Preemptive Rights and Wrongs: First-Refusal and First-Offer Rights.

Author:Krumbein, Sandra E.
Position:Real Property, Probate and Trust Law

Sitting in your office, basking in the sense of accomplishment, perhaps hugging a beer or a glass of pinot noir, you have finished the All Brands USA lease for 50,000 square feet at Mallchester Mall after six months of exhausting negotiations. With a few clean up changes, you can complete the lease in a few minutes. Then, the phone rings and it is your client, Boris Bellicose, the owner of Mallchester Mall.

"Lynn," he says, "I just got off the phone with All Brands USA, and they are ready to sign. However, their board says they need a first-refusal right if we intend to sell. Just add a sentence to that effect to the lease and shoot it over to me for signature."

"Boris," you reply, the afterglow of the alcohol being replaced with whispers from your malpractice carrier, "how can we give them a refusal right on their store when it is part of the Mallchester Mall and not separately described?"

"Lynn," is the response, "I don't give a [expletive deleted], I need the lease to refinance the mall. If you cannot give them their building, give them something else, the whole center is OK, we need to give them something."

Bearing in mind that your client will be unable to recall this conversation five seconds after he hangs up, you will need to consider the below matters.

Rights of First Refusal

A right of first refusal, frequently referred to as an ROFR, is the right of its holder to match the purchase terms of a third-party purchase offer. This right is "triggered" or activated when the owner of the property burdened by the right obtains a purchase offer from a third party, either in the form of a purchase contract or a term sheet or letter of intent, that the owner would like to accept. (1)

* The Property--It is important to determine the property encumbered by the refusal right. The above example reflects that it may be impractical to afford a tenant a refusal right over its space. If the leased space is part of a larger parcel, it is unlikely that the tenant will have the ability to acquire the larger parcel. Perhaps the rights holder isn't interested in the entire shopping center but only in its parcel. If you are able to obtain a separate legal description, but then your client receives an offer to purchase the shopping center, and not merely the separate parcel, what is the result? Would your client lose the unencumbered right to sell a larger parcel? Similarly, should you grant a tenant a refusal right on the shopping center, would that create a problem upon a sale of Mallchester Mall in a portfolio transaction where a fund is purchasing Mallchester Mall and six other shopping centers from your client? (2)

A preemptive right applicable to real estate generally only applies to the sale of real property. Accordingly, a sale of ownership interests in the property owner may be a method of avoiding the ROFR. (3)

* The Trigger--The trigger for activating the first refusal right may be a term sheet, a letter of intent or an executed purchase contract. Is it likely that a third-party purchaser will negotiate a purchase contract and undertake the expenses of due diligence and legal fees with the threat of losing the property to the rights holder overlaying the transaction? A ROFR should not be viewed as a meaningless right offered to satisfy a request by a tenant without giving thought to what it means in for future marketability of the underlying property. It could definitely adversely impact the ability to sell the property in the future. If you try to rely on a term sheet or letter of intent to sidestep this problem, the holder of the refusal right may argue that the final contract with a third party contains material terms not contained in the term sheet. Any failure of the rights holder to exercise its ROFR might, therefore, not be deemed a waiver of the right. The holder might contend it should be entitled to another chance to purchase when the full terms are disclosed. (4)

* Ability to Sell--The existence of a refusal right will typically adversely affect the owner's ability to sell the burdened property as long as the refusal right is outstanding. But its effect may be more profound. If the rights holder exercises its refusal right but the purchase agreement contains a diligence period, will the rights holder obtain the same diligence period? Unless this point is specifically addressed in the ROFR grant, the rights holder will have all of the rights of the prospective purchaser even though it may have occupied the property for many years before the refusal right was triggered. Such a diligence period may allow the rights holder the ability to exercise the ROFR and tie up the property for 30, 60, or 90 days, then cancel prior to the expiration of the diligence period, thereby potentially derailing a prospective sale.

What about the effect of a tenant's failure to close the purchase if it exercises the refusal right, for example, because of its inability to obtain necessary financing? (5) In such an event, you may have lost two potential purchasers and tied up the property for...

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