Legal Briefs

Reviewing the Rule

Avoid contract confusion by examining this age-old regulation.

By Jennifer J. Coyne, JD, and Jeffrey P. Reilly, JD |

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.

Rule Analysis

While 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.

Acknowledging 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 estate transactions.

Court Decisions

The 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.

The 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.

However, 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.

This 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 third-party purchaser.

Recognizing the Rule

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.

The 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 deadline.

If 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.

Finally, 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.