How Do You Spell Trouble? ROFR, ROFO, ROLO, ROFN? All?

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Last week we expressed the belief that very few tenants are “entitled” to receive a Right of First Refusal (First Offer, Last Offer, First Notice) and that very few landlords should give in when any of these are requested. We also wrote that we didn’t think any deals would go south if the landlord said, “No.” Well, that’s the ideal world as seen by Ruminations. But, we also live in the real world. Sometimes leases give tenants one of those rights.

On August 4, 2013, in our 125th blog posting (this is our 383rd), we used this title: “What Were You Thinking? Was It a ROFO, ROFN, ROFR or ROLO?” Those who weren’t with us five years ago and those with sieve-like memories similar to our own, may want to visit that posting. That’s easy – just click: HERE.

The biggest issue with a landlord giving one of these rights to its tenant is not a legal one; it is not a business one; it is much simpler. Most landlords forget they’ve given them. It’s one thing to know that you’ve got to look at a lease to find its notice requirements. That’s a regularly occurring event and landlords develop the habit to do so. It’s the same thing when a landlord wants to send out a default notice. It knows that every lease is a little different and every lease has such provisions. So, it becomes a habit to look.

But, landlords don’t sell properties every day. They sell them once and done. So, there’s no habit to be developed. It is very unusual to have a lease that gives a tenant the right to lease adjacent space at the property. There are a small percentage of leases that give such a right and in only a small percentage of those situations will the adjacent space come up for lease. [That’s pretty much true at shopping centers and less true in office buildings.] Thus, only those landlords who have been burned by overlooking a tenant’s lease with such a right ever looks each and every time they lease or sell property. Even landlords who prepare information-laden lease abstracts forget to look at them when they should be doing so. And, for those who say that the prospective buyer will scour all of the leases and find those provisions, we answer that this happens after a bona fide offer has already been made.

So, what is a landlord to do if it has given any tenant some form of right to buy a property if and when the landlord has decided to sell? First, it needs to remember that it has given the right. We have no (practical) suggestions in that regard. That’s because all “methods,” whether those be “Post-Its” or lease abstracts, require that the landlord remember to look for those notes. We’ve conceived of an impractical approach. In the lease, require the tenant to send a reminder notice in “January” of every year and make the failure to do so into elimination of the right.

That leads to a common feature of these “rights,” the “use or lose it” one. Once the property has been offered to the tenant, if the tenant “passes” and the property is sold, the right is extinguished. If every new owner is going to be burdened by the ROFR, ROFO, etc., it will further chill the market.

The time period to respond to an “offer,” whether it is to match a bona fide one just received (ROFR) or it is from the landlord that the property will be going on the market (ROFO or ROFN), should be as short as can be negotiated. That will serve to reduce the drag on the market a ROFR, etc. creates. Prospective buyers would rather wait 10 days to know if they have a deal than wait 60 days. Of course, tenant-buyers would wisely resist because the issue isn’t “how long it takes to “decide,” but “where is the money going to come from?” Unless the tenant is well-funded or has an appropriately-sized line of credit, it will take more than 10 days to line up reliable financing.

What kind of property transfer (usually, a sale) should be “intercepted, so to speak” by a tenant? Foreclosure sales and transfers by way of a deed in lieu of foreclosure should top the list and, if one takes place, the tenant’s right should be extinguished at that time. Even where a lease is made subordinate to a later mortgage, the common non-disturbance provisions in the lease or, more commonly, in a subordination, non-disturbance, and attornment (SNDA) agreement might preserve the purchase right. So, if the lease doesn’t extinguish such a right when a lender takes the property, the SNDA should. While we are at it, let’s not forget a carve-out for any legitimate form of auction sale.

Tenants might want to negotiate to limit the lender to “institutional” ones so as to reduce the probability of a “friendly” deed to, or foreclosure by, a disguised buyer, possibly one who has “lent” the entire purchase price to the landlord.

Upon death, the decedent’s property is transferred to a devisee or to the estate. It might be acceptable for the tenant’s right to survive such a transfer, but should a tenant’s right to buy the property be activated? Perhaps the will says that one of the children has the right to buy the property from the estate? And, what about pre-death transfers in anticipation of death? We’re thinking of estate plans that gradually shift ownership to younger generations. Sometimes, interests are sold to children by way of self-cancelling notes. That’s a way to reduce or eliminate the tax consequence of gifting those interests. Tenants should not have the right to step into the shoes of the (not so real) buyers. Sometimes, the property is transferred to a family-owned entity, such as a “family” limited partnership or trust or limited liability company. Such “sales” need to be excluded. [None of this is to say that the tenant’s rights shouldn’t continue after one of these transactions.]

