What is a Right of First Refusal Clause?
Under a right of first refusal clause, a landlord would give the tenant the right to acquire a property that the tenant is leasing, or any other property that is contiguous to the property that the tenant is leasing. In such an event, the landlord is obligated to seek an offer and offer the same terms and conditions to the tenant to see if the tenant is interested. Thereafter, if the tenant is not interested, the landlord is free to sell to the third party on terms that are equal to, better than or worse than the ones presented to the tenant . A right of first refusal clause can allow the tenant to control an entire area and gain control of properties that are next to or near the property that the tenant is leasing.
A right of first refusal clause gives the tenant the exclusive ability to purchase property that is next to or near what the tenant leases. It means that the tenant is not only leasing that property for its own use but also has the ability to buy it and possibly other nearby properties.
How does a Right of First Refusal work in a Lease?
You may be familiar with a right of first refusal provision in an owner’s governing documents. Owners often have a right of first refusal over a transfer of contract control of a unit (i.e., in connection with a sale of a unit). A right of first refusal can also be used in lease agreements.
In the lease context, this clause is used to give a tenant the right to match any bona fide offer received by the landlord for the purchase of the property (or at least the tenant’s space in a multi-tenant property). A right of first refusal differs from a buy-sell agreement because it may come into play only if the landlord receives an unsolicited outside offer. A buy-sell agreement would govern all sales of the property, not just those offered to the landlord.
Here’s how it works: A landlord who has a right of first refusal in a lease may receive another offer to purchase the property. Before accepting the offer, the landlord must notify the tenant of the proposed outside sale and the terms of that offer. The tenant then has a specified period of time (often within 30 days) to match the offer. If the tenant matches, the deal goes through. If the tenant doesn’t match or the matching price terms are unsatisfactory to the parties (e.g., the tenant only wants the right to match but not the obligation to match), the landlord can then accept the outside offer.
A lease right of first refusal should only apply to the same parcel of land, not to nearby land. The right of first refusal should also set forth who must be notified of an outside offer and when notice must be given. If a tenant subleases space, the right of first refusal must address whether subtenants will be entitled to exercise the tenant’s right in case the landlord receives an offer to purchase the property. Of course, as with any lease provision, the right of first refusal should always be the subject of negotiation between the landlord and the tenant.
Pros and Cons to Tenants and Landlords
The right of first refusal clause can work to the benefit of both public and private tenants if they are considering the purchase of a commercial space that they currently occupy. Moreover, it provides security for the tenant, who has the right of first refusal, and provides flexibility for the landlord to maintain the ability to lease the property to a different party. A tenant also knows at what price it could purchase the property should it decline the tenant upon the terms contained in the right of first refusal clause. If the tenant uses an option to the right of first refusal clause, it can be forced to purchase the property, generally at the fair market value, but the tenant has not had an opportunity to negotiate a price as with an option. Since the right of first refusal clause generally only requires that a third party offer the same amount to the landlord, the tenant could ultimately pay more for the property than if it had negotiated an option. For example, assume the tenant has a lease under which it has the option to purchase the property at $1,000,000. Under the right of first refusal clause, the tenant would have to pay $1,000,000 if there was an offer from a third party to purchase the property for the same amount. If, for example, however, the property increased in value to $1,900,000 over time, the right of first refusal clause would require the tenant to pay $1,900,000, while the tenant could have used the option to negotiate a price closer to $1,000,000. The right of first refusal clause also provides similar benefits and risks for landlords. The landlord can obtain a potentially higher price for the property, whereas the tenant may be happy to pay a higher price than it would have otherwise agreed to if it did not have the right of first refusal clause. The landlord may be able to deal with other potential buyers who might be reluctant to make an offer because they know they will have to sell at the same price to the tenant. Like a tenant, the landlord may be stuck with a price that a tenant is willing to pay when a higher offering price is available, although in practice the landlord has the discretion to accept a different offer because the right of first refusal clause only requires matching the price. A landlord may also be forced to sell to a possible troublesome tenant if the right of first refusal clause was made for a specific tenant.
