At the beginning of any landlord/tenant relationship, it is common for a landlord and tenant to execute a Lease Agreement with a defined initial lease term. In most leases (particularly commercial leases), there is also a provision that allows for an additional extension or extensions of the lease term, commonly called an “Option to Renew” provision. Historically, Michigan courts have required tenants to strictly comply with all of the requirements of the Option to Renew in order for the extension of the lease to be valid. Recently, Michigan courts have taken a less stringent approach under appropriate circumstances and looked more toward the behavior, actions or conduct of the landlord and tenant to ascertain whether an Option to Renew was properly exercised. This article gives an example of an Option to Renew provision, discusses the historical approach compelling strict compliance with an Option to Renew and discusses recent cases that hold strict compliance for an Option to Renew is no longer required in appropriate cases.
Option to Renew Generally
An Option to Renew may take various forms, but as an example, a commercial tenant may sign a 10 year initial term lease with the possibility for one or two 5 year extensions. An example provision is below:
Tenant shall have the option to renew this Lease for two (2) additional five (5) year terms (the “Option Terms”) at the end of the initial term of the Lease. In order to exercise the First Option, Tenant must give written notice to Landlord three (3) months prior to the expiration of the initial term of the Lease, provided that the Tenant is not in default under the terms and conditions of this Lease at the time the Tenant exercises its option to renew and the Tenant has not previously been in default resulting in the issuance of either a demand for possession for nonpayment of rent due or written demand for possession for termination of the Lease for a non-monetary default. In order to exercise the Second Option, Tenant must give written notice to Landlord three (3) months prior to the expiration of the term of the First Option, provided that the Tenant is not in default under the terms and conditions of this Lease at the time the Tenant exercises its option to renew and the Tenant has not previously been in default resulting in the issuance of either a demand for possession for nonpayment of rent due or written demand for possession for termination of the Lease for a non-monetary default. If Tenant exercises the First Option or both the First Option and the Second Option, the basic monthly rent shall increase by One Thousand Dollars ($1,000.00) per month during the First Option and an additional Five Hundred Dollars ($500.00) per month during the Second Option.
As exemplified above, an Option to Renew provision routinely carries some sort of 30, 60, 90 or 180 day notice by the tenant to the landlord informing the landlord that the tenant is invoking the Option to Renew. Further, most Option to Renew provisions will also require that the exercise of the option must be in writing to the landlord.
An Option to Renew can be beneficial for both the landlord and the tenant. The landlord benefits because it gives the landlord notice in advance of a tenant’s intention to leave the leased space and time to find another tenant in anticipation of the current tenant moving out. This helps the landlord with business planning. The tenant benefits because the tenant is permitted to stay in the same space for an additional period of time without looking for alternative space at an agreed upon increase in rent, if any. Also, for business planning purposes for the tenant, if the increase in the monthly rental rate is agreed upon in advance in the initial lease and over time the market declines toward the end of the initial term of the lease, the tenant has more leverage to negotiate a better extension of the lease by threatening to leave or the tenant may find cheaper leased space.
The largest issue that arises with an Option to Renew is what happens if the tenant intends to renew the lease, but fails to strictly comply with lease’s Option to Renew language and the landlord refuses to allow the extension? For example, what if the tenant calls the landlord in attempt to exercise the option, but fails to send a written notice? What if the tenant sends an e-mail, but the lease agreement states that notice must be by first class mail? What happens if the tenant misses the deadline by a few days and then exercises the Option to Renew? What happens if the tenant makes significant improvements to the leased space in anticipation of the extension of the lease, but the landlord claims that the tenant “missed” a payment or allegedly claims that the tenant sent in a “late payment” and claims the tenant cannot exercise the renewal option? What happens if a landlord tells a tenant “don’t worry about renewing in writing, you just need to tell me a few weeks before your decision, but then later changes his/her mind? Would that constitute a waiver? All of these issues can and do happen and the question becomes whether a court should require strict compliance or review the facts and circumstances to prevent an inequity in certain cases.
Strict Compliance: LeBaron Homes v. Pontiac Housing Funds (1947)
Historically, Michigan has held that strict compliance with the terms of the Option to Renew is required otherwise the extension is invalid. In 1947, the Michigan Supreme Court held:
An option is but an offer, strict compliance with the terms of which is required; acceptance must be in compliance with the terms proposed by the option both as to the exact thing offered and within the time specified; otherwise the right is lost (internal citations omitted).
LeBaron Homes v Pontiac Housing Funds, 319 Mich 310, 313; 29 NW 704 (1947). The Michigan Supreme Court has held that substantial compliance is insufficient to exercise an option; rather “exact compliance with the terms of the option agreement” is necessary. Beecher v Morse, 286 Mich 513, 516; 282 NW 226 (1938). See also, Bergman v Dykhouse, 316 Mich 315; 25 NW2d 210 (1946) (the optionee was not entitled to either specific performance or damages where he did not exercise the option in accordance with its terms), and Beller v Robinson, 50 Mich 264; 15 NW 448 (1883) (oral exercise of an option for a three-year lease extension was ineffective, even though the tenant held over for two years, where written notice of acceptance was required).
