STATE OF SOUTH DAKOTA
OFFICE OF
THE ATTORNEY GENERAL

January 25, 1969

Thomas F. Martin
State's Attorney, Brookings County
Brookings, South Dakota 57006

OFFICIAL OPINION NO. 69-4

Municipalities may enter into a long term lease, containing an option to purchase at end of leasehold estate to obtain facilities for a municipal home for the aged

Dear Mr. Martin:

You have requested an official opinion to supplement my opinion to you dated June 25, 1968 (1967-68 AGR 496), In that opinion I ruled that a municipality had the authority to lease facilities from a private corporation next to a municipal hospital to be used as a municipal home for the aged. You have advised me that the agreement to effect such lease has been reduced to writing and are requesting my opinion as to the validity of such agreement. The proposed agreement provides that the lessor, a private corporation, construct the nursing home or facilities for the agent upon the premises, and thereafter for a base rental of $3248.00 a month, together with an amount equal to all taxes and assessments against the premises, annual insurance premiums, together with the costs and expenses of maintaining such facility, the city shall lease such premises for a term of twenty-five (25) years.

However, in such proposed agreement, provisions not contemplated in the June 1968 request have been provided. Such provisions are that after the expiration of the twenty-five year term, the lessee, the city, may renew or extend the lease-or (quoting from such proposed agreement):

". . . or in the alternative, the lessee may elect to purchase the real estate, structures and improvements for the sum of one hundred and no/100 ($100.00) dollars."

It has been suggested that because of the "nominal value" placed in the option of purchase, that this agreement is not a lease agreement with an option to purchase, but rather is a contract for the sale of such premises to the municipality.

In this situation you have submitted these questions:

"1. Does the City of Brookings have the authority to enter into a lease agreement with the option to renew the lease or in the alternative, to elect to purchase the real estate, structures, and improvements for the nominal sum of one hundred dollars at the expiration of the original term of such lease?

"2. Does the fact that the lease provides for an option to purchase at a nominal sum change the substance of such agreement so that it is to be considered a contract of purchase and sale rather than a lease agreement embodying an option to purchase?"

Question 1: An examination of my June 1968 opinion together with consideration of SDC 45.0201(13) therein cited, makes it plain the city has the authority to purchase the premises. However, because of the difficulties connected with the financing of such purchase, as a practical matter, if Question No.2 is answered that this agreement amounts to a contract of purchase and sale, it must be held that it is improper to enter into a contract to purchase such premises at this time.

QUESTION 2: It is my opinion that the agreement in question amounts to a lease agreement with the option in the alternative to either extend the lease or to purchase the property. This agreement cannot be construed as a contract of purchase and sale of such premises.

While in certain instances it is difficult to draw the line of demarcation between a contract of sale and an option to purchase, the law has always recognized a distinction between these legal propositions. Our Supreme Court has recognized such distinction. See Heimberger v. Rudd (1912) 30 SD 289, 138 NW 374; Renner v. Crisman (1964) 80 SD 532, 127 NW 2d 717, and the authorities cited therein.

Perhaps the best test evolved in distinguishing a contract of sale from an option contract is to answer the question: "Could this agreement be specifically enforced by either party?" (See Brickell v. Atlas Assurance Co., 10 Cal App 17, 101 P 16.) If either party has a right of specific performance there is no question the agreement is a contract for sale; however, if such is not so specifically enforceable, then it is a unilateral contract, as all authorities admit an option contract is until such option is exercised. (See Hampton v. Dobson (1912) 156 Iowa 315, 136 NW 682 which reviews the earlier decisions of Iowa and other states as to what constitutes an option contract.

The agreement in question certainly is one which is a lease agreement coupled with an option granted to the lessee. Is the fact that it provides that at the expiration of the leasehold term the alternative that the lessee can purchase the premises for a nominal sum, such as to transform such agreement from a lease-option to a purchase agreement, to an ordinary contract of sale and purchase of the premises?

It is my opinion that this fact alone will not change the form of the agreement.

I am forwarding you a copy of 405 Monroe Company v. City of Asbury Park (1963) 40 NJ 457, 193 A 2d 115, which in principle presented the same problem you have submitted in this request. It is interesting to notice in this decision the claim that the agreement was merely a contract for sale was raised as a defense on the part of the city. As this decision is so long, I will summarize it for this opinion.

In the New Jersey case the facts showed that the lessor remodeled a ramp garage to be used as a Municipal Building. The cost of the original building and remodeling was in excess of two hundred fifty thousand dollars. The agreement called for the city to lease the premises for a twenty-five year term, at a specified rental, plus a payment of all burdens thereon, including taxes, insurance, and repairs. The lease then provided that the city had the option to take title to the premises at the end of the twenty-five year leasehold term upon payment of one dollar to the lessor.

The city argued that because of the low option to purchase price, together with the periodic payment of rent, demonstrated the whole agreement was a contract of sale and not a lease with the option to purchase. It argued that as a contract of sale such violated both constitutional and statutory provisions.

The court, in its opinion, admitted that although the city had the authority, but not the financial ability to either construct or purchase such facilities, it also had the power to meet its needs by means of a lease, rather than by purchase. It held that when the evidence showed the agreement was entered into in good faith, and the periodic rental approximated the cost of the structure, and its alteration, the depreciation on the premises, together with a return of interest upon the investment, that in such circumstances the option to buy the residual value at the end of the leasehold term for a small sum was compatible with the concept of a lease. The court held such agreement was a lease agreement with an option to purchase, and being within the powers of the municipality was valid.

In the instant case, I must assume that the fixed rental provided will approximate the investment of the lessor together with depreciaion and a return of interest on such investment. The nominal sum fixed in the option to purchase in such instance is compatible with a lease.

Your attention is called to Denver Plastics Co. v. Snyder (Colo 1966) 416 P. 370 which involved an option similar to that in the proposed agreement in question. In that case where the alternative was granted to either extend the lease or purchase the premise, the court held that the exercise of the option to renew the lease acted to extinguish the option to purchase, so that thereafter the lessee had no authority to exercise the option to purchase. I point this out for the benefit of the city in being properly advised as to its rights under this agreement.

My answer to Question No.2 is NO.

In conclusion, it is my opinion that the City of Brookings has authority to enter into the agreement in question.

Respectfully submitted,

Gordon Mydland
Attorney General