““Avoiding Lease Meltdowns in the Post-Gilded Age””by Mark Schwarz, Esq.)


        Recent developments in the New York courts raise concerns of interest equally to landlord and tenants both in the commercial and residential real estate sectors. A recent decision involved the well-known Hershey’s sign in Times Square which is on long term lease from a major landlord to an advertising concern hired by Hershey’s. As is customary, the lease provided for an initial base term with several 10-year options, which is a format designed to allow a tenant to recoup its cost of improvements then make a decision whether to continue at the location. The fixed rent for the options is normally “bumped” to track cost of living increases, but not necessarily the market. Exercise of the options is achieved by the tenant giving the landlord notice within specific time-frames carved out of the base term. The notice feature is critical in that it serves the double purpose of allowing the landlord to relet the premises in sufficient time if the tenant does not exercise the option, or to make investment decisions based upon the fixed rent stated in the lease should the lease be extended. In this case, the tenant neglected to exercise the option until 26 days following the end of the exercise period then, in an effort to preserve the lease, moved the court to restrain the landlord from evicting the tenant and to permit it to exercise its option.

Contracting parties in the U.S. for decades have expressly chosen New York as the governing body of law due to the strict reading given written legal agreements by New York tribunals. So at the hearing, the landlord pointed to the clear language of the lease setting forth the requirement of written notice of exercise of the extension option as well as the manner of giving the notice and form thereof. It pointed out, and the court agreed, that the tenant had failed to prove that its failure to timely exercise the option was due to inadvertent error, as opposed to carelessness. Yet, in granting the tenant’s request for an injunction, the court was persuaded by the fact that the tenant had made extensive investment in constructing the sign, a portion of which is it had not yet recouped through depreciation, as well as by the “unique” location and importance of the sign to the tenant’s marketing program. What is most significant is the court’s brushing aside of a most significant factor, namely, whether there is prejudice to the landlord–here, the court found no prejudice on the grounds that the tenant was current on the rent and was prepared to pay the option increase.

The fallacy in our view lies in the court’s failure to weigh the economic impact of continuing the lease in the face of what both sides agreed was a tight real estate market. By upholding the tenant’s extension, thereby continuing the prior rent, the landlord was being denied the benefit of the higher rent which the market afforded. Far from being a windfall, the ability to access a rising market at the time of a lease expiration is a material consideration running to the landlord, and surely a factor in pricing every economic term of the lease upon execution, including the rent on the extension options and even the notice provisions which the tenant had violated. Experienced counsel had participated in all phases of the lease negotiation and both sides represented sizeable economic business enterprises, yet the tenant was allowed to continue in possession despite its nearly fatal mistake.

Another appellate decision in the New York courts which came down about a month later highlights the strict constructionist traditions of the New York appellate courts referred to above. The lease in question here contained an unusual provision highly favorable to the tenant and clearly the result of an effort by the tenant’s counsel to protect her client, which probably seemed a victory at the time. (Remember what was said above regarding the importance to the landlord of the notification requirement!) The case involved a long-term ground lease of a cooperative apartment building which, unlike the lease discussed above, contained a provision stating that if the tenant failed to exercise the options within the window specified in the lease, the landlord nevertheless could not terminate the lease but itself had to notify the tenant of its failure and allow the tenant a further opportunity to extend the lease! Even more extraordinary was a provision saying that if the tenant still failed to exercise and the expiration date of the lease arrived and passed, the lease would continue month-to-month until the tenant did exercise within a stated period. The lease was well into the month-to-month mode when the tenant finally woke up and exercised the option. At that point, the landlord endeavored to terminate the lease on the grounds that the options violated New York’s centuries’-old rule against arrangements tying up real property for impermissibly extensive periods (the “rule against perpetuities”).

The tenant argued, correctly, that the rule against perpetuities does not generally apply to leases, citing as examples the numerous office building leases in Manhattan’s financial district which date to the reign of Queen Anne. Yes, the court said, this is true, but to no avail since because the lease had expired there was no lease to deal with, and the options to extend were thus “not part” of the lease. Since the options then stood on their own as independent contracts, they were held subject to the rule. This is the result despite the fact that the building was home to many families who had paid valuable consideration for their apartments.

Comments: Real property litigation is equivalent to sailing the high seas, since “atmospheric” factors may affect the outcome notwithstanding all the charts and compasses at your disposal. We see that in the first case, the court took pains to protect the tenant’s interest despite tangible hardship to the landlord and despite the tenant’s failure to explain its lapse. In the second case, the court could have found that the month-to-month feature was also “part of the lease”, thereby saving the homes of the many families who were ultimately dispossessed.

Having a lawyer with a good business head is always a plus, but it is no substitute for absolute command of the legal principles involved in the project. It is the best quality of legal advice for which you are paying. In our second case above, the attorney had obviously faced the problem before, and strained to make the lease foolproof so that what befell the Times Square tenant couldn’t happen to her client. Best what got lost in the sauce was the strict rule against perpetuities which alas, proved fatal.