Word-of-the-Week: Right of First Refusal

Tenants with rights to acquire a leased premises

A right of first refusal is a contractual pre-emptive right held by another person to buy a property if the owner later decides to sell it.

This terminology is frequently confused with an option to buy, which is an irrevocable right to purchase a property for a specific price during a specified period of time. [See RPI Form 161]

A right of first refusal, though similar, refers to an opportunity held by someone, often a tenant, to purchase the property if the owner, such as the landlord, chooses to sell it.

Further, if a third-party offers to buy the property, a right of first refusal also provides a tenant the ability to purchase the property under the same price and terms offered by the third-party.

The right of first refusal is a short agreement with its provisions either included in the body of the lease agreement or by an addendum. Unlike the option to buy, the right of first refusal provisions rarely contain any terms of a sale. [See RPI Form 579]

Triggering the right

A landlord need not enter into an actual purchase agreement to trigger the tenant’s right of first refusal. Any indication the landlord has decided to sell the property is sufficient to activate the right to buy.

The landlord may indicate their decision to sell by:

listing or advertising the property for sale;
offering the property to a buyer;
accepting an offer or making a counteroffer involving a sale to a buyer, or
granting a purchase option on the property to a third party.

To exercise the right of first refusal to buy, the tenant needs to agree to match the sales terms set by the landlord within the time period set in the right of first refusal provision.

The right of first refusal is not triggered by the conveyance of the property to the seller’s heirs on the seller’s death.

Matching the back-up offer

The landlord subject to a right of first refusal held by a tenant is obligated to notify the tenant of the terms of any sales listing, option to buy, offer to purchase, counteroffer or acceptance of an offer to purchase which triggers the tenant’s right to buy under the right of first refusal provision. [See RPI Form 579-2]

The tenant who decides to purchase the property agrees to match the sales terms within the time period set in the right of first refusal provision. Failure to do so is a failure to exercise their right of first refusal, resulting in a loss of their right to buy.

Consider a tenant who holds a right of first refusal on the industrial property they lease. A buyer makes an offer to purchase the property. The terms for the payment of the price in the buyer’s offer include cash and an assumption of the existing first trust deed on the property. The property is also encumbered with a nonrecourse second trust deed to be paid off and reconveyed on closing under the terms of the buyer’s offer.

The landlord accepts the offer and notifies the tenant, giving the tenant the opportunity to match the buyer’s offer under the right of first refusal provision in the lease agreement. The tenant exercises their right of first refusal by agreeing to purchase the property at the same price.

However, the tenant alters the terms for payment of that price as they will assume both the existing first trust deed and nonrecourse second, paying the remainder of the price in cash. The landlord rejects the tenant’s conditions and refuses to sell to the tenant. Here, the landlord is to comply with the tenant’s terms for payment of the price since they are the financial equivalent of the proposed sale.

The tenant need merely provide the same net financial result to the landlord as the offer being matched — a cash-out of the landlord’s equity in the property. The tenant’s performance under the right of first refusal does not need to be identical in all aspects to the buyer’s offer.

Thus, the landlord is to perform and deliver title to the tenant. Here the landlord’s net proceeds, economic benefits and liabilities resulting from the terms for performance set by the tenant are the same as those the landlord experiences under the purchase offer which triggered the right of first refusal.

Reinstatement of the right of first refusal

A right of first refusal provision is automatically reinstated when:

the landlord agrees to sell the property on terms different from those terms offered to the tenant; or
the property remains unsold after the running of an agreed-to period of time following the tenant’s waiver of the right to buy.

Consider a landlord who, under a right of first refusal, notifies their tenant of the purchase terms on which they have listed the property for sale. The tenant chooses not to exercise their option to buy at the price and on the terms offered. The landlord later modifies the listing by lowering the sales price or altering the terms for payment of the price.

The price reduction or modification of terms automatically reinstates the tenant’s right of first refusal obligating the landlord to re-notify the tenant of new terms for purchase of the property. The tenant only waived their right of first refusal for a sale based on the terms originally given to them by the landlord, not on the different price or set of terms.

When a buyer purchases the property on terms other than those offered to the tenant, the buyer takes title subject to the tenant’s preemptive right to buy. This right is reinstated due to the sale on different terms.

Thus, the buyer is to resell to the tenant on the same price and terms the buyer paid. The buyer had either actual or constructive notice of the tenant’s unrecorded right to acquire the property due to the tenant’s possession of the property.

History of the term

“Refusal” finds its root in the old French term “refus,” from 16^th century meaning, “act of refusing to do something, rejection of anything demanded.” It was first used to reference the sense of “choice of refusing or taking,” as in right of first refusal, in the 1570s.