Obviously, these decisions were written at a time without voicemails, text messages, e-mails, and numerous other forms of communication demonstrating the landlord and tenant’s intent and business relationship/dealings. In recent years, courts have found creative ways to avoid this bright line test if the court decides there would be an unreasonable forfeiture or a harsh result.
Equity Under Certain Circumstances: Market Development Co. v.
Village Green Properties, LTD (2000)
In Market Development Co. v. Village Green Properties, LTD, Unpublished Per Curiam Opinion of the Michigan Court of Appeals, Docket No. 208856 (September 12, 2000), the option to renew had to be exercised at least four (4) months before the expiration of the initial lease term. Four days after the deadline passed, the landlord wrote the tenant a letter stating that the lease would expire at the end of the initial lease term and no extensions would be granted. Two days later, the tenant sent a letter confirming the exercise of the option for the first five (5) year extension. The court held that 1) the delay in renewing was slight, 2) there was no prejudice to the landlord, and 3) forfeiture would cause unconscionable harm because of the “substantial costly improvements” made by the tenant. Therefore, the court held in favor of the tenant. The Michigan Court of Appeals held:
Defendant is correct that a number of Michigan cases have stated the rule that strict compliance with the terms of an option is required. See, e.g., LeBaron Homes v Pontiac Housing Fund, 319 Mich 310; 29 NW2d 704 (1947), and Rapanos v Plumer, 41 Mich App 586, 588; 200 NW2d 462 (1972). However, defendant’s argument ignores that equity, by its nature, most often applies in unusual circumstances, that the cases do not preclude equitable intervention, and that Michigan has long recognized that equity can and should intervene to prevent an unreasonable forfeiture or harsh result.
Nothing in LeBaron precludes a court from utilizing its discretion to intervene equitably given proper circumstances. Nor do the cases cited in LaBaron preclude the application of equity.
Although the Michigan cases do not involve the grant of equitable relief under the precise circumstances presented here, i.e., a lessee’s failure to timely exercise an option to renew a lease, the cases discussed above support the trial court’s exercise of its discretionary power to equitably intervene in the instant case. Further, as the trial court noted, the majority of jurisdictions recognize the principle that courts may exercise their equitable discretion to grant tenants relief from the consequences of failure to give timely notice of renewal under special circumstances. (Emphasis added).
Id. at 6, 9 and 10. The Court in Market Development further held,
Thus, equitable relief may be available to a tenant who fails to give timely notice of an intention to exercise an option to renew or extend a lease, as required by the option, where the delay has been slight, the delay has not prejudiced the landlord, and the failure to grant relief will result in an unconscionable hardship to the tenant.
Equitable relief from late notification may also be allowed where the nonrenewal of the lease would result in a substantial forfeiture by the tenant, the landlord would not be prejudiced by the delay in renewal, and the tenant’s failure to exercise the option in a timely fashion resulted from an honest mistake or inadvertence, or even negligence of the lessee, at least where the forfeiture would be out of proportion to the lessee’s fault.
Id. at 11; citing 49 Am Jur 2d, Landlord and Tenant, § § 197-198, pp 195-196. Thus, the Michigan Court of Appeals has created a new test, albeit in an unpublished decision, that allows a tenant to avoid a harsh result under appropriate circumstances. This opinion gave tenants an argument that the failure to strictly comply with the Option to Renew language does not mean the tenant automatically loses. The impact of the decision in Market Development has not been fully determined. In another unpublished opinion from a different panel of the Michigan Court of Appeals appears to have limited the analysis in Market Development. In Hunter Square v. Paragon, Unpublished Per Curiam Opinion of the Michigan Court of Appeals, Docket No. 235115 (May 20, 2003), the Michigan Court of Appeals applied the test expounded above in Market Development and held against the tenant:
First, Market Development, supra, is an unpublished opinion that lacks binding precedence under the rule of stare decisis. MCR 7.215(C)(1). Second, “[o]ption contracts do not come within the equitable rule against forfeiture, inasmuch as failure to comply strictly with the conditions of the option deprives no party of any right and abrogates no contract.” 17A Am Jur 2d, Contracts, § 73, p 97. Third, no forfeiture or harsh result occurred here.
Given that Market Development and Hunter Square are both unpublished decisions, this area of law is still unsettled and practitioners should be aware of these decisions.
When drafting a lease, the landlord should include specific language regarding exactly how an Option to Renew must be effectuated by the tenant. As a tenant, negotiating more flexible renewal terms is important, but also making sure to have multiple reminders to timely and appropriately exercise an Option to Renew to avoid litigation over whether the Option to Renew was exercised properly. If you have any questions or need help drafting or interpreting Option to Renew language, please contact our office.
The team at Hirzel Law, PLC is composed of award-winning real estate attorneys that can offer quality representation for Michigan clients. Regardless of if you are a commercial real estate developer or individual homeowner, our real estate attorneys can help. We fully understand how unique and complex the challenges that our clients may face, and our real estate attorneys are prepared to help in whatever way necessary. Contact Hirzel Law online or call 248-986-2921 (Farmington) or 231-486-5600 (Traverse City) or 616-319-9964 (Grand Rapids) to learn how our Michigan real estate lawyers can help protect your Michigan real estate investment today.