OK, The Deal Will Contain A Right Of First Refusal. How Do You Write That Up?

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Why should anyone grant someone else a Right of First Refusal? Here’s an uncharacteristically succinct answer: “because they have no choice.” Yes, make the deal or not.

Granting any option rights always seems like a one-way deal. The optionee (i.e., the one who gets the “right”) isn’t bound to do anything, but the optionor (i.e., the one who gives the right to the other) is “stuck” if the option is exercised. The only reason it isn’t a “one-way deal,” is because the party granting the option right gets the deal by reason of having granted the option right – small comfort, but true.

Today, we’re going to begin covering a particular right – a “Right of First Refusal,” for short, a ROFR. A ROFR can apply to a number of real estate agreements, but for simplicity, we’ll use examples from a lease. In particular, we’ll “pretend” that a tenant has negotiated for a ROFR to buy the property if its landlord is going to sell it.

Other than because it wanted to get the lease in the first place, giving its tenant a ROFR to buy the property is never a good deal for a landlord. It might be a good deal if the rent it was getting was more than that under an identical lease without such a ROFR, but the market doesn’t work that way. Tenants who negotiate for a ROFR don’t pay higher rent than those who don’t get a ROFR. Tenants who don’t ask for a ROFR don’t get a commensurate discount.

Why isn’t this kind of ROFR a good deal for the landlord?

The reason most commonly raised, and a valid one at that, is its adverse effect on the universe of willing third-party buyers. British historian C. Northcote Parkinson put it this way: “Delay is the deadliest form of denial.” Even if we weren’t living in a society that demands instant gratification, it would still be an issue. While waiting for a ROFR-empowered tenant to decide whether it will “take the deal away,” other buying opportunities may be missed. At least, that’s the fear. And, “fear breeds fear.” [Byron Janis]. Whatever the reality, and each of us has our own, unique version of that, a deal that has to pass through the ROFR gauntlet chills the market: fewer offers, lower prices.

The reality of a delay isn’t the only thing that can chill the market; buyers’ psychology is a factor as well. No one wants to feel “taken advantage of,” and that translates into the general reluctance of buyers to be a “stalking horse,” and we’re not talking about becoming the vodka bar in Baltimore. Feelings of “being taken advantage of” aside, a potential buyer rightly should object to the cost of negotiating a deal, in some cases, even getting to an executed purchase agreement (as we would recommend), and being left with no more than a burnt pocket hole as a memory of the one that got away. In other “marketplaces,” these “costs” are dealt with by way of “break-up” fees, but not very often at all in the leasing or single-property sale marketplace. Nonetheless, a landlord can keep that “technique” in mind should it get that far in negotiations and the ROFR gets in the way. We’ll leave it to others to see if a lease can be drafted to directly or indirectly get the tenant to “cover” a break-up fee.

Once it is agreed that a lease (or other agreement) will include a ROFR, other concerns rear their heads. Some go to “certainty,” and others go to honoring the real essence of the “deal.”

As to issues of certainty, a properly prepared ROFR provision will eliminate disputes as to what constitutes the offer to be accepted or rejected; how one knows if the offer has been presented to the tenant; how one knows if the ROFR unequivocally has been accepted; and by when the deal will close.

The basic concept of a ROFR is that its holder (e.g., a tenant) gets to step into the offeror’s shoes, right away – no changes, no bargaining. How can that happen if all that the landlord has is a napkin upon which the offer’s terms are scribbled. Yet, that’s what most ROFR provisions call for – the tenant must be presented with the offer. We won’t waste a lot of internet electrons to tell anyone that a piece of paper with a price and an estimated closing date is an invitation to negotiate. Suppose a tenant says, “Yes, I’ll step into the prospective buyer’s shoes,” where do those shoes take the tenant? If all that is presented is a proposed deal sheet, those shoes only get you as far as the box office at the Theater for Negotiations. That deprives both parties of any certainty that the tenant will be purchasing the property even though the tenant has “exercised” the ROFR. What is nearly certain, however, is that the landlord has lost what might have been a real and motivated buyer. So, if you want to be “more” certain, a ROFR should “offer” a tenant a fully executed agreement signed by the contract purchaser and the landlord. Then, either the tenant signs the same contract or waives its right to do so.

OK, we know the approach of presenting the tenant with an executed agreement can double down on the reasons we’ve already given as to “Why isn’t this kind of ROFR a good deal for the landlord,” but you can’t be all things to all people. If nothing else, readers may even better appreciate why a landlord or other person in a similar situation should resist giving a ROFR.

