Leases: Rights of First Refusal and First Offer
By David Tevlin
In a weak rental market, tenants are in a position to request favorable lease terms. One such term is the right to purchase the leased premises in the event the landlord decides to sell. Such a right can be important for a retail tenant that hopes to build up a significant degree of good will during the lease term that would be lost if the tenant were forced to move. A related term is the right to acquire additional space in a multi-tenant building in the event such space becomes available during the lease term. Such a right can be valuable for a retail or office tenant that anticipates a need for expanded space during the lease term. This type of right comes in two forms: the right of first refusal (RFR) and the right of first offer (RFO). Both raise a number of issues that should be clarified in order to avoid disputes and possible litigation if and when the right is exercised by the tenant.
Right of First Refusal
Under an RFR, if the landlord during the lease term receives a bona fide offer of purchase from a third party, or the landlord puts the property up for sale or premises for lease on specified terms, the tenant must be given the opportunity to purchase the property or lease the space on the same terms as offered by the landlord. The primary difficulty with an RFR is that a prospective buyer or tenant, learning of the RFR, will be unwilling to proceed with negotiations or incur expenses for inspections and legal fees when it may ultimately benefit the present tenant.
However, if this initial obstacle is overcome, the parties must then agree on just how the RFR is to work. One issue is when the right is triggered. This usually is when the landlord receives a written offer for the premises or for available space (or by a third party's acceptance of written terms specified by the landlord). Once triggered, the right must be exercised within a specified period of time, which may not exceed 10 or 20 days.
If the present tenant declines to exercise the right, the second issue is whether the RFR is revived if the landlord improves the offer to the third party following negotiations. Not requiring the landlord to do so could make the RFR meaningless; on the other hand, a landlord will normally not be willing to reopen the RFR after minor changes in the agreement with the third party. The solution, although imperfect, is to provide that the RFR is revived if negotiations result in "materially better" terms to the third party.
Right of First Offer
From the landlord's point of view, an RFO has one significant advantage over an RFR: The tenant, rather than a third party, must make the first decision as to whether to accept the offered terms. If the tenant rejects the offer, the landlord then is free to sell or lease to a third party on the same terms without resubmitting the offer to the tenant. However, in the event the landlord ends up offering better terms to the third party, the tenant usually has the right to another look (although, as in the case of an RFR, this may apply only when the changes are material).
David Tevlin is Managing Director, Corporate Real Estate Services, in our New York office. The lease audit consulting group represents large space users throughout the United States in operating expense and electric energy audits. David can be reached at 212 885-8457.
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