Why this matters: A landlord and tenant may agree to grant the tenant a right of first refusal in an addendum to the lease agreement. A tenant broker needs to enter into a written fee agreement to receive a fee whenever the lease agreement with a right of first refusal is negotiated and entered into.
The right of first refusal in leasing
A right of first refusal, granted to a tenant, gives an owner total discretion to decide when, if ever, to sell. Until the seller makes the decision to sell, the buyer has no right to purchase the property.
The first refusal right, when triggered by the seller’s decision to sell their property, becomes a purchase option — in essence an offer to acquire — giving the buyer the right to buy the property if they so choose. As an option to buy, the buyer has the unconditional right to buy the property by exercising the right of first refusal within a fixed period following notice of the seller’s intent to sell.
Until notice of the seller’s intent to sell is given to the buyer, the buyer does nothing but wait to see whether the owner decides to sell, which may never occur.
A right of first refusal is often used with a commercial transaction involving a landlord and tenant.
A landlord subject to a right of first refusal held by a tenant is obligated to notify the tenant of the landlord’s decision to sell. The notice to sell triggers the tenant’s right to buy under the right of first refusal provisions. The terms for purchasing the property are generally set out in the notice of intent to sell, but may be set by an:
- MLS posting that the property is available for sale;
- option to buy granted to another;
- acceptance of an offer from another to purchase the property;
- counteroffer made by the landlord to sell the property; and
- all the above events properly conditioned on the outstanding right of first refusal held by the tenant.
A tenant who decides to purchase the property on receipt of the notice to sell, needs to then agree to match the sales terms within the time period set in the right of first refusal provision, called an acceptance. Failure to timely accept is a failure to exercise their right of first refusal, resulting in a loss of the tenant’s right to buy.
The tenant’s performance under the right of first refusal need not be identical in all aspects to the buyer’s offer. However, the tenant’s offer needs to be financially equivalent to the buyer’s offer.
The right of first refusal is not the same as an option. The grant of an option to a buyer requires the seller to sell the property on the buyer’s exercise of the option. A right of first refusal only gives the buyer an opportunity to buy when the owner decides to sell.
Representing a tenant without a representation agreement on a first refusal right
Consider a tenant broker who locates a property available for rent and suitable for their tenant-client’s needs. The tenant agrees to negotiate a lease of the space for their business operations.
The tenant broker and tenant do not enter into a tenant representation agreement or any other documentation for earning a fee or payment. Not even a conversation with the tenant-client takes place about the amount of fees the tenant broker expects to earn or the source of the payment. When asked, the tenant broker explains they cooperate with the landlord broker on fees.
Following past fee-fixing protocol, the tenant broker contacts the landlord broker to confirm the traditional 50:50 fee-sharing ratio and percentage fees the landlord has agreed to pay. Thus, the brokers mutually agree to their fee sharing arrangements in reliance on the written landlord representation agreement retaining the landlord broker. [See RPI Form 106]
Further, since a leasehold interest, not a fee ownership of the property, is being acquired by the tenant-client, the tenant broker does not enter into a separate buyer representation agreement to establish their right to collect the expected fees. [See RPI Form 103.1 and 103.2]
The tenant enters into and is granted leasehold possession under a lease agreement which includes a right of first refusal to buy, a common provision added by an addendum to commercial leases of single-user buildings. [See RPI Form 579]
Years later, the landlord decides to sell the property.
The landlord notifies the tenant, and the tenant chooses to exercise — accept — what is now their option to acquire the fee simple ownership interest in the property. The tenant broker expected to receive a fee on the tenant’s acquisition of ownership.
Was the tenant broker mandated to have entered into a buyer representation agreement with their tenant-client prior to negotiating the right of first refusal to buy fee ownership, stating the amount of the fee earned on the client’s acquisition of fee simple ownership?
Yes!
Here, the tenant broker expected to earn a fee on the tenant’s exercise of the first refusal right negotiated by the tenant broker as part of the leasing transaction. Thus, negotiating and entering into a tenant representation agreement is required before the landlord granting a right of first refusal first enters the lease negotiations — at the letter of intent (LOI), offer to lease, preparation of the lease agreement or extension/renewal of the lease term.
