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What Does the Right of Refusal Mean in Real Estate?

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Published on Monday, May 21, 2018 by Land Century

The first right of refusal in real estate is a provision an agreement or lease that gives a potentially interested party the right to buy the property before the seller negotiates other offers. This provision is typically drawn up before the seller puts the property up for sale.

Let's take a closer look at what the right of refusal is and how it works in real estate.

Right of First Refusal Definition

Imagine having first dibs on a piece of land or home that you love. Negotiating a first right of refusal into a housing agreement or lease can give you this option.

A first right of refusal contract allows the seller to market the property freely, but he or she must notify the interested party before entertaining any offers. The interested party has the right of first refusal. If the interested party declines, the seller is then free to negotiate offers from other buyers.

When Would Right of First Refusal be Used?

There are a few scenarios in which a right of first refusal agreement may be relevant.

  • Among Family Members. A right of first refusal clause may be used when a family member wants to buy the home.
  • Between Landlord and Tenant. A tenant may be interested in buying the landlord's home. A right of first refusal clause, written into the lease, would require the landlord to consider an offer from the tenant before negotiating with another buyer.
  • HOA or Condo Board. Some condo boards and HOAs will add a right of first refusal clause into their governing documents, which allows the board to vet potential buyers before sellers can accept an offer. Depending on the terms of the clause, the board may have the right to reject an offer entirely.
  • Adjacent Property Owners. If someone owns a large piece of land and decides to subdivide it, he or she may want to maintain the right of first refusal to allow for some degree of control over who is buying the property in the future. Two landowners who own adjacent properties may also choose to give each other first right of refusal as a way to give each other options in the future.

How Does First Right of Refusal Work?

A right of first refusal, or ROFR, is a future right. The terms can either be vague and non-binding, or very specific and binding. ROFR can mean different things to different people, so it's important that both parties be on the same page when drawing up the agreement.

There are a few different types of ROFR.

  • Option. One type is an option to buy a property that's for sale before it's sold to any other buyer. The interested party and seller may or may not come to an agreement on price and other terms when the agreement is drawn up. The seller isn't obligated to sell if the terms and price were not established when the ROFR was drawn up.
  • Right of its Holder to Match. Another type of ROFR is the right of the holder to match an offer the seller has. The holder is typically not obligated to match an offer, but may choose to do so.

An ROFR is drafted as either a contract or agreement. This agreement may run with the land, or it may bind to the current owner.

Both parties benefit from an ROFR. The seller benefits from having cash in hand at the time of the agreement, while the interested party receives a favorable price and terms. If the interested party cannot meet the terms of the of the ROFR in the future, the ROFR will not be exercised and the seller is free to sell the property to anyone.

When property is jointly held by multiple parties, an ROFR can be drawn up to give those who wish to continue owning the property the right to make a first offer or match an offer to a party who wants to exit the partnership. Depending on the terms of the agreement, a sale outside of the group may penalize the seller.

No matter the type, ROFRs typically have a set expiration date in the future. The longer the term of the ROFR, the greater the risk and uncertainty, as the market changes and property values fluctuate over the long-term. Most ROFRs are active for one or two years.

Depending on the ROFR, the interested party may be able to make an offer any time during its term, or the interested party may only be able to make an offer at the end of the specified term.

An ROFR is a complicated agreement and not a DIY legal project. Both parties should have lawyers involved in the drafting of the agreement. Everyone needs to be on the same page about the terms of the ROFR and how it will work.

Things That Should be Covered in the ROFR

An ROFR provision should cover a number of issues to ensure that there is no confusion in how the ROFR will work and how it will be executed.

Transfers

Some ROFR provisions state that "any sale or transfer" will trigger the ROFR. This language is a little vague, and both parties rarely intend for every transfer to trigger the clause.

Most owners do not want the ROFR to prevent them from transferring property to trusts or family members. Owners also don't expect to trigger the ROFR when giving their lender a lien, although the lien may involve transferring the legal title to the lender.

To avoid the above-mentioned scenarios, sellers can exclude these types of transfers from the definition of a sale or transfer. The interested party will still maintain his or her rights, as the new owner will also be subject to the terms of the ROFR.

Expiration Date

The ROFR should also include an expiration date. Both parties usually have a timeline in mind when negotiating the ROFR.

The duration of the ROFR should be clear and care should be taken to address potential ambiguities.

A good example would be an ROFR between a landlord and a tenant. The clause may state that the tenant has a right of first refusal on the leased property. But does this mean the tenant has the ROFR every time the property is offered for sale, or will the tenant only have one right to purchase the property on the first sale of the property (excluding future sales)?

In this case, the ROFR should state whether this is an ongoing right, or a one-time right that will expire if not exercised during the first sale.

Notice of Offer

The ROFR should clarify how the owner will notify the ROFR holder that an offer has been received that the owner intends to accept. Notice provisions are especially important to owners.

Notice provisions can avoid questions about whether a notice was valid, whether it was received, and what to do if the holder cannot be located.

Ideally, the ROFR should specify:

  • The address of the ROFR holder, and the holder's obligation to notify the owner of an address change.
  • The delivery methods used for the notices.
  • How much time the ROFR holder has to respond to the notice.
  • What the ROFR holder must do to accept the offer.

By including these details in the ROFR, the ROFR holder is obligated to inform the owner of address changes, and the ROFR holder cannot claim that the delivery method was invalid or ineffective.

Additionally, owners may want to include a provision that obligates the ROFR holder to sign a document acknowledging that he or she did not exercise his or her right to purchase the property.

The ROFR should also clarify what the notice should contain regarding the third party's offer.

Property Covered

This may seem like an obvious inclusion, but the ROFR should clearly state what real property will be covered by the ROFR.

The agreement should also cover the rules that will apply if the owner sells the property as part of a package-type deal with other properties. Does the ROFR holder have the right to make the owner offer the property separately? This can be a tricky area, but it's important to negotiate these terms while drafting the ROFR to ensure that no party feels like it's being taken advantage of if the situation arises.

How ROFR Affects Third Party Buyers

For third party buyers, an ROFR will likely slow down the purchase process a little. Additionally, the ROFR may carry with the property, which means you will need to deal with it again if you decide to sell the property in the future. Know and understand the terms of the ROFR before deciding to purchase the property, or in the very least, find out if the ROFR would transfer with the sale of the property.

Experts agree that an ROFR is rarely beneficial to a property owner, although it does have its place in certain scenarios. If you do decide that an ROFR is the right choice, do make sure that the terms and conditions are clearly spelled out and agreed upon by both parties to avoid conflict in the future.



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