In the Spotlight: The Rule Against Perpetuities

In New York, the Rule has two sections. First, New York Estates, Powers, and Trusts Law (“N.Y. E.P.T.L.”) ' 9-1.1(a) sets forth the suspension of alienation rule, which deems void any estate in which the conveying instrument suspends the absolute power of alienation for longer than a life in being at the creation of the estate plus 21 years. Simply stated, the power of alienation is suspended when there are no persons in being who can transfer a fee simple absolute.

Second, N.Y. E.P.T.L. ' 9-1.1(b) states 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 Rule Against Remote Vesting). A vested interest is one that is certain when created to become an estate in possession whenever and however the preceding estates end. Pursuant to the Rule, therefore, a perpetuities violation will occur if the interest may vest too remotely. Notwithstanding the foregoing, the Rule does not require that the interest vest within the perpetuities period. Rather, it merely requires that the interest must vest, if at all, within that time.

Two additional caveats are important to take into consideration. First, in New York, where parties to an agreement are corporations and no measuring life or lives in being were stated in the instrument, the statutory period under the Rule is 21 years. Second, New York retains the more flexible common law rule against unreasonable restraints on alienation. That is, in contrast to the statutory Rule, which is measured exclusively by the passage of time, the common law rule evaluates the reasonableness of the restraint based on its duration, purpose and designated method for fixing the purchase price. Although the common law rule against unreasonable restraints on alienation is separate and distinct from N.Y. E.P.T.L. ' 9-1.1(a) and (b), it is frequently considered in the same category of cases.

Preemptive Rights

The Rule Against Remote Vesting does not apply to preemptive rights in a “commercial or governmental transaction.” In Metropolitan Trans. Auth. v. Bruken Realty Corp., 67 N.Y.2d 156 (1986), New York's highest court, the Court of Appeals, opined that “[a]n option grants to the holder the power to compel the owner of property to sell it whether the owner is willing to part with ownership or not. A preemptive right, or right of first refusal, does not give its holder the power to compel an unwilling owner to sell; it merely requires the owner, when and if he decides to sell, to offer the property first to the party holding the preemptive right so that he may meet a third party offer or buy the property at some other price set by a previously stipulated method.” Bruken, 67 N.Y.2d at 163. Further, the court suggested that the enforcement of the preemptive right in the context of the governmental and commercial transaction encourages the use and development of land, which outweighs any minor impediment to alienability. Therefore, the court held that the Rule Against Remote Vesting did not apply to a preemptive right in a “commercial and governmental transaction” that lasted beyond the statutory perpetuities period.

Shortly thereafter, the Court of Appeals clarified this position. In Morrison v. Piper, 77 N.Y.2d 165 (1990), the court concluded that, ordinarily, preemptive rights are subject to the statutory Rule Against Remote Vesting, and that only where the right arises in a “governmental or commercial” agreement is the slight restraint on transferability offset by the holder's incentive to improve the property. Morrison, 77 N.Y.2d at 170. The Morrison court distinguished Bruken by reiterating its position “that neither 'lives in being' nor 'twenty-one years' were time periods having relevance to commercial preemptive rights involving parties other than individuals.” Id. at 170. Therefore, the court held that where the parties to the transactions are individuals, the time limitations on vesting are clearly relevant and the parties failed to suggest a reason that the time limitations should not be fully applicable.

Options to Purchase

Options to purchase land also are subject to the Rule Against Remote Vesting. Options to purchase are specifically enforceable and give the option holder a contingent, equitable interest in the land, which may discourage the landowner to develop the property and hinder its alienability, thereby thwarting the policy objectives underlying the Rule. Thus, courts have concluded that, ordinarily, N.Y. E.P.T.L. ' 9-1.1(b) applies.

However, in Symphony Space v. Pergola Props., 88 N.Y.2d. 466 (1996) the court held that purchase options appurtenant to a lease are excepted from N.Y. E.P.T.L. '9-1.1(b) if they satisfy three requirements: 1) the option must originate in a lease; 2) it must not be exercisable after the lease expires; and 3) it must be incapable of separation from the lease. An option to purchase that satisfies these three criteria, is considered “appurtenant” to the lease and therefore is not subject to N.Y. E.P.T.L. ' 9-1.1(b), no matter how long the term of the lease might be or how far into the future the option may be exercised.

