Post modified 9.6.22, Arnold Heller, Esq.
What is a Right of First Refusal?
It's not unusual for a landlord to grant a tenant a right of first refusal (ROFR) to purchase the landlord’s property if they decide to sell. Typically, a RORF is used for these purposes:
- As an incentive for lease tenants in a buyer's market
- For buyers with a contingency in a seller's market
- To prevent issues among family members over an inheritance
In any of these cases, the right of first refusal obligates the seller to give the holder the first chance at the property before accepting any alternative offers from third parties. The right's holder can elect to proceed with the purchase. However, if they decline, the seller can entertain other offers.
As a lessee, a ROFR can provide a preference for the property they occupy. So, it's regarded favorably. But from an owner's standpoint, it may represent an encumbrance as they cannot entertain offers from competing parties.
Whether a buyer or seller, it pays to discuss a right of first refusal agreement with a real estate lawyer.
How a Right of First Refusal Works
Rights of first refusal allow individuals or businesses to assess the landscape before committing. As a result, they don't have to make a purchase decision immediately but can elect to see how things pan out. The ROFR lets them do that without risking losing the property.
You can customize the right of first refusal clauses. For example, the parties can specify the length of the ROFR. Indeed, most rights of first refusal agreements include a time limit. So when that limit expires, the owner is free to sell to other interested buyers.
Most right of first refusal ingredients includes these items:
- Time Limit: The buyer receives a pre-determined amount of time without having to compete for the property.
- Sale Price: The sale price is included if a seller decides to list the property.
- Breach Remedies: The buyer is given their option if the ROFR is rejected.
- Exceptions: Special situations altering the terms of ROFR. For example, how a cash offer impacts the sale.
ROFR versus ROFO
As mentioned, a right of first refusal requires a property owner to allow the right holder to purchase the property. They may only proceed to sell the property when the holder of the ROFR doesn't exercise that right or do so promptly.
A right of first offer (ROFO) triggers when a property owner elects to sell or lease their property. However, the property owner must first offer to sell or lease the property to the holder of the ROFO based on its terms and conditions. If the holder of the ROFO fails to exercise that right to purchase, the property owner may proceed to offer the property for sale or lease to third parties.
What are the Pros and Cons of a ROFR for Buyers?
A right of first refusal agreement has its up and downs for buyers and sellers alike. Here's a look from a buyer's perspective:
- You have no worries about a bidding war for the property.
- The agreement often includes pricing terms, so you know what you'll pay. That's especially beneficial in a market that continues to escalate.
- You have time to work toward the purchase.
- A right of first refusal includes a specific timeframe, so you must be ready to move. That could mean coming up with a payment in short order.
- If the ROFR includes a predetermined selling price, you could overpay in a market where property costs are declining.
What are the Seller's Pros and Cons?
- You can sell the property without listing it, saving you those costs.
- If you include a purchase price in the right of first refusal. You'll have no surprises. And you could enjoy a windfall depending on market conditions.
- There's safety in knowing you have a potential buyer on the hook.
- The buyer isn't obligated to purchase the property.
- If you receive a better offer, you could lose money if the ROFR holder has a lower offer.
- You limit your market for the property. The more buyers, the better chance you'll get a better offer.
- Lenders typically prohibit loans with properties, including a right of first refusal clause.
Right of First Refusal and Corporate Mergers
Can property burdened by a right of first refusal be included in the sale or merger of the owner?
n one Pennsylvania case (Seven Springs Farm, Inc. v. Croker), the Superior Court decided that shareholders in a cash-out merger were not bound by first refusal rights held by other shareholders. The Court determined the merger was a corporate act. In contrast, the right of first refusal is only a shareholders’ act.
The Pennsylvania Supreme Court affirmed this decision but drew sharp criticism from both courts' justices. It points out the importance of specifically addressing this potential scenario.
Multiple Properties Including a Right to First Refusal
Sometimes an owner with a right of first refusal decides to sell multiple properties at once, including the burdened property. Often, ROFR agreements don’t address this situation, even though it is not particularly unusual.
The Pennsylvania Superior Court ruled (in Boyd & Mahoney v. Chevron) that as long as the tenant meets the conditions provided in the ROFR, an owner cannot nullify the right by packaging the property for sale with other assets.
In this case, for example, Chevron purchased a gas station and gave the seller a right of first refusal as part of the deal. Subsequently, Chevron sold the gas station to Cumberland Farms as part of a more significant transaction that included real estate across the country.
The court ruled that the right of first refusal was a valuable property right that Chevron had to honor by offering the property to the original owner at the market value of $158,000. However, the Court went even further, upholding the trial court’s award of damages against Chevron of more than $500,000!
In a more recent case (Hahalyak v. A. Frost, Inc.), the Superior Court applied the same reasoning to prevent a landlord from circumventing the tenant’s right of first refusal. Here, the landlord offered a package deal that included the ROFR premises to another tenant, conditioned upon the other tenant’s surrender of its existing space.
Our Real Estate Lawyers Can Offer Guidance
For property owners, bestowing a right of first refusal often seems harmless to close a deal and provide a potential exit strategy. But property owners must never forget that giving your tenant a right of first refusal may come back and bite you without proper attention. So, talk with an experienced real estate lawyer at our local law firm with offices in Doylestown and Norristown, PA. They can provide appropriate guidance to help you determine whether a ROFR is a solid option for your property;
The information above is general: we recommend you consult an attorney regarding your circumstances. The content of this information is not meant to be considered legal advice or a substitute for legal representation.