This article presents a right of first refusal provision, distinguishing it from a purchase option and contingency waiver provision.
A buyer’s preemptive right to purchase
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A buyer is interested in purchasing a parcel of real estate. The seller also owns an adjacent parcel, which the buyer is also interested in purchasing. The seller, however, is not willing to sell the adjacent parcel. The buyer’s offer to purchase one parcel provides for the seller to grant an option to purchase the adjacent parcel. The option to purchase gives the buyer an unconditional right to later buy the adjacent parcel at his discretion. Should the seller accept the offer, he will have no choice but to sell the adjacent property if the buyer decides to purchase the first parcel. |
Should the seller decide to sell during the period of the right of first refusal, the buyer can then acquire the property. |
The seller is unwilling to leave the timing of the sale in the buyer’s control, or to set a certain date for exercise of a purchase option.
The seller counteroffers to grant the buyer a right of first refusal for a five-year period, also called a preemptive right to purchase. Should the seller decide to sell the adjacent parcel during the period of the right of first refusal, the buyer can then acquire the property.
If the seller decides to sell the adjacent property within the right of first refusal period, the buyer will be notified of the price and terms of sale. Most commonly, the terms set for the sale are the terms of another buyer’s offer which the seller is willing to accept. The buyer, to exercise the right of first refusal, must then match the other buyer’s offer.
The price and terms may also be agreed to as the property’s fair market value, as set by a court decision, such as a court-ordered probate sale, or simply by the seller deciding the price and terms acceptable to him.
Editor’s note — When granting a right of first refusal, the seller must be careful not to set the price in advance. If a fixed price is set in the right of first refusal agreement, the seller is bound to that price should he later decide to sell. If the property is sold to another buyer at a higher price in violation of the first refusal right, the seller must pay the difference to the holder of the right of first refusal. [Mercer v. Lemmens (1964) 230 CA2d 167]
Refusal vs. option
The right of first refusal is different from an option agreement. In an option, the owner agrees to sell the property on specific terms. The buyer has the discretionary right to buy or not to buy the property on those terms within the time period fixed for the exercise of the option. The decision to buy the property by exercising the option rests solely with the buyer.
In a right of first refusal agreement, the decision to sell or not to sell is entirely within the seller’s discretion. Until the seller makes the decision to sell, the buyer has no right to purchase the property.
Once triggered by the seller’s decision to sell, the first refusal right results in a purchase option – no different from any other purchase option. The buyer has an unconditional right to buy or not to buy the property within a fixed period of time, called an acceptance or exercise of the right of first refusal.
Seller’s motives
The seller’s reasons for granting the buyer a right of first refusal may vary. Possible motives for delaying the decision to sell the real estate include:
- tax benefits, such as wishing to delay the reporting of profit from a sale until a year when the profit can be offset by losses on the sale or operation of other properties;
- financial incentives, such as wanting to delay the sale of the property to attain the highest price possible due to a rising market, leasing negotiations, rehab, or rezoning;
- legal problems, such as a lis pendens or toxic cleanup hindering the sale of the property; and
- personal concerns, such as not being ready to sell the property for health or family reasons.
Finally, the owner may simply have no intention to ever sell the property. In such a case, the buyer might request a right of first refusal on the theory the owner may someday change his mind.
Ultimately, the right of first refusal serves the same purpose for the seller as an option serves for the buyer – to avoid entering into an enforceable commitment to sell or buy real estate.
Buyer’s commitment
A buyer wants to purchase the best property available at the best price. Ideally, a buyer would acquire purchase options on numerous properties, then watch the market and purchase only the most desirable of the optioned properties.
However, buyers should not play the option game too loosely. Creating an enforceable option or right of first refusal agreement requires a mutual obligation. Each party must commit himself in some way before he can enforce the agreement against the other. [Kowal v. Day (1971) 20 CA3d 720]
Forms of commitment include giving up a legal right, assuming a legal obligation, a promise to pay, or payment of a consideration to the other party (though it may only be a small amount).