Once again, policy goals played a significant role in the court's decision. The court explained that options appurtenant to leases are excluded from N.Y. E.P.T.L. ' 9-1.1(b) because they promote investment in the leased premises by the tenant. In Symphony Space, because the corporate tenant's option did not meet the three criteria necessary to be excluded, the court held that the option to purchase was not appurtenant to the lease and was invalid from its inception because the option could be exercised more than 21 years after it was granted.

Options to Renew

The Court of Appeals recently turned to the question of whether a lease renewal option is also subject to N.Y. E.P.T.L. ' 9-1.1(b). In relevant respects, the lease at issue in Bleecker Street Tenants Corp. v. Bleecker Jones, LLC, 16 N.Y.3d 272 (2011) provided for an initial lease term of 14 years, with nine consecutive options to renew for a 10-year period. Each renewal was to commence on the first day of the calendar month immediately following the expiration of the immediate preceding term of this lease. Renewal options could be exercised together or successively and by giving written notice to the lessor at least six months in advance. If the lessee did not timely exercise a renewal option, and the lessor did not provide notice of the existence of an option within seven months prior to the date of each expiring term, then each renewal option remained in effect until the lessor notified the lessee in writing of its right to exercise each option. As a result, the lessee then had 60 days to exercise such renewal option. Finally, if the term expired, the lessee would have remained in possession as a month-to-month tenant until the lessor satisfied the notice requirements. Ultimately, the parties agreed that, under these provisions, a renewal option could be exercised even after the original lease term had expired, during the month-to-month tenancies resulting from the absence of written notice.

The initial 14-year lease term expired, and the defendant did not exercise any lease option thereafter. However, the defendant remained in possession as a month-to-month tenant, until eventually the plaintiff commenced the action seeking to void the lease renewal options pursuant to N.Y. E.P.T.L. ' 9-1.1(b) as well as the common law rule against unreasonable restraints on alienation.

In its decision, the court held that options to renew leases are not subject to N.Y. E.P.T.L. ' 9-1.1(b), because the 1966 New York statute codified the American common law, which historically did not apply to options to renew leases. Bleecker St. Tenants Corp., 16 N.Y.3d at 277. The court further noted that the exclusion of lease renewal options from its effect is appropriate because lease renewal options are inherently appurtenant to the lease and do not grant the beneficiary the power to divest title to the property. Id. at 277-78. Options to renew leases further the policy goals of the Rule Against Remote Vesting because the tenant is assured of continuous possession of the property without interruption, thus encouraging the tenant's productive use of and investment in the property.

The decision in Bleecker Street was decided by the slimmest of margins, with concurring and dissenting opinions, both of which concluded that options to renew leases should be subject to the Rule. As a result, until further clarification is provided, when drafting an option to renew a lease, the safest approach is to ensure that either: 1) the option must be exercised fewer than 21 years after one or more lives in being (or 21 years for corporate tenants); or 2) the option: (i) arises in the underlying lease, (ii) must be exercised before the lease expires, and (iii) cannot be separated from the lease. By utilizing one of these strategies, the drafter will assure the option's enforceability.

Conclusion

Recent cases have held that preemptive rights are subject to N.Y. E.P.T.L. ' 9-1.1(b), except in the context of governmental and commercial transactions in which case it is not applied. Options to purchase are subject to N.Y. E.P.T.L.
' 9-1.1(b), except when they can be proven to be “appurtenant” to a lease. On the other hand, options to renew are not subject to N.Y. E.P.T.L. ' 9-1.1(b), but the wise drafter will either observe the Rule or be certain the renewal rights derive only from a viable, unexpired lease.

Donna Hoelscher Suchan, a member of this newsletter's Board of Editors, and Patrick T. Fitzgerald are attorneys with Phillips Lytle LLP, resident in the Buffalo, NY, office. Ms. Suchan can be reached at 716-847-5420 or [email protected]. Mr. Fitzgerald can be reached at 716-847-8315 or [email protected].

The legendary Rule Against Perpetuities (“the Rule”) originated centuries ago. Today, it continues to generate strikingly complex legal problems worthy of judicial review. In the context of commercial leases, it is important to be aware of when and if the Rule applies. Specifically, variations in the law exist as to when and if the Rule applies to preemptive rights, options to purchase and lease renewal options, and the law continues to evolve. (Many states have some version of the Rule, so practitioners are cautioned to check the applicable statutes. This article uses New York as an example to discuss the complications that can arise when the Rule is applied to leases.) As recently as 2011, the New York Court of Appeals addressed the Rule's applicability when a series of lease renewal options extend many years into the future.

