Form-of-the-week: Option, and Exercise of Option to Renew/Extend Lease – Form 565 and 566

Grant of an option to renew/extend a lease

Tenants frequently negotiate lease agreements with provisions or addendums which, on proper notice, allow the tenant to continue in lawful possession of the unit after the initial lease term expires. A prior agreement allowing continued occupancy of a rented premises is called an option to renew/extend a lease. [See RPI Form 565]

For a commercial or residential tenant, a lease renewal/extension option is a financial imperative. The option gives the tenant time to determine whether:

  • the economic and financial conditions of their trade or business (or residency) at this location favor continued possession, and thus they are to exercise the option and remain; or
  • the premises is not what they need for the future and, being under no obligation to exercise the option, they are to vacate the premises on expiration of the lease.

Thus, the well-informed tenant at the instruction of their agent will consider negotiating an option for one or more consecutive renewal/extension periods when entering into a lease agreement rather than agreeing to a singular long-term lease. The tenant is under no obligation to exercise the option, and benefits greatly from the added flexibility. [See RPI Form 565]

The landlord also benefits from an option to renew/extend. A renewal option encourages a tenant to enter into the lease since it affords the tenant has the right to continue in possession if the property proves beneficial to their business. Additionally, the renewal/extension option encourages improvements and promotion of the location by the tenant in anticipation of being able to remain in possession. Thus, the option is both an inducement to let and an inducement to stay.

Renew vs. extend

A technical, but very critical, distinction exists between the renewal and extension of a lease.

An extension stretches out of the original lease term while retaining all aspects and conditions created by the original lease agreement. On exercise of the option to extend, the original termination date for vacating stated in the lease agreement is modified as provided in the option provisions, extending the term for the additional period.

Alternatively, a renewal requires the tenant and landlord to enter into a new lease on identical conditions to the original lease agreement. Thus, a renewal is not a continuation of the old lease. [In re Marriage of Joaquin (1987) 193 CA3d 1529]

A renewal involves the preparation and signing of a new lease which creates an entirely new and thus different tenancy. The new tenancy is subject to any change in law affecting the rights and obligations of the landlord or the tenant since entering into the original lease agreement. More importantly, the new lease is subordinate to any encumbrances — mortgages, judgments or tax liens — which the landlord caused to be recorded during the term of the prior lease. This creates a precarious situation for the tenant since the landlord can give others rights which have priority over the new lease agreement — rights to the property sandwiched into title between the landlord’s fee rights and the tenant’s rights to occupancy.

Alternatively, an extension merely modifies the original lease by extending its expiration date. Thus, the modified lease is not subject to changes in the law or encumbrances occurring during the term of the original lease. [See RPI Form 550 – 552-4]

Quite often, however, everyone involved carelessly uses the terms interchangeably. In doing so, they neglect to maintain clarity of purpose, legal rights and the paperwork involved.

For instance, a lease agreement granting the tenant an “option to renew” which does not specify the manner or method for exercise of the option and does not call for the signing of a new lease is considered an extension of the original lease agreement. As a result, the provisions and conditions created by the original lease apply to the continuing tenancy on exercise of the option, but with a new expiration date by modification. [In re Marriage of Joaquin, supra]

The Option to Renew/Extend Lease form published by RPI (Realty Publications, Inc.) is used by a leasing agent or landlord when negotiating a residential or commercial lease agreement. It is used as an addendum in which the landlord grants to the tenant the option to either extend possession under the original lease agreement or renew under a new lease agreement on the same conditions as the expiring lease. [See RPI Form 565]

Exercise of the option

When the tenant makes the decision to exercise a lease renewal/extension option, the tenant needs to properly notify the landlord of their unqualified intention to renew or extend the lease on the terms contained in the option. The notice needs to be timely delivered to the landlord, and be unequivocal and precise in its terms for the specific period offered in the option. If the notice is lacking these critical elements, it is ineffective and may be ignored by the landlord. [See RPI Form 566]

Also, when the renewal/extension option agreement specifies the steps to be taken and the time period in which they are to occur to properly exercise the option, the tenant must strictly comply. If the tenant fails to perform any of the steps outlined in the option agreement, the option is not exercised and the lease will expire at the end of its original term. [Bekins Moving & Storage Co. v. Prudential Insurance Company of America (1985) 176 CA3d 245]

Usually, the tenant is required to give written notice of their exercise of the option several months before the current term of the lease expires — typically a period of time ending three to six months before expiration of the original lease.

