Lease renewal options explained

Beware the distinction between a 'right of first refusal' and 'an option' in lease agreements when renewing a lease, warns Erika Petersen in Shepstone & Wylie's latest commercial law review.

"It is well-known in the context of a right to purchase a leased property, but is equally important when renewing and may determine whether the renewal is enforceable of not," she says.

A right of first refusal is often worded as follows: "The tenant has the first refusal of renewing this lease for a further period of 1 year upon such terms and conditions and at such rental as may be mutually agreed upon. If the tenant wishes to exercise such right, he must give the landlord 3 months' notice prior to the expiration of this lease of his intention to do so."

An option to renew a lease may be phrased as follows: "The tenant may renew this lease for a further period of 1 year upon such terms and conditions and at such rental as may be mutually agreed upon. If the tenant wishes to exercise such right, he must give the landlord 3 months' notice prior to the expiration of this lease of his intention to do so."

What is important is that the first clause is enforceable by the tenant but the second is not. In an option to renew, where the clause does not stipulate the rental for the renewal period, the clause constitutes an "agreement to agree" and is unenforceable.

She adds that a right of first refusal, however, does not require rental to be stipulated in the renewal clause.

The grantor of such a right of first refusal cannot be compelled to renew the lease but, on expiry or termination of the current lease, he may not lease the property to any third party without first offering the property to let by the existing tenant who holds the right of first refusal. This right exists even where rental is not stipulated in the renewal clause.

"It is of course inevitable that the landlord must state a rental when offering the renewal to the tenant. It is then up to the tenant to accept or refuse such offer," says Petersen.

She adds that the landlord may not then rent the property to a third party unless the rental offered to the third party is at least equal to or more than that offered to the existing tenant.

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