Lease Renewal Options and the Rule Against Perpetuities

In February, the Court of Appeals once again faced the application of the Rule Against Perpetuities to commercial options. This time, in Bleecker Street Tenants Corp. v. Bleeker Jones, LLC, the court held that the Rule does not apply to leasehold options to renew.

The Case

In 1983, when the subject building was converted to co-operative ownership, the co-op corporation executed a lease of first-floor commercial space. The lease was for an initial term of 14 years, and gave the tenant nine successive options to renew, each for a period of ten years. The lease entitled the tenant to exercise the options together or successively by giving the landlord written notice at least six months before the expiration date of the prior lease term. The lease also extended the time for the tenant to exercise the renewal option if the landlord did not provide notice of the option's existence at least seven months before the option's expiration. In that event, the tenant would have 60 days to exercise the option, measured from the time the landlord provided notice. If a term expired before the landlord provided notice, the tenant would become a month-to-month tenant until the landlord provided notice. As a result, the lease envisioned the possibility that the option might be exercised after expiration of the original lease term.

When the initial lease term expired in 1997, the landlord did not provide notice of the option to renew, and the tenant did not exercise the option, but instead remained in possession as a month-to-month tenant. Ten years later, in 2007, landlord brought this action seeking to void the lease renewal option under the Rule Against Perpetuities (EPTL 9-1.1(b)) and the common law rule against restraints on alienation.

The Rule

EPTL 9-1-1(b) 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 and any period of gestation involved.” The statute codifies the common law Rule Against Perpetuities, and replaced an idiosyncratic predecessor that had been in effect in New York until 1965. The Rule's primary target ' as emphasized by the statutory reference to “periods of gestation” ' has been gratuitous transfers by wealthy owners seeking to perpetuate their own control over land for generations after their own demise. By its terms, however, the Rule does not distinguish between gratuitous and commercial transfers, leading to considerable litigation over the Rule's scope.

By requiring estates in property to vest within the statutorily specified period, the Rule advances a policy in favor of freer alienation of land; historically, the existence of contingent interests made it difficult for a prospective purchaser to buy a fee interest in land. The Rule operates by invalidating interests that remain contingent for too long.

Options and the Rule

As scholars have recognized for generations, applying the Rule to commercial options makes no sense. All parties to a commercial option agreement have an incentive to consider whether any restraint on alienation inherent in the option would reduce the total value of interests in the land; if it would, rational commercial parties would not structure a transaction to reduce that total value. For years, under New York's idiosyncratic statutory rule against perpetuities, the Court of Appeal had held that options were not covered by the rule ' a felicitous result. But when the legislature repealed the prior rule and replaced it with language identical to the common law Rule Against Perpetuities, the legislature included no blanket exemption for commercial transactions. Because the common law rule had been construed to apply to commercial options the Court of Appeals has been unwilling to create, by judicial decision, an exemption from the statutory codification of that rule. The result has been a series of cases in which the court has made it difficult to predict when a commercial option will be held invalid under the Rule.

Start with an option in gross to purchase real property. In Buffalo Seminary v. McCarthy, 86 AD2d 435, affd 58 NY2d 867, the landowner acquired an option in gross to buy a strip of land along the boundary with his neighbor, at market price at the time of exercise. The option agreement provided a mechanism for determining market price if the parties could not agree. From the standpoint of alienability, the option in Buffalo Seminary was among the most harmless imaginable. Anyone who wanted to buy the strip (whether the prospective purchaser be a successor to the landowner, or anyone else) would only have to buy the option from the landowner who owned it, and then pay the market price for the strip. At that point, the purchaser would have a fee simple absolute in the strip. The neighbor who owned the strip could not stop the purchase, because he had already granted an option to purchase at market price. The option did not in any way impede alienability. Nevertheless, the Court of Appeals held that the option in gross violated the Rule Against Perpetuities, and was therefore invalid.

Next consider a pre-emptive right, or right of first refusal. That right creates a more significant impediment to alienability, because a prospective purchaser of the land needs to acquire the rights of both the fee owner and the holder of the pre-emptive right in order to acquire a fee simple interest in the property. In light of Buffalo Seminary, one might have expected the court to invalidate rights of first refusal that extend beyond the rule's period. But in Metropolitan Transp. Auth v. Bruken Realty Corp., 67 NY2d 156, the court upheld such an option. The court confused matters several years later, however, when, in Morrison v. Piper, 77 N.Y.2d 165, the court indicated that Bruken had not established that all pre-emptive rights were exempt from the Rule, but only those of a commercial or governmental nature. Fortunately, the court's language in Morrison was dictum, since the court went on to find no violation of the Rule, and the court has not actually invalidated a pre-emptive right on Rule Against Perpetuities grounds.