Absent this written buyer representation agreement for acquiring a fee interest in real estate, the tenant broker expecting a fee is not in compliance with the antitrust code mandating the written representation agreement, has not earned a fee, and is subject to disciplinary action from the Department of Real Estate (DRE). [Calif. Civil Code §1670.50(a)]
Practical steps for tenant brokers
When a broker, or their agent, and a tenant determine the broker is to assist the tenant to locate a suitable property as the tenant-client’s representative, the tenant broker initially always negotiates and enters into a tenant representation agreement with the client. The representation agreement outlines all transactions in which the broker earns a fee, and the amount of the fee earned, as well as other terms of representation. [See RPI Form 105.1 and 105.2]
There are more ways to document the tenant broker’s fee.
Having entered into a tenant representation agreement laying out the fees expected by the tenant broker, a Fee Schedule for Tenant Broker form is an addendum attached to the lease agreement. [See RPI Form 552-9]
The fee addendum covers all transactions in which the tenant broker expects to earn a fee — on the leasing transaction delivering possession to the client-tenant, any occupancy beyond the term of the lease agreement, and on exercise of the right of first refusal (or an option to buy or other basis for the tenant acquiring ownership) granted to the tenant on conveyance to the tenant of the leasehold interest in the property.
Each agreement for fees earned or to be earned covers all fee situations, just like the fee provisions in the tenant representation agreement — on leasing, on extended occupancy and any acquisition of ownership of the property. [See RPI Form 552-9]
Similarly, the Landlord Representation Agreement is all-inclusive of the fees the landlord broker expects to earn, covering all situations likely to arise in leasing. [See RPI Form 106]
When the lease agreement includes the grant of a right of first refusal to purchase the property, the broker must have previously entered into a buyer representation agreement, or a tenant representation agreement which provides for fees earned and payable on any acquisition of the property’s fee simple ownership. [See RPI Form 103.1, 103.2, 105.1 and 105.2]
When the landlord decides to sell the property, the broker has an agency duty owed the tenant to follow up with the tenant as to whether the tenant chooses to exercise their right of first refusal. The tenant must agree to match the sales terms set by the landlord within the specified time period controlling the tenant’s acceptance to successfully exercise their right of first refusal.
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Analyzing the right of first refusal to buy
An agent or prospective tenant uses the Right of First Refusal to Buy published by Realty Publications, Inc. (RPI) when negotiating a rental or lease agreement with the landlord. The form is attached to offers and the lease agreement as an addendum. By the wording of the form, the landlord grants to the tenant the right of first refusal to purchase fee ownership of the leased property. [See RPI Form 579]
Within the Right of First Refusal to Buy, the tenant and landlord both agree to the following:
- the commencement and expiration of the term of the right of first refusal to purchase fee ownership of the leased premises, which may cease on termination of the tenant’s right of occupancy or on a specific date [See RPI Form 579 §2];
- when the landlord decides to sell the property during the term of the tenant’s right of first refusal, the landlord notifies the tenant of the terms on which the landlord is willing to sell, using a Notice of Decision to Sell Property or Lease Additional Space form [See RPI Form 579-2; See RPI Form 579 §3];
- the number of days the tenant has after receiving the landlord’s written notice sent by certified mail or personal delivery to agree to purchase the premises on the terms stated in the notice [See RPI Form 579 §3.1];
- when the tenant fails to exercise the option within the option period, the landlord has the right to sell the premises to a third party on the same terms stated in the landlord’s notice to the tenant [See RPI Form 579 §3.2];
- any sale on different terms reinstates the tenant’s right of first refusal [See RPI Form 579 §3.3];
- when the landlord has not closed a sale of the property within six months after the tenant’s receipt of the landlord’s notice, the tenant’s right of first refusal is reinstated [See RPI Form 579 §4]; and
- the landlord is to pay the tenant broker fees according to the separate fee agreement as earned and due on the tenant’s acquisition of fee ownership by exercise of the right of first refusal to purchase. [See RPI Form 579 §5]
When executing the lease agreement with the attached right of first refusal addendum, the landlord and tenant also sign the right of first refusal form.
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