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Exercising a Real Estate Option: the Devil is in the Details

Leases often contain options to renew or extend the lease, and sometimes also an option to purchase the property at the end of the lease term.

Under California law, some cases have strictly enforced the procedural requirements for the exercise of an option, especially when timing requirements are not met.  (See, e.g., Simons v. Young (1979) 93 Cal.App.3d 170.)

Other courts, however, have been more forgiving when it comes to minor defects in the form of an option exercise.  (See, e.g., Leonhardi-Smith, Inc. v. Cameron (1980) 108 Cal.App.3d 42.)

A recent opinion from the federal Ninth Circuit Court of Appeals — United States Postal Service v. Bellevue Post Office LLC — provides an example of how courts may enforce an option exercise despite asserted minor defects in form.

Facts

The Lease and Options to Extend and Purchase

In 1963, the United States Postal Service (USPS) signed the initial lease with the predecessor of Bellevue Post Office LLC (Bellevue).  The lease had an initial term of twenty years, with five options to renew the lease totaling thirty additional years through 2013.  Each lease renewal option could be exercised by giving the lessor written notice at least 90 days prior to expiration of the current term.

The lease also contained an option to purchase the property, which could be exercised one year in advance of the end of the initial twenty year term, at the end of each option term, or at the end of the full fifty-year term.  To exercise the option to purchase, all prior lease extension options must have been validly exercised.

At each potential purchase point, the purchase price was lower than the last one.  At the end of the full fifty year term, the option purchase price was $300,000.  Bellevue estimated the market value of the property at that time was over $20 million.

USPS’s Exercise of Its Options to Extend Amid Bellevue’s Shuffling Ownership

In 1964, the original lessor (Baugh Construction Company) transferred the property to Edward Ester, Lorraine Ester, Josef Diamond, and Violett Diamond, who were each granted a 25% interest in the property.

Then, even though Baugh had already transferred the property, Baugh purported to assign to John Hancock Life Insurance Company all rights to receive the lease rents, and appointed Edward Ester and Josef Diamond as “attorneys in fact” to receive the rents.  From that point, USPS made rental payments to Edward Ester and Josef Diamond as attorneys in fact for John Hancock.

In 1978, the Diamonds transferred their interests to the trustees of four trusts they had established for their grandchildren.

Several months before the expiration of the initial lease term in May 1983, USPS mailed a form renewal to Edward Ester and Josef Diamond, “attorneys in fact under the lease.”  In the renewal form, USPS requested that the recipient notify USPS of any change in the address or ownership for the lessor.

All parties proceeded for the next ten years as if the option to extend was effective.  USPS paid the rent, and the rent was accepted.  None of the owners notified USPS of the change in ownership involving the Diamond family trusts, or directed USPS to send notices in any different manner than previously.

In 1989, the trustees of each of the four Diamond family trusts transferred the trust’s interest in the property to the grandchild who was the beneficiary of that trust, giving each grandchild a 12.5% ownership interest.  USPS received no notice of these transfers.

In 1992, USPS sent a timely notice to exercise its next option to extend the lease term.  The notice was addressed to Edward and Lorraine Ester and the four Diamond grandchildren, but was mailed in the form of a single copy only to Edward Ester.  Again, all parties proceeded as if the option exercise was effective.

In 1993, the four Diamond grandchildren transferred their interests in the property to Edward and Lorraine Ester, resulting in Edward owning 50% and Lorraine owning 50%.  USPS was not informed of this transfer.  Later that year, Edward Ester died, leaving Lorraine Ester as the owner of 50% individually, and 50% as the personal representative of Edward’s estate.

In 1997, USPS sent its next notice exercising its option to extend the lease.  The notice was addressed to the Estate of Edward Ester, Lorraine Ester, and the four Diamond grandchildren.  All parties proceeded as if the option had been validly exercised.

USPS exercised additional options in 2001 and in 2005, and all parties honored those extensions.

USPS’s Exercise of Its Option to Purchase

The final lease term was set to expire in May 2013.  In 2008, several years before the 2012 option to purchase notice cut-off date, USPS sent a letter to “Lorraine Ester, Trustee” providing written notice of USPS’s exercise of its option to purchase the property for $300,000.  USPS sent another letter in April 2012, also to “Lorraine Ester, Trustee” reminding her that it was exercising the option to purchase.

In May 2012, Lorraine Ester transferred her entire interest in the property to Bellevue Post Office LLC.

In October 2012, counsel for Bellevue sent a letter to USPS stating that USPS had no right to purchase the property.

The District Court’s Grant of Summary Judgment for USPS

USPS sued for specific performance.

Bellevue argued that the lease (and all future options) had terminated before USPS exercised the option to purchase because the lease extension notices had incomplete or inaccurate name and address information, and because USPS failed to send separate copies of the notices to each lessor.

The district court granted summary judgment in favor of USPS, and Bellevue appealed.

The Ninth Circuit’s Opinion

The Ninth Circuit affirmed, ruling in favor of USPS.

The court acknowledged the general rule of contract law that an option holder can only exercise an option “strictly in accordance with its terms.”  But, the court observed, “this standard of exactitude is calibrated to what the contract actually requires, not an indefinite standard of scrupulous paperwork or best practices.”  The lease simply required USPS to give notice of its option exercise in writing to the lessor.

Bellevue argued that each and every one of USPS’s prior exercises of its lease extension options were invalid because they were not addressed or mailed to all of the technical lessors, and thus, the option to purchase could not be exercised.

The court rejected Bellevue’s argument, holding the lease simply required written notice to the lessor, which was effectively given.  The option language did not require multiple copies of the written notice to be specifically delivered to each and every lessor, or that the names and addresses accurately depict the name and legal role of each and every lessor.  Significantly, for each lease renewal, USPS gave written notice to “at least one person who was a Lessor at the time of the renewal[.]”

The court also highlighted that the parties’ actions demonstrated the effectiveness of the prior notices exercising the extension options.  Everyone involved “continued to perform the lease as agreed upon for thirty years after the first alleged defect.”

Lesson

It’s hard to fault Bellevue for trying to evade USPS’s option to purchase here.  The difference between the option purchase price ($300,000) and the asserted market value of the property ($20 million) is staggering.  And case law provides some support for the “strict enforcement” view of options.

However, courts are known to elevate “substance over form.”  While defects in the timing of an option exercise may be fatal, other lesser defects in form (like the name and address technicalities urged by Bellevue here) are less likely to invalidate an option exercise.

While this case is from the Ninth Circuit and therefore not binding on California courts, the holding seems to be consistent with California authority.

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