Tenant Not in Possession Cannot Rely on Equitable Rule Allowing for Late Renewal of Commercial Lease

On October 27, 2020, Justice Emerson of the Suffolk County Commercial Division issued a decision in SVC W. Babylon LLC v. 204 Great E. Neck Rd. LLC, 2020 NY Slip Op. 20289, holding that a tenant not in possession cannot rely on an equitable rule allowing for the late renewal of a commercial lease, explaining:

Contrary to the plaintiff's contentions, Baygold Assoc., Inc. v Congregation Yetev Lev of Monsey, Inc (19 NY3d 223), upon which the defendant relies, is directly on point. In J. N. A. Realty Corp. v Cross Bay Chelsea, Inc. (42 NY2d 392), the Court of Appeals held that equity will intervene to relieve a commercial tenant's failure to timely exercise an option to renew a lease when (1) such failure was the result of inadvertence, negligence, or honest mistake, (2) the nonrenewal would result in a forfeiture by the tenant, and (3) the landlord would not be prejudiced by the tenant's failure to send, or its delay in sending, the renewal notice. The issue in Baygold was whether an out-of-possession tenant was entitled to equitable relief excusing its failure to timely exercise an option to renew a commercial lease. The Court of Appeals answered that question in the negative.

Like the plaintiff in this case, the plaintiff in Baygold ("Baygold") had a ground lease with the owner of the premises and subleased the premises. The ground lease, which was for a term of 10 years, gave Baygold the option to extend the lease term for four additional 10-year periods. Baygold failed to comply with the lease-renewal provision. The Court of Appeals found that Baygold had failed to meet the second prong of the J. N. A. Realty test, i.e, that the nonrenewal would result in a forfeiture by Baygold. The Court explained that the forfeiture rule was crafted to protect tenants in possession who make improvements of a substantial character with an eye toward renewing a lease, not to protect the revenue stream of an out-of-possession tenant like Baygold. The Court found that Baygold's improvements to the premises, which were made between 1972 and 1985 when Baygold was a tenant in possession, were not made with a view toward renewal of the lease and were too attenuated from Baygold's failure to exercise the option over 20 years later. The Court explained that its holding in J.N.A. Realty is restricted to tenants who make considerable investment in improvements to the premises in anticipation of the lease renewal or would lose a considerable amount of customer goodwill should the lease not be renewed. It was never intended to apply in circumstances where an out-of-possession tenant fails to make any improvements in anticipation of renewal and does not possess any good will in a going concern.

The plaintiff in this case, SVC West Babylon LLC ("SVC"), contends that it has expended substantial sums of capital (approximately $2.4 million) to acquire its leasehold interest in the property and to manage, maintain, and repair the property (approximately $35,000). SVC contends that the loss thereof is sufficient to satisfy the second prong of the J. N. A. Realty test.

SVC is an out-of-possession tenant whose investment in the property consists of the $2.4 million purchase price for the CVS Ground Lease. SVC's investment in the property was not made in anticipation of renewal of the CVS Ground Lease. It was made to acquire the CVS Ground Lease with the expectation that SVC would derive revenue from possessing a long-term lease. The forfeiture rule was not crafted to protect the revenue stream of an out-of-possession tenant like SVC. The additional $35,000 that SVC spent to manage, maintain, and repair the property was not spent on improvements to the property in anticipation of the Ground Lease's renewal either. The record reflects that it was spent on maintenance and repairs for which SVC was responsible under the CVS Ground Lease. Even if the court were to attribute the improvements made by Berkshire to the plaintiff, they were not made with a view toward renewal of the lease and were too attenuated from the plaintiff's failure to exercise the option 20 years later.

Relying on Souslain Wholesale Beer & Soda v 380-4 Union Ave. Realty Corp. (166 AD2d 435), SVC contends that a plaintiff's loss of its investment in the acquisition of a business is sufficient to satisfy the second prong of the J. N. A. Realty test. In Souslain, the plaintiff was a tenant in possession who purchased a wholesale beer and soda business from the defendant landlord seven years before. The Second Department held that the plaintiff's default in renewing the lease would result in a substantial forfeiture of the plaintiff's investment in the purchase of the business. In Souslain, the plaintiff had good will in a going concern, unlike SVC, who will not lose any customer good will if the lease is not renewed. This is not a case in which the business location itself is a valuable asset and SVC stands to lose customer goodwill associated with that location. The goodwill that a tenant has created among its subtenants is not of the sort that creates an equitable interest in the leasehold, as the rule protects the tenant's interest in a long-standing location for a retail business. SVC does not own or operate the CVS pharmacy located on parcel A. It merely subleases parcel A to CVS West Babylon, LLC.

SVC contends that no appellate court has interpreted Baygold to require that the tenant must be in possession in order to seek equitable relief. In several of the cases on which SVC relies, however, the tenant was in possession of the premises. In Laundry Mgt.—N.3rd St. Inc. v BFN Realty Assoc., LLC(179 AD3d 776), the plaintiff tenant operated a laundromat on the premises owned by the defendant landlord. In Robert B. Jetter, M.D., PLLC v 737 Park Ave. Acquisition LLC, (162 AD3d 444), the plaintiff operated a medical office on the premises leased from the defendant landlord. In Nichols v Didas(137 AD3d 1495), the plaintiff operated a pub on the premises leased from the defendant landlord. In Waterfalls Italian Cuisine, Inc. v Tamarin(149 AD3d 1141 & 119 AD3d 773), the plaintiff operated a restaurant on the premises owned by the defendant landlord. The other cases on which SVC relies do not involve the equitable renewal of leases and have no application to the facts of this case.

SVC contends that, in 205-215 Lexington Ave. Assoc. LLC v 201-203 Lexington Ave. Corp.(supra), the Supreme Court, New York County, rejected the argument that Baygold requires the tenant to be in possession in order to seek equitable relief:

To the extent that Landlord relies on Baygold Assoc., Inc. v Congregation Yetev Lev of Monsey, Inc., 19 NY3d 223, (2012) to argue that this narrow equitable doctrine is not intended to protect an out-of-possession tenant that merely collects rents from subtenants, Landlord's reliance is misplaced. In that case, the Court of Appeals based its decision on the fact that the out-of-possession commercial tenant failed to make any improvements in anticipation of renewal and did not possess any good will in a going concern. Here, unlike in Baygold Assoc., Inc., Tenant has expended substantial monies on improvements and, therefore, is distinguishable. The interpretation of Baygold by the Supreme Court, New York County, is not binding on this court. In any event, that court found that the tenant had made substantial improvements to the premises, some as recently as one day before it received notice of termination of the lease, with the intention of renewing the lease. The record in this case reveals that SVC made no improvements to the property in anticipation of renewing the lease. Thus, 205-215 Lexington Ave. Assoc. is not applicable to the facts of this case.

The Court of Appeals made it clear in Baygold that its holding in J.N.A. Realty was restricted to tenants who make considerable investment in improvements to the premises in anticipation of the lease renewal or would lose a considerable amount of customer goodwill should the lease not be renewed. The court is not aware of any cases, nor has the plaintiff cited to any, in which a tenant, like SVC, who does not fall into one of those two categories has obtained equitable relief excusing its failure to timely exercise an option to renew a commercial lease. In fact, the Court of Appeals explicitly stated in Baygold, This narrow equitable doctrine was never intended to apply in a circumstance, like this, where the out-of-possession tenant fails to make any improvements in anticipation of renewal and does not possess any good will in a going concern.

(Internal quotations and citations omitted).

We frequently litigate disputes over the sale or leasing of commercial property. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you are involved in a dispute regarding a commercial real estate transaction.