Smyth vs. Berman (Cal.App.) – Holdover Tenant Cannot Invoke Right of First Refusal Contained in Expired Commercial Lease

The following is a case update prepared by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, analyzing a recent decision of interest:

SUMMARY:

A California appellate court has held that a holdover tenant cannot invoke a right of first refusal that was contained in an expired commercial lease. [Smyth vs. Berman, 2019 Westlaw 156761 (Cal.App.).]

Facts: A landlord and a commercial tenant executed a lease. The tenant added a handwritten notation, “Right of 1st refusal to purchase.” Both parties initialed that notation. The lease also provided: “If the Tenant remains in possession after this lease ends, the continuing tenancy will be from month to month.”

Following the expiration of that lease, the tenant remained in possession and continued to pay rent on a monthly basis. The landlord entered into a purchase agreement with a third party. Just before the new purchaser recorded the deed to the property, the tenant brought suit against the landlord and the purchaser, asserting claims for breach of contract and fraud. The trial court eventually sustained the defendants’ demurrers without leave to amend, and the tenant appealed.

Reasoning: The court affirmed, stating the issue: “If the expired lease contained a right of first refusal, is that right one of the ‘terms’ that presumptively carries forward into the holdover tenancy?” The court answered the question in the negative, holding that 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 the payment of rent. Purchase options and rights of first refusal are not carried forward into the holdover tenancy:

Of course, the parties to a lease certainly have the power to rebut the general presumption that a right of first refusal does not carry forward into a holdover tenancy by expressing a contrary intent . . . . But [the landlord and the tenant] did not do so in the . . . Lease, which merely provided that any “continuing [holdover] tenancy will be from month to month.” This holdover provision does not incorporate, or even mention, the right of first refusal or, for that matter, any other term of the . . . Lease.

The court also invoked public policy in support of its result:

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.

The court observed that although there is a split of authority on this issue throughout the nation, the weight of authority was in support of the result reached in this case.

The tenant also argued that an exchange of emails between the parties showed an intent to carry forward the right of first refusal into the holdover period, but the court disagreed, reasoning that the landlord never expressed an intent to be bound by that provision.

Author’s Comment: This has to be the right result, but the pertinent California statute is not very clear. Civil Code §1945 provides:

If a lessee of real property remains in possession thereof after the expiration of the hiring, and the lessor accepts rent from him, the parties are presumed to have renewed the hiring on the same terms and for the same time, not exceeding one month when the rent is payable monthly, nor in any case one year.

There is California Supreme Court authority for the proposition that §1945 only encompasses “essential” terms” of the leasehold, which does not include purchase options; but the statute says that the holdover will be “on the same terms” as the original lease. The modifier “essential” does not appear. Since this problem has now been resolved by case law, I doubt whether an amendment of the statute is needed; but the wording is troubling.

Given the phrasing the statute, I wonder if it would make sense to include a limiting description in the original lease:

“If the Tenant remains in possession after this lease ends, the continuing tenancy will be from month to month; provided, however, that any purchase option or right of first refusal held by Tenant under this lease will not carry forward into any period of holdover possession.”

It may also be a good idea, from the standpoint of the prospective purchaser, to obtain an estoppel certificate from existing tenants, in order to preclude last-minute assertions of alleged rights of first refusal. Leases often contain provisions requiring tenants to respond to timely demands for estoppel certificates. For a discussion of a case involving that issue, see 2004 Comm. Fin. News. 15, Estoppel Certificate That Does Not List Options but Incorporates Lease Containing Renewal Option Is Ambiguous and May Not Estop Tenant from Renewing.

For discussions of other cases involving holdover tenancies, see:

• 2018-15 Comm. Fin. News. NL 30, Guarantor of Original Sublessee’s Obligations to Sublessor Is Not Liable for Successor Sublessee’s Unpaid Holdover Rent, Even Though Guarantee Applied to “Any Holdover Term.”
• 2016-05 Comm. Fin. News. NL 10, Foreclosure Purchaser’s Eviction of Holdover Homeowner Does Not Violate Automatic Stay in Bankruptcy Because Unlawful Detainer Judgment Terminated Former Homeowner’s Possessory Rights.

These materials were written by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, for his Commercial Finance Newsletter, published weekly on Westlaw. Westlaw holds the copyright on these materials and has permitted the Insolvency Law Committee to reprint them.