Similarly, inter-owner changes (partners, members, etc. coming in or out) should be excluded. All in all, landlords should seek to limit any form of its tenant’s purchase rights to a sale of the entire property, not just a sale or transfer of a partial interest in the property. The rights should be limited to when there will be a sale to an unrelated third-party. Owners should be entitled to choose their own roommates. Under such carve-outs, however, it would be reasonable for the tenant’s purchase right to survive.

While we are at it, tenants who have negotiated for the right to “take over” a deal from a legitimate buyer (ROFR) or to “get in front of the line” (ROFO or ROFN) or to get the “final bite” (ROLO), will want to have those same rights even if the property is transferred by way of a sale of the landlord’s ownership entity. While there are very good reasons buyers don’t want to buy the entity that owns a property, but under some circumstances this will be done. One such “circumstance” is to circumvent a ROFR triggered by a sale of the “property.”

Tenants have their own concerns, ones that go beyond having enough time to decide or to get funding. There are tons of ways that can make exercising a ROFR impossible or impracticable. Very few tenants have their own real estate investment trust (REIT). So, a sale to a REIT (actually a contribution to the REIT) will be impossible to match. Sale of the property as part of a group of properties is another case. Very few tenants want to, or are prepared to, buy all ten properties just to acquire the one where its premises is located. [Landlords would be wise to avoid any legal fights over this. They should carve-out multiple property sale situations.]

A similar challenge is where the purchase price on the table includes cash and a particular property owned by the prospective buyer. How can a tenant match such an offer when it doesn’t own the property to be tendered by that buyer? There are ways to handle this, such as by allowing the tenant to substitute money for any non-cash consideration to be paid by a prospective buyer. Speaking of non-cash consideration, one needs to consider seller financing as part of the bona fide offer on the table. Tenants may have lower cost money available to them than the “notes” that would be taken back by their landlords. Landlords might have lowered the property’s price because they are going to get higher than market rate interest on those notes. And, cash isn’t always what a selling landlord wants. It might want the tax deferral that comes from an instalment sale. That might have been why those “notes” are part of the sale.

Generally, a ROFR will say that a tenant has the right to “take over” any deal the landlord is willing to make. The lease needs to be clear as to the stage at which there is a “deal.” Tenants will want to see a signed purchase contract. Landlords will want to get its tenant’s commitment at an earlier stage – when there is a bona fide letter of intent. [By the way, that’s why landlords should prefer ROFOs and ROFNs – they’ll know, at the outset, whether their tenant is in or out.] Of course, the problem with having the rights adhere to a letter of intent is that the deal hasn’t been worked out. Using the letter of intent as a trigger is akin to a ROFO except that the core of the offer – purchase price and other major terms – are already set. But, “there’s many a slip ‘twixt the cup and the lip” when a letter of intent needs to be translated into an enforceable purchase agreement.

Using a final contract, one that is subject to the tenant’s right, creates other problems. As noted above, it might call for seller financing. Should the selling landlord be obligated to take the same “notes” from its tenant? What if its tenant isn’t credit-worthy? What would that negotiation look like? While not a complete solution, especially where high interest notes are tied to a lower purchase price, landlords should insist on the right to require a tenant with a ROFR to pay cash.

There are plenty of ways for a landlord and a prospective buyer to “poison” the contract to be “taken over” by a tenant with a ROFR. Many are based on having the buyer deliver something the tenant can’t deliver. That could include a unique item such as $19 million plus a specific Picasso painting. There’s only one such painting. If that doesn’t sound legitimate, then how about $19 million and a 2% interest in another property? How about $19 million and a binding agreement not to sell a particular type of merchandise, in particular the merchandise that the tenant with the ROFR sells? Does that last one sound out of bounds? Well, not to the New York court that upheld a proposed contract with something very much like that. It included a provision that the deed would include a restrictive covenant that the property could not be used for the very business being conducted by the party holding the ROFR. [It wasn’t a tenant, so its use wasn’t a pre-existing one. But, the ROFR had been intended to allow the party holding the ROFR to expand its business, and the deed restriction made the negotiated-for property useless to that party.]

This is where we will end. It isn’t because we can’t give readers a comprehensive or more comprehensible set of guidelines. We stop here for two reasons. One is that this is a blog posting, not an “article” or treatise. More importantly, it wasn’t really our objective to create a checklist for readers. It was to show the morass that a ROFR, ROFO, ROLO or ROFN can create. It sounds pretty simple when a tenant or its broker asks for one, but it is far from simple. And that’s not just from the landlord’s point of view. Tenants also need to negotiate the details very carefully so that the right it receives isn’t illusory.

We invite readers to pile on with what they like to see in the “details” when a lease includes any one of these “purchase rights.” So, please add your thoughts by using the comments feature below.

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