Oh No, What Have I Done? Not A Right Of First Refusal! Here Are Some Common Headaches, But Only A Handful Of Solutions.

Print
Print Friendly

While problems associated with giving or getting Right of First Refusal (ROFR) may vary depending on the subject matter of the right (adjacent space, post-lease expiration renewal, purchase of the underlying property, right to provide financing, etc.), the one problem all have in common is that there is always a mismatch between what the grantee (usually a tenant) would design for itself and what a third party concocts in the form of its own offer.

Let’s give an example based upon a ROFR to lease adjacent space. Assume that a 9,000 square foot tenant has three years to go in its lease term followed by a five year extension option. Conveniently, two adjoining spaces, each measuring 3,000 square feet, become available, one of which is incontestably adjacent to that tenant’s space.

Along comes a prospective user offering to take both spaces, 6,000 square feet in all, for 10 years at a market rent. The market rent at that time includes a substantial tenant fit-up allowance, but it is offered on a “use it or lose it” basis. Of course, the way the market works, the tenant allowance isn’t manna, something of value that a person receives unexpectedly, but has been included in the rent, penny for penny. After all, as all of us know, There’s No Such Thing as a Free Lunch [Friedman, Milton, Open Court Publishing Company, 1975] – tenant allowances are, in effect, loans to a tenant, repaid as part of the rent.

So, the tenant was thinking, “If we need a little more space, say another 3,000 square feet, and ‘next door’ becomes available, we’ll add it. If our landlord tries to extract too big a bonus from us because we’ll be seen as being over a barrel, we’ll wait until someone else comes along who isn’t seen to be under the same pressure, and makes a ‘market’ offer.” Basically, the tenant thought that having  the right to match a ‘market’ offer would provide adequate protection against being “held up.” But, depending on how its ROFR is worded, it may not have gotten any real protection.

As our example illustrates, this tenant (with the ROFR) is now looking at a market offer that doesn’t line up very well with its perceived needs. The offer is for a 10 year term, yet, even after it exercises its extension option, the tenant will have no more than 8 years left. If it really needs additional space and the adjacent space is leased to someone else for 10 years, the tenant can begin planning its move right now, though it is going to take place three years from now. Even if its ROFR is written to allow (require) it to exercise its option and further extend its now 8 year lease term to 10 years, with all of the “new” issues that raises, is that what the tenant expected? What if it only had five years to go, would it want to decide now that it will double the length of its occupancy?

What about the prospect of taking on another 6,000 square feet of space, a 2/3 increase in floor area? Let’s say the tenant’s lease specifically identified just the immediately adjacent 3,000 square foot space as the ROFR’s subject? What should the lease’s ROFR provision say to cover the new “facts on the ground”? If it favors the tenant’s interests by allowing the tenant to “strip” just the immediately adjacent space from the “offer,” the landlord has lost a tenant for the remaining 3,000 square feet of space. [And, that space may not be as valuable without the “stripped” space. Basically, the offered rent might be an average of a “high” rent for the immediately adjacent space, and a “low” rent for the remnant space. In the alternative, what if the offer said that the rent for the immediately adjacent space was $51 per square foot and rent for the non-adjacent 3,000 square foot space was $1 per square foot? Is that what the ROFR holding tenant expected?] How often, if ever, have you seen a ROFR provision address this kind of situation?

What about the rent? For the offeror, as a “new” tenant, the “use it or lose it” tenant allowance isn’t a problem – it negotiated for exactly what it needed for its own use, perhaps for a very fancy storefront, entranceway or reception lobby. On the other hand, the existing client already has a very fancy storefront, entranceway or reception lobby. Yes, “use it or lose it” doesn’t work for the tenant with the ROFR.

Take the case of a ROFR to purchase the “property.” Keep in mind, we’re not writing about the wisdom of including such a ROFR in a lease or other agreement; we’re assuming that there is such a ROFR. What happens if the offer is that the third-party will pay one barleycorn and its firstborn child for the property? For some parents, that’s a pretty appealing use of a child. How is the holder of the ROFR going to match such an offer (unless it is the other parent of that child)? Yes, we know that there is some case law dealing with this issue. Some of these “barter” offers do get in front of a court. The gist of the likely result is that courts convert the “barter” to a money value and allow the ROFR holder to substitute that money for the offered property. But, what value would a court place on the offered child? And, how long has the property been kept off the market?

