• Options: Renewal At "Market Rental Rate" Too Vague To Be Valid
  • July 15, 2003 | Author: Harris Ominsky
  • Law Firm: Blank Rome LLP - Philadelphia Office
  • In some states an option to renew a lease at the "then existing market rental rate for comparable shopping centers" is too vague to be enforceable. Even when that formula is used as part of the stated standard for calculating rent, the vagueness may taint the whole option so that the tenant loses its right to renew the lease. In the case of AMB Property, LP v. MTS, Inc., 551 S.E. 2d 102, (Ga. App. 2001) cert. den. 2002, a Georgia court of appeals ruled that when one part of an "either-or" formula is too vague, the entire provision is void.

    "Market Rental Rate"

    MTS, Inc. had leased space for 10 years and 5 months, with a five-year renewal option. That option provided that the new rent "shall be the greater of (a) base rent for the last year of the original term; or (b) the then existing market rental rate for comparable shopping centers." When the tenant exercised the renewal option, the landlord set the rent at $29.50 per square foot, which it claimed was comparable to the rent charged in other shopping centers. The tenant objected and requested a declaratory judgment to have the "market- rental-rate" language severed, and therefore base the renewal rent on the rent for the last year of the original term as set forth in the first part of the rental formula.

    The trial court supported the tenant's argument that the second part of the renewal option was unenforceable because it was too vague. Therefore, it concluded that the alternative standard for the rent would apply, i.e. the rent at the end of the initial term.

    When the landlord appealed, the court of appeals reversed, and held that although alternative (b) of the renewal option was unenforceable, it was an integral part of the lease agreement and could not be severed because it provided a formula for determining the rent. The use of the words "the greater of" in the provision shows an intent that the pricing be used as an integrated formula requiring that two components be compared. Removing one component destroys the formula. The court held that this results in a pricing provision radically different from the language agreed to by the parties and, therefore, no renewal was available to the tenant.

    The court stated:

    . . . Rather than being assured that the renewal rental rate would not be less than the current market rental rate, the landlords under the modified provision are required to accept a rate applicable to the original term. Although they originally negotiated that the last year's rental rate would be the floor or minimum rent for the renewal, under the trial court's order, that has suddenly become the ceiling also.

    Unintended Consequences

    This decision emphasizes the rule of unintended consequences. From the landlord's perspective, by insisting on a renewal option which included a market-rent-rate formula as an alternative, it inadvertently provided the tenant with a renewal option that was not even enforceable.

    One could test the implications of the decision by looking at it from the perspective of a devious landlord who wants to avoid being stuck with renewal options. It could simply negotiate an option that has a vague formula. By that strategy, the landlord could sign up a 10-year tenant without the burden of an unwanted option. In effect, the formula gives the landlord a veto over the renewal option.From the tenant's perspective, the tenant who wanted to renew but held out for paying rent based on the rent for the last year of the original term, as set forth in the (a) section of the formula, could be literally "betting the store" by not accepting the landlord's computation of "market rental" under the (b) portion of the formula. By that tactic, the tenant in AMB Property lost the right to renew on any terms.

    Suppose a tenant in negotiating a lease, had tried to negotiate an alternative renewal rent in its favor. For example, a tenant sometimes asks for a renewal rate at a set rental or in the alternative, the "then existing market rental rate, if that is less." Unlike the MTS, Inc. formula, this formula would be to the tenant's advantage because the rent would be based on the lower of two alternatives, rather than on the "greater of" those alternatives . Based on the reasoning of the AMB Property case, that formula would still be considered vague and unenforceable. Therefore, by pushing for a better renewal rent, the tenant would have negotiated itself out of the renewal option at any rent.

    That only goes to illustrate the old expression, "be careful about what you wish for, because your wish may come true."

    When prices or rentals are based on a "fair market value," courts will differ on whether that language is too "indefinite, uncertain and incomplete" to be enforceable. Generally, courts will honor that provision if the document also contains a method to resolve the issue, such as through a designated appraisal or arbitration procedure.

    The MTS decision probably would have gone the other way in Pennsylvania because Pennsylvania is one of the jurisdictions that tend to enforce "fair-market-value" provisions. See Harris Ominsky, Real Estate Practice, Breaking New Ground, pages 25-27, 402-404 (Pennsylvania Bar Institute 2000). However, the main lesson from the case is that parties who use "fair-market" formulas may be unnecessarily setting themselves up for future conflict. Also, if they must use such a standard, they should be careful to spell out how that value may be determined in some objective way, and who will make that determination if the parties are unable to agree.