The seller commits himself by granting the buyer the right of first refusal in a signed writing. To bind the seller’s promise to sell and make the right of first refusal enforceable against the seller, the buyer must make a commitment in return.
For instance, the person who negotiates a right of first refusal typically has some involvement with the property, such as occupying it as a tenant or buying other property owned by the seller. Otherwise, a buyer would have little incentive to pay for a right which may never ripen into a right to buy.
If the right of first refusal is negotiated simultaneously with a lease or purchase agreement, consideration for the right is simply the promise to pay rent and perform under the lease, or the purchase of other property owned by the seller. The right is simply one of the provisions of the agreement.
If a right of first refusal is added to an existing lease, or granted to the buyer of an adjacent property after the lease or purchase has been agreed to, some additional consideration must be negotiated and paid to the seller.
Triggering the right
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The right of first refusal is not triggered by the conveyance of the property to the seller’s heirs on the seller’s death. |
The seller need not enter into an actual purchase agreement to trigger the tenant’s right of first refusal. Any indication that the seller has decided to sell the property is sufficient to activate the right to buy.The seller may indicate his decision to sell by:
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For example, a buyer with knowledge of an outstanding right of first refusal tries to avoid the first refusal right by negotiating an option to buy the property which is exercisable only after the right of first refusal expires.
The seller grants the option to purchase the property to the buyer. The granting of the option now binds the seller unconditionally to sell the property, should the option be exercised.
The seller’s willingness to enter into the option agreement is a clear indication of a decision to sell. Thus, the right of first refusal is triggered. [Rollins v. Stokes (1981) 123 CA3d 701]
The right of first refusal is not triggered by the conveyance of the property to the seller’s heirs on the seller’s death. The heirs simply take title subject to the first refusal right.
However, the right of first refusal is triggered by the probate court’s order of a sale of the property. To exercise the first refusal right, the buyer must match the highest offer submitted in open bidding and approved by the court. [Estate of Patterson (1980) 108 CA3d 197]
Once the seller’s decision to sell is manifested, the right of first refusal becomes a purchase option. Control of the transaction thus passes to the holder of the first refusal right who is now an optionee.
The seller may no longer delay or retract the sale of the property – colorfully referred to as an attempt to “un-ring the bell” – without breaching the right of first refusal agreement.
Matching the back-up offer
Most of the disputes concerning the right of first refusal arise when the seller accepts another buyer’s offer to purchase. If another buyer makes an offer on the property which the owner accepts or counteroffers, the owner must notify the holder of the first refusal right of the terms of the sale.
The holder of the preemptive right must then either agree to match the back-up offer within the fixed period of time or waive the right of first refusal.
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For example, a buyer offers to exchange a property he owns for a property that is subject to a tenant’s right of first refusal. The seller notifies the tenant and gives him the right to match the buyer’s offer. The tenant obviously is not able to offer the seller the same property in exchange, nor is he expected to. |
The tenant’s offer under the right of first refusal need not be identical in all aspects to the other buyer’s offer. |
The tenant’s offer under the right of first refusal need not be identical in all aspects to the other buyer’s offer. To match the back-up offer, the tenant must merely provide the same net financial result to the seller. [C. Robert Nattress & Associates v. CIDCO (1986) 184 CA3d 55]
In another example, a tenant holds a right of first refusal. Another buyer offers to purchase the property with a cash down payment and a note secured by property other than the real estate being purchased. The seller accepts the offer and notifies the tenant of his right to match the offer.
The tenant offers to pay the same amount as the other buyer, also in the form of a cash down payment and a note secured by other property. However, the seller refuses to perform because the value of the property the tenant offers as security is insufficient.
The seller in this case is not obligated to accept the tenant’s offer. Due to the inadequacy of the security offered for an identical note from the tenant, the tenant’s offer is not financially equivalent to the terms of the other buyer’s offer. [McCulloch v. M & C Beauty Colleges (1987) 194 CA3d 1338]
Lease rights remain
When a tenant’s right of first refusal to buy property is not exercised, it is extinguished by a sale to another buyer.
