The Use of ‘Options’ in Commercial Leases
November 1, 2017
There are many reasons why a Landlord and Tenant may choose to include an “option” in a commercial lease. The most common type of option is one that gives the Tenant the right to extend the lease term, usually for additional — sometimes two or more — terms of equal length to the original term. While an option is found within the lease itself, it must independently include all the requisite elements for all contracts to be enforceable; namely, it must include “consideration,” and all its material terms must be clearly stated.
The requirement of “consideration,” meaning something of value, is satisfied by the lease itself, as both the Landlord and the Tenant are benefitting from the contractual relationship established by the lease. The material terms for an option to extend a lease include: when the option must be exercised (e.g. within six months prior to the termination of the lease), how it must be exercised (e.g. by the giving of written notice), the length of the option term and the rental rate for the option term. One common mistake made in the drafting of options to extend a lease term is to state that the rent during the option period will be an amount “to be agreed upon.” Such a provision, commonly referred to as “an agreement to agree,” is legally unenforceable, thus rendering the option meaningless, as the courts will not force either party into an agreement to “agree” to terms to which they do not want to agree, no matter how unreasonable their position may be (subject only to the implied covenant in every contract to act in good faith).
Only somewhat better, but still not advisable, is a statement that the rent during the option period will be “at fair market rent,” without any indication as to how “fair market rent” will be determined. If the parties wish to set the option rent at “fair market rent,” as opposed to a determinable amount, such as a fixed percentage over the rent at the end of the term preceding the option term, they should include a mechanism for determining exactly what “fair market rent” is. There are many ways to do this, including having independent appraisers establish the amount, or basing the amount upon an average of rents being charged at other properties within a stated radius from the subject property.
Another less common use of options in commercial leases is an option given to the Tenant to purchase the property. A Landlord may consider granting such an option to entice a Tenant to lease an otherwise difficult-to-lease property. A Tenant who wishes to eventually own the property they occupy but who is not currently in a financial position to buy it may desire to lease a property they otherwise would not if they are given the “upside” of purchasing it at some future time.
Like options to extend the lease term, options to purchase must also be specific as to the terms of the purchase. One way that the parties can satisfy such requirements is to attach to the lease a copy of the actual purchase contract that the parties will utilize if the option is exercised.
David Allen is a real estate attorney at the Phoenix law firm of Jaburg & Wilk. David has been representing clients in both transactional & litigation real estate & business-related matters for over 30 years. He is licensed as an attorney in both Arizona & California, & is also a licensed Arizona real estate broker. David can be reached at email@example.com or at 602.248.1082.