The judicially created common law Rule dates back to 17th-century England, and its purpose is to avoid the suspension of alienation or remote vesting for periods of time considered to be “socially undesirable.” Throughout history, this occurred when people gifted property to their heirs or beneficiaries with restrictions attached that limited whether, when or to whom that property could later be sold. Courts developed the Rule to prevent current owners from restricting (beyond the Rule's time limits) the rights of subsequent owners to sell their property in an effort to encourage investment in, and maintenance, development and use of, the property. As a result of its success, the Rule similarly became a creature of American common law, where it was eventually codified and later enacted as a statute in New York State.

Example: New York

In New York, the Rule has two sections. First, New York Estates, Powers, and Trusts Law (“N.Y. E.P.T.L.”) ' 9-1.1(a) sets forth the suspension of alienation rule, which deems void any estate in which the conveying instrument suspends the absolute power of alienation for longer than a life in being at the creation of the estate plus 21 years. Simply stated, the power of alienation is suspended when there are no persons in being who can transfer a fee simple absolute.

Second, N.Y. E.P.T.L. ' 9-1.1(b) states 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 Rule Against Remote Vesting). A vested interest is one that is certain when created to become an estate in possession whenever and however the preceding estates end. Pursuant to the Rule, therefore, a perpetuities violation will occur if the interest may vest too remotely. Notwithstanding the foregoing, the Rule does not require that the interest vest within the perpetuities period. Rather, it merely requires that the interest must vest, if at all, within that time.

Two additional caveats are important to take into consideration. First, in New York, where parties to an agreement are corporations and no measuring life or lives in being were stated in the instrument, the statutory period under the Rule is 21 years. Second, New York retains the more flexible common law rule against unreasonable restraints on alienation. That is, in contrast to the statutory Rule, which is measured exclusively by the passage of time, the common law rule evaluates the reasonableness of the restraint based on its duration, purpose and designated method for fixing the purchase price. Although the common law rule against unreasonable restraints on alienation is separate and distinct from N.Y. E.P.T.L. ' 9-1.1(a) and (b), it is frequently considered in the same category of cases.

Preemptive Rights

The Rule Against Remote Vesting does not apply to preemptive rights in a “commercial or governmental transaction.” In Metropolitan Trans. Auth. v. Bruken Realty Corp. , 67 N.Y.2d 156 (1986), New York's highest court, the Court of Appeals, opined that “[a]n option grants to the holder the power to compel the owner of property to sell it whether the owner is willing to part with ownership or not. A preemptive right, or right of first refusal, does not give its holder the power to compel an unwilling owner to sell; it merely requires the owner, when and if he decides to sell, to offer the property first to the party holding the preemptive right so that he may meet a third party offer or buy the property at some other price set by a previously stipulated method.” Bruken, 67 N.Y.2d at 163. Further, the court suggested that the enforcement of the preemptive right in the context of the governmental and commercial transaction encourages the use and development of land, which outweighs any minor impediment to alienability. Therefore, the court held that the Rule Against Remote Vesting did not apply to a preemptive right in a “commercial and governmental transaction” that lasted beyond the statutory perpetuities period.

Shortly thereafter, the Court of Appeals clarified this position. In Morrison v. Piper , 77 N.Y.2d 165 (1990), the court concluded that, ordinarily, preemptive rights are subject to the statutory Rule Against Remote Vesting, and that only where the right arises in a “governmental or commercial” agreement is the slight restraint on transferability offset by the holder's incentive to improve the property. Morrison, 77 N.Y.2d at 170. The Morrison court distinguished Bruken by reiterating its position “that neither 'lives in being' nor 'twenty-one years' were time periods having relevance to commercial preemptive rights involving parties other than individuals.” Id. at 170. Therefore, the court held that where the parties to the transactions are individuals, the time limitations on vesting are clearly relevant and the parties failed to suggest a reason that the time limitations should not be fully applicable.

Options to Purchase

Options to purchase land also are subject to the Rule Against Remote Vesting. Options to purchase are specifically enforceable and give the option holder a contingent, equitable interest in the land, which may discourage the landowner to develop the property and hinder its alienability, thereby thwarting the policy objectives underlying the Rule. Thus, courts have concluded that, ordinarily, N.Y. E.P.T.L. ' 9-1.1(b) applies.

