Reviewing the Rule
Avoid contract confusion by examining this age-old regulation.
In a series of cases culminating in two recent
decisions, the Maryland Court of Appeals clarified the scope and application of
the rule against perpetuities in a broad range of real estate transactions.
While the rule’s enforceability varies from state to state, commercial real
estate pros in all markets need to understand how this often-ignored and
frequently misunderstood common law can affect their deals. Carefully drafting
contracts and documents and understanding state laws can help to ensure commercial
real estate transactions do not violate this centuries-old rule.
complex, the rule against perpetuities is stated clearly in Selig v. State
Highway Administration: “No interest is good unless it must vest, if at all,
not later than 21 years after some life in being at the creation of the
interest.” In essence, the rule prevents the enforcement of a provision that
may tie up a real property interest for more than 21 years after the death of
all concerned individuals living at the time the provision was drafted. The
rule’s original purpose was to force the timely exercise of real estate
interests to prevent uncertainty of title and to encourage owners to make
effective use of their property. That original function still is applicable,
which helps to explain its durability through the years.
the rule’s theoretical complexity, many states have passed uniform legislation
to modify the rule and some have abolished it. However, in those states where
the traditional rule still is recognized, courts apply it to deeds, wills, and
real estate contracts. In these states, the rule against perpetuities is
capable of creating serious and unexpected problems for commercial real estate
professionals. Specifically, if a provision in a real estate contract or deed
violates the rule, the provision is unenforceable. Failing to recognize and
address these problems in commercial real estate contracts can result in lost
opportunities to sell or develop properties. The challenge for many commercial
real estate investors is to recognize when the rule is implicated and when it
has the potential to alter a transaction. Understanding how the courts ruled in
Maryland offers some perspective on how the rule can affect commercial real
Arundel Corporation v. Marie is a prime example of how the rule against
perpetuities can alter an entity’s expectations in a commercial real estate
transaction. In 1960, the original property owners of a valuable tract of land had
signed a deed promising Arundel Corp. that upon the land’s sale, the company
would have the first right to purchase the property for $2,250 per acre. When
the original property owners died more than 40 years later, their estate sought
to sell the property free of the right of first refusal. The estate argued and
the court agreed that the promise violated the rule against perpetuities. As a
result, Arundel Corp. was denied the first opportunity to purchase the sizeable
tract of land for a nominal amount.
case clearly demonstrates the importance of carefully drafting documents that
deal with future real property interests, particularly rights of first refusal,
to ensure their enforceability. The case also demonstrates that attentive
commercial real estate professionals can avoid problems in enforcing rights of
first refusal by negotiating a certain dateline in the prospective purchaser’s
ability to assert the right.
in Selig, the court determined that the rule against perpetuities did not apply
and that a property owner’s right to enforce a promise to re-purchase real
property was intact. In a 1978 deed, the property owner conveyed the property
to the Maryland State Highway Administration. The deed included language giving
the owner or his successor the right of first refusal to re-purchase the
property at a set price for an unlimited time period.
language violated the rule against perpetuities. Perhaps presuming the
provision was unenforceable, the State Highway Administration then re-sold the
property to a third party without first offering it back to the original
owner’s successor. The court determined that state legislation in effect at the
time the deed was signed created an exception to the rule against perpetuities
and that the original owners were entitled to re-acquire the property from the
implications of these recent cases are clear: Future interests in commercial
real estate are not always enforceable. In Arundel, the rule had serious
implications because the corporate entity relied on a right contained in a
40-year-old deed, only to learn that the right did not exist. On the other
hand, in Selig, the State Highway Administration incorrectly assumed a right of
first refusal was unenforceable under the rule, and after selling the property
to a third party, learned that the party seeking to enforce the right of first
refusal was entitled to the property.
key to avoiding situations like these is the ability to recognize potential
rule against perpetuity issues when evaluating and drafting transaction
documents. To help avoid problems, have legal counsel review transaction
documents that contain a property interest that is executed years before
property is to be conveyed, a right of first refusal, an indefinite settlement
date, and an interest in a will or trust, particularly those with property
rights contingent on an occurrence, such as death, and/or without a contingency
document provisions contain potential rule against perpetuities concerns,
carefully research state law on the topic as well as the law existing at the
time the document was executed.
it is important to beware of rights of first refusal that offer property at a
set price well below market value. In general, if a document’s provisions sound
too good to be true, they very well may be too good to be enforceable in court.