Articles

February, 2007

Contractual Deadlines for the Exercise of Options: Do They Mean What They Say?

 

By John C. Murray

 

In a recent decision, Metro Dev. Group, L.L.C. v. 3D-C & C, Inc., 941 So. 2d 11 (Fla. Dist. Ct. App. 2d Dist. 2006), the Florida Appellate Court affirmed the decision of the trial court that an option contract requiring that an option extension payment by made on a Saturday, should be interpreted so that an extension payment made on the following Monday (the first business day after the day provided for in the option agreement) would be ineffective and would terminate the rights of the option holder.

 

The option contract provided that if Metro Development Group, L.L.C. (“Optionee”) chose not to terminate the option contract, it was required to make an additional escrow deposit of $ 20,000 and a payment of either $ 119,000 or $ 29,575 to 3D-C & C, Inc. (“Optionor”) to extend the option, depending on the length of the extension that the Optionee desired. The option contract required that an additional escrow deposit and extension payment be made on or before the forty-fifth day after its effective date. The contract also provided that “[a]t any time when these payments are not made within the time described, the purchaser[‘]s rights under this contract will terminate [and the] obligations of the seller to the [p]urchaser shall terminate.” Another paragraph in the contract simply referred to the “45 th” day and made no reference to “business days.” In fact, the only reference to “business days” in the contract was contained in a provision that extended the time for the Optionee’s inspection of the property “until the expiration of five (5) business days from the date cured or waived by the Purchasers, whichever last occurs.” The contract further contained a provision that “time is of the essence of this agreement.”

 

The appellate court determined that August 18, 2004, was the effective date of the option contract, and that the 45 th day after that date was Saturday, October 2, 2004. On Friday, October 1, 2004, the Optionee paid an additional escrow deposit of $20,000 but failed to make the required extension payment, in the amount of $29,575, until the following Monday, October 4, 2004. The Optionor rejected this payment as untimely and insufficient to extend the option, which it deemed terminated. The escrow agent filed an interpleader action to resolve this issue, and the Optionee filed a cross-claim seeking specific performance of the agreement or, alternatively, for damages for breach of contract. The Optionor filed a motion to dismiss and for summary judgment, arguing that the option had expired because the Optionee had failed to timely make the required extension payment. The Optionee argued that a “latent ambiguity” existed because the parties had failed to address the specific situation of what would happen if the extension fell on a Saturday, Sunday, or holiday. The Optionee also claimed that the court should look to “custom and usage” in the real estate industry and the conduct of the parties, “both of which indicated that payment should be made on the next business day after the deadline.” Id. at 13 (emphasis in text).

 

The court granted summary judgment for the Optionor, ruling that the contract was clear on its face and that no latent ambiguity existed. The court refused to consider any parol evidence to ascertain the parties’ intent because it found that paragraph 3 of the contract was clear and unambiguous, i.e., that the payment extension must be paid on or before the forty-fifth day after the date of the initial contract as it simply referred to “the 45 th day” and made no reference to “business days.” According to the court, “[t]he circumstance that the forty-fifth day after the effective date of the contract might fall on a weekend or holiday is a circumstance that is obvious.” Id. at 14. The court therefore reasoned that the Optionee’s claim that a latent ambiguity existed under the circumstances in this case “borders on the nonsensical.” Id. The court noted that this was highlighted by the fact that the only provision in the contract that referred to “business days” specifically extended the inspection period “until five business days after the cure or waiver of title defects. The inclusion of that provision demonstrates that the parties were well aware of the difference between ‘days’ and ‘business days.’” Id. The court also held that the Optionee’s reliance on purported “custom and usage” in the real estate industry was unavailing, because the parties to such agreements are free to contract as they choose, and often agree that the time for performance will be extended when the final date for performance would fall on a Saturday, Sunday, or holiday; in this case, the parties decided not to provide for such an extension. In addition, the contract contained a clear “time is of the essence” provision, and the court found that there was “no reason to believe this provision was not intended to apply to the obligation to make payments for extending the option.” Id. The court simply refused to “rewrite the agreement of the parties or alter the obligation for timely performance to which [the Optionee] unequivocally agreed.” Id.

