This article was posted on Friday, Apr 01, 2016

Hello everybody.  Let’s start with a multiple choice question about options: Assume that the 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, January 1, 2017.

If the tenant gives written notice of exercise of the option on Monday, January 2, 2017, the exercise is: 

    A. Unenforceable because the exercise was late.

    B. Enforceable because January 1 is a national holiday.

    C. Enforceable because January 1 is a Sunday, rather than a business day.

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    D. Enforceable because a one-day grace period is reasonable.   

Select the best answer.  (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 choose not to exercise, the option, then the arrangement is, in fact, an option.

Generally, an option must contain the following elements: (1) the names of the parties, (2) the price or other consideration that the optionee 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 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 rent will be in future years for the property if the tenant exercises the option.  If the option fails to provide a basis by which the rent can be 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 at the time of the exercise of the option.”

Such a provision is merely an agreement to agree.  It provides no ascertainable standard by which anyone, including a court, can determine what the rent is supposed to be.

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 preceding language, knowing that the court will not enforce the provision.  (Etco Corp. v. Hauer 161 C.A.3d 154)

On the other hand, if the option does not specify the amount of the new rent but provides a basis by which the rent can objectively be determined, then the option will be enforceable.  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.

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 to 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)   The problem, obviously, is that the parties may differ in opinion as to what constitutes a “reasonable” time, and that disagreement may lead to litigation.

An even greater problem arises where the date specified for the exercise of the option falls on a Saturday, Sunday or legal holiday.  In most fields of the law, where the last date to perform an act falls on such a date, there is a statute (i.e., C.C.P. Section 12a) which extends the right to perform the act until the next business day.  For example, assume a tenant is served with a 3-day notice to pay rent or quit on Wednesday April 6, 2016.  The third day will fall on Saturday, April 9, 2016.  The tenant will then be allowed until Monday, April 11, 2016 during which to pay his rent.  (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.  That is a huge trap for the unwary, including attorneys.  I estimate that 99 lawyers out 100 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 preceding multiple choice question is “A.”

In the context of buy/sell agreements or leases with an option to purchase, the same rules apply as with leases to extend the term of an option.

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

On the other hand, if the option provided that the price would be at the fair market value at 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 Superior Court could determine the market value and compel the landlord/seller to convey the property to the buyer at the market value, as determined by the court.

As with an option to extend a lease term, an option to purchase real property must be exercised on or before the deadline date.  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 should always be certain that the lease or contract contains very clear and definite terms relative to the option, particularly with respect to the rent which will be charged during the extended term of the lease or the purchase price which will be paid in order to acquire the property.

Similarly, the lessor/seller should be certain that the terms of the option are specific and definite in order to avoid future disputes with the tenant/purchaser and to avoid ending up in expensive litigation which might include the recordation of a lis pendens against the optionor’s property.

If the optionor is a landlord who wants to be tricky by making it look like he is giving the tenant an option to extend but in fact have the provision be unenforceable or void, then the lessor might utilize the exact language of unenforceable options as appear in several California cases (such as Etco Corp., 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 case law will hold it to be void. 

Dale Alberstone is a prominent litigation and transactional real estate attorney who has specialized in real property law for the past 39 years.  He has been appointed to periodically serve as a judge pro tem of the Los Angeles Superior Court and is a former arbitrator for the American Arbitration Association.  He also testifies as an expert witness for and against other attorneys who have been accused of legal malpractice.

            Mr. Alberstone has been awarded an AV rating from Martindale-Hubbell.  An AV rating reflects an attorney who has reached the heights of professional excellence and is recognized for the highest levels of skill and integrity. You may Google “Dale S. Alberstone” for further background.       

            The foregoing article was authored in March 2016.  It is intended as a general overview of the law and may not apply to the reader’s particular case.  Readers are cautioned to consult an advisor 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, 1900 Avenue of the Stars, Suite 650, Los Angeles, California 90067.  Phone:  (310) 277-7300.