DAVID J. WILLIS ATTORNEY
Copyright © 2013. All rights reserved worldwide.
RIGHTS OF FIRST REFUSAL IN TEXAS
by David J. Willis, J.D., LL.M.
A right of first refusal ("ROFR") is a preemptive right to purchase specific real property at some future time upon certain defined terms and conditions. ROFR’s do not specify a price. Circumstances vary, and therefore the language of a ROFR clause will vary as well. For example, a ROFR may be triggered by an offer received by the owner from a third party; in such a case, the owner is obligated to first offer the property for sale to the holder of the ROFR at the same price and upon the same terms. Another scenario may occur if the owner makes the decision to sell the property but does not yet have a buyer; the ROFR may obligate him to offer the property first to the holder of the ROFR. The principal benefit to a ROFR is that it is not an executory contract, even when combined with a lease.
Caution: As soon as a specific price is included, it is likely that a ROFR will be transformed into an option and fall within the definition of an executory contract (See our article on Executory Contracts in Texas). ROFR’s are therefore not an effective substitute for an investor seller who wants to pre-set an above-market price in order to lock in a long-term profit.
ROFR vs. Options
Certain characteristics are shared by ROFR’s and options. Both are exercisable in the future. The validity of both can be limited to certain time periods or terms, i.e., either may expire before it is exercised. They can occur in both residential and commercial situations. Also both ROFR’s and options grantor the holder the power but not the obligation to act. There is generally no breach or liability for damages if the holder of an option chooses to do nothing.
However, a ROFR differs from an option in that it is conditional, not fixed, and does not specify a dollar price. An option to purchase, on the other hand, is a unilateral contract which gives the holder the right to compel sale of the property at certain price within a certain option term. When an owner gives notice of intent to sell, the ROFR matures or "ripens" and becomes enforceable. The terms of the option consist of the contractual provisions granting the option along with the terms and conditions of any third-party offer. Once the property owner has given the holder notice of his intent to sell, the terms of the option cannot be changed for as long as the option is binding on the owner. City of Brownsville v. Golden Spread Electric Cooperative, Inc., 192 W.W.3d 876 (Tex.App.– Dallas 2006, pet. denied).
What if an investor/seller gets creative with document wording and deletes "option" from a lease-option or lease-purchase document, substitutes ROFR language in its place, and then goes on to specify a dollar price? Under The City of Brownsville case, once price is specified, it is likely that the ROFR becomes an option and therefore an executory device. Further, courts are more likely to interpret a contract clause in light of what it actually is rather than what it pretends to be (the "quacks like a duck" rule). The result could be a finding that the executory contract rules have been violated, or worse, that fraud has been committed by the investor.
Drafting ROFR Language
All of this presents an interesting challenge when attempting to draft a ROFR. Here is one example:
In the event OWNER offers the Property for sale, then HOLDER shall have the right (but not the obligation) to purchase the Property under the following terms and conditions: (1) Once OWNER has established an asking or listing price for the Property, OWNER shall first notify HOLDER in writing of OWNER’s intent to sell and shall then offer the Property for sale to HOLDER at this price. HOLDER shall have 10 days from receipt of such notice to consider this offer, and if HOLDER accepts, HOLDER shall have 45 days to close. Consideration may be cash or third-party financing or, if agreed between OWNER and HOLDER, by assumption, wraparound, or owner finance. (2) If HOLDER shall decline or fail to purchase the Property at the listing or asking price, OWNER shall be free to offer the Property for sale to others. However, if a bona fide offer is received from a third-party prospective buyer, then OWNER shall again notify HOLDER in writing and offer the Property to HOLDER at the price and upon the same or better terms as named by the prospective buyer. HOLDER shall have 10 days from receipt of such notice to consider this offer, and if HOLDER accepts, HOLDER shall have 45 days to close. HOLDER may shorten or eliminate any applicable time periods in this paragraph by waiving or declining in writing to exercise HOLDER’s right of first refusal. [IF A TIME PERIOD IS DESIRED]. The right of first refusal described in this section shall expire on [DATE].
The advantage of the foregoing method is that the ROFR sales price is ultimately set by a third-party buyer. However, what if the ROFR as drafted merely gives the Holder a general right? Some method has to be found to establish price. In the following instance, value is determined by reference to prevailing fair market value:
In the event OWNER intends to offer the Property for sale, OWNER must first offer the Property for sale to HOLDER at a price equivalent to prevailing fair market value. Terms of sale shall be cash or third-party finance, and closing shall be within 45 days.
If the parties cannot agree on what constitutes fair market value, then two appraisers shall be promptly selected, one by OWNER and another by HOLDER. The two appraisers selected shall proceed to promptly determine the fair market value of the Property, taking into consideration its condition, the comparables, and any outstanding indebtedness, liabilities, liens, and obligations relating to the Property. The appraisers shall deliver their respective reports within thirty (30) days. If the two appraisers arrive at different valuations, then these two valuations shall be averaged in order to produce a final valuation. The final valuation shall be binding on both parties. Each party waives the right to contest the final valuation in court. The costs of the appraisals shall be split equally between OWNER and HOLDER.
The ROFR is a useful tool which stops short of being an executory device, but only so long as one does not try to stretch the language in order to make it an option by a different name.
Other Preferential Rights
There are similar but lesser preferential rights that also falls within this general category. One is a right of first negotiation ("ROFN") which means exactly what the title suggests and no more. There is no mention of price and no obligation to conclude a deal. Another is a right of first offer (ROFO) which obligates the seller to notify a buyer of his intention to sell, and the buyer will then have the right to make an offer, the terms of which are not specified in advance. Along with ROFR’s, ROFO’s and ROFN’s are potentially useful substitutes for a lease-purchase, but they must be carefully structured and worded so as not to fall into the executory conveyance trap.
Information in this article is proved for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. No attorney-client relationship is created by the offering of this article. This firm does not represent you unless and until it is expressly retained in writing to do so. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well.
Copyright © 2013 by David J. Willis. All rights reserved worldwide. Mr. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, http://www.LoneStarLandLaw.com.