September 9, 2015
It is not unusual for a landlord to grant a tenant a right of first refusal to purchase the landlord’s property if the landlord decides to sell. While this may be just the additional incentive needed to persuade a prospective tenant to sign a lease, rights of first refusal are property rights and can become a burden for the landlord/owner.
A “right of first refusal,” or “ROFR,” gives the tenant the right to match an outsider’s offer when the landlord/property owner puts its property up for sale. There are pitfalls that can hamstring landlords, and here are just a few of them that you should watch out for:
Corporate mergers. Can property burdened by a right of first refusal be included in the sale or merger of the owner? In 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, finding that the merger was a corporate act, while the right of first refusal was only a shareholders’ act. This decision was affirmed by the Pennsylvania Supreme Court, but drew sharp criticism from justices on both Courts and pointed up the importance of specifically addressing this potential scenario.
Package deals. Sometimes an owner who has granted a right of first refusal will decide to sell multiple properties at one time, including the burdened property. Often ROFR agreements won’t address this situation, even though it is not particularly unusual.
The Pennsylvania Superior Court has 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 together with other assets. In that case, Chevron purchased a gas station, and as part of the deal gave the seller a right of first refusal. Subsequently, Chevron sold the gas station to Cumberland Farms as part of a larger 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 market value of $158,000. Then the Court went even farther, 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 by offering a package deal that included the ROFR premises to another tenant, conditioned upon the other tenant’s surrender of its existing space.
Gifts. Property owners will sometimes “gift” property to a friend, loved one, or colleague. If no money changes hands, it would be unreasonable for a party holding a right of first refusal to take advantage of this type of transaction. However, in such a case a new question arises – should the right of first refusal survive the transfer to the new owner? Proper drafting of the ROFR can address this situation.
Exercise of the Right. With a right of first refusal, the tenant gets to make a decision after the landlord has received an offer. The landlord does not want to have to wait too long for the tenant to respond, because it might jeopardize the sale of the property to the outside buyer. For the same reason, the landlord will want the tenant to quickly sign an agreement of sale and post a deposit for the property. While these risks can be mitigated by proper drafting, an alternative approach is to grant the tenant a right of first offer. In this scenario, the landlord/property owner gives the tenant the right to make an offer on the property before the owner takes the property to market. This can also help the landlord determine whether there is a viable market for the property, and alleviate potential snags with the eventual buyer.
For property owners, bestowing a right of first refusal often seems like a harmless way to close a deal and provide a potential exit strategy. But property owners must always remember that without proper attention, giving your tenant a right of first refusal may come back and bite you.
Visit the firm’s Real Estate Law page here.
The information above is general: we recommend that you consult an attorney regarding your specific circumstances. The content of this information is not meant to be considered as legal advice or a substitute for legal representation.