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Lease/Option Agreements: How to Make Sure
Your Option to Purchase Is Not an Illusion

Tenants are sometimes able to negotiate an option to purchase in connection with their lease. Occasionally they are even able to negotiate a provision that all or a portion of the rent payments will apply to the purchase price. Options of this kind are most commonly found in leases of single-user improved property, such as restaurants or manufacturing plants, or in leases of single-family residential properties. This can be an important and valuable provision for the tenant, especially if he has a special need for the particular property.

If the landlord fails to honor the option, the tenant has to look to his legal remedies. Generally, the tenant has two kinds of remedies available in which the landlord breaches an option: (1) damages, and (2) specific performance. Unless the tenant has one or both of these remedies available, the option is nothing more than an illusion that depends solely on the good will of the landlord.

If the tenant seeks to recover damages, he is entitled to recover the difference between the option price and the fair market value of the property at the time the option is exercised. In some cases, this is an adequate remedy. In other cases, however, this is totally inadequate, particularly if the tenant has a special need for the property. Damages are also inadequate when the option price is the same or higher than the market price because in the eyes of the law there are no damages. Therefore, it is critical for the tenant to have specific performance available as one of his remedies.

Specific Performance
Specific performance means that the court orders the breaching party to perform the contract as written. If he does not, the court can enforce its order by the contempt power--that is, the court can put the party in jail until he complies with the court's order. This is usually enough to persuade a reluctant landlord that he should comply with the terms of the option.

Unfortunately, the tenant's efforts to obtain specific performance to enforce his option are often frustrated. The reason is usually that the option is legally incomplete. In order to qualify for specific performance, an option must contain all the essential terms of the deal. The courts like to say that they will not write a contract for the parties, which means that they will not order a party to perform a contract unless all the material terms of the contract are specified.

This kind of legal deficiency is usually not a problem when the parties enter into a contract for sale, as opposed to a lease. The parties to a sale typically go to great lengths to write out all sorts of detailed provisions: who pays the closing costs, how any deferred balance of the purchase price is to be structured, whether there are any warranties and if so what they are, who is responsible for risk of loss prior to the closing, what the status of title is to be, and so on. As a result, specific performance is usually available to enforce a sales contract. On the other hand, when the parties insert an option in a lease, there is a tendency to specify little more than the price, payment terms, means of exercise, and closing date. For whatever reason, the parties to a lease/option contract often seem to leave out many of the important details found in a real estate purchase contract. As a result, they often lose the remedy of specific performance.

The failure to specify all the details does not necessarily mean the option is unenforceable, however. If the major terms are specified, there could be enough to sustain an action for damages, even though there may not be enough for specific performance.

To make sure your option qualifies for specific performance, include all of the things a purchaser and seller would normally put in a real estate purchase. Clearly the price, payment, terms, and the closing date must be specified. But this is not nearly enough. The contract should also specify the condition of title, type of deed, closing costs, warranties, indemnifications, title insurance, prorations, and other typical terms found in a sales contract. A good approach is just to do a separate purchase contract and attach it to the lease as an exhibit, stating that if the option is exercised, the terms of the purchase contract will govern the sale.

If you are negotiating an option to purchase as part of your lease, be certain to include all the terms you would have in a purchase contract. Do not simply insert a short paragraph specifying the price, terms, and closing date, or you risk losing the important remedy of specific performance, and perhaps even the remedy of damages, leaving you with an illusory option.

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