 

The court cited and quoted approvingly from an earlier Florida decision, C.W. Kistler Co. v Hotel Martinique, Inc., 44 So. 2d 288, 291, (Fla. Dist. Ct. App. 2d Dist.), which held that “where a stipulated time is mentioned in an option contract, it becomes the essence of the contract, which must be performed within the time mentioned.” See also Brick Plaza, Inc. v. Humble Oil & Refining Co., 218 N.J. Super. 101 (App. Div. 1987). In this case the optionee requested that the court allow it to exercise an expired option to purchase land it had leased from the optionor, asserting that its failure to exercise the option to purchase was an honest mistake on its part. The court affirmed the lower court’s grant of summary judgment in favor of the optionor because the optionee’s delay was not slight and it had committed positive neglect when it did not exercise its option in a timely fashion. The court found that the clearly fixed obligations of the optionee had been so grossly breached that the court's interest in preserving the stability of business arrangements outweighed whatever equitable purpose may have been served if the optionee had been relieved from the consequences of its own neglect. (The Brick case also sets forth in detail “the cases in which equity has intervened to mitigate the hardship resulting from a tenant’s failure to give timely notice where it is found that the tenant’s delay was ‘slight,’ where it did not prejudice the landlord and where failure to grant relief would cause the tenant unconscionable hardship” Id. at 104). The court in the Brick case noted that the delay extended almost five and a half months beyond the expiration of the three-month period limited for the giving of notice. The court stated that “The maxim has long been recognized that equity aids the vigilant, not those who sleep on their rights.” Id. at 104 (citation omitted).

 

Many of these types of cases (i.e., those dealing with the issue of whether an exercise of an option is timely made) are fact-specific, and courts will often apply equitable principles to prevent what they may deem to be an unjust result. (But in these days of sophisticated computer programs with automatic tickler and follow-up features, the parties should be vigilant and strive to meet the option and other deadlines expressed in leases and other real-estate contracts.) See, e.g., Brunswick Hills Racquet Club, Inc. v. Route 18 Shopping Center Assocs., 182 N.J. 210 (N.J. 2005). In this case, the lessee-plaintiff sought to exercise a lease option that allowed for a 99-year renewal, and notified the landlord-defendant of its intention to do so on numerous occasions but without realizing that it had failed to meet all requirements for valid exercise. Despite knowing of the plaintiff's stated intention to exercise the lease option, "defendant, through its agents, engaged in a pattern of evasion, sidestepping every request by plaintiff to discuss the option and ignoring plaintiff's repeated written and verbal entreaties to move forward on closing the ninety-nine year lease." Id. at 229. The Supreme Court of New Jersey explained that the lessee-defendant's receipt of plaintiff's repeated letters and telephone calls concerning the exercise of the option obliged the lessee-defendant to respond and to respond truthfully. Despite the court's reluctance to interfere in commercial relationships between knowledgeable parties, it found the landlord's subterfuges and evasions so clearly indicative of bad faith that under the circumstances of the case the tenant had shown breach of the covenant of good faith and fair dealing, so that a grant of equitable relief was appropriate because of the lessor-defendant’s “demonstrable course of conduct, a series of evasions and delays, that lulled plaintiff into believing it had exercised the lease option properly." Id. at 230-31. (The Brunswick case contains a lengthy and comprehensive discussion of what constitutes a breach of the implied covenant of good faith and fair dealing in connection with a commercial lease dispute). See also Pitkin Seafood, Inc. v. Pitrock Realty Corp., 536 N.Y.S. 2d 527 ( N.Y. App. Div. 2d Dep't 1989 ), where the court permitted the late exercise of an option where there was a likely loss of investment and the optionor was not harmed. According to the court:

 

Even if [the optionee’s] initial exercise of the option was not proper, the subsequent attempt by [the assignee of the lessee’s interest in the lease] should be given effect. Although it is a settled principle of law that a notice exercising an option is ineffective if not given within the time specified (citations omitted), it is further recognized that a tenant's equitable interest is protected against forfeiture where the tenant has in good faith made improvements, if the landlord has not been harmed by the delay. The Court of Appeals has held that a tenant is equitably entitled to the benefit of the rule which relieves against such forfeitures of valuable lease terms, when default in notice did not prejudice the landlord, and resulted from an honest mistake, or similar excusable default (citations omitted).