The court added to the confusion in The Symphony Space, Inc. v. Pergola Properties, Inc., 88 NY2d 466, where it held that some, but not all, leasehold options might be invalid under the Rule Against Perpetuities. In Symphony Space itself, Broadwest sold an entire building to Symphony, and took back both a lease on part of the building and an option to repurchase the entire building. The court held that the option to repurchase violated the Rule Against Perpetuities ' providing an enormous windfall to Symphony ' while indicating that an option to purchase appurtenant to a lease would be valid under the Rule. Apparently, because Broadwest had agreed to lease only part of the building, rather than all of it, its lease was not appurtenant (although one suspects that Broadwest's motivation for the transaction ' a desire to avoid real estate taxes ' played some role in the court's decision).

In Bleecker Street, the dispute involved not an option to purchase or a pre-emptive right but an option to renew a lease. What was clear to the court's majority and to Judge Susan Read, concurring in result, was that perpetual options to renew present no Rule Against Perpetuities violation because the holder of a perpetual option to renew holds the equivalent of a fee simple absolute. The majority, in an opinion by Judge Theodore Jones, saw no reason to distinguish perpetual options to renew from time limited options to renew. Judge Read, by contrast, was not willing to equate the two, but nevertheless was prepared to uphold the renewal option in Bleecker Street based on Symphony Space's holding that an option appurtenant to a lease should be valid under the Rule. Judge Victoria Graffeo dissented, arguing that because the option in this case could have been exercised after the lease's term ended, the option should not be regarded as appurtenant, and should therefore be invalid under the Rule.

Conclusion

Although the result in Bleecker Street is a sensible one ' so long as a lease for 104 years would not violate the Rule Against Perpetuities, it is hard to see why an initial 14-year lease with nine 10-year renewals should violate the Rule ' the differing approaches taken in the separate opinions should not be reassuring to lawyers drafting commercial agreements. One can only hope that the court ' or the legislature ' cleans up the current mess.

Stewart E. Sterk, Mack Professor of Law at Benjamin N. Cardozo School of Law, is Editor-in-Chief of this newsletter.

In February, the Court of Appeals once again faced the application of the Rule Against Perpetuities to commercial options. This time, in Bleecker Street Tenants Corp. v. Bleeker Jones, LLC, the court held that the Rule does not apply to leasehold options to renew.

The Case

In 1983, when the subject building was converted to co-operative ownership, the co-op corporation executed a lease of first-floor commercial space. The lease was for an initial term of 14 years, and gave the tenant nine successive options to renew, each for a period of ten years. The lease entitled the tenant to exercise the options together or successively by giving the landlord written notice at least six months before the expiration date of the prior lease term. The lease also extended the time for the tenant to exercise the renewal option if the landlord did not provide notice of the option's existence at least seven months before the option's expiration. In that event, the tenant would have 60 days to exercise the option, measured from the time the landlord provided notice. If a term expired before the landlord provided notice, the tenant would become a month-to-month tenant until the landlord provided notice. As a result, the lease envisioned the possibility that the option might be exercised after expiration of the original lease term.

When the initial lease term expired in 1997, the landlord did not provide notice of the option to renew, and the tenant did not exercise the option, but instead remained in possession as a month-to-month tenant. Ten years later, in 2007, landlord brought this action seeking to void the lease renewal option under the Rule Against Perpetuities (EPTL 9-1.1(b)) and the common law rule against restraints on alienation.

The Rule

EPTL 9-1-1(b) 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 and any period of gestation involved.” The statute codifies the common law Rule Against Perpetuities, and replaced an idiosyncratic predecessor that had been in effect in New York until 1965. The Rule's primary target ' as emphasized by the statutory reference to “periods of gestation” ' has been gratuitous transfers by wealthy owners seeking to perpetuate their own control over land for generations after their own demise. By its terms, however, the Rule does not distinguish between gratuitous and commercial transfers, leading to considerable litigation over the Rule's scope.

By requiring estates in property to vest within the statutorily specified period, the Rule advances a policy in favor of freer alienation of land; historically, the existence of contingent interests made it difficult for a prospective purchaser to buy a fee interest in land. The Rule operates by invalidating interests that remain contingent for too long.

