Hello everybody.  Let’s start with a multiple choice pop quiz about options: 

Assume that a landlord gives his tenant an option to extend the term of their lease by five years provided that the tenant exercises the option in writing on or before Sunday, July 4, 2021, i.e., Independence Day next year.

If the tenant gives written notice of exercise of the option on Monday, July 5, 2021, the exercise is: 

  1. Unenforceable because the exercise was one day too late.
  2. Enforceable because the 4th of July is a national holiday.
  3. Enforceable because July 4, 2021 is a Sunday, rather than a business day.
  4. Enforceable because a one-day grace period is reasonable.
  5. Cannot be determined from the facts presented. 

Circle the correct answer(s).  There may be more than one.  (Most attorneys will get this hypothetical wrong.)  The correct answer appears later in this article. 

The Nature of an Option

An option is an agreement between at least two parties whereby the “optionor” (i.e., the person giving the option) empowers the “optionee” (i.e., the person receiving the option) to exercise (or choose not to exercise) a right under a contract.  In a real estate context, options usually involve the right of a tenant to extend or renew the term of a lease or the right of a buyer to purchase certain real property.

If the optionee is compelled to exercise the option, then the agreement is not an option at all, but rather a covenant of the party to perform an obligation under the contract.  On the other hand, if the party has the discretionary right and power to exercise, or to choose not to exercise, the option, then the arrangement is, in fact, an option.

An option must contain the following elements: (1) the identities of the parties, (2) the price or other consideration that the optionee (tenant or buyer) gives to acquire the option, (3) the time and manner of payment or giving of other consideration, (4) a description of the property, and (5) a statement of the rights the optionee (tenant or buyer) acquires relative to the property.

 

Option Pitfalls

With respect to options given by lessors to lessees, disputes generally arise over the issue of how much the future rent will be or the purchase price will be if the tenant exercises the option.  If the option fails to provide a basis by which the rent or price can be objectively determined, then the option will be void or unenforceable.  For example, consider the following option provision

“Lessor grants to Lessee an option to extend the term of this Lease for an additional five years under all of the same provisions and conditions, except for the rent which shall be determined by mutual agreement of the parties at the time the lessee exercises the option.”

Such an option is unenforceable by the lessee because it is merely an agreement to agree.  It provides no ascertainable standard by which anyone, including a court, could determine what the rent is supposed to be. (Albett v. Clauson, 43 C.2d 280)

Thus, a clever, if not unscrupulous, landlord who wants to make it appear to the tenant that the landlord is conferring an option might use the above legalese, knowing that the court will not enforce the provision.  (Etco Corp. v. Hauer 161 C.A.3d 154)

On the other hand, even if the option does not specify the amount of the new rent but nevertheless provides a basis by which the rent can objectively be determined, then the option will be enforceable. (Goodwest v. Munoz, 170 CA3d 919; Petrolink v Lantel, 21 CA5th 375) As an example, the following provision would be upheld: 

“Lessor grants Lessee an option to extend the term of this Lease for an additional period of five years under all of the same provisions and conditions, except for the rent which shall be the reasonable rental value as of the time of the exercise of the option.”

The preceding option provision is enforceable because the reasonable rental value could be established by the testimony of experts in the field, such as appraisers.  

Of course, the best way to provide certainty and lessen the likelihood that litigation will ensue is for the parties to specify the exact rent or provide that the rent will increase by some specified mathematical formula.  One such formula would be for the rent to increase by the same percentage that the consumer price index increases over a stated period of time.

Another problem with options is the timing for their exercise.  If the option does not specify the exact time for exercise, then a “reasonable” amount of time will be allowed.  (Allen v. Smith 94, C.A.4th 1270)   But the problem there is that the parties may differ in opinion as to what constitutes a “reasonable” time, and that disagreement may lead to litigation.  Thus, the exact amount of time the optionee will have to exercise the option should be clearly specified.

