A right of first refusal (“ROFR”) is a preemptive right to purchase specific real property at some future time upon defined terms and conditions. “A right of first refusal is essentially a dormant option. It requires the owner, before selling the property to another, to offer it to the rightholder on the terms and conditions specified in the contract granting the right. . . . When the property owner expresses [an] intention to sell, the rightholder must elect to either purchase the property or decline to purchase it and allow the owner to sell it to another. . . . A purchaser from a lessor who has given a right of first refusal takes the property subject to that right. When a sale is made in breach of the right of first refusal, it therefore creates in the rightholder an enforceable option to acquire the property according to the terms of the sale. . . . However, the option is not perpetual and the rightholder must choose between exercising it or acquiescing in the transfer of property.” A.G.E., Inc. vs. Buford, 105 S.W.3d 667 (Tex.App.—Austin 2003, pet. denied).
Avoiding the Executory Contract Trap
Although a mechanism for determining price should be included in the contract, ROFRs do not specify a fixed price. As soon as a specific fixed price is included, it is likely that a ROFR will be transformed into an option and then fall within the definition of an executory contract.
Executory contract rules contained in Property Code Section 5.061 et seq. impose burdensome rules and liability upon the seller. For executory contracts longer than 180 days, the landlord-seller must provide the Buyer with a recent survey or a current plat; copies of liens, restrictive covenants, and easements; a statutory disclosure; a disclosure for non-subdivision properties stating utilities may not be available until the subdivision is recorded; tax certificates; a copy of the insurance policy showing the name of the insurer and insured along with a description of the insured property and the policy amount; a seven-day notice letter; and an annual accounting that includes amounts paid, amounts owed, payments remaining, taxes paid, and the amount paid for insurance premiums plus an accounting for any insurance proceeds. All of this must be done before the contract is signed. Prop. Code Sec. 5.069 et seq.
ROFR Versus Options
Certain characteristics are shared by ROFRs 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 ROFRs and options grant 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 property at a certain price within a certain option term. When an owner gives notice of intent to sell, the ROFR matures or ripens and then becomes enforceable.
The terms of an 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 Elec. Coop., Inc., 192 S.W.3d 876 (Tex. App.—Dallas 2006, pet. denied).
What if an investor-seller gets creative with document wording and deletes the word “option” from the document, substitutes ROFR language in its place, and then goes on to specify a dollar price? Under the 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 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. Critical considerations include: (1) the duration of the right—is it a one-time right? Does it expire at some point or does it endure? What are the specific provisions for giving notice, whether that be notice of a pending offer or notice of exercise of the ROFR? (2) What is the geographical scope of the ROFR? Does it extend to a proposed sale of a portion of the subject tract or only to the tract in its entirety? Does the ROFR contain within it an express or implied right to partition the property? Will a new survey be required to delineate the acreage covered by the ROFR? (3) How exactly is the right triggered? If it is triggered by a “bona fide offer” from a third-party, does that mean a verbal offer? An email? The submission of a formal contract as offer? Clearly, “Bona fide offer” must be one of several carefully defined terms. (4) If the ROFR is silent as to price, how will price be determined? A stipulated sum or current fair market value? Does the ROFR clause include a mechanism for this? (5) Can the holder of the ROFR assign it, perhaps to a real estate investor? Contract and property interests are generally assignable unless prohibited by law or by express language in the contract itself. (6) What are the remedies for breach of the ROFR? Every good contract includes a default section. Do the parties stipulate to the application of injunctive relief or liquidated damages? Can the ROFR be waived by inaction? (7) Will the ROFR be recorded in the real property records or kept confidential between the parties?
Back to the meaning of the critical term “bona fide offer:” case law states that in order for an offer to constitute a “bona fide offer within the meaning of that phrase . . . such offer had to not only be made in good faith, but it had to also be of such a nature and in such form that it could be, by an acceptance thereof by the offeree, caused to ripen into a valid and binding contract that could be enforced by any party to it.” Jones v. Riley, 471 S.W.2d 650 (Tex.App.—Fort Worth 1971, writ ref’d n.r.e.). However, the meaning of important contract terms should not be left to definitions derived from old cases. Good legal draftsmanship requires that terms like “bona fide offer” and “bona fide purchaser” be defined within the contract itself, in a way that is suitably specific to the circumstances and the parties.
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.
Statute of Frauds Applies
A ROFR must be express (not implied) and in writing in order to comply with the statute of frauds. Provisions of the Statute of Frauds applicable to real estate are found in Business & Commerce Code section 26.01 and 26.02(b): “[A] contract for the sale of real estate is not enforceable unless the promise or agreement, or a memorandum of it, is (1) in writing; and (2) signed by the person to be charged with the promise or agreement. . . . “The statute of frauds requires that a memorandum of an agreement, in addition to being signed by the party to be charged, must be complete within itself in every material detail and contain all of the essential elements of the agreement so that the contract can be ascertained from the writings without resorting to oral testimony.” Sterrett v. Jacobs, 118 S.W.3d 877, 879-80 (Tex.App.—Texarkana 2003, pet. denied). Note, however, that the contract need not be contained with the four corners of a single document. “A valid memorandum of the contract may consist of numerous communiques [or emails] signed by the party to be charged. . . .” Key v. Pierce, 8 S.W.3d 704, 708 (Tex.App.—Fort Worth 1999, pet. denied). For more information on the Statute of Frauds, see our companion web article on this subject.
There is another statute that may be applicable: Property Code section 5.021, sometimes referred to as the “Statute of Conveyances,” which states: “A conveyance of an estate of inheritance, a freehold, or an estate for more than one year, in land and tenements, must be in writing and must be subscribed and delivered by the conveyor or by the conveyor’s agent authorized in writing.”
Other Preferential Rights
There are similar preferential rights that also falls within this general category. One is a right of first negotiation (“ROFN,” sometimes called a right of first opportunity) which means exactly what the title suggests and no more. The seller is obligated to notify the holder of a ROFN of his intention to sell, and the holder will then have the right to negotiate and make an offer, which the seller is not obligated to accept. There is no mention of price and no obligation to conclude a deal. Another somewhat lesser right 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. There is no right to negotiate ROFRs, ROFOs and ROFNs 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.
Caution to Investors: Avoid the Courtroom
Preferential rights like ROFRs, ROFNs, and ROFOs, when properly written, have the advantage of avoiding the requirements and liability imposed upon executory contracts by the Property Code and the Deceptive Trade Practices Act. They are nonetheless creative techniques that may not be readily understandable by a jury. Combine this with the fact that real estate investors are often viewed as predators who exploit the weak, and the courtroom can become a dangerous place. Even if executory contract rules are inapplicable, a court can still look to DTPA Section 17.50(a)(3) which prohibits “any unconscionable action or course of action by any person”—a multi-edged weapon to say the least. Investors should find a good real estate lawyer, one with courtroom experience, and pay attention to what he or she says about how a judge or jury may react to a proposed deal and the documents that underlie it, particularly if the parties are significantly unequal in experience and expertise. A good lawyer knows that real estate documents should always be drafted as if one will someday have to defend them in court.
Information in this article is provided 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 © 2022 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 web site, www.LoneStarLandLaw.com.