However, the tenant may retain possession under the terms of the lease after the property is sold to another buyer. The sale is subject to the tenant’s leasehold interest but not to his preemptive right. [Manasse v. Ford (1922) 58 CA 312]
Reinstatement of preemptive rights
The right of first refusal agreement should include a provision calling for the reinstatement of the right of first refusal when:
- the landlord sells to another buyer on different terms than those offered to the tenant; or
- the property remains unsold for a fixed period of time after the tenant waives the right. [See Figure 1]
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Figure 1 Lease provision: right of first refusal to buy |
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Landlord hereby grants tenant a right of first refusal to purchase the leased premises, for a term commencing _____________ and expiring _____________. Should Landlord decide to sell the premises during the term of the tenant’s right of first refusal, Landlord shall notify tenant of the terms on which Landlord is willing to sell. Tenant shall have the option for a period of _______ days after receiving notice to purchase premises on terms stated in notice. Should tenant fail to exercise the option within the option period, Landlord shall have the right to sell premises to a third party on the same terms stated in the notice to tenant. Any sale on different terms reinstates the right of first refusal. If property is not sold within six (6) months after tenant’s receipt of notice, the right of first refusal is reinstated. |
Consider an owner under a right of first refusal who notifies his tenant of terms of sale he has agreed to with a buyer. The tenant chooses not to exercise his right of first refusal, since he finds the price and terms unacceptable.
The owner later modifies the terms of sale and closes the transaction.
However, the tenant’s right of first refusal is reinstated, since the buyer purchased the property on terms other than the terms stated in the notice to the tenant. The tenant waived his right of first refusal based on the original terms in the notice given to him by the owner. Thus, the buyer now takes title subject to the tenant’s preemptive right to purchase on the modified terms, since the buyer is aware of the existence of the tenant and is charged with knowledge of the right of first refusal.
The reinstatement clause simply reinforces the tenant’s right to match any purchase offer the landlord is willing to accept.
The right of first refusal agreement also calls for reinstatement of the preemptive right should the owner not sell the property within a fixed time period after the buyer fails to exercise his right of first refusal.
Contingency waiver distinguished
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The contingency waiver clause is frequently misnamed a buyer’s right of first refusal. |
The title “Right of first refusal” is sometimes incorrectly applied to contingency waiver clauses written into counteroffers. A contingency waiver provision is occasionally agreed to when a purchase agreement contains contingencies allowing the buyer to cancel. |
For example, the closing of the sale may be conditioned on the buyer’s sale of other property, or the buyer’s obtaining a purchase loan.
The seller may be uncertain whether the buyer’s contingencies will be met, and may want to be able to accept a back-up sale and eliminate the buyer’s contingencies.
The seller always has the right to enter into back-up sale arrangements (which would be contingent on the cancellation of the existing purchase agreement with the buyer) while the property is in escrow.
However, for the seller to be able to close a back-up sale to another buyer, the first buyer must have agreed to a contingency waiver provision. Upon notice of a back-up sale, the buyer subject to a contingency waiver provision must waive the remaining contingencies within a given period of time, or the seller can cancel the transaction and proceed to close the back-up sale.
The contingency waiver clause is frequently misnamed a buyer’s right of first refusal, since it shares a similar triangular structure of a buyer, a seller and another buyer’s offer.
In essence, the buyer may refuse to waive his contingencies, thereby losing the property to another buyer should the seller cancel, or waive the contingencies and attempt to close the purchase escrow as agreed.
However, the contingency waiver provision differs from a right of first refusal since the obligation to perform and the terms of the sale transaction are already agreed upon, although subject to the seller’s right to cancel should the buyer refuse to waive his contingencies on notice. Conversely, under a right of first refusal agreement, the seller has no obligation to sell until he decides to sell, and no purchase agreement exists.
In negotiating a contingency waiver clause, the seller has essentially secured a contingency for himself: to eliminate the buyer’s contingencies or cancel the sale should a more acceptable sales arrangement be negotiated with a back-up buyer.
