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Right of First Refusal and Broker’s Commission

by / Sunday, 14 April 2013 / Published in Articles

Right of First Refusal and Broker’s Commission 

By Bryan Mashian, Esq.  

 

A right of first refusal may appear straightforward, but certain factors, such as a broker’s potential commission, can make them complex. To make a lease deal, the landlord often provides the tenant a right of first refusal to purchase since it “doesn’t cost anything,” and the tenant may never exercise the right. However, a right of first refusal rarely benefitsthe landlord and will certainly complicate matters.

Under the typical right of first refusal procedure, before the landlord/owner can sell the property, the tenant must be given the opportunity to purchase the property on the same terms and conditions that the owner is prepared to sell to a third party. So, the owner must hire a broker, market the property, find a suitable buyer, negotiate the best deal, reduce the sale terms to writing, have the buyer sign the offer, and then present it to the tenant. The tenant will then have a certain number of days to decide whether or not to purchase the property on the offered terms.

One of the many complications that can arise during this process was highlighted in a California case in which the lease provided the tenant with the right of first refusal to purchase. Several years after the lease was signed, a prospective buyer submitted an offer which was acceptable to the owner. This buyer had a broker who was to be paid a commission.

The tenant exercised its right of first refusal, but reduced the purchase price by the commission that would have been payable. This reduction was acceptable to the owner since the net sale proceeds were the same, regardless of which deal seller accepted. The first buyer, however, sued and claimed that the tenant was not purchasing the property for the same price and on the same terms and conditions that were offered, but for a lower price. The court held that since the net sale price to the owner was the same in both cases, the tenant was in fact purchasing the property on the same terms and conditions.

The court then dealt with the issue of whether the owner was liable to pay a commission to the real estate broker who procured the offer from the first buyer. The court held that the owner was not liable to pay such a commission because there was no specific understanding that the owner would be liable for any commission if the tenant exercised the right of first refusal to purchase.

There are lessons to be learned by all parties. If possible, a landlord should avoid giving a right of first refusal. If the tenant really wants a chance to buy the property, it is less cumbersome for the landlord to provide a right of first offer instead since the landlord does not have to go to nearly the end of the sale process to fulfill its obligations as it would under a right of first refusal. Instead, the tenant has a chance to make an offer at the inception, before the landlord markets the property.

If a right of first refusal is to be given at all, it should be tightly drawn to avoid any ambiguities or loose ends, such as the amount of time the tenant has to accept or reject the proposal. The provisions should anticipate and clearly address events and changes that can happen during a transaction. For example, the provision should state what happens if after the tenant declines to exercise its right of first refusal, the purchase price is reduced, as often happens due to defects discovered during escrow.

Also, the provision should be clear as to whether the right of first refusal is a one-time right or a continuing right during the entire term of the lease. In other words, if a tenant does not exercise its right of first refusal and the property sells, does the tenant still have a right of first refusal if the new owner wants to sell to someone else?

The existence of a right of first refusal may dampen the broker’s interest in marketing a property unless the broker is certain that it will be paid a commission if the tenant exercises its right of first refusal. So, before taking on a listing, the broker should find out (and the owner should disclose) if there is an existing right of first refusal. The parties need to clearly agree if, when and how much brokerage commission will be paid if the broker procures a third party offer which triggers the tenant’s exercise of the right of first refusal.

 

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