Cliff Horner

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Pursuant to a recent California Court ruling, the exercise of a purchase option in a lease terminates the lease with the former lessee’s obligation to pay rent under the lease also terminating, unless there is an express provision in the agreement that requires the lessee to continue making rent or similar payments after the exercise of the purchase option. (See Petrolink, Inc. v. Lantel Enterprises (2018) 21 Cal.App.5th 375).

Summary:

In this case, the lease gave the lessee the right to purchase the property at “fair market value … based on an appraisal.” Lessee-Buyer timely exercised the option, however, unsurprisingly, given the vague terms of the option, the parties could not agree on the fair market value purchase price. The parties ultimately sued one another for breach of contract and specific performance. The Court then determined the fair market value purchase price and ordered specific performance of the purchase agreement. Lessee-Buyer argued that it should be credited for the rent it paid after it exercised the option on the grounds that upon its exercise of the option, the lease terminated and was replaced by a contract to purchase the property. The Court found that when the tenant notified the landlord of its intent to exercise the option, the option was transformed into a contract for the purchase of the property. As such, upon exercise of the option, the tenant’s obligation to pay rent under the lease terminated despite the fact that the parties were not in agreement as to the market value of the property. The Court determined that to the extent possible, the parties must be placed in the same position that they would have been if there was a timely purchase after Lessee-Buyer exercised the option. Therefore, Lessee-Buyer was credited with the rent it paid following its exercise of the option while the Landlord-Seller conversely received interest on the purchase price from the date the option was exercised.

Take Away:

Numerous portions of any commercial lease naturally gave rise to litigation – one being the ambiguity in determining the “fair market value” price under a lease option to purchase. Additionally, this lease failed to address whether rent remained due after the date of the Lessee-Buyer’s exercise of the option and up to close of escrow. In that the Lessor-Seller would still be required to pay any mortgage on the property or provide a return to investors during this period and the tenant/buyer remains in possession and use of the property during this time, lease drafters should be mindful to include rent or some other payment requirement during the post option exercise and escrow period as agreed upon by the parties.

*The above does not constitute legal advice and should not be acted upon without seeking advice from a licensed lawyer.