A Right of First Refusal (ROFR) is the right to match an offer to purchase a seller’s property. ROFRs can be found in different types of documents relating to both real and personal property. Often, they are contained in leases, giving the tenant a ROFR to purchase the leasehold property. They are also used in shareholder, partnership and operating agreements giving “partners” the ROFR to purchase each other’s interest in the entity.

ROFRs often have a chilling effect on a seller’s ability to sell property, particularly real estate. Potential buyers won’t put forth much time, effort or due diligence in looking at a property knowing that an offer could be matched and the property sold to the holder of the ROFR. If a property is very desirable, a potential buyer might have to overpay in order to discourage the ROFR holder from exercising.

Generally, ROFRs require that the holders close on the same terms as set forth in the offer. Therefore, if a seller receives an all cash, no-contingency deal, the holder would have to close without financing and with no contingencies. Sometimes this will also work to the potential buyer’s advantage. While the price might be attractive to the ROFR holder, the terms of the offer might make it difficult, if not impossible for the ROFR holder to close.

Usually, the event that triggers the ROFR is a “bona fide, 3rd party offer” duly accepted by the seller. What constitutes a bona fide 3rd party offer? The easy, legal answer is an offer made by an unrelated 3rd party purchaser who purchases the property for valuable consideration that is inducement for the entering into a contract without fraud or deception.

I recently had a tenant ask me to analyze a situation relating to a ROFR. The tenant had completed its 10 year initial lease term and the 1st year of its 5 year renewal term. There were 4 years remaining on the lease. The landlord had received an unsolicited offer to sell the building from an unrelated 3rd party. Though the landlord had not intended to sell, landlord was inclined to accept and forwarded the offer on to tenant with a note saying that landlord would pass on the offer if tenant would agree to purchase the property at the end of the lease term for a price that was $200,000 less than the current offer.

Needless to say, the tenant was confused. To make it more confusing, the offer was full of contingencies. The first major contingency was that the buyer had to get 3 adjacent properties under contract and then simultaneously close with this property. So, the contract was intended to be a property assemblage and this was the 1st of 4 parcels that the buyer had made an offer on. The other major contingency was re-zoning and site plan of the assembled property. However, the contract did not describe the intended use or the required approvals. My primary question was whether we even had a bona fide contract that triggered the ROFR.

The biggest problem was that tenant’s ROFR required that tenant respond in 15 days and close within 45 days thereafter. Given that the buyer’s contingencies had not yet been satisfied and that there was no possible way that they could be satisfied before tenant would be obligated to exercise the ROFR and then close, the contract was not yet ripe and therefore, not a bona fide contract for which tenant’s ROFR had been triggered. Until the buyer satisfied or waived the contingencies, the buyer had not obligation to close and therefore, the buyer was not a bona fide purchaser.

Further, landlord’s action in advising the tenant that it would reject the offer and enter into a different purchase agreement with tenant indicated that landlord had not accepted the contract and was using it as a method to force tenant to purchase the property using the ROFR. Landlord wanted the best of both worlds – 4 more years of cash flow via rent, and a guaranteed buy out at the end of the term. Landlord could not get either of these through the contingent offer but had to accept the offer when tenant rejected the offer and put landlord on notice that the offer was not bona fide. This could come down to a shoving match if and when the proposed buyer satisfies its contingencies and attempts to close.

Lesson learned? Make sure you understand the triggering event of the ROFR before signing a lease whether you are the landlord or the tenant. Any ambiguity in an offer can be exploited and delay the exit strategy for one side or the other.

Forming a business entity with partners for real estate or other purposes requires careful thought. There are many factors to consider. We have written about some of the important considerations before (see prior posts HERE and HERE). One consideration that deserves particular attention is the exit strategy if the business doesn’t go as planned or, more specifically, if one partner doesn’t perform as expected. This is extremely important for the money partner where the minority or sweat partner is given equity up front without making a cash contribution or with only a small cash contribution or has options to acquire equity for little to no investment other than “sweat”.

Two years ago, I drafted such an Operating Agreement for a client. My client, the money partner, who would also be taking an active role in the company. The client was funding 100% of the initial cash needs of the company. As such, he would receive 99% of the membership interests in the newly formed LLC. The minority partner was to provide only sweat for a 1% stake. We treated the client’s investment as a loan. The minority partner had an option to receive up to 49% of the interest in the company if he made a $100,000 contribution to the company in the first 2 years. That contribution would be used to pay down the client’s loan. Upon making the contribution, the client would immediately transfer 10% of his shares to the minority partner. If the partner did not make the contribution on time, the option to acquire a larger share of the company was reduced to 30% and either way, transfers of membership interests to the minority shareholder would occur going forward only when the company was able to generate sufficient revenue to pay down the debt owed to the client. Transfers would occur at certain benchmarks.

The partner did not make the capital contribution and the company was unable to generate revenue so the loan was not repaid at all. Instead, the client made additional loans to the company. The client recently decided that he wanted a way to change the deal. Fortunately, we planned for that.   We added provision to the Operating Agreement allowing the client, as the manager, to terminate the minority partner’s employment with the company without cause. Upon such termination, the company was obligated to buyout the partner at an agreed price of 150% of the value of the partner’s interest in the company. The company value would be determined by the company’s accountant.

This provision is very clear and the partner had a decision to make. He either had to renegotiate the option provision, which the client felt was necessary in order to attract new investors to the company. Or, the partner could allow the termination provision to kick in. That would, in effect force the partner to pay his share of the company debt to the client because the company debt is currently greater than its assets.

Planning for the worst can help to avoid protracted disagreements. While the partner, in this case, was initially uncooperative, after further thought and conversation, the parties did, in fact, come to a satisfactory conclusion. The client’s position was protected and he will be able to attract new investors to the company in the future and hopefully, grow the company and recover his investment.

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