However, in Symphony Space v. Pergola Props. , 88 N.Y.2d. 466 (1996) the court held that purchase options appurtenant to a lease are excepted from N.Y. E.P.T.L. '9-1.1(b) if they satisfy three requirements: 1) the option must originate in a lease; 2) it must not be exercisable after the lease expires; and 3) it must be incapable of separation from the lease. An option to purchase that satisfies these three criteria, is considered “appurtenant” to the lease and therefore is not subject to N.Y. E.P.T.L. ' 9-1.1(b), no matter how long the term of the lease might be or how far into the future the option may be exercised.

Once again, policy goals played a significant role in the court's decision. The court explained that options appurtenant to leases are excluded from N.Y. E.P.T.L. ' 9-1.1(b) because they promote investment in the leased premises by the tenant. In Symphony Space, because the corporate tenant's option did not meet the three criteria necessary to be excluded, the court held that the option to purchase was not appurtenant to the lease and was invalid from its inception because the option could be exercised more than 21 years after it was granted.

Options to Renew

The Court of Appeals recently turned to the question of whether a lease renewal option is also subject to N.Y. E.P.T.L. ' 9-1.1(b). In relevant respects, the lease at issue in Bleecker Street Tenants Corp. v. Bleecker Jones, LLC , 16 N.Y.3d 272 (2011) provided for an initial lease term of 14 years, with nine consecutive options to renew for a 10-year period. Each renewal was to commence on the first day of the calendar month immediately following the expiration of the immediate preceding term of this lease. Renewal options could be exercised together or successively and by giving written notice to the lessor at least six months in advance. If the lessee did not timely exercise a renewal option, and the lessor did not provide notice of the existence of an option within seven months prior to the date of each expiring term, then each renewal option remained in effect until the lessor notified the lessee in writing of its right to exercise each option. As a result, the lessee then had 60 days to exercise such renewal option. Finally, if the term expired, the lessee would have remained in possession as a month-to-month tenant until the lessor satisfied the notice requirements. Ultimately, the parties agreed that, under these provisions, a renewal option could be exercised even after the original lease term had expired, during the month-to-month tenancies resulting from the absence of written notice.

The initial 14-year lease term expired, and the defendant did not exercise any lease option thereafter. However, the defendant remained in possession as a month-to-month tenant, until eventually the plaintiff commenced the action seeking to void the lease renewal options pursuant to N.Y. E.P.T.L. ' 9-1.1(b) as well as the common law rule against unreasonable restraints on alienation.

In its decision, the court held that options to renew leases are not subject to N.Y. E.P.T.L. ' 9-1.1(b), because the 1966 New York statute codified the American common law, which historically did not apply to options to renew leases. Bleecker St. Tenants Corp., 16 N.Y.3d at 277. The court further noted that the exclusion of lease renewal options from its effect is appropriate because lease renewal options are inherently appurtenant to the lease and do not grant the beneficiary the power to divest title to the property. Id. at 277-78. Options to renew leases further the policy goals of the Rule Against Remote Vesting because the tenant is assured of continuous possession of the property without interruption, thus encouraging the tenant's productive use of and investment in the property.

The decision in Bleecker Street was decided by the slimmest of margins, with concurring and dissenting opinions, both of which concluded that options to renew leases should be subject to the Rule. As a result, until further clarification is provided, when drafting an option to renew a lease, the safest approach is to ensure that either: 1) the option must be exercised fewer than 21 years after one or more lives in being (or 21 years for corporate tenants); or 2) the option: (i) arises in the underlying lease, (ii) must be exercised before the lease expires, and (iii) cannot be separated from the lease. By utilizing one of these strategies, the drafter will assure the option's enforceability.

Conclusion

Recent cases have held that preemptive rights are subject to N.Y. E.P.T.L. ' 9-1.1(b), except in the context of governmental and commercial transactions in which case it is not applied. Options to purchase are subject to N.Y. E.P.T.L.
' 9-1.1(b), except when they can be proven to be “appurtenant” to a lease. On the other hand, options to renew are not subject to N.Y. E.P.T.L. ' 9-1.1(b), but the wise drafter will either observe the Rule or be certain the renewal rights derive only from a viable, unexpired lease.

Donna Hoelscher Suchan, a member of this newsletter's Board of Editors, and Patrick T. Fitzgerald are attorneys with Phillips Lytle LLP, resident in the Buffalo, NY, office. Ms. Suchan can be reached at 716-847-5420 or [email protected]. Mr. Fitzgerald can be reached at 716-847-8315 or [email protected].