 

Id. at 619; P.L.I. Dev., Inc. v. Fetterman, 293 A.D. 2d 657, 658 (N.Y. App. Div. 2002) (“given the plaintiff's large expenditures on the property, the lack of prejudice to the defendants if the option is given effect, and the honest mistake which led to the plaintiff's short delay in exercising its option, equity compels specific performance of the option”); Weissman v. Adler, 187 A.D.2d 647, 647 ( N.Y. App. Div. 2d Dep't 1992)     (holding that claims by the tenant that he has made substantial improvements to property during his tenancy and that he has established goodwill during the years he conducted his business at that location, if proven, would entitle the tenant to enforce an option agreement provided that the landlord fails to demonstrate prejudice); Unique Marble & Granite Org. Corp. v. Hamil Stratten Props., LLC, 2006 N.Y. Slip Op. 52174U (3 N.Y. Misc. 2006) at *3 (“the option was timely exercised and signed by the president of the corporate tenant, John Manasakis, who is and remains in possession of the premises. There is no evidence that Manasakis intended to exercise the option in his individual capacity. The failure to change the name of the tenant from John Manasakis to Unique Marble & Granite Org. Corp., as amended by hand on the lease, and the failure to insert the name of the corporation before his signature is an insignificant defect and may be the product of negligence or mistake rather than an attempt to modify or undermine the agreement of the parties”); In re Royal Yarn Dyeing Corp., 114 B.R. 852, 862 (Bankr. D.N.Y. 1990) (“In the instant case, there is ample support on equitable grounds for protecting the Debtor from the forfeiture that would result if it were held to the letter of the lease agreement and the deadline for exercising the renewal option. The testimony taken before this Court and the record is replete with evidence that Royal Yarn has made substantial improvements to the premises over the life of its tenancy”).

 

Cf. Comerica Bank v. Harbor Northwestern-38000, 2003 Mich. App. LEXIS 3042 ( Mich. Ct. App. Dec. 2, 2003). In this case, it was undisputed that the optionee did not exercise its option to renew the lease within the time period specified (April 30, 1999) because it was trying to renegotiate the rent. Such notice was not in fact given by the tenant until June 11, 1999. The court held that the optionor could have refused to renew the lease and the optionee would have lost all interest in the premises when the lease term ended on October 31, 1999. But the optionor instead accepted the optionee’s late offer to renew for a five-year term ending October 31, 2004. The court ruled that the parties’ rights and obligations during the renewal term were the same as in the original lease except as otherwise provided. The renewal agreement did not expressly delete or modify the option clause in the original lease and therefore, the court held that the optionee had one more option to renew.

 

See also Market Street Assoc. v. Frey , 21 F.3d 782 (7 th Cir. 1994). In this case (which arose out of a sale-leaseback transaction), the contract provided that if the lessee wished to improve the property, it was first required to ask the lessor to provide the needed financing. In particular, the contract contained a provision (paragraph 34) stating that the lessor agreed “to give reasonable consideration to providing the financing of such additional Improvements and Lessor and Lessee shall negotiate in good faith concerning the construction of Improvements and the financing by Lessor of Improvements and the financing by Lessor of such costs and expenses.” Id . at 784. If, after negotiations, the lessor declined to provide any such financing of additional improvements, the lessee was then authorized to purchase the property at a price determined by a specific formula set forth in paragraph 34 of the contract. In 1988 the parties negotiated over the financing of improvements on, or a possible sale of, one of the four properties covered by the contract. They did not reach an agreement, and the lessee filed suit for specific performance to force the sale of the property to it pursuant to the contractual formula. If specific performance were granted, the tenant would be able to buy the property at a discounted price, due to appreciation in values in the unexpectedly long time that had run before the tenant asked for the financing. But the court held that because of the tenant’s deliberate intention “to deceive the [landlord] through a series of vague and ambiguous letters,” the tenant had “violated its duty of good faith and fair dealing in performance of the contract.” Id. at 788. The court found that by deliberately failing to make specific mention of paragraph 34 of the contract in any of the relevant correspondence and conversations that occurred between the parties in 1988, and knowing that the landlord “was not operating under paragraph 34,” Id. at 787, “[the tenant] did not bring this matter to the [landlord’s] attention, and continued to write ambiguous letters, until he wished to utilize the purchase option, thereby purchasing the property at a discounted cost.” Id. Thus, the court held, the tenant had breached its duty of good faith and fair dealing and “intended to trick the [landlord] by implementing a plan designed to acquire a valuable piece of real property at a price substantially below its market value.” Id. Because the landlord had breached its duty of good faith and fair dealing in the performance of the contract and took advantage of the tenant’s “unilateral, inadvertent mistake regarding financing opportunities,” the court refused to award specific performance to the landlord. Id . at 788. See generally , George A. Locke, Annot., Timeliness of Notice of Exercise of Option to Purchase Realty , 87 A.L.R.3d 805, supp. sec. 3.