Dancing Around Landlord-Tenant Lease Problems: Options to Renew Under California Law

The real estate market is surging across the nation, and California is no different. Real estate in California is expensive, and many tenants can keep their valuable space with favorable lease terms by exercising an option to renew a lease for consecutive, multi-year terms. But what happens when a poorly drafted lease – or a boilerplate lease incorrectly filled out by the parties — causes an ambiguity or omission of the tenants’ renewal rights? Poorly drafted leases (and clients declining to confer with attorneys before executing the lease) leave both parties to learn “the hard way” and potentially incur significant litigation fees.

Common requirements to exercise an option to renew

An option to renew (or extend) a lease allows the tenant to continue to lease a property if the tenant exercises its right to renew before the expiration of the current lease term. Landlords commonly require that the tenant is not in breach of the lease agreement and gives notice of the election to renew by a specified date. See, e.g., Howell v. Hamburg Co. (1913) 165 Cal. 172, 177. The tenant must give notice of intent to renew in unequivocal and unqualified terms. See Hayward Lumber & Inv. Co. v. Construction Prods. Corp. (1953) 117 Cal.App.2d 221, 227-228. Notice to the landlord is dictated by the terms in the lease, and landlords in California rarely require more than six months’ notice. But landlords should not overlook the need for all tenants to exercise renewal rights or have written authority to bind other tenants. See Jeffrey Kavin, Inc. v. Fyre (2012) 204 Cal.App.4th 35, 45 (finding that one tenant does not have authority to bind co-tenants to an option to renew, and the landlord cannot unilaterally waive these contractual provisions).

A lease should not last forever and parties cannot contract to agree in the future

Having clear requirements protects both parties’ intentions and provides the framework for an uncontested renewal of a lease. But even with these terms, disputes occur when an option to renew for successive, additional periods fails to limit the number of renewals. Here, the tenant argues that it can exercise its renewal right indefinitely; the landlord claims that the ambiguous language should be construed as allowing only one extension period or the right to renew should be unenforceable. In Ginsberg v. Gamson (2012) 205 Cal.App.4th 873, the court of appeal noted that a “general” covenant to renew – or a provision lacking clear and explicit language – will be construed as providing only a single renewal. See id. at 895. The court of appeal’s decision was welcomed by landlords, as it reversed the trial court decision providing the tenant unlimited five-year extensions for 99 years! In California, indefinite or perpetual lease terms are disfavored and are likely to be unenforceable. Despite being disfavored, courts will enforce a lease provision that grants a tenant the right to unlimited renewals, so long as the parties’ intent to create that right is explicit and clear. See Becker v. Submarine Oil Co. (1921) 55 Cal.App. 698, 700 (discussing that if a lease is to be perpetually renewed is at all uncertain, it “will be construed as importing but one renewal.”)

Secondarily, it is well-established in California that a contract to agree in the future is unenforceable. More specifically:

Although a promise may be sufficiently definite when it contains an option given to the promisor or promisee, yet if an essential element is reserved for the future agreement of both parties, the promise can give rise to no legal obligation until such future agreement. Since either party by the terms of the promise may refuse to agree to anything to which the other party will agree, it is impossible for the law to affix any obligation to such a promise.

Ablett v. Clauson (1954) 43 Cal.2d 280, 284-85 (citing 1 Williston, Contracts (Rev. ed. 1936) 131, § 45). Several courts have found that an option agreement which leaves an essential term to future agreement is not enforceable. See id; e.g., Morrison v. Rossignol, (1855) 5 Cal. 64, 65-66; cf. Los Angeles Soda Works v. Aquazone Co. (1930) 103 Cal.App. 105, 108.

The primary analysis is whether certain language, or other compelling indications from the parties, shows that the parties reserved an essential element for future agreement. When conducting this analysis and interpreting contractual rights, courts look at the “four corners” of the contract and will not consider evidence outside the parties’ written agreement. See Riverisland Cold Storage, Inc. v. Fresno-Madera Credit Assn. (2013) 55 Cal.4th 1169, 1174-75. The parol evidence rule, codified in California Code of Civil Procedure § 1856 and Civil Code § 1625, precludes extrinsic evidence to be relied upon to alter or add to the terms of the writing. If the lease has an integration clause but no other language supporting the need for a future agreement – such as the new base rent and other obligations in effect during the renewal period – the court may find the option to renew enforceable, and that the contractual terms must include the same terms and conditions as the original lease term.

The Tenant’s Hope: Paying the same rent for several years

A tenant may exercise an option to renew solely because no additional terms were drafted into the lease, thereby allowing the tenant to declare that it can continue its tenancy under the same terms as the original lease. In the 1927 case of Penilla v. Gerstenkorn (1927) 86 Cal.App. 668, the lease gave the tenant a right of renewal at the end of a four-year term without additional language regarding the base rent during the renewal period. The court agreed with the tenant and enforced the renewal period under the same terms because the lease included no evidence that a different rental amount was intended. The lease therefore created a right to renew the tenancy for the specified term on the same terms as the original tenancy, including the amount of rent. See id. at 671-72. That the rental value of the property had increased since the lease was executed was immaterial to the court’s decision. Id. Thus, in this situation, a landlord’s complaint that the rent must be raised, or that the renewal period requires additional terms that have yet to be negotiated, may be rejected by a court.