Advance notice requirements give the landlord ample time to locate a new tenant if the present tenant elects not to renew/extend the lease.

The option provisions further state the method for delivery of the tenant’s notice of their intent to exercise the option to renew/extend. Notice of exercise is to be provided in writing and personally handed or sent by certified mail to the landlord within a specific window period of time, such as three months, which closes three to six months prior to the expiration of the current lease term. [See RPI Form 566]

If notice is to be delivered by certified mail, the risk of the notice being lost in the mail is on the landlord. When a receipt for certified mail is issued by the post office, the tenant is no longer responsible for its physical delivery to the landlord. It is unnecessary to request a return receipt. [Jenkins v. Tuneup Masters (1987) 190 CA3d 1]

The tenant’s failure to timely comply with delivery of a written notice of exercise to the landlord within the window period for exercise of the option causes the lease to automatically expire at the end of its term. To prevent an unintended expiration of a lease (and loss of an additional fee), the tenant’s broker is advised to prepare and hand the tenant an exercise of option to renew/extend lease form or make one available to the tenant during the window period for exercise of the option. [See RPI Form 566]

The Exercise of Option to Renew/Extend Lease form published by RPI is used by a tenant or their agent, when they hold an option to renew or extend their lease term, to exercise their option to occupy for the additional term. On proper delivery, it informs the landlord of the tenant’s intent to exercise the renewal/extension option on its terms and conditions, without qualification or equivocation. [See RPI Form 566]

The Exercise of Option to Renew/Extend Lease form provides the tenant with the paperwork needed to exercise the option.

Editor’s note — Another step or activity may be called for in the option which is requisite to the exercise of the option, such as the landlord requiring a substantial renovation of the leased premises in a certain year as a condition to exercising the option to renew. If such an activity or step is required, it needs to be performed or properly addressed in the form used to exercise the option.

Typically, the broker’s fee arrangement on the original lease calls for a fee on any extension or renewal of the lease. Not only is the exercise by the tenant a benefit for the tenant, the leasing agent benefits by earning an additional fee for the renewal/extension. [See RPI Form 113 §2.2 and 3.1]

Notice of option’s expiration

A leasing agent who negotiates an option to renew or extend on behalf of a tenant needs to consider arranging for the inclusion of a notice provision in the option that requires the landlord to give the tenant notice of the option’s expiration 60 to 180 days prior to the expiration of the option period for exercise.

This notice from the landlord to the tenant of expiration of the option eliminates the element of surprise for both the landlord and tenant.

The tenant’s inadvertent failure to exercise the lease renewal option can prove disastrous for the tenant who plans to continue in occupancy after the expiration of the original lease term.

If the landlord will re-rent the premises to the existing tenant despite the tenant’s failure to exercise a renewal/extension option, the tenant will be forced to negotiate the terms of a new lease under the then existing market conditions. Thus, the landlord may be in a position, if availability of space has become extremely tight, to take unconscionable advantage of the tenant, an over-reach situation the landlord is to be careful to avoid.

Further, renegotiation of rent and lease terms on expiration of a lease can result in increased rental rates, higher common area maintenance fees and other landlord charges, or changes in responsibilities imposed on the tenant if the landlord choose to negotiate a lease with the holdover tenant whose option to renew/extend expired unexercised. [Bekins Moving & Storage Co., supra]

Thus, a tenant’s broker needs to inform their tenant as to when and how the renewal option is to be exercised, and then provide the tenant with the necessary forms. [See RPI Form 565 and 566]

565-1565-2566