Just Say No To The Request For A ROFR [What Say?]

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A contract, such as a lease, gives one party, say a tenant, a right it would not have without the agreement. That means the other party, in the case of our example – the landlord, has an obligation it would not otherwise have had. That’s the essence of a contract – an exchange of rights for obligations or duties. Think about it, without some kind of enforceable agreement, a lease (oral or written), a license agreement or a use and occupancy agreement, what right would a tenant have to possess its premises and what obligation would the owner have to allow it?

In real property law, a lease is a conveyance of an interest in real property just like an ordinary deed is a conveyance of an interest in real property. The difference is that an ordinary deed, one that conveys what the law calls a “fee simple interest,” gives the “grantee” the entire “bundle of rights” that come with ownership. A lease gives the grantee (the “tenant”) an “estate for years.” An estate for years has a “termination date,” a date upon which the tenant loses the right to remain in the premises. Basically, the tenant does not get any “ownership” rights after that date.

So, it is not uncommon for a prospective tenant (or, more likely its real estate broker) to request a “right” to become the property’s owner under some conditions. We aren’t going to write about the unilateral right of a tenant to buy the property as represented by a purchase option. That’s because we think that landlords confronted with such a request understand the implications of giving a tenant the option to buy the leased property. It’s a pretty direct business proposition though we admit to having seen some pretty convoluted agreements.

So, that leaves us with the lesser understood rights, those of first refusal, first notice, first offer, and last offer. [Ruminations has trampled over this landscape a number of times in the past. If interested in what we’ve written before, click: HERE or use the search feature with the term: “first offer.”] The trick about these rights [in the order presented, abbreviated as: ROFR, ROFN, ROFO, and ROLO], is that Newton’s Third Law, as applied to real property law, tells us there is also a corresponding obligation undertaken by the landlord: the obligation of first refusal (OOFR) and so forth.

What is the prime obligation imposed on a landlord? It is the obligation to remember that years ago it gave the right to its tenant. Yes, the most common dispute that comes up is that a landlord makes a deal to sell its property, very often an enforceable one with a buyer (and, by extension, with a broker), and then the tenant steps in to assert its ROFR and, at a minimum, it screws up the deal. Sometimes, it leads to litigation, unpleasant and expensive litigation. It could lead to the owner owing big dollars to the contract-buyer.

When a prospective tenant makes a request for some kind of purchase right, it is almost always for a right of first refusal (ROFR). If the request is granted, it means that there will now be a wizard behind the curtain when a prospective buyer shows up. That’s someone who is involved in the negotiation but can’t be seen and might or might not be real. Such a wizard influences the decisions the property owner and its prospective buyer must make, but when the curtain is finally pulled aside, it might reveal an empty stage or a tenant powerless to actually “take over the deal.”

Imagine that you are the prospective buyer. Do you want to be the existing tenant’s negotiator, one who is working to get the best possible deal for the tenant to buy the property? If so, then you are the rare buyer. The marketplace of “rare buyers” is a very small subset of the entire marketplace of buyers. Smaller marketplaces mean smaller demand. Smaller demand means smaller prices. Yes, giving a tenant a ROFR not only complicates future sale negotiations but can depress the price of the property.

There are other complications or downsides to giving a tenant a ROFR. For one, in their unadulterated or purest form, lenders don’t like them. They apply at foreclosure auctions and drive bidders away. Families don’t like them. They complicate estate planning and impede estate administration. They make contributions to joint ventures or REITs complicated (to say the least). What if the landlord wants to donate the property or sell it to a charity at a bargain price?

Yes, there are ways to limit a ROFR to ameliorate the problems described above and there are counter-offers that a landlord can make at the outset, ones like the ROFO, ROLO, and ROFN alluded to above. None of those avoid the number one problem – faulty memory – but they can, in one way or another, make it easier to find prospective third-party buyers.

There is another alternative, a valuable one – reject the request for a ROFR in the first place. Experience has shown us that requests for a ROFR are almost always “throw-ins,” something that sounded good to the tenant or its broker, but isn’t even close to a deal breaker. Yes, there are circumstances where they are central to a deal, but everyone knows that even before a leasing offer is made. This is most common in leases for industrial properties where a tenant is making very, very, very expensive and extensive changes to the property, ones that any future buyer would have to rip out. This comes up when the property owner would be willing to sell the property to the tenant, just not “now.” The property owner may have personal or tax reasons not to make the sale at the time of leasing, but would be willing to do so at a later time of its choosing. That’s not the ordinary situation. The ordinary situation is the “throw-in.”

We’ll dig in deeper next week, sharing some thoughts about ways to write a ROFR and its siblings (or, perhaps, cousins) in less burdensome ways. Today, we just wanted to emphasize the Nancy Reagan approach (alternative) – “Just say No.” We doubt any ordinary tenant would walk away from a deal in response to such a response.

[Again, for those who want to get a head start on next week’s blog posting, use the search feature with the term: “first offer.”]

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