Purchase Options & Fixed-Term Leases

Purchase Options & Fixed-Term Leases

Updated on October 18, 2019

By law, purchase options are not essential terms to a lease.  Tenants should take this into consideration before negotiating purchase options into their next lease.  This is especially true for tenants on a fixed-term lease who expect to remain on the premises on a month-to-month basis after the term expires.  Smyth v. Berman (“Smyth”), a case decided earlier this year, is on point.  Therein, the court held that the underlying lease purchase option did not survive the expiration of the fixed term.  A discussion of the relevant facts and law from Smyth follows.

The subject lease in Smyth granted the tenant the right of first refusal to purchase the leased premises.  After a term of several years, the lease converted into a holdover month-to-month tenancy.  During the month-to-month tenancy, a third-party buyer came forward and offered to purchase the leased premises.  Upon learning of the offer, the tenant invoked its purported right of first refusal and offered the landlord $505,000 for the rental premises.  This amount was lower than that offered by the third party.  Unsatisfied with the tenant’s offer, the landlord rejected it.  The landlord then discontinued all negotiations with the tenant and sold the property to the other party.   Needless to say, the tenant sued the landlord.

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The general rule is that when a lease becomes a holdover tenancy, the tenancy “is ‘presumed’ to continue ‘[under] the same terms’ contained in the now-expired lease ‘except [as those terms] may have been … modified’ by the landlord and tenant.”  (Smyth v. Berman (2019) 31 Cal.App.5th 183, 192; Civ. Code, § 1945.)  However, outside of any modified terms, not all the lease terms remain.  As Smyth emphasized, only the essential terms apply.  (Smyth v. Berman (2019) 31 Cal.App.5th 183, 192.). Examples of essential terms are the “term[s] or condition[s] of the demise” such as the “‘amount and time of payment of rent’” (Id.)

Thus, in denying the tenant’s action, the Smyth court first had to find that the lease purchase option was not an essential lease term.  In finding that it was not, the Smyth court relied on precedent from the California Supreme Court that purchase options are nonessential lease terms.  (See Smyth v. Berman (2019) 31 Cal.App.5th 183, 192.)  Specifically, in Spaulding v. Yovino Young (“Spaulding”), the California Supreme Court held that “an option to purchase property set forth in a lease was a “separate and distinct right[ ] and power[ ]” that was not an “essential covenant” of that lease, and thus presumptively did not carry forward into a holdover tenancy.”  (Id.)  The tenant in Smyth argued that Spaulding was inapplicable because a right of first refusal was different from a purchase option.  The Smyth court was not convinced.  In response, Smyth held that Spaulding’s “logic applies with equal force to a right of first refusal.”  (Id.)

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Tenants should consider this case when entering into a lease.  Our real estate attorneys at Schorr Law have a great deal of experience with real estate matters and disputes. To schedule a consultation, contact us today!

See related: Los Angeles Commercial Lease Attorney – Negotiating an Option