The Landlord’s Response: The option to renew without more terms is unenforceable

When landlords argue that an option to renew is unenforceable, they commonly rely on case law authority known as Ablett and Etco. Despite their fault in offering a lease with ambiguous or omitted terms, landlords argue the lack of ascertainable standards for determining rent for the renewal period preclude enforceability of the option to renew. In making such arguments, landlords commonly ignore that the lease has no language suggesting the rent for the renewal period was left for future negotiation.

Ablett involved an option to renew a lease for five years “upon terms to be then agreed upon.” Ablett, 43 Cal.2d at 281. The court discussed that the original lease was nine pages with 17 separated numbered clauses. The only terms fixed by the option provision for the new lease was the duration. Under those circumstances, the terms of the option were “too uncertain to make it enforceable as a contract right.” Id. at 286. The California Supreme Court in Ablett also stated that the landlord may be estopped from denying an “absolute option to renew upon the same terms and conditions as provided by the original lease.” This proclamation, although primarily immaterial to the result in Ablett, cannot be taken lightly by landlords. If there are factual circumstances or a course of conduct between the landlord and tenant suggesting the tenant may have estoppel claims against landlord, it may gravely affect the arguments and defenses invoked by the landlord.

The Etco case followed Ablett and concerned the court’s ability to determine the base rent for a renewal period. The court concluded “a provision for renewal of a lease at a rent to be determined in the future is enforceable, absent agreement of the parties, only if the lease agreement contains an ascertainable standard for the determination of such rent.” Etco Corp. v. Hauer (1984) 161 Cal.App.3d 1154, 1161. The Etco court highlighted the reasonableness of its opinion, as follows:

More recently, in holding unenforceable a provision that rent for a renewal period was “to be agreed upon,” the court in Joseph Martin, Jr., Delicatessen, Inc. v. Schumacher, supra, 417 N.E.2d 541, stated: “This is not to say that the requirement for definiteness in the case before us now could only have been met by explicit expression of the rent to be paid. The concern is with substance, not form. It certainly would have sufficed, for instance, if a methodology for determining the rent was to be found within the four corners of the lease, for a rent so arrived at would have been the end product of agreement between the parties themselves. Nor would the agreement have failed for indefiniteness because it invited recourse to an objective extrinsic event, condition or standard on which the amount was made to depend.”. . . Since the lease provision in this case contains no ascertainable standards for determining rent for the renewal period, it is unenforceable.

See id. at 1161.

In Chaney v. Schneider, a California court found the agreement to renew the lease was of the essence of a contract, and when the parties could not agree as to the amount of rent at the time of the extension, the court would determine the rent. See Chaney v. Schneider (1949) 92 Cal.App.2d 88, 91. The court’s right to equitably fix a reasonable rental rate under an option provision was later questioned (but not overruled) by Ablett. This case, however, may not be persuasive without a tenant conducting substantial improvements as those actions allowed the court to find that the tenant should not lose its investment in the property because additional terms of the renewal period were not outlined in the original lease. The circumstances in Chaney are more consistent with the view that the lessor was estopped from denying the lessee had an absolute right to renew the lease under the facts of that specific case, rather than with a broad view that option provisions without ascertainable standards for determining rent can generally be enforced.

Without language expressing the parties’ intention to make a future agreement, these cases demonstrate that a court may allow an increase in rent during the renewal period, at best. But a landlord’s conclusion that these cases should lead a court to strike the option to renew as unenforceable seems to be wishful thinking.

Conclusion

The specific language in the contract is important. If a lease requires material terms to be negotiated and agreed to in the future, the option to renew is probably not sufficiently clear and therefore unenforceable. Where only the base rent was left undetermined, California courts have split their decisions between determining a “reasonable” rate, enforcing the methodology or process required by the lease to determine the base rent (such as using a third party or arbitrator to determine the rent, if it cannot be agreed to by the parties), or finding the option to renew unenforceable because it did not include sufficiently definite terms regarding the base rent. Clients with contracts and leases in California should be mindful of these case law decisions when negotiating contractual terms. Tenants not understanding that a future agreement could be found unenforceable may have a false sense of hope while investing significant resources into their leased space. And on the other hand, a court is unlikely to sympathize with a landlord that failed to draft language in a lease when it had the opportunity to do so.

Ethan Birnberg is licensed in California, Nevada, Colorado, and Wyoming and was named a 2020 Northern California Super Lawyer. He regularly assist clients with all types of asset sales, acquisitions, and real estate issues, including landlord/tenant matters, lease formation and construction issues, and HOA disputes. He holds dual certifications as a business bankruptcy and consumer bankruptcy specialist from the American Board of Certification, and has extensive insolvency experience assisting entities seeking to restructure under chapter 11 of the U.S. Bankruptcy Code, borrowers and lenders seeking out-of-court workouts, representing chapter 7 trustees, and advising directors, officers, and executive management regarding fiduciary duties and corporate governance issues. He can be reached at birnberg@portersimon.com.