Let’s talk about timing. This is pretty simple. Make sure the ROFR provision has unambiguous timelines; ones that a child can use to mark a calendar with an absolute deadline. Ruminations thinks that if someone has “x” days within which to respond to a notice, the “x” should be measured from the date that person receives the notice. We also think that if someone has to respond by a given time (“x” days after something), the deadline for such a response should be measured by when it is received. That lets the parties know where they stand, and “move on” if that’s the outcome. For more elaborate ruminations, take a look at this posting from October 24, 2011 by clicking HERE. And, make TIME OF THE ESSENCE so that a court knows that you really meant that a deadline is a deadline. And, in practice, don’t play fast and loose with the notice requirements. If you do, a court might make a deal for you that you didn’t intend to make.

We know how to get you back. So, next week, “same time, same station,” we’ll share more ROFR thoughts with you. We’ve written all we wanted to write about “certainty.” So, next week we’ll visit issues about offers that, on their face, can’t be matched because of aspects that are unique to the offeror. We’ll talk about issues arising out of the mere fact that the holder of the ROFR (e.g., a tenant) isn’t the offeror. We’ll talk about a tenant who “claims” the deal, but doesn’t close. And, we’ll cover a number of other issues, familiar to some readers, but not to others.

If any reader wants to toss some of her or his own thoughts into next week’s posting or if anyone has any burning questions, add them as a comment right below the period that ends this sentence.

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  1. Jim Henegan says:

    I might be getting ahead of you, but a right of first refusal to purchase should only be granted to a tenant who is leasing the entire development that is being sold. It should be a way for a tenant to elect to buy its own premises were the Landlord is in effect selling the rent stream being paid by the Tenant. I don’t like having a space tenant leasing 50% of a strip center having the right to purchase the entire center.

    Free standing retailers/Tenants like Walgreen’s, CVS, Firestone and many banks want a purchase option to buy their Premises. They especially want the right when they are the ground lessee. It would make sense to offer the Premises to the Tenant first regardless of whether it has a ROFR. It might save you time as the Tenant would be a natural buyer.

    It gets more complicated if the Tenant’s right is just to buy its premises and the Landlord is selling a larger parcel. Does the Landlord have to split off the Premises and sell it to the Tenant? I would hope not, but it might depending on how the language is drafted. Does the Tenant have to buy the entire Center?

    The purchaser might not want the property if the Walgreen’s store isn’t part of the deal. Also, the rents are probably not the same throughout the Center and the Tenant’s premises might be more or less valuable psf than the rest of the center.

    A Landlord should only have the obligation to submit an offer to the Tenant which the Landlord wants to accept. Presumably the Landlord wouldn’t want to sign the napkin and so the Landlord would not have to submit it to the Tenant. If the Landlord signs a purchase agreement it should be conditioned upon the Tenant waiving the ROFR. Hopefully there is a deemed waived provision in the ROFR.

    It would be probably be best to submit an identical contract to the Tenant and get him to sign it if he wants to exercise its option, although I know one Tenant who wouldn’t sign a contract when exercising its ROFR, saying that the terms of the Lease controlled and it didn’t have to sign an new contract to exercise its ROFR.

  2. The issue of reassessment on a sale, and the pass thru of likely increased property taxes, is also a valid reason for a ROFR. Delay of a deal is easily solved with a right of first offer…tell the Tenant the price you will accept, they take the deal or you can market it and so long as you acheive a sales price in excess of what you offered it for, a legitimate deal, they have no more right to buy…but if you decide to accept less, you have to give em a chance again, that just fair play.

  3. What about the practice of offering a “one time” ROFR for adjoining space? Also, any thoughts on the difference between “adjacent space” and “contiguous space” (and even “adjoining space”, if you feel like it)?

    • Jim Henegan says:

      Rights of first refusal to lease contiguous space is pretty common in office buildings, but not common in shopping centers. Most national retailers have their typical store size and they lay it out to fit the premises that they have.

      I worked on leasing Sears Tower for about 4 years and keeping track of all of the tenants’ expansion and ROFRs and ROFOs was a full time job.

      As a Landlord I do not like rights of first refusal to lease contiguous space. If you have a 10,000 square foot tenant and you give him a ROFR to lease 2,000 contiguous square feet, how to you handle it if a tenant wants to lease 4,000 square feet including the 2,000 you have given the ROFR over. If the tenant can take the 2,000 square feet, then you have lost a 4,000 square foot tenant and still have 2,000 square feet of empty space. I suppose if you know the ROFR space will never be packaged with additional space, then it isn’t a problem.

      Also, what if the 4,000 square foot lease is for a longer term than the 10,000 square foot lease? Does the 10,000 square foot lease get extended to match the 4,000 square foot lease? If the 2,000 square foot lease term is reduced to match the existing 10,000 square foot lease, your term might not be long enough to fully amortize the construction allowance and so the Landlord might want it reduced or the rent increased to amortize it sooner.

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