How can a buyer ensure a future sales price? How can a seller with nearby land protect itself against unwelcome future neighbors? Repurchase options.
Though a right of first option can provide more certainty for both parties, it also can lock a landowner in to a certain sales price, for better and worse.
While there are many types of options related to real property transactions, this article focuses on two common options – the right of first refusal and the right of first offer. Repurchase options, most commonly granted either in the form of a right of first offer or a right of first refusal, are contractual rights granted by the owner of the property, which give a third-party holder a contingent right to purchase land at a later date. A right of first offer mandates that the landowner give the holder the opportunity to respond to a third-party offer to purchase the land before the landowner can accept the offer from the third party. Generally, the holder must purchase the property on the same terms and conditions as the third-party offer or made to the landowner.
Under a right of first offer, the holder’s rights are triggered by the owner of the property desiring to take the property to market. Under a right of first offer, the owner must offer to sell the property to the holder first, often pursuant to previously agreed upon terms.
Benefits of a right of first offer. Rights of first offer can provide both parties with more certainty as a right of first offer generally is drafted to include terms of a sale in the event the right of first offer is exercised. As the holder of a right of first offer, you know you get the first bite at the apple. As the landowner, you can negotiate that the holder’s right be a certain price, or some escalation of the price you paid for the property. If the right of first offer is based on a “market” price, depending on how the right of first offer is drafted, the landowner likely will have the ability to hire a broker and get an accurate picture of the market before presenting the holder with its right to offer.
Benefits of a right of first refusal. Rights of first refusal can provide the holder with some defense (to a loss of control or undesirable neighbors) and opens the landowner to receiving market prices. As the holder of a right of first refusal, it can be advantageous for the price to be set by the market, and not a formula based on the landowner’s purchase price. As a landowner, a right of first refusal can help ensure your sales price is a market price.
Considering the trade-offs. While there are advantages to using a right of first refusal, there also are drawbacks. Because the holder must purchase the property at the same price as the third-party offer made to the landowner, the price may be higher than what the holder wants to pay. In addition, the holder must purchase the property on the same terms and conditions as the third-party offer, meaning that the timing of the transaction and additional otherwise-negotiable terms of the transaction are dictated by the third-party offer. Rights of first refusal also can be challenging for the landowner as he may not get the best price at market when a third party knows that someone else ultimately can take the deal they negotiated.
Though a right of first option can provide more certainty for both parties, it also can lock a landowner in to a certain sales price, for better and worse. If the right of first option provides a certain calculation based on an escalation of the landowner’s purchase price, the landowner may be stuck selling the property for less than market value.
On the other hand, if the value of the property has decreased, the holder may be locked in to an above-market sales price under a right of first option.
Drafting and negotiation considerations. While there are various considerations when drafting and negotiating rights of first offer and rights of first refusal, we have found the following considerations to be key:
Definition of the triggering event. What event, series of events or conditions trigger the option holder’s ability to exercise the right? These can be narrowly tailored to benefit the landowner, and broadly drafted to benefit the holder. No matter which side of the transaction you represent, it’s important to consider how the triggering event is defined.
Length of term. How long will the right of first refusal or right of first offer last? Some rights last a few months and others last years.
Definition of the holder. Is the right personal? Is it in favor of a corporate entity? Can the holder of the right assign the right to a third party or an affiliate? If you represent the landowner, you want this right to be narrowly tailored to the current party. If you represent the holder, perhaps a broader definition is beneficial.
Mechanics of offer or refusal.
How long does the holder have to consider the offer? A shorter time frame may be merited under a right of first refusal so as to not lose the third-party offer or.
Summary. Both a right of first offer and a right of first refusal can benefit sellers and purchasers in a larger transaction. Depending on the type of transaction, considering the benefits of each type of right is essential.
This article was originally published in the April 7 edition of the Colorado Real Estate Journal.