Ruling offers ‘bright-line test’ for real estate lawyers

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A key plot point in the 1981 neo-noir classic “Body Heat” is the revelation that a wealthy man’s will was drawn up in such a way that it violated the rule against perpetuities. The byzantine rule has long tripped up law school exam-takers; some contend the writers of “Body Heat” misunderstood how it works.

Today, the rule against perpetuities retains its power to ensnare unsuspecting drafters of contracts, as was the case in a Jan. 20 opinion by the North Carolina Court of Appeals where the court voided a right of first refusal that had been tucked into a commercial lease.

In 2009, Mohammed Khan and his wife, Haseeb Akhtar, signed a contract to lease a commercial building in Davidson County to Tariq Khwaja. The lease provided an initial term of 15 years and granted Khwaja an option to renew for an additional term of five to 10 years. It also provided that if Khan and Akhtar agreed to sell the property to a third party at any time during the period of the lease, they would have  to first give Khwaja a chance to purchase the property under the same terms.

Khan and Akhtar approached Khwaja in late 2011 to see if he had any interest in buying the property, but Khwaja said he didn’t have the desire or money to do so. Shortly thereafter, they sold the property to a third party, who then promptly sold the property back to Khan and Akhtar on a financed basis. When Khwaja learned about the re-sale, he sent Khan and Akhtar a letter demanding that they sell him the property at the amount they bought and sold it for, and filed suit after they refused.

A trial court entered orders granting summary judgment in favor of Khwaja, decreeing essentially that Khan and Akhtar sell him the property free and clear for the amount they sold it for. Khan and Akhtar appealed, and the Court of Appeals unanimously held that the right of first refusal granted to Khwaja violated the state’s rule against perpetuities, and therefore was void and unenforceable.

Confusing matters even more, there are actually multiple rules against perpetuities. In North Carolina, a right of first refusal in a commercial lease is subject to the common law rule against perpetuities, not the statutory rule. The common law rule holds that a future interest in property is void if there is any chance that it could ripen more than 21 years after the birth of some person who wasn’t yet conceived at the time the interest was created.

In this case, the court noted that while the initial term of the lease was for 15 years, it could be extended for as many as 10 years — just barely enough that the right of first refusal could materialize just outside the time limits imposed by the rule against perpetuities, although the court had to propose a rather Rube Goldberg-like set of hypothetical facts to get it there.

Judge Chris Dillon, writing for the court, reasoned that both the tenant and the landlords could have had children in 2010, the year after the contract was signed, and then all died in 2011. In 2024, the tenant’s hypothetical child could have extended the lease for the full 10 years, and in 2032, the landlords’ child could decide to sell the property, at which time the right of first refusal would finally materialize —more than 21 years after the birth of the children, neither of whom was yet conceived at the time the initial contract was signed.

A convoluted chain of events, to be sure, but theoretically possible, the court noted, which was enough for the court to overturn the lower court’s ruling and void the right of first refusal entirely. (The fact that these events did not actually come to pass did not change the outcome, the court explained — what mattered is what was possible when the contract was signed.)

Judge Wanda Bryant concurred in the result only, writing separately to express her concern that the court should proceed cautiously in applying the common law rule against perpetuities to commercial leases.

Gene Lester of Sharpless & Stavola in Greensboro represented Khan and Akhtar on appeal but did not handle the case at trial. Lester said that the fatal problem for the first refusal provision in this case was that the language of the contract provided that the lease could be renewed by the tenant’s heirs. If the contract had been for a nonassignable lease, that likely would have been a way to cure the language.

“Here, the lease did provide for the continuation, and I think that’s what the court picked up on and said, ‘We’ll use our bright-line rule here.’ That’s certainly fine with us, and it provides a bright-line test for lawyers in North Carolina about how to avoid a problem with a commercial lease. We think it’s a good marker for lawyers in North Carolina in this area,” Lester said.

John Haworth and James Morgan of Morgan Herring Morgan Green & Rosenblutt in High Point represented Khwaja.

DAVID DONOVAN can be reached at [email protected] or (704) 817-1355. Follow David Donovan on Twitter @NCLWDonovan.