Understanding the Right of First Refusal Clause in Real Estate Transactions

What is a right of first refusal clause in a real estate transaction?

A right of first refusal, “ROFR,” may be considered a common clause seen in real estate agreements. But the effects of an ROFR can be quite harmful if they are not properly negotiated.

ROFR is a concept that restricts the owner of real estate from selling property to anyone they desire. A ROFR is typically embedded in an agreement between the owner of real estate and the party who is granted the ROFR. The party who holds a ROFR has the right to purchase property from a seller who would otherwise sell it to a different buyer.

For example, if a seller desires to sell its property to A, but B is the ROFR holder under an agreement, the seller must first present the offer to B to give B the chance to accept or decline. The terms of the ROFR would be governed by the agreement between the seller and the holder of the ROFR.

What issues are faced by owners when dealing with ROFRs and why are these clauses disfavored?

When A is told that its offer must first be presented to B, it may be discouraged from moving forward, and may even back out of the deal. Such clauses are risky because they can reduce the marketability of the property by deterring potential buyers. Most buyers would not be ready for the delays caused by deals where ROFRs are involved. The owner might also have its own reasons for wanting to sell to a third party rather than the ROFR holder. When the owner is locked into a ROFR, it loses its ability to freely negotiate with multiple buyers.

Let’s assume B was presented with the offer and declined. Does the ROFR continue if the original purchase terms between seller and A have changed?

It depends. The right varies depending on the way the parties structure the agreement. More often than not, agreements such as the one granting B the ROFR are not entirely clear. In such case, New Jersey law suggests that where the new terms are considered more favorable or more beneficial to a buyer, those terms must be presented to B. The test is whether the new terms are “materially” different from the original terms.

For example, if the purchase price was reduced, this would be considered a material term that is more beneficial to a buyer, and would need to be presented to B. However, whether an extension of the due diligence period under the original terms would rise to the same level is not as clear cut. Another legal concept that can come into play is the covenant of good faith and fair dealings. Courts have ruled in favor of ROFR holders if they can prove that the seller violated its general duty of good faith and fair dealing by not re-offering the new terms.

What are some tips a seller can follow when agreeing to a ROFR?

In the above scenario, having to present new terms to B can hold up the closing with A, or even cause A to walk away. Unfortunately, agreements with a ROFR clause lead to frequent litigation. As a result, the seller should try to avoid such clauses, or ensure that the terms of the ROFR are explicitly clear and properly negotiated. Some of these terms include: the triggering event for the ROFR, the expiration date of the ROFR, conditions for exercising the right, and the timing involved in accepting or rejecting the offer.

ROFR clauses are also seen in commercial leases where the tenant is the holder of the ROFR. In such case, the tenant is given the right to purchase the property if the landlord receives a third-party offer. The landlord should keep the same considerations in mind during lease negotiations. Many times, ambiguous language in leases will give a tenant the right to a ROFR “during the term of the lease.” This is problematic as it raises the question of whether the tenant has a ROFR each time the property is offered for sale during the term or just one right that terminates if the first offer is rejected. Again, it is important to clearly indicate whether the ROFR is an ongoing right.

Do not get stuck with a ROFR clause that has the potential to diminish the value of your property. Contact the Real Estate team at Stark & Stark to learn more about ROFR clauses in real estate transactions.