As commercial tenants do not have a default legal entitlement to renew or extend an existing lease, a common element of many leases is a right in favour of the tenant to continue its occupancy beyond the expiry of the current term. While the terms used to describe such rights ("Right to Renew" and "Option to Extend") are often used interchangeably, the concepts have distinct legal ramifications which merit careful consideration by tenants and landlords.
The legal effect of exercising an option to renew is to terminate the original lease upon its expiry and immediately begin a new lease. Generally speaking, the renewal lease will contain all of the terms of the existing lease, with the exception of: (i) any rights which are personal to the tenant and (ii) the rental rate to be paid during the renewal term. In contrast, the effect of a lease extension is to continue the original lease for an extended term, generally on the same terms and conditions as the initial lease term, with the exception of the rental rate to be paid during the extension period.
There are two key impacts of this distinction: first, on any rights deemed to be personal to the tenant and second, on the parties following an assignment of lease.
Even where a renewal lease is granted on the same terms and conditions as the initial lease, unless the lease expressly provides otherwise, personal covenants, such as a right of first refusal, a right to purchase the property, or any exclusivity rights, will not apply during any period of renewal. The courts have found that these rights do not run with the land and are personal to the tenant. One right which has been found to run with the land is a right of renewal/extension. From the tenant's perspective, a right to extend the lease may be preferable because it operates to continue, without interruption, all rights in the lease, including those that are personal to the tenant.
Conversely, in the case where the original tenant has assigned its interest in a lease, the original tenant may benefit when a right to continue the tenant's occupancy of the premises beyond the expiry of the current term is structured as a right to renew. The exercise of the renewal option by the assignee operates to create a new lease directly between the landlord and the assignee after the expiration of the original term. This precludes any continued liability on the part of the tenant during the renewal period, absent express language to the contrary. If, instead, an option to extend the lease is exercised, the original tenant will remain responsible to the landlord for performance of lease covenants by the assignee as a result of the continuation of the lease and privity of contract between the original tenant and the landlord.
Accordingly, both tenants and landlords are well advised to think carefully about whether a negotiated right on the part of the tenant to continue its occupancy of leased premises should be drafted as an option to renew the lease or as a right to extend the lease term.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
