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Real Estate Tools Rights Of First Refusal

Stewart Title of California
Stewart Title of California

What is a right of first refusal?

A right of first refusal is the conditional right to acquire property, depending on the owner’s willingness to sell. The holder of the right merely has the preference to purchase the property over other purchasers if the owner of the property elects to sell the property. For example, the most common use of a right of first refusal is where a landlord incorporates it into a lease, giving the tenant the right to purchase the property at the same price, terms and conditions as a third party’s offer.

Not An OptionYet.

The right is not an option to purchase since the right holder does not have an absolute right to buy the property at a set time for a set price. If the owner decides to hold the property, the right holder cannot force the owner to sell the property.

The right does not become an option to purchase until the owner of the property voluntarily decides to sell the property and accepts a bona fide offer to purchase it from a third party. At that time, the price, terms and conditions are set by the bona fide offer received from the third party. It is at this time that the right holder has a form of option to purchase the property.

Matching Terms.

The right does not allow the right holder to buy the property at a lesser amount or on different terms and conditions. Basically, the right holder must match the competing offer. However, if the right holder matches the competing offer, the right holder has preference and will be first in line to purchase the property.

The right is also enforceable against third persons entering into a contract to buy the property with notice of the holder’s right.

What Should The Right of First Refusal Say?

When inserting a right of first refusal in a lease, the parties should include the following terms:

1. The Landlord will give notice to the tenant of the exact and complete terms of any proposed sale and will give a copy of the offer and any counter-offers signed by both the landlord and the prospective purchaser. [Landlords, make sure that your prospective purchaser knows that your proposed sale is subject to a right of first refusal!].

2. A time limit for the tenant to exercise the right by giving written notice.

3. The ability of the landlord and the prospective purchaser to make changes to the offer within a defined range without the right applying again. For example, the landlord and the prospective purchaser can modify the purchase price or down payment by up to 5% without retriggering the right of first refusal. However, a tenant will want to retain the right if there is a material change to the offer, such as the landlord offering more seller financing

4. A time limit to close the sale before the right is triggered again. For example, if the purchase is not closed within 180 days, then the tenant will once again have a right of first refusal.

In addition, if the original deal falls through, the tenant will want to retain the right of first refusal on subsequent offers.

Limitations to the Right of First Refusal.

The landlord will also want to include limitations on what is considered a bona fide offer. Because transfers may be necessary for estate planning or tax planning purposes, such transfers should be specifically excluded from the right of first refusal. Such exclusions should include property being taken by eminent domain or under threat of condemnation, inter-family or inter-ownership transfers, transfers to a trust created by the landlord, or, if the landlord is a trust, transfers to a trust beneficiary.

A landlord should also consider limiting a tenant’s right to first refusal when the tenant is in default under the lease.

Where Rights of First Refusal Get Tricky.

Rights of first refusal appear simple on their face. However, clever third party buyers, in conjunction with the seller, often create subterfuges intended to prevent the right holder from being able to exercise the right. Some examples of this include inserting conditions in the offer that have no effect on the seller or third party but frustrate the right holder’s use of the property. For example, in one case in which the right holder was a mining company on adjacent land, the seller entered into a contract with a third party buyer which prohibited mining on the property. The court found that condition to have been made in bad faith simply to prevent the right holder from gaining the property.

A Balancing Test.

More commonly, the seller will include the parcel in the sale of a larger parcel and ask the right holder to match the terms for the entire parcel rather than the parcel subject to the right. In some cases courts have barred this tactic. In other cases unique consideration will make it difficult for the right holder to match the offer. For example, an offer may involve exchanging the property for another specific property. Courts try to balance the competing needs of a right holder having to match exactly the terms of the triggering offer versus looking past bad faith conditions in the offer which are only intended to defeat the right of first refusal.

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