Purchase Rights And Poison Pills

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There is so much to say about purchase rights: straightforward ones, rights of first refusal, rights of first offer, rights of last offer, and rights of first notice). There is so little time to do so. [For those with time to spare, click HERE for a primer.]

Very often, a contractarian approach is taken by courts when exploring contract terms. After all, absent overreaching in one form or another by one party, those participating in commercial transactions are believed to be grown-ups. That is, they are expected to understand the impact of their agreements and to abide by the consequences. However, there are exceptions. Today, as we describe a New York court’s protecting a party’s right of first refusal to purchase a property, we get yet another opportunity to drag out a well-worn Ruminations’ topic: The Implied Covenant of Good Faith and Fair Dealing.

In an October 2018 decision from the Appellate Division of the New York Supreme Court [seen by clicking: HERE], we hear about a car wash purchase transaction. As part of that transaction, the buyer was given a right of first refusal to purchase a second car wash location from the same seller. It was set forth in a separate agreement and required the seller to “give written notice to [the option holder] of any acceptable offer to purchase” the remotely located property, whereupon the buyer (holding the right) “would then have five days to notify [the seller] of its agreement to purchase the property “on the same terms as set forth in the third-party offer.” That’s pretty familiar language, though five days is an unusually short time period, a non-issue with regard to what happened once the seller gave such a notice.

Across the street from the subject property was a competing car wash. Its owner made a purchase offer. The relevant terms of that offer, i.e., the ones of interest to us today, were that: it would be buying only the land, but not the business; at closing, the seller would shut down the still-operating car wash; and (critically, as will be obvious), the deed would include a restrictive covenant barring future use of the property as a car wash. The option holding car wash owner cried “foul” and responded, “that it wished to exercise its right of first refusal by purchasing the property at the price specified, but that it would not accept a deed that restricted the use of the property for a car wash.” The sale did not go through and a lawsuit followed with each of the property owner and the option holder asking the court to rule in their respective favors. In essence, the property owner sought a declaration that the “acceptance,” conditioned on the deletion of the restriction against a car wash, was invalid. On the other side, the option holder sought an Order requiring the property owner to sell the property to it.

The trial court found in favor of the property owner, holding that the property owner-seller had complied with the terms of the right of first refusal and that the option holder had improperly conditioned its acceptance, a fatal defect to its effectiveness. Briefly stated, the appellate court overturned the lower court’s rulings and flipped the result. Here’s why it did that and here is a lesson (or a reaffirmation) that circumvention is not fair play.

The opposing arguments were simple. The property owner asserted that the option holder had not matched the “precise terms” of the offer. In response, the option holder contended that the buyer’s offer was not bona fide because the buyer and the property owner “had entered into the purchase contract in bad faith for the specific purpose of defeating the … right of first refusal, thus depriving [it] of the benefit of its bargain and breaching the covenant of good faith and fair dealing implicit in that agreement.” [Ruminations would call that an attempt to circumvent.]

Normally, we would hold the following “fact” until much later, but (today) that would be unfair because, to do so, would leave some readers grumbling (until that point): How would anyone know?

It turns out there was email correspondence from the car wash competitor-buyer “stating that [the option holder’s] right of first refusal was “a serious sticking point” and that [it] was unwilling to negotiate an agreement only to have [the option holder] exercise its right by purchasing the property.” On top of that, the owner of that competing car wash-buyer “stated that, as a result, he had ‘already spent a lot of money with [his] attorney discussing how to structure [an agreement] as a ‘poison pill’ … and that they planned to ‘do[] very unusual things with deed restrictions to accomplish this.’”

What are the “unwritten” rules when it comes to how contracting parties are required to act in the carrying out of their contractual obligations? With limited exceptions, such as in employment agreements and perhaps oil and gas transactions, universal contract law in the United States includes an implied covenant of good faith and fair dealing. Different courts explain that covenant in different words. Here are those used by this particular New York Court:

In every contract there is an implied undertaking on the part of each party that he [or she] will not intentionally and purposely do anything to prevent the other party from carrying out the agreement on his [or her] part. The idea is simply that when A and B agree that B will do something it is understood that A will not prevent B from doing it. The concept is rooted in notions of common sense and fairness.

The parties involved in the story we have been relating were not the first to try the “circumvention ploy.” Here are a couple of “clips” found in other New York court decisions:

Consistent with that obligation, it is well established that landowners and potential buyers may not structure property transfers in bad faith for the purpose of defeating the exercise of rights of first refusal.

Likewise, an offer that circumvents a right of first refusal by including conditions that are impossible for the holder to fulfill does not constitute a bona fide offer requiring the holder to exercise the right.

In this case, it didn’t matter that there was no direct evidence that the property owner did not participate in planning the transaction that led to the contract with the poison pill. It was enough that it knew that:

the transaction had been purposefully structured to include the “poison pill.” The inclusion of the deed restriction within the purchase agreement was precisely targeted to prevent [the option holder] — which [the property owner] knew was in the car wash business and had entered into the right of first refusal as a means of preserving its opportunity to operate a car wash on the property — from exercising its first refusal rights.

Yes, combined with what the property owner clearly knew about why the option holder wanted the property, the purchase contract, standing alone, was enough to show the owner’s involvement in the attempted circumvention.

We’ve written about this general topic before. If you missed that blog posting from last year, there’s a second chance available if you click: HERE.] If you are interested in trying your hand at circumventing an option holder’s rights, then we suggest you read the New York court’s decision by clicking the link we’ve provided at the outset of today’s posting. That way, you’ll learn of what hasn’t worked in the past.

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