Common Terms in a Right of First Refusal Clause
When negotiating over right of first refusals, you will often see the following terms:
Right of First Refusal
The right of first refusal is a unilateral option that allows the tenant to match or exceed a bona fide offer received by its landlord from a third party. In order for something to be a "bona fide offer", typically, the offer must be a written offer for the purchase, lease or expansion of existing space and include information that is not proprietary to the third party or its financial condition – price, term and space to be leased must be specifically stated.
The right of first refusal should expire or terminate if the landlord has not delivered and tenant has not countered its election to exercise its option to match the offer within a prescribed period of time (generally between 5-10 days). These periods of time typically do not include weekends or holidays.
Condition Precedent for Exercise
Most right of first refusals have a provision that say that a broker or commission has been expressly waived by the tenant in order for an option to be exercised. Standard language includes: "Brokers. In the event Tenant exercises an Option, no brokerage fee shall be due Landlord with respect to the Option, and Landlord shall be entitled to be indemnified by Tenant from and against any liability arising from any claim for any broker’s or finder’s fee in connection with the negotiation and execution of this Option."
Timing of Termination
It is customary for the right of first refusal to terminate if it is not exercised within a prescribed period of time or, if the tenant has countered to match the offer, within a prescribed period of time.
Legal Considerations and Implications
As with any contractual clause, the right of first refusal can have serious legal implications if it is not fairly negotiated and properly written. For both landlords and tenants, the right of first refusal cannot contradict the lease agreement or other documents related to the real estate being leased. For example, a tenant cannot use a right of first refusal that allows them the first chance to purchase property to avoid paying the defined rental cost of the property. The tenants cannot use the right of first refusal clause to make a profit off the sale the same way an owner would. In the same vein, the right of first refusal clause cannot be used as sloppy legal language to keep an owner from selling a property. As with any change in a contract , such language could get a landlord into breach of a lease agreement with cash damages and other fines as a result of a legal action.
Instead, the language of a right of first refusal clause should be specific. It should include factors such as the exact expiration date for exercising the right and how much openness there is for changes in ownership over time, among other items. This is especially important for subleases of other commercial real estate. When drafting the clause, the most important thing to consider is how to write the language of the right of first refusal clause to best serve the needs of both parties.
Sample Right of First Refusal Clause
A right of first refusal can be drafted in several different ways, but it should be clear and unambiguous on both sides. The lease should define all terms clearly so that neither party has any misunderstanding.
The right of first refusal should be nicely incorporated into the lease to form a proper legal leasehold agreement.
The following is a basic guideline and suggestion for drafting a sample right of first refusal clause:
In the event the landlord receives or accepts an offer from any third party (the "3rd Party") to sell or lease all or any portion of the land leased by the tenant under this lease (the "Premises"), or any interest of the landlord therein or the building(s) now located or later built thereon, the landlord will first submit the offer and the 3rd Party’s bona fide written offer, if there be one, to the tenant for its acceptance or rejection. The tenant will then have sixty (60) days from receipt of written notice from the landlord within which to give the landlord written notice of whether the tenant intends to exercise its right hereunder. If the tenant fails to give said written notice to the landlord within the said sixty (60) day period, the tenant will be deemed to have waived its rights hereunder and the landlord will be free to lease or sell to the 3rd Party in accordance with the offer.
If the tenant gives notice to the landlord within the said sixty (60) day period of its intent to exercise its right hereunder, then the tenant will have an additional sixty (60) days from the receipt of the landlord’s written notice of the 3rd Party’s offer within which to either negotiate the terms of the offer with the landlord or decline such third party offer. If the parties are able to agree on the terms of the leasing or sale, then the matter will be reduced to writing and executed by the parties. If the parties cannot agree on terms within such additional sixty (60) day period, then the landlord may proceed and consummate the transaction with the 3rd Party in accordance with the terms and conditions of the 3rd Party’s offer.
