Mortgages Prime Unrecorded Lease With Right of First Refusal

In a 2016 decision, Dahari v. Villafana, No. 20219/2013, 2016 NY slip op. 31859(U) (Oct. 3, 2016), a New York Court looked at a long-standing concept in real property: whether an unrecorded conveyance is void against a subsequent good faith purchaser for value.

This case arose out of an unrecorded lease which contained a right of first refusal. In 2010, the seller of the property, the owner at that time, renewed and amended a lease with the tenant to include the tenant’s right of first refusal to purchase the property. In 2013, the seller sold the property to the buyer who purchased the property with financing. At closing, the seller represented that the tenant’s lease did not contain a right of first refusal and executed a tenant estoppel certificate on the tenant’s behalf. Thereafter, the tenant initiated this lawsuit to void the sale and force specific performance of its right of first refusal.

The buyer argued it was entitled to summary judgment as it did not have notice of the tenant’s right of first refusal as the lease was not recorded, the tenant was aware of the contract to sell the property and did not attempt to exercise its right of first refusal until nearly 9 months later, and the tenant was not ready, willing or able to purchase the property because it did not have enough net worth to do so. The bank, which financed the purchase of the property, also moved for summary judgment, asserting that its mortgages were superior to the tenant’s right of first refusal because the lease was not recorded, the title search and assurances obtained from the buyer prior to closing did not disclose a right of first refusal, and the tenant continued to make rental payments post-closing.

Before giving its ruling, the Court gave a primer on basic real estate notice rules. An unrecorded conveyance is void against a subsequent good faith purchaser for value who is without knowledge or notice of a prior interest in property. See, Dahari at Page 3, citing Real Property Law, § 291 and Barrett v. Littles, 201 AD2d 444 [2d Dept 1994]. However, “Actual possession of real estate is sufficient notice  . . . to all of the world of the existence of any right which the person in possession is able to establish” Dahari at Page 3, citing 1426 46 St., LLC v. Klein, 60 AD3d 740, 743 [2d Dept 2009].

The Court denied the buyer’s motion for summary judgment as issues of fact existed as to whether it had notice of the tenant’s right of first refusal because the buyer was aware of the tenant’s possession of the property prior to closing, it failed to obtain an estoppel from the tenant, and whether the tenant attempted to exercise her right of first refusal in a timely manner.

As to the bank, the Court granted its motion for summary judgment. The Court found that since the tenant failed to record the lease coupled with the bank’s title search and buyer’s assurances that the tenant did not have any rights of first refusal, the bank had no knowledge that the tenant had any rights to the property.

The lesson here is threefold. First, as a purchaser and as a lender, it is imperative to receive sufficient estoppels from the tenant, and not an agent of tenant, to determine or confirm if there is an option to purchase or right of first refusal on a property. Current estoppels can also reveal existing issues that may lead to claims of offset or alter landlord liability, or a tenant who is paying rent on time, but may have vacated the property or “gone dark.”  Second, a savvy tenant should negotiate in its lease the ability to record a memorandum of lease in the public records if the tenant has an option to purchase or right of first refusal on the property. Third, a prudent buyer of real estate should review the leases it is taking title subject to for any unwelcome surprises.