Options and the Rule

As scholars have recognized for generations, applying the Rule to commercial options makes no sense. All parties to a commercial option agreement have an incentive to consider whether any restraint on alienation inherent in the option would reduce the total value of interests in the land; if it would, rational commercial parties would not structure a transaction to reduce that total value. For years, under New York's idiosyncratic statutory rule against perpetuities, the Court of Appeal had held that options were not covered by the rule ' a felicitous result. But when the legislature repealed the prior rule and replaced it with language identical to the common law Rule Against Perpetuities, the legislature included no blanket exemption for commercial transactions. Because the common law rule had been construed to apply to commercial options the Court of Appeals has been unwilling to create, by judicial decision, an exemption from the statutory codification of that rule. The result has been a series of cases in which the court has made it difficult to predict when a commercial option will be held invalid under the Rule.

Start with an option in gross to purchase real property. In Buffalo Seminary v. McCarthy , 86 AD2d 435, affd 58 NY2d 867, the landowner acquired an option in gross to buy a strip of land along the boundary with his neighbor, at market price at the time of exercise. The option agreement provided a mechanism for determining market price if the parties could not agree. From the standpoint of alienability, the option in Buffalo Seminary was among the most harmless imaginable. Anyone who wanted to buy the strip (whether the prospective purchaser be a successor to the landowner, or anyone else) would only have to buy the option from the landowner who owned it, and then pay the market price for the strip. At that point, the purchaser would have a fee simple absolute in the strip. The neighbor who owned the strip could not stop the purchase, because he had already granted an option to purchase at market price. The option did not in any way impede alienability. Nevertheless, the Court of Appeals held that the option in gross violated the Rule Against Perpetuities, and was therefore invalid.

Next consider a pre-emptive right, or right of first refusal. That right creates a more significant impediment to alienability, because a prospective purchaser of the land needs to acquire the rights of both the fee owner and the holder of the pre-emptive right in order to acquire a fee simple interest in the property. In light of Buffalo Seminary, one might have expected the court to invalidate rights of first refusal that extend beyond the rule's period. But in Metropolitan Transp. Auth v. Bruken Realty Corp. , 67 NY2d 156, the court upheld such an option. The court confused matters several years later, however, when, in Morrison v. Piper , 77 N.Y.2d 165, the court indicated that Bruken had not established that all pre-emptive rights were exempt from the Rule, but only those of a commercial or governmental nature. Fortunately, the court's language in Morrison was dictum, since the court went on to find no violation of the Rule, and the court has not actually invalidated a pre-emptive right on Rule Against Perpetuities grounds.

The court added to the confusion in The Symphony Space, Inc. v. Pergola Properties, Inc. , 88 NY2d 466, where it held that some, but not all, leasehold options might be invalid under the Rule Against Perpetuities. In Symphony Space itself, Broadwest sold an entire building to Symphony, and took back both a lease on part of the building and an option to repurchase the entire building. The court held that the option to repurchase violated the Rule Against Perpetuities ' providing an enormous windfall to Symphony ' while indicating that an option to purchase appurtenant to a lease would be valid under the Rule. Apparently, because Broadwest had agreed to lease only part of the building, rather than all of it, its lease was not appurtenant (although one suspects that Broadwest's motivation for the transaction ' a desire to avoid real estate taxes ' played some role in the court's decision).

In Bleecker Street, the dispute involved not an option to purchase or a pre-emptive right but an option to renew a lease. What was clear to the court's majority and to Judge Susan Read, concurring in result, was that perpetual options to renew present no Rule Against Perpetuities violation because the holder of a perpetual option to renew holds the equivalent of a fee simple absolute. The majority, in an opinion by Judge Theodore Jones, saw no reason to distinguish perpetual options to renew from time limited options to renew. Judge Read, by contrast, was not willing to equate the two, but nevertheless was prepared to uphold the renewal option in Bleecker Street based on Symphony Space's holding that an option appurtenant to a lease should be valid under the Rule. Judge Victoria Graffeo dissented, arguing that because the option in this case could have been exercised after the lease's term ended, the option should not be regarded as appurtenant, and should therefore be invalid under the Rule.

Conclusion

Although the result in Bleecker Street is a sensible one ' so long as a lease for 104 years would not violate the Rule Against Perpetuities, it is hard to see why an initial 14-year lease with nine 10-year renewals should violate the Rule ' the differing approaches taken in the separate opinions should not be reassuring to lawyers drafting commercial agreements. One can only hope that the court ' or the legislature ' cleans up the current mess.

Stewart E. Sterk, Mack Professor of Law at Benjamin N. Cardozo School of Law, is Editor-in-Chief of this newsletter.