How about where the third party offer calls for seller financing because the buyer is exceptionally creditworthy, but the ROFR holder is objectively creditworthy, but not even in the same ball park as the offeror? Should the property owner be required to extend credit to the ROFR holder when the ROFR holder exercises its option?

What about the more common situation: an offer without a financing contingency and with a promised short closing time. A property owner and a willing third party buyer could create such a situation. Let the buyer do all of its due diligence work, physical, title, environmental, etc., before executing a contract. Let it arrange its financing before executing a contract. Then, sign an all-cash contract with a three-day closing. Can the ROFR holder arrange for all of that within the time period it has to exercise its ROFR?

To remind all of us, the preceding eight paragraphs were just examples. We’re not going to insult your intelligence by filling the rest of this posting with dozens more because, as a Ruminations reader, you get the idea. The bottom line is that unless the stars are perfectly aligned, when an offer comes onto the table for “matching,” it is very, very unlikely to be a “no loss, no gain” situation. After all, with rare exception, “One can gain something, Only by losing something, That’s the law of nature” [from (what else) Rajaram Ramachandran’s poem, No Loss, No Gain].

Try as we may, if the ROFR is negotiated to be a “general” right, applicable to unknown, future “possibilities,” no one is going to draft a provision that “reads dead on” to what may happen. And, a creative landlord, property owner or anyone granting a ROFR will be able to circumvent the ROFR if its offeror it willing to join in the effort.

We haven’t yet reached our self-imposed word limit, so we’ll press on.

A ROFR chills the market and the longer the grantee gets to mull the “offer” over, the deeper the chill. Thus, in all fairness, the review and decision period should be short. How short? Well, it depends. Ten days seems about right, but if the choice is simple (such as, do we want to extend our lease even though we are out of renewal options?); perhaps five days would make more sense. If the choice is difficult (such as, can the money be raised) perhaps up to thirty days makes sense. Keeping the time period short addresses the giver’s (say, the landlord’s) legitimate concerns about “losing the offered deal.” Making it longer should only be based on the getter’s (say, the tenant’s) legitimate concerns.

Shortsightedness in drafting creates additional problems. What is “adjacent space”? Is it also the floor above and the floor below? Is it space whose corner, but only the corner, touches the existing leased space? Go to town; make up your own examples.

How about the all too common error of a tenant having a ROFR for its own premises, one of many in a multi-tenanted property, when the offer (as should have been expected) covers the entire property? What were the parties thinking? The astute among you will point out that we’ve already covered this category when we wrote about the problem of a mismatch in lease expiration dates.

How many times have many of us seen problems raised by not defining what constitutes an “offer.” Does it encompass a “part sale – part gift” transfer for estate planning purposes; is that a “sale”? What about a sale with a disappearing installment note, again for estate planning purposes. What about a restructuring of the property-owning entity, involving a sale from an existing investor to another investor? What if the property is owned, or comes to be owned, by tenants-in-common?

How is the real estate commission to be handled? Does the existing tenant’s lease come with a brokerage agreement requiring the landlord to pay an additional leasing commission upon an “expansion” at the same time as the listing broker has an “exclusive” requiring the payment of a commission even if a ROFR is exercised? Does the ROFR effectively require the existing tenant to pick up that tab? [Of course, shouldn’t the landlord have anticipated such a situation (and others) when signing any brokerage agreement?]

We’re already over our 1,500 word limit (a goal, not a promise), including 30 questions for the reader to ponder. So, we’ll wrap today’s posting up with some random thoughts and one more question. Some of the comments to last week’s posting [seen by clicking HERE] describe other situations that ought to be “handled” when crafting a “workable” ROFR. Perhaps some energetic readers will supplement them by posting their own thoughts, using the comment invitation below. Lastly, we think that if the parties want to give respect to each other’s legitimate concerns, they should “talk” when the subject matter of the ROFR looks like it will become available – they should bargain in good faith. We understand that where the parties are legitimately far apart in what they think constitutes the “market,” only a genuine third-party offer will inject a dose of reality, but why play games if the ROFR holder really knows it doesn’t need the newly available space (or somesuch) or can’t pay for it or if the property owner is only trying to extract “more” from the ROFR holder than it would otherwise be getting in the market? Ruminations knows that thought is Utopian, but if we don’t know where the goalposts are located, we can never score any points but by sheer blunder.

Print

Comments

  1. Thanks for making that easier to understand. A friend and I were discussing right of refusal a few weeks ago and she sent me this link today. Very helpful.

Leave a Reply