Options and the First Right of Refusal

By David Allen

It is common in commercial leases for the tenant to be given the “option” to continue to lease their premises for a new term commencing immediately upon the expiration of the existing term.  Although the option only favors the tenant, who has the sole right to either exercise or decline to exercise it, there is usually little reason for a landlord to refuse to give such right to the tenant – in most circumstances the landlord is better off having the existing tenant continue its tenancy, as opposed to having to procure a new tenant.

Sometimes, in addition to having the “option” to continue to lease the premises, the tenant also wants to have the “first right of refusal” to lease other, usually contiguous space, which is currently either vacant or more often leased to someone else.  A “right of first refusal” is similar to an “option” in that it only favors the tenant who has the sole right to either exercise or decline to exercise such a right. This is unlike with the granting of an option – there are many issues that can arise