A huge potential pitfall arises when the last date specified for the exercise of the option falls on a Saturday, Sunday or legal holiday.  In many fields of the law when the last date to perform an act falls on one of those three days, there is a statute (i.e., C.C.P. Section 12a) which extends the right to perform the act until the next business day.  (Lamanna v. Vogner, 17 C.A.4th Supp. 4) 

The law is different with respect to an option.   In the all-important case of Gans v. Smull (111 C.A.4th 985), the court held that no statute governs the exercise of an option to extend a lease.  Thus, if the lease sets forth a 60-day deadline for the exercise of the option, the tenant must exercise the option on or before the 60th day, even if the 60th day is a Saturday, Sunday or legal holiday.  There is no automatic extension.  

That is a huge trap for the unwary, including lawyers.  I estimate that 99 out of 100 attorneys would erroneously opine, if asked, that the deadline for the exercise of such an option would extend to the next business day following the weekend or holiday.  

Thus, the correct answer to the pop quiz I posed at the outset of this article is “A.”  B, C, D and E are wrong answers.  (Lawyers who missed the correct answer might review Holiday Inns v. Knight, 70 Cal.2d 327, 330.)

In the context of a lease containing an option to purchase, similar rules apply as with a lease containing an option to extend the expiration date of the tenancy.

Thus, if a lease provides that the tenant has an option to purchase the property at a price to be mutually agreed upon by the landlord and tenant, the provision would be void and unenforceable.  

On the other hand, if the option provides that the price will be set at the fair market value as of the time of the exercise, then the option would be enforceable even though the parties might not then agree upon the fair market value.  With the testimony of qualified appraisers, the Court could determine the market value and compel the landlord/seller to convey the property to the tenant/buyer at the market value as determined by the court. (See Goodwest v. Munoz, cited above.)

As with an option to extend a lease term, an option conferred in a lease to purchase real property must be exercised on or before the deadline date specified in the agreement.  No grace period is allowed even if the option does not state that “time is of the essence.”  Under law, time is always deemed to be of the essence in connection with the exercise of an option, unless the option specifically states otherwise (which it never does).  

 

Concluding Remarks

An optionee (usually the tenant or buyer) should always be certain that the lease or contract contains very clear and definite terms relative to the option, particularly with respect to the amount of rent which will be charged during the extended term of the lease or the purchase price amount which must be paid in order to buy the property.

For example, if a tenant exercises the option under a lease to purchase the property, the option should specifically address whether the tenant will be required to pay the monthly rent from the date of the exercise through the date the escrow closes several months later. 

An additional reason why the lessor should be certain that the terms of the option are specific and definite is to avoid future disputes that may end up in expensive litigation and which might also include the lessee’s recordation of a lis pendens (i.e., a lawsuit encumbrance) against the real estate.

That said, a landlord who wants to be tricky by making it appear that he or she is giving the tenant an option to extend or an option to purchase, but in fact wants the provision to be unenforceable, might incorporate the exact verbiage of options that our courts have previously held to be unenforceable, such as in Etco Corp., as cited above).  

Of course, such a landlord ought to look deeply into his soul before doing so.  He ought to be certain that he believes that he is not acting unethically or fraudulently by inserting legalese which is intended to deceive the tenant into believing that the option is valid under circumstances where the landlord (or his lawyer) knows that our courts will not enforce the option. 

 

Dale Alberstone is a prominent real estate attorney who has specialized in real property and resident manager law for the past 40+ years.  He also serves as a mediator of real estate disputes and is a former arbitrator for the American Arbitration Association.  

Mr. Alberstone has been awarded a 5-Star AV rating from Martindale-Hubbell, the 125 year old national rating service of attorneys.  A 5-Star AV rating is the highest possible rating bestowed and reflects an attorney who has reached the heights of professional excellence and who is recognized for the highest levels of skill and ethical standards.    

The foregoing article was authored on August 1, 2020.  It is intended as a general overview of California law only and may not apply to the reader’s particular case.  Readers are cautioned to consult a lawyer of their own selection with respect to any particular situation.

Questions of a general nature are warmly invited.  Address correspondence to Dale S. Alberstone, Esq., ALBERSTONE & ALBERSTONE, 269 S. Beverly Drive, Suite 1670; Beverly Hills, California 90212, or phone: (310) 277-7300.