. Unfortunately for the tenant, the lease also required the landlord to serve the tenant with a reminder notice if the tenant had not exercised the option withing seven months of the expiration of the lease term, and provided that the renewal option would remain in effect until the landlord served the reminder notice. The court relying on an earlier First Department case, Warren St. Assoc v. City Hall Tower Corp. , 202 AD2d 200, seized upon this language, and noted that if landlord did not serve the notice, the renewal option might remain in effect past the expiration of the lease term. As a result, the court held the renewal option invalid under the Rule Against Perpetuities. The effort by the tenant's lawyer to assure that the option did not expire due to the tenant's inadvertence led to invalidity of the option under the Rule Against Perpetuities ' a result that advances none of the policies behind the rule, and a result surely not contemplated by the parties.

Conclusion

One can only hope that either the legislature or the Court of Appeals cleans up this mess, which leads
to results that provide nearly random windfalls, while subjecting earnest lawyers to potential malpractice claims.

Stewart E. Sterk is Editor-in-Chief of this newsletter.