In Pack 2000, Inc. v. Cushman, 311 Conn. 622 (2014), the Connecticut Supreme Court recently applied a “substantial compliance” standard to the exercise of tenant options contained in a lease, including purchase options. According to the Supreme Court, when the exercise of an option is conditioned upon the tenant being in compliance with the terms of the lease, the tenant need only be in substantial compliance with the lease (i.e., not in material default) at the time of exercise. The substantial compliance standard is in contrast to the “strict compliance” standard affirmed a year earlier by the Connecticut Appellate Court in Howard-Arnold, Inc. v. T.N.T. Realty, Inc., 145 Conn. App. 696 (2013). Arguably, the strict compliance standard of Howard-Arnold, Inc. still applies, but only to the method of exercising an option; this standard requires the tenant to exercise an option exactly as prescribed in the lease, including strict compliance with timing and notice requirements. If we can reconcile these divergent cases, two different standards may now apply to determine whether a tenant has validly exercised an option; landlords and tenants need to be aware of the potential application of these cases to their leases. These cases also demonstrate why careful attention is critically important in drafting option clauses.
In Pack 2000, the landlord refused to recognize the tenant’s exercise of an option to purchase the leased property because the tenant had failed to make several payments required by the lease over the term of the lease, including payments of rent. The landlord never sent a default notice, and the trial court had found that the tenant had made all payments within a commercially reasonable period of time. The Appellate Court later reversed the trial court, applying a strict compliance standard, but the Supreme Court, applying a substantial compliance standard, held that the tenant validly exercised the option because late payments as made under the lease were not material breaches of the lease. The Supreme Court did imply, however, that parties can contractually adopt a standard more stringent than substantial compliance (such as a strict compliance standard).
Pack 2000 has important consequences for both landlords and tenants. From a landlord’s perspective, in order to avoid an outcome similar to that in Pack 2000, the lease must explicitly state that the tenant’s exercise of an option is conditioned upon the tenant being in strict compliance with the terms of the lease. In addition, landlords must adhere to default and notice requirements in the lease since a landlord’s failure to send formal default notices may impair its ability to claim that the tenant has not validly exercised an option. From a tenant’s perspective, Pack 2000 provides a tenant with a measure of forgiveness where the tenant has committed an immaterial breach.
These cases create differing standards for different parts of the option exercise process, and it is unknown whether, given the opportunity, the Supreme Court would apply the substantial compliance standard in both instances. At minimum, landlords and tenants should review their leases to determine if they want to expressly alter the application of the substantial compliance standard of Pack 2000 and to confirm the specific method by which an option must be exercised. At this point, only care in drafting will avoid the uncertainty recently created. While not addressed by either case, it would also appear prudent to observe the same principle in drafting option contracts for land purchases and in other matters involving the exercise of rights.