ROFOs and ROFRs – Traps for the Unwary
Purchase Options: Traps for the Unwary
In the realm of commercial real estate, the terms Right of First Offer (ROFO) and Right of First Refusal (ROFR) are commonplace, often finding their way into leases and other agreements. At first glance, these rights might seem benign or even beneficial in fostering good tenant-landlord relationships. However, granting such rights can significantly impact a property’s value and marketability, potentially costing landlords millions of dollars. This post explores why commercial real estate landlords must exercise extreme caution before granting ROFOs, ROFRs,
or similar rights that could limit their ability to sell or transfer their property in the future.
Understanding ROFOs and ROFRs
Right of First Offer (ROFO): A ROFO grants a tenant or other party the first opportunity to purchase or lease a property before the owner can offer it to the open market. Essentially, the landlord must present their offer to the tenant first, who can then decide whether to accept or decline.
Right of First Refusal (ROFR): A ROFR provides the tenant or other party the right to match any offer that the landlord receives from a third party before the sale or lease can proceed. If the tenant matches the offer, the landlord is obligated to complete the transaction with the tenant instead of the third party.
Many landlords, particularly those less experienced in commercial real estate transactions, might perceive these rights as mere formalities. A common rationale is grounded in a spirit of good faith: “of course, we’ll have a conversation with the tenant before we sell, what could the possible harm be?” While these sentiments foster trust and collaboration, they often overlook the severe financial implications and legal complexities associated with granting ROFOs and ROFRs.
ROFOs and ROFRs can significantly diminish the property’s appeal to potential buyers. Knowing that a tenant or another party has preemptive rights tends to deter offers, as third parties are reluctant to engage in the cost and expense of evaluating a property and negotiating purchase agreement where their efforts can ultimately be pre-empted by a tenant with a ROFR. This reduction in competition can lower the final sale price, often substantially, potentially costing a landlord millions of dollars in lost profit.
Why a ROFO May Be Preferable to a ROFR for Commercial Landlords
While both ROFOs and ROFRs can limit a landlord’s ability to freely sell or transfer their property, in many instances in which a landlord wants to grant a purchase option to a tenant a ROFO may be more advantageous than a ROFR. This is primarily because a ROFO provides a process for negotiating a potential sale with a tenant before the property is offered to the open market, rather than after the landlord has secured a potential third-party purchaser that is interested in purchasing the property. If the landlord offers to sell the property to the tenant and the tenant decides not to purchase the property, the landlord can then proceed to sell it to a third party without the encumbrance of a preferential right in favor of the tenant.
Benefits of a ROFO Over a ROFR
- Clearer Marketing Process: A ROFO requires the landlord to offer the property to the tenant first, but if the tenant declines, the landlord is free to take the property to the market. This sequential process can simplify the sales strategy and timelines for the landlord. With a ROFR, potential buyers know that any offer they make could be matched by the tenant, which might discourage them from engaging in the bidding process. A ROFO, on the other hand, allows the landlord to engage with the market more freely once the tenant’s option period has expired.
- Negotiation Flexibility: A ROFO allows landlords to negotiate terms directly with the tenant before opening the sale to the public. This direct negotiation can often be faster and less cumbersome than dealing with multiple potential buyers, and it provides an opportunity to address any tenant-specific concerns upfront.
- Increased Market Value: Once a ROFO process has been completed and the tenant has passed on the opportunity, the property can be marketed without the encumbrance of a preferential right in favor of the tenant. This unencumbered status can make the property more attractive to potential buyers, helping the landlord to maximize the sale price.
Conclusion
While the notion of acting in good faith and maintaining open conversations with tenants is commendable, commercial real estate landlords must recognize the substantial risks associated with ROFOs, ROFRs, and similar rights. These provisions can severely limit the ability to sell or transfer property freely, resulting in significant financial losses. By understanding the implications and approaching lease negotiations with caution and professional guidance, landlords can protect their property’s value and ensure they are not unwittingly trapping themselves in disadvantageous agreements.
