Real estate professionals in North Carolina may already be familiar with memoranda of lease, but the average business owner may lack familiarity. However, any party entering into a lease would be well-advised to understand when a memorandum of lease should be recorded and why it is important. Tenants, in particular, should understand that recording a memorandum of lease may be essential to preserving certain rights that the tenant enjoys under its lease. Landlords should also understand the consequences of recordation of such memoranda.
The Connor Act
Pursuant to North Carolina law, a lease for a term of more than three years will not “pass any property interest as against lien creditors or purchasers for a valuable consideration from the donor, bargainor, or lessor but from the time of its registration in the county where the land lies.” North Carolina Gen. Stat. § 47-18(a). Put simply, if a landlord and a tenant enter into an unrecorded lease for a term longer than three years, and the landlord sells the property, then, pursuant to this statute, the lease is not enforceable as between the buyer and the new owner/landlord.
In almost all circumstances, landlords and tenants want to keep the terms of their leases confidential. Recording a lease with the register of deeds would make that document a matter of public record, readily available for review by competitors of the landlord or the tenant. Fortunately, North Carolina law provides a simple solution: registration of a lease can be accomplished by memorandum.
Memorandum of Lease Overview
For a memorandum of lease to be effective in preserving the rights of the parties thereto, the instrument must include: (i) the names of the landlord and tenant, (ii) a description of the property leased, (iii) the term of the lease, including extensions, renewals and options to purchase, if any, and (iv) reference sufficient to identify the complete agreement between the parties. North Carolina Gen. Stat. § 47-118. Additionally, for the memorandum of lease to be eligible for recordation, all signatures must be notarized and the original instrument must be submitted to the office of the register of deeds for the county where the property is located for recordation. North Carolina Gen. Stat. § 47-1 et seq. In a world where leases are frequently electronically executed, the requirement for notarization creates a relatively minor additional administrative burden, but one that should not be ignored.
Consequences of Failure to Memorialize or Record a Lease
Imagine a situation where a local small business enters into a lease with a landlord for a term of ten years to occupy a warehouse. The business spends hours negotiating their optimal terms and finally reaches a deal with the landlord. Years pass, and landlord decides to sell the warehouse. After closing, under the Connor Act, the buyer, who would otherwise step into the shoes of the previous landlord, has the right to refuse to acknowledge the lease. The new landlord now has leverage to force the tenant to: (i) vacate the warehouse, or (ii) renegotiate the terms of the lease. This creates a nightmare situation for the tenant where it loses the benefit of its initial bargain, all because it did not take the simple steps to memorialize the lease by recording a memorandum of lease shortly after the negotiation and execution of the lease.
Consequences of Recording a Memorandum of Lease
While a memorandum of lease is typically a simple document to draft, execute, and record, a prudent landlord should give thoughtful consideration to the consequences of recording any document relating to their land. A recorded memorandum of lease creates a cloud on landlord’s title, something that will need to be evaluated whenever the landlord engages in subsequent transactions involving title to the land. Typically, if a landlord of tenant-occupied real estate seeks financing, a secured lender will require recordable subordination, non-disturbance, and attornment agreements to be executed by any tenant who is a party to a recorded memorandum of lease. This means, practically, that the recordation of a memorandum of lease may generate additional documentation for which the landlord may have to pay in the event that landlord seeks to enter into and close a real estate loan transaction. It also means that landlord, and landlord’s counsel, will have to expend extra time and energy to reach the closing table.
Recent Developments
The provisions of the Connor Act calling for the recordation of leases were first implemented over one hundred and fifty years ago. Given the age of the statute, new legal developments relating to the memorandum of lease may seem surprising. But, in February of 2023, the parties involved in the proceeding entitled Greaseoutlet.com, LLC v. MK South II, LLC took a dispute regarding the validity of a lease and an accompanying memorandum of lease all the way to the North Carolina Court of Appeals. See Greaseoutlet.com, LLC v. MK South II, LLC, 892 S.E.2d 68 (N.C. Ct. App., 2023).
In 2016, the plaintiff in that case, Greaseoutlet.com, LLC, as tenant, leased an industrial property located in Raleigh pursuant to a written lease. The lease was for a five-year term, set to expire on April 30, 2021. Shortly after the lease was executed, the parties executed a memorandum of lease memorializing the terms of the lease and recorded it in office of the register of deeds for the county in which the industrial property was located.
At first glance, it would appear that the tenant took all appropriate actions to preserve its interest in the premises from the interests of third parties. Unfortunately, subsequent events, and inaction by the tenant, would undermine these initial efforts.
Sometime after the execution of the lease and the recordation of the memorandum of lease, the landlord and the tenant amended the lease in order to grant the tenant two successive five-year renewal options. This amendment was never memorialized on the record. The lease now provided that the tenant could elect to remain in the premises until 2031, however, the recorded memorandum of lease still reflected that the lease would expire in 2021.
In 2019, the original landlord conveyed title to the leased premises to MK South II, LLC, the defendant in the proceeding. From 2019 to 2021, the new landlord and the tenant acknowledged and abided by the terms of the lease. As the end of the initial term of the lease approached, the tenant gave notice of its intent to renew the lease. At that time, the tenant also delivered pre-paid rent for 2021 to the landlord, which included pre-paid rent for a portion of the first renewal term. Several months after the renewal notice and pre-paid rent were delivered, the landlord notified the tenant that it would not acknowledge the amendment to the lease and the applicable renewal terms thereunder. Landlord then returned the portion of the pre-paid rent attributable to the renewal term. Ultimately, the tenant pursued litigation to enforce its renewal right.
The case proceeded through the court system until the North Carolina Court of Appeals agreed to hear the case on the question of whether the new landlord was required to acknowledge the lease. Under these facts, the North Carolina Court of Appeals upheld the lower court’s decision that the landlord was under no obligation to acknowledge the renewals. Although the lease was properly memorialized through the recordation of the memorandum of lease, the amendment to the lease was not. The memorandum of lease recorded in the public record reflected that the lease expired by its terms in 2021. Thus, the court determined that the parties to the lease as amended failed to comply with the Connor Act, and that as such the amended lease was unenforceable against the new landlord.
Because the landlord knew about the lease and the amendments thereto, performed under the lease, and even accepted pre-paid rent for a portion of the renewal term of the lease as amended, the court also undertook an analysis regarding whether the landlord was estopped from refusing to acknowledge the lease amendment. Despite these factors, the court rejected the argument that the landlord was estopped from refusing to acknowledge the amended lease.
Additionally, it is important to note that, by statute, memoranda of lease recorded in the public record expire sixty days after the expiration date stated in such memoranda or in any properly notarized and recorded extension or renewal thereto. North Carolina Gen. Stat. § 47-120. Although the North Carolina Court of Appeals did not discuss any effect that this statute may have had in its ruling, this statute provides additional insight as to why the original memorandum of lease may have been deemed ineffective with respect to the rights of Greaseoutlet.com, LLC.
Takeaways from Greaseoutlet.com, LLC
The Greaseoutlet.com, LLC case is a remarkable example of the importance of recording memoranda of lease to preserve a tenant’s interests in leased premises, and of the importance of recording memoranda of amendment, extension, or renewal of lease when previously memorialized leases are amended, extended, or renewed. This is especially important in light of the fact that while landlords and tenants frequently consult attorneys when preparing leases, those same parties also frequently execute self-prepared amendments with limited or no guidance of counsel. Tenants would be well-advised to understand the importance of recording a memoranda of lease memorializing the terms of those self-prepared amendments.
While such memoranda largely serve to protect tenants’ interests, landlords also need to understand the consequences of recordation of memoranda of lease and the state of the law surrounding them. This is especially the case in light of the possibility that tenants, and their attorneys, will push harder to require the recordation of memoranda of lease in light of the Court of Appeals’ ruling in Greasoutlet.com, LLC. In particular, landlords should be aware that the recordation of a memorandum of lease generate additional paperwork and require both them and their attorneys to exert additional time and effort when engaging in transactions such as real estate financing transactions. Landlords should anticipate those challenges when evaluating whether to agree to the recordation of such memoranda, and should be prepared to navigate discussions surrounding the recordation of memoranda of lease accordingly. It is also important for successor landlords to note that the holding in Greasoutlet.com, LLC does not open the door for the carte blanche eviction of tenants of a prior landlord, and that successor landlords should exercise caution and consult with counsel when making decisions to evict as such decisions may have serious consequences.
Britton Lewis is an experienced member of the Commercial Real Estate and Finance practice groups at Carruthers & Roth, P.A. Britton, along with the other members of the Commercial Real Estate and Finance practice groups, frequently represents landlords, tenants, buyers, sellers, lenders, and borrowers in a host of commercial real estate and other matters implicated in this article. If you have any questions related to any matters discussed in this article, please feel free to contact Britton (336-478-1137, bcl@crlaw.com) or any other members of our Commercial Real Estate and Finance practice groups. If you wish to read it for yourself, a full copy of Greaseoutlet.com, LLC, v. MK South II, LLC, 892 S.E.2d 68, is available at the following link: appellate.nccourts.org/opinions/?c=2&pdf=42611.