KNOW YOUR OPTIONS
by Michael A. Starvaggi, Esq.
Recently, one of my clients asked me to draft a lease for a commercial building. He told me that, although his objective had been to sell the building, the proposed tenant did not have money for a down payment and did not want to commit to a purchase at the time. The solution, he said, was that they would enter into a five year lease “with an option.” When I asked him for more details he said that the tenant would have a “right of first refusal” during the lease term, using the phrase interchangeably with “option.”
This scenario highlights several pitfalls for parties who negotiate the terms of their leases carelessly or without legal counsel. Rights of first refusal (“ROFRs”) and options are very different devices and both should be approached with precision and caution. It is crucial that landlords and tenants understand the difference between the two.
In order to distinguish one from the other, we need look no further than the names of the two devices. A ROFR is just what it says, the right of a tenant to match an offer to purchase the property which is made by a third party. An option is a unilateral right of the tenant to purchase the property (with or without pre-determined terms such as price) that is exercisable by the tenant during a specified period.
An ROFR allows the landlord to keep the property on the market, with the caveat that any offers made by third parties may be matched by the tenant. This seems harmless enough until you consider the fact that bidders are loathe to go through the time and effort of investigating a property and negotiating a purchase price, when someone else has the legal right to step in at the end and take the property on the same terms. Failing to disclose the existence of the ROFR to the bidder is a dangerous and unethical practice that would expose the landlord to liability from the bidder and the tenant.
By contrast to the ROFR, an option is the singular right of the tenant to purchase the property to the exclusion of anyone and everyone else for a defined period of time. Furthermore, it is a “one way street” in that it gives the tenant an exercisable right but includes no corresponding right of the landlord to compel the tenant to buy. Thus, when there is an existing option on the premises, it should not be held out for sale because the landlord is not free to convey title to anyone other than the tenant during the option period.
Once the devices are understood, landlords and tenants must keep in mind that renting with an option or a ROFR is not a logical alternative to selling. In fact, under common practice, where the negotiated rent is at market value and the other lease terms are equitable between the parties, options and ROFRs are typically not given. This is because there is no extra consideration being given by the tenant to support the additional rights that an option or a ROFR entail. This is a key concept to grasp. Options and ROFRs are additional rights that benefit the tenant only. Thus, if there is no extra consideration paid by the tenant for one of these rights, there is no logical reason to include them just because it is contemplated that the tenant may one day wish to buy the building. The tenant, like anyone else, is always free to make an offer of purchase, and parties should avoid the temptation to “throw in” an option or a ROFR for the mere purpose of memorializing a discussion about the tenant buying the building some day.
In conclusion, remember that both the ROFR and the option are powerful legal devices that convey specific, and different, rights. If you truly intend to include one or the other in your lease negotiation, be clear about which one you intend. Once that decision is made, there are many drafting considerations to be addressed regarding exactly how either right can be exercised. The failure to clearly spell out these details is an invitation to litigation.
Leases are important instruments. And leases with options or ROFRs are all the more complex. You are encouraged to always seek the advice of counsel when negotiating and drafting a lease.
By: Michael A. Starvaggi, Esq. Starvaggi Law Offices, P.C.
Phone: (845) 589-9456 | Email: firstname.lastname@example.org