Dibs!: Understanding Right of First Refusal

By Judon Fambrough

“When you get ready to sell, give me a call.” Ever heard that from a potential buyer?

If the buyer is serious, he or she should be asking,

“Will you grant me a right of first refusal for this property?”\

What Is A Right of First Refusal?

A right of first refusal (ROFR) is a written agreement between a person wishing to
purchase real property that is not currently for sale and the property owner who
currently is not ready to sell it. The owner grants the prospective buyer an option
to buy in the future after the owner-seller receives a bonafide (good faith) offer
from a third party.

The ROFR does not grant the would-be buyer (holder) any immediate ownership
rights. Instead, the owner simply agrees not to sell the property without giving
the holder an opportunity to purchase the property based on the third party’s
offer.

Who Enters Into A Right of Refusal?

Generally, the ROFR is between or among co-owners or cotenants. When one
cotenant gets ready to sell his or her undivided interest, the other cotenant(s)
have the right, based on the ROFR, to purchase the interest and avoid an
unwanted cotenant. An ROFR may be between adjacent landowners. Parties
leasing land may want an ROFR from the owner.

The ROFR should not be confused with other “first rights,” such as the
“right of first offer” or the “right of first negotiations.” A right of first offer
requires the owner to notify the holder before offering the land for sale to
a third party. The holder has the right to make an offer that the owner may
or may not accept.

Because the holder does not know how the owner may value the property,
a common practice requires the owner to specify the price and terms he or
she is willing to accept. The price may be based on an appraisal or some
other determinant.

Similar First Rights: The Right of First Negotiations

A right of first negotiations, on the other hand, is less burdensome. This requires
the owner to notify the holder of the owner’s intent to sell the property. The
parties have a specified period in which to negotiate exclusively for the purchase.
If the parties cannot reach an agreement, the owner is free to sell the property to
anyone.

Consideration for ROFR

For the most part, Texas law requires the exchange of consideration to make a
contract (or option) irrevocable. But this is not necessarily true. Texas courts
have long held that consideration is required to create a binding, irrevocable
agreement.

However, in the Joppich opinion rendered by the Texas Supreme Court in 2004,
the high court held that the mere mention of consideration in the agreement,
even when not paid, is sufficient. To avoid problems, the agreement should spell
out that consideration is required for the option, and the holder should pay it.
The consideration should never be applied toward the purchase price.

Matching Bona Fide Offer

The owner’s receipt of a bona fide, third-party offer generally triggers the ROFR.
Thereafter, the holder must agree to match both the price and the terms of the
agreement within a specified period. This raises the possibility of collusion
between the seller and the third party.

Suppose a potential cash buyer approaches the owner to purchase the
property. Before the buyer tenders an offer, the owner allows him or her
to survey the property and conduct environmental assessments. The
parties then contract for a cash closing in five days. The holder, on the
other hand, needs several weeks (possibly months) to arrange for a survey,
acquire third-party financing and conduct environmental assessments.

According to the agreement, the holder has 15 days to accept or
reject the option and close within five days thereafter. Has the owner received
a bona fide offer in this situation? Must the holder match exactly the terms and
conditions set forth in the third party’s cash offer? Although there are some
differences among the states, Texas case law generally requires the holder to
match exactly the terms and conditions of the third party’s offer unless the
agreement states otherwise.

To avoid this scenario, here are some considerations:

• A bona fide offer should not include a nonbinding, goodfaith proposal or a
letter of intent.

• A bona fide offer requires the owner’s receipt of nonrefundable
consideration from the third party based on a percentage of the purchase
price. (The consideration should be refunded if the holder accepts the offer.)

• The holder must match the price, but only the material or essential
nonmonetary terms of the contract.

• Despite the terms of the third party’s offer, the holder should be allowed
reasonable time to seek third-party financing, conduct surveys and complete
environmental assessments of the property before having to accept or
reject the option. If this is not acceptable, see the next suggestion.

• Any special knowledge acquired or held by the third party seeking to
purchase the property, such as surveys, environmental assessments and
inspections, must be shared with the holder. The holder may be required to
reimburse the third party for reasonable costs of acquiring the information
if the holder relies on it to purchase the property.

• The owner may not, without reasonable justification, accept or insert
special terms and conditions in the third party’s offer known to be repugnant
to the holder.

• The owner may not, without reasonable justification or without the holder’s
consent, place deed restrictions on the property after entering the ROFR that
the owner knows contradicts the holder’s anticipated use of the property.

Defining ‘Triggering Event’

The ROFR agreement must address what event(s) trigger the option.
For example:

• Do transfers by will or gifts to family members or to coowners
trigger the option? If not, does the ROFR continue to run with the land
and bind the grantees?

• Do mortgage sales, tax foreclosures, bankruptcy and condemnation
trigger the ROFR? Texas case law indicates that a mortgage foreclosure
does not rise to the level of a right of first refusal bona fide purchase
and trigger the ROFR when the ROFR was placed on the property prior to
the mortgage. Otherwise, it does. This should be addressed in the
agreement.

Reinstating the ROFR

The agreement needs to address what events, if any, reinstate the ROFR.
Suppose the holder rejects the option to purchase, but subsequent
problems develop between the owner and the third-party buyer. The
contract does not close or is amended significantly before closing. What
effect does this have on the ROFR?

These may be included in the agreement to avoid problems.

• If the third-party contract does not close, the ROFR must be reinstated
against the property.

• If the owner and third party alter the price or amend significant terms
and provisions of the contract after the option is rejected by the holder,
the amended contract must be resubmitted to the holder. Otherwise, the
holder has the following election. He or she may reinstate the ROFR
against the property or immediately enforce it against the new buyer based
on the terms of the amended contract.

• If the third-party buyer does not share special knowledge or information
about the property with the holder when required, the ROFR may be
reinstated against the property once the breach is discovered.

Duration of ROFR

Texas recognizes the Rule Against Perpetuities. This rule limits the length
of time a restriction on conveyance, such as an ROFR, may be placed on
(or enforced against) property. Generally, it cannot exceed 21 years after
an identified living person or persons die. If no living person or persons are
identified, the courts may find the interest void from its inception or that it
lasts only 21 years after its creation. To avoid the issue, the agreement
should state the ROFR terminates upon the death of the owner (or owners)
or 21 years after their death(s). The parties may agree to terminate it much
sooner (five to ten years, for example). However, a termination date that
does not violate the Rule Against Perpetuities should be stated.

ROFR Notifications

The agreement should specify how notice of the offer must be sent to the
holder and how the holder must respond. Here is some suggested language:

The owner must send the holder notice of receipt of a bona fide offer
within ___ days after receiving it. The notice must be sent by certified mail,
return receipt requested.

The holder must respond within ___ days (the first day being the day after
the notice is received) by certified mail, return receipt requested.

If the holder does not respond within the specified time, the ROFR is
deemed waived and a third party may rely on owner’s recorded affidavit
to that effect. In lieu of the affidavit, some agreements require the holder
to submit a recordable release of the ROFR to verify termination of
agreement if the offer is rejected. The affidavit works better when the
holder cannot be located.

Of course, the owner needs to be able to locate the holder when the option
materializes. The agreement may require the notice be sent to the last known
address. If the address is incorrect or if the holder refuses to accept the
certified letter, the owner has fulfilled his or her obligation, and the ROFR
terminates.

• The owner and holder must reduce the contract to writing on an
approved TREC Form and sign it within ___days after acceptance of the
option.

• The holder must tender an escrow payment (of a certain amount)
whenever the purchase contract is signed. Finally, the agreement may
allow the owner and holder to mutually modify the terms of the third-party
contract. subject to the agreement. The effect of the owner’s entering an
oil and gas lease (which is a deed in Texas) needs to be discussed if the
minerals are subject to the agreement. If the ROFR is for rural land, the
issue of subsequent partitioning and sale of the property needs to be
resolved. Typically, the agreement states that the option continues and
applies to any and all offers for all or any part of the described tract.

Recording the Agreement

The ROFR agreement binds the owner, the holder and those with actual or
constructive knowledge of the agreement. The agreement is void
(unenforceable) against a third party who pays valuable consideration for
the property and has no actual or constructive knowledge of the ROFR.
(This person is better known as a bona fide purchaser.) Recording the
agreement imparts constructive knowledge and prevents the possibility of
a bona fide purchaser. For this reason, the ROFR should be recorded in
each county where the property is located.

Deaths and Assignments

The effect of an owner’s death was discussed earlier. However, what about
the death of the holder? Does the ROFR pass to the holder’s heirs,
devisees or both? Likewise, can the holder assign the ROFR rights to a third
party? Typically, the ROFR binds only the owner and holder. This issue should
be addressed in the agreement.

Property Description, Partitioning

The agreement must contain a legal description of the property. The street
address of residential property appears to be sufficient. Rural land needs to be
described more precisely. The agreement must detail whether the minerals,
wind rights or other interests attached to the property (if owned by the seller)
are.

THE TAKEAWAY

A right of first refusal is an agreement between a property owner and a
second party who wants to have the first chance to purchase the property
when it comes on the market. The agreement is triggered when the owner
receives a third-party offer to buy the property. For the agreement to be
recordable, it must be signed by the owner and acknowledged before a notary
or two or more credible witnesses (Section 12.001, Texas Property Code). For
more details on bona fide purchasers, see “Deeds and the Texas Recording
Statutes” (publication 1267) at recenter.tamu.edu.

To avoid problems, both the owner and the holder should sign the agreement
before a notary and record it. This ensures that the parties are in agreement
regarding the details and no unauthorized changes occur.

Remedies for Breach

According to Texas case law, the owner’s breach of the agreement (failure to
submit the third party’s offer to the holder) gives the holder an election to
purchase based on the terms of the third party’s offer or decline. This election
must be made within the time specified in the agreement starting from the time
the holder learns of the violation. According to case law, if no time is specified,
it expires: (1) within a reasonable time, (2) by holder’s express rejection or
(3) by the holder demonstrating conduct inconsistent with an intent to
purchase. The holder has the right of specific performance against the
party in possession if he or she decides to purchase. Basically, specific
performance is a legal procedure whereby the courts enforce the terms of
the ROFR against the owner. This could be against the owner, the third-party
purchaser or some other party depending on the circumstances.

The owner and holder may wish to supplement these remedies. Perhaps the
owner may be given the right to purchase a release of the ROFR from the
holder for a stated amount — one price for purchasing the release before
the sale and another after the sale based on a percentage of the purchase
price. The agreement may impose liability on the owner for the holder’s
attorneys’ fees if the owner breaches the agreement and the holder seeks
specific performance in a court of law.

Licensees will encounter an ROFR sooner or later in the practice of real
estate. When that happens, they need to be able to evaluate the
agreement for themselves and for clients. Unforeseen and unanticipated
problems not addressed in the agreement may cause misunderstandings
and could result in llitigation.

Fambrough (judon@recenter.tamu.edu) is a member of the State Bar of Texas
and a lawyer with the Real Estate Center at Texas A&M University.
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