Right of First Refusal: A Complete Tenant Guide | Hunt KL Office

November 26, 2018 No Comments

Right of First Refusal: A Complete Tenant Guide


Posted by Ten Fong in Negotiating

 

Right of First Refusal: A Complete Tenant Guide

If you are negotiating a commercial lease and want flexible expansion rights you will want a right of first refusal (ROFR). 

 

What is an Expansion Right?

A right to expand is an agreed to clause in a commercial lease between the landlord and tenant.  It covers the tenant’s ability to acquire additional space to lease. 

Landlords will typically not volunteer to provide any rights to expand, as they become cumbersome to administer. 

For example, if every tenant in a building had a right to expand, it requires the landlord to know which tenant has the first right, who has the second right, etc. 

 

How Easy is it to Get an Expansion Right?

It depends.  It really comes down to negotiating leverage.

A large, creditworthy tenant in a soft market with a small landlord will have much more bargaining power than a small tenant, with a big landlord in a tight market. 

The specifics of the right will also matter, as some expansion rights are much more onerous on the landlord than others. 

 

What is a Right of First Offer?

A right of first offer (ROFO) has the least amount of value for the tenant.  It requires the landlord to offer the space to the tenant before the general public. 

Typically there is no set price or length of lease term attached to the offer.  The clause is normally just worded to obligate the landlord to offer the space to the tenant before the rest of the marketplace. 

The tenant typically has a defined period of time to indicate they are willing to lease the expansion premises failing which, the landlord shall be entitled to lease the space to a third party. 

 

Right of First Offer Timelines

This is up for negotiation, but typically a landlord would want a tenant to make a decision within five business days.  It is unlikely that you could extend this to more than ten business days. 

What Expansion Spaces Would This Apply To?

Expansion rights normally cover three areas:

1) Contiguous space (any space touching your existing premises)

2) Other space on the same floor as your suite, or

3) Any space that becomes available anywhere else in the building. 

It can also apply to spaces of certain sizes (for instance, any space under 2,000 square feet, or any space over 2,000 square feet).

 

Right of First Offer Sample Lease Clause

A sample clause for a right of first offer might look like this:

The Tenant shall have a right of first offer to lease any premises that becomes available on the 2nd floor of the building.  The landlord shall notify the tenant of the availability of said premises and the tenant shall have five (5) business days to inform the landlord of their desire to lease the premises.  The failure by tenant to notify the landlord shall result in the exhaustion of this right and the landlord shall be free to lease the premises to a third party. 

 

Note that this is broad and generic wording, and that is what is used in most cases.

Here are elements that were missing: is the rental rate the same as the lease, or at market rates?  Since this is not defined, the landlord could simply be unreasonable, and then after five business days be free to lease the premises to any other tenant. 

Does the lease have to be extended?  Can the tenant receive a tenant improvement allowance as part of the deal?  Can the tenant take the space on a co-terminus basis as the existing expiry? 

Does the negotiation have to be completed by a certain time?  The clause just states the notice has to be provided. 

Unfortunately most rights of first offers are constructed by a tenant’s broker, they are poorly worded and if a landlord accepts, he knows it has enough problems that the landlord can effectively dodge the obligation to live up to the right. 

It is more advantageous for the tenant to have a clause that clearly states that the rent will be consistent with what they are paying and that the main lease does not have to be extended. 

 

What is a Right of First Refusal?

A right of first refusal is much more powerful for the tenant. 

Rather than being given a short period of time to agree to lease expansion space, a right of first refusal allows a tenant to wait for a space to be leased and then has an opportunity to match that offer. 

This allows a tenant to sit back and wait. 

Once the space in question becomes conditionally leased, the landlord approaches the tenant with the deal and the tenant has the opportunity to steal that deal. 

Of course, since this is so advantageous for the tenant, it is a clause that is despised by landlords. 

It really dampens their ability to lease space once any prospective tenants learn they could negotiate on a space only to have it scooped on them, they typically turn their attention elsewhere.

 

Disadvantages of a Right of First Refusal

While much more powerful than a right of first offer, typically a right of first refusal has less flexible terms. 

For instance, in the case of a tenant with 2 years remaining on a lease:

1) if that tenant had a right of first offer, most landlords would be satisfied leasing the expansion space to the tenant on a 2 year, co-terminus basis. 

2) if that tenant instead had a right of first refusal and another tenant came in with a 10 year lease proposal, then the existing tenant would need to match all the terms of that proposal, and would have to agree to the 10 year term. 

 

What if the Landlord Violates the Right of First Refusal?

A landlord who violates a right of first refusal has not lived up to the terms of the contract and therefore would be in default of the lease. 

If there are material damages, such as your business not being able to expand and accommodate growth, then you would have a legal claim to be made with your landlord, but that is beyond the context of this article. 

Here is a sample law case in which a landlord is liable for damages by not following the right of first refusal steps.

Note that there can be room for ambiguities in a right of first refusal clause. 

The landlord received an offer for multiple floors, and Equinox wanted to exercise their right of first offer on one of those floors.  The judge ruled that their right in this case does not apply, since the offer was for multiple floors. 

 

Expiration of Rights of First Refusal

Be very careful about how your right of first refusal clause is worded. 

In most cases a landlord will intentionally ensure that the right is extinguished upon the first opportunity regardless of whether you decide to exercise or decline. 

In order to overcome such a cancellation of the ROFR right, you would need the right to be continuous, and the clause would need to be clear that in the event you decline your option, that your right shall live on. 

For example, what if the tenant how leases the expansion space goes out of business or completes a short term lease?  Or if you have a right on space for the entire building you would want a continuous right of first refusal, which would apply to any space that becomes available, at any time not just the first time. 

 

Ability to Transfer a Right of First Refusal

Unless otherwise stated in the lease, it would be normal for right of first refusal to be assignable to any subtenants, successors or assigns. 

 

Conclusion

Expansion rights are not easily obtained and much of it comes down to negotiating leverage how desirable of a tenant are you and how soft are the market conditions. 

A continuous right of first refusal for any space in a building is the gold standard of expansion rights, but most tenants who are able to negotiate for expansion rights end up with a one time right of first offer.

 

For more questions, you can refer to www.huntkloffice.com


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