The tenant acknowledges and agrees that upon the leasing or sale of any or all of the permitted premises, the landlord’s obligations under this tenancy may terminate. Tenant further acknowledges and agrees that the right of first refusal granted to it hereunder terminates upon the occurrence of an Event of Bankruptcy, as such term is hereinafter defined. Tenant further acknowledges and agrees that the right of first refusal hereby granted to the tenant under this lease is specific and not general in nature, is personal to the tenant, is not assignable by the tenant, and the landlord is making the right of first refusal herein granted to the tenant in exchange for the tenant’s acceptance of the terms and conditions of this lease for the full term thereof.
For purposes of this agreement, "Event of Bankruptcy" means any of the following events: (i) any petition in bankruptcy, insolvency or receiver proceedings shall be filed by or against tenant, or (ii) the making by tenant of an assignment for the benefit of creditors, or (iii) the institution by or against tenant of judicial proceedings to be adjudicated a voluntary or involuntary bankrupt or insolvent.
Case, Statute and Practice Examples
Case studies and real-life examples of right of first refusal clauses in action can shed light on their significance. For instance, in a landmark case, an office building in New York City was sold to a third party despite the tenant occupying the space having a right of first refusal to purchase the property. The court ruled that the tenant’s failure to actively pursue their right of first refusal constituted a waiver of the rights, demonstrating the importance of tenants being proactive in exercising their rights.
In another example, a tenant in a retail space held a right of first refusal for additional space in a shopping center. When the landlord approached the tenant with an offer to lease the space to a third party, the tenant negotiated better terms to match the competitor’s offer, which ultimately benefited both parties. This case showed the value of having a right of first refusal for tenants, as it allowed them to become stakeholders in their surroundings.
Certain jurisdictions have specific regulations governing rights of first refusal in commercial lease agreements. For example, in California, a commercial tenant’s right of first refusal must be exercised in writing within the timeframe stated in the lease, making it imperative for all parties to understand the statutory requirements for exercising the right.
In addition, the benefits of a right of first refusal clause can extend to other stakeholders. In a case involving a planned community, homeowners had a right of first refusal to purchase adjacent land before it was sold to a third party. This right allowed homeowners to prevent unwanted development and ensure the long-term value of their properties and the community as a whole.
Other examples can be found in the residential sector, with homeowners’ associations marketing their right of first refusal clauses as a benefit to owners. By targeting buyers who recognize the long-term value of owning property within a particular community, the association creates a carefully curated neighborhood.
Similarly, in commercial office leases, such clauses can be used to encourage entrepreneurial ventures, enabling business tenants to build equity in their locations as they expand.
These real-life examples highlight the importance of assessing a right of first refusal and understanding its implications before entering into a lease agreement.
Right of First Refusal Clauses FAQs
A right of first refusal clause (also known as a right of first refusal or ROFR) is a clause that gives the tenant the right to purchase the property at the same price a third party buyer has agreed to buy it for. This means that if you are the tenant in a leasing agreement, you have the right to purchase the property the lease is attached to. However, you must be the one to notify the property owner that you wish to do so.
Below are some frequently asked questions regarding right of first refusal clauses:
What happens if I don’t find out about the right of first refusal?
The owner of the property is responsible for notifying you about the right of first refusal within a certain amount of time, according to the terms of the right of first refusal clause. If they fail to do so and you were interested in purchasing the property , you may have some legal recourse against the property owner.
Does the property owner have to sell me the property at the same price as the right of first refusal clause states?
Yes, the property owner has to sell you the property at the same price as agreed upon by a third party buyer.
What if the buyer decides not to go through with the purchase?
The right of first refusal clause will still be in effect and the landlord will have to notify you again of a potential buyer and give you the option of purchasing the property first.
If I decide to purchase the property, what’s the next step?
You will usually have to write a letter of intent to the owner that states you wish to purchase the property and the terms of the deal. Once you give this letter to the landlord, the deal will be finalized.