Off the Record: Buyer Terminates Tenant’s Lease

In most states, a buyer of real estate property acquires the property subject to all existing leases that the buyer knows or should know about.  In Greaseoutlet.com, LLC v. MK South II, LLC, 892 S.E.2d 68 (N.C. Ct. App. 2023), the Court of Appeals of North Carolina surprised some in the leasing industry by holding that a buyer of real estate property was not required to honor the terms of an existing lease despite having full prior knowledge of it because the lease was not recorded in the public records.

In Greaseoutlet.com, the tenant signed a lease for industrial space in the Spring of 2016 for a five-year term, set to expire on April 30, 2021.  In August 2016, the then-owner of the property and the tenant signed a memorandum of the lease and recorded it in the public records.  Then, in December 2016, the then-owner and the tenant signed an amendment of the lease containing two options to extend the term for an additional five years each; however, no new memorandum was recorded regarding this amendment.

In December 2019, the then-owner sold the property.  During the due diligence period, the buyer (now the new owner) received a copy of the lease and the amendment, and the tenant signed an estoppel certificate addressed to the new owner.  The court does not indicate whether the estoppel included a reference to the option terms.

In August 2020, the tenant attempted to exercise its first option to extend the term of the lease for an additional five years.  The buyer, now the new owner, notified the tenant that it would only allow the tenant to exercise its five-year extension if the tenant gave the new owner a unilateral right to terminate the lease after two years. The tenant refused, and the new owner informed the tenant that it was not bound by the option term and that the lease would terminate on April 30, 2021.  The Tenant sued.  The trial court ruled in favor of the buyer and the tenant appealed.

The Court of Appeals analyzed the history of the recording statutes in North Carolina and concluded that based on the state’s Connor Act there was clear intent to make North Carolina a “pure race” state, where the validity of a lease, subject to a few exceptions, will often turn on whether it is recorded regardless of the prior knowledge of the buyer.  The Court stated, “…[T]he Connor Act affirms the principle that ‘[a]ctual knowledge, however full and formal, of a…..[long-term] lease will not defeat his title as a purchaser for value in the absence of fraud or matters creating estoppel.’”

The tenant made several arguments in an attempt to overcome these principles.  First, the tenant argued that the memorandum that was recorded satisfied these requirements because it contained a clause that stated, “The provisions set for the [sic] in the Lease and any amendments entered into by the parties subsequent to this Memorandum between [the Current Owner] and Tenant are hereby incorporated into this Memorandum by reference.”  (emphasis in the original).  The Court rejected this argument explaining that the Connor Act requires that the memorandum must specifically include all then-existing extension terms.

The tenant next argued that the new owner was barred from rejecting its lease because of estoppel principles.  Specifically, the purchase and sale contract included language that stated that the buyer was assuming all lease obligations owed to any tenant in purchasing the property.  The Court rejected this claim explaining that under North Carolina law, estoppel only applies in the circumstance where the deed (vs the purchase contract) transferring the property includes language stating that the buyer was purchasing the property “subject to” a specific tenant’s unrecorded leasehold interest, which the tenant failed to allege occurred in this case.

Finally, the tenant argued that the new owner is estopped from rejecting the lease option term because the tenant provided an estoppel certificate.  The Court dismissed this argument, however, holding that there was nothing in the estoppel certificate that stated that the new owner would be bound by tenant’s unrecorded leasehold renewal interest.  The tenant made a few additional arguments, but the Court ultimately rejected them all and upheld the new owner’s right to reject the tenant’s extension options.

The Court did clarify that this rule does not apply to all leases and that the Connor Act only requires leases with terms of more than three years to be recorded.  The Court also noted that it is sufficient if a memorandum of the lease (vs the entire lease) is recorded, so long as the memorandum recites the lease’s key terms.

With this holding, North Carolina joins a few other states that require long-term leases (or detailed memoranda of such leases) be recorded to avoid being rejected by a new buyer.   

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