Don't Inadvertently Give Defaulting Tenant an Option to Buy

The last thing any landlord wants is to allow a tenant to purchase the property while it’s in default. Unfortunately, that’s exactly what you might have to do if the purchase option clause in your lease contains a common loophole.  

The Problem

Selling to a tenant that’s in default hurts your legal position in a number of ways. For one thing, once the sale closes, you can’t take advantage of the special court proceeding that most states allow landlords to use to recover a tenant’s back rent on an expedited basis. Instead, you’ll have to go through the lengthy and cumbersome standard litigation process to get your money back.

You could also find yourself in a bad spot if the tenant in default has allowed the space to deteriorate. This is especially risky if the tenant opts to buy only a part of the property or you own other property in the same area. In either case, you’ll be stuck with a bad neighbor who poses a potential threat to your remaining investment. During the lease term, you’re in a position to force the tenant to clean up and make repairs. But once the tenant buys the property, you lose your lease leverage. And the poor condition of the space may lower the value of your remaining property and/or make it harder to lease to other tenants.

Defaulting Tenant Forces NYC Owner to Sell

The experience of a New York City owner is a reminder of how a bad lease clause may enable tenants in default to get away with exercising their purchase option. The lease gave the tenant the option to purchase. The tenant environmentally contaminated the space, which constituted a default under the lease. So, when the tenant sought to exercise the purchase option, the landlord refused to sell.

The court ruled that the landlord had to honor the option and sell the property to the polluting tenant. A lease default doesn’t affect the tenant’s option to purchase unless the lease specifically says that it does, the court reasoned. Since the lease in this case didn’t preclude a tenant from exercising the option while in default, the tenant had the right to buy the property [Curry Road Ltd. v. Rotterdam Realties Inc., 600 N.Y.S.2d 339 (A.D. 3 Dept. 1993)].

The Solution: Say Tenant Must Be Default-Free to Exercise Option

The good news is that once you spot this loophole, it’s pretty easy to fix. Simply specify that the tenant can’t exercise its purchase option if it’s in default. The lease should indicate that this disqualifying condition applies at both the time the tenant exercises the option and at the time of sale. That way, the tenant won’t be able to get away with a default that occurs after the option is exercised and before the lease ends.

Here’s some model language you can use to qualify a tenant’s option to purchase; the language also works for limiting a defaulting tenant’s right of first refusal:

Model Lease Language

[Tenant may exercise its right to purchase the Premises], provided that Tenant is in compliance with all of the terms and conditions of this Lease both at the time of Tenant’s exercise of the option and at the time of closing.