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Can a Holdover Commercial Tenant Hold On to a Right of First Refusal?

In California, a holdover tenant (a tenant who remains in possession after the expiration of the written lease) has fewer rights than a tenant operating under a lease.

Several months ago, Money and Dirt covered a recent Court of Appeal opinion holding that a holdover tenant operating a medical clinic could not recover damages from a commercial landlord after raw sewage destroyed expensive medical equipment at the leased premises.  See that prior post here: Commercial Landlord Not Liable to Holdover Tenant for Damages on the Leased Premises.  In that opinion, the court held that the holdover tenant had only a right of “naked possession,” and no longer had property rights arising from the terminated lease.

More recently, another Court of Appeal opinion from California’s Second Appellate District — Smyth v. Berman — addressed whether a holdover tenant could assert a right of first refusal to purchase the leased property.

Facts: holdover tenant asserts lease right of first refusal

The tenant, James Smyth, operated an audio recording company at the leased commercial property on Cahuenga Boulevard in North Hollywood.  Smyth began leasing the property in the mid-1990s, and in 1999 he bought the property next door as his residence.  Also in 1999, Daryl Ann Berman bought the commercial property and became Smyth’s landlord.

The parties signed their most recent written lease in 2011.  Under the lease’s written terms, the lease would expire in December 2012, but contained an option to renew the lease for an additional three years.  The lease also contained a handwritten right of first refusal, initialed by both parties.

By 2016, the lease had expired and Smyth remained in possession as a holdover tenant.

In June 2016, a third party submitted a written offer to buy the property from Berman.  Smyth objected to the sale, and submitted his own offer to purchase the property pursuant to the expired lease’s right of first refusal.

Berman rejected Smyth’s offer and sold the property to the third party.  Smyth sued.

Trial court’s ruling: case dismissed

The trial court sustained Berman’s demurrer to Smyth’s complaint without leave to amend and dismissed his case.  The court held that Smyth no longer had a right of first refusal by 2016 because he was a holdover tenant.

Court of Appeal’s Opinion: affirmed; right of first refusal expired when the lease expired

The Court of Appeal affirmed the trial court’s judgment.

The court held that when a written lease expires and the tenant remains in possession as a holdover tenant, the relationship of the landlord and tenant “changes.”  Specifically, “the only terms from the expired lease that are presumed to carry forward into a holdover tenancy are the ‘essential’ terms of that lease” such as the “amount and time of payment of rent.”

The court noted that other decisions have held that an option to purchase property set forth in a lease was a “separate and distinct right and power that was not an essential covenant of that lease” and did not carry forward into the holdover tenancy, and that a right of first refusal “is a species of option to purchase.”  Unless the evidence shows that the parties intended such a right to carry over into the holdover tenancy, it will expire with the lease.

The court also relied on the public policy favoring the stability of commercial tenancies.  The court observed:

Holdover tenancies exist to ensure stability because they are a mechanism by which tenants may remain in possession without disruption, albeit typically only on a month to month basis. … If a right of first refusal presumptively carried forward into a holdover tenancy, a landlord wishing to nullify that right could easily do so by evicting the holdover tenant and selling the property one day later, both of which would be within its rights as the landlord of a holdover tenant. This ‘creates an incentive for landlords to evict holdover tenants as soon as possible’ …, a result at odds with the stability of commercial tenancies. The contrary rule that carries such purchase options forward only if the parties so specify avoids this result, thereby making holdover tenancies more stable.

Lesson

Under the Smyth v. Berman opinion, unless the landlord and tenant agree otherwise, a right of first refusal — just like an option to purchase — will expire when the lease expires.  A holdover tenant cannot enforce a right of first refusal from the expired lease.

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