A recent North Carolina Court of Appeals decisions underscores the importance of properly recording lease terms and renewal options.
North Carolina’s Connor Act (codified as N.C. Gen. Stat. § 47-18) provides that North Carolina operates under a “pure race” system, where the first person to record an interest in real property has priority over subsequent purchasers or interest holders. This means that if the first person fails to properly record an interest in real property through a deed, memorandum, or other instrument, a second person can record their own instrument and have a superseding interest in the real property, even if the second person has actual or imputed knowledge of the first person’s interest in the real property.
The Connor Act applies to a number of interests in real property, including any lease with a term of greater than three years, which term includes any subsequent renewal rights. A recorded memorandum of lease outlining the relevant terms of the lease is necessary to protect the tenant’s interest in the real property and place subsequent purchasers or interest holders on notice of such lease. On August 1, 2023, the North Carolina Court of Appeals decided GreaseOutlet.com, LLC v. MK South II, LLC, No. COA22-648 (N.C. Ct. App. Aug. 1, 2023) (“GreaseOutlet”). The GreaseOutlet opinion clarified that lease renewal options must be affirmatively recorded through a memorandum to be binding on subsequent purchasers of the underlying real property.
In the GreaseOutlet case, the plaintiff, tenant, rented a commercial space from the then-owner of the property for a term of 5 years. The terms of the initial lease were properly recorded pursuant to a memorandum and stated that the lease would automatically terminate on April 30, 2021. However, after the recording of the memorandum of lease, the plaintiff and the property owner modified the terms of the original lease through an amendment (the “Amendment”) and granted the plaintiff the option to renew the lease for 2 successive 5-year terms after April 30, 2021. The plaintiff failed to record a modification to the memorandum of lease to memorialize the Amendment in the public records.
Later, the real property was purchased by the defendant, making the defendant the plaintiff’s new landlord. During the sale, the defendant received copies of both the original lease and the Amendment. In August 2020, the plaintiff attempted to exercise its option to renew the lease and sent the defendant a check prepaying the rent for the first 8 months of the renewed term. In November 2020, plaintiff sought to renew its permit with the State of North Carolina to operate its business and requested that defendant execute a new landlord authorization as part of its permit renewal. Defendant refused to sign the landlord authorization and instead merely discussed an extension of the lease beyond April 2021. Defendant conditioned the lease extension on its ability to unilaterally terminate the lease after 2 years of any proposed renewal term. Plaintiff refused this offer and in March 2021, the defendant rejected the plaintiff’s attempt to renew the lease, reimbursing the plaintiff for the prepaid rent.
The plaintiff then filed 6 claims against the defendant in North Carolina state court. The trial court granted the defendant’s motion to dismiss, and the plaintiff appealed the dismissal. The plaintiff argued that the defendant should be bound by the Amendment because the defendant had actual notice of the Amendment’s existence. However, the North Carolina Court of Appeals rejected this argument, stating that in a pure race state like North Carolina, notice of an unrecorded interest does not bind subsequent purchasers. The court also rejected the plaintiff’s second argument that it had “won the race” because the initial lease was recorded before the defendant purchased the property. The court reasoned that the initial memorandum of lease only bound the defendant for the first 5-year term and that plaintiff should have recorded a new memorandum to evidence the Amendment put future purchasers on notice of its extended leasehold interest pursuant to the Amendment.
In summary, the GreaseOutlet opinion highlights the importance of ensuring that lease terms and renewal options are adequately memorialized in writing and recorded in the applicable real estate records in North Carolina to protect tenants’ property interests. Failure to properly record such terms and options can result in them being deemed invalid and unenforceable against subsequent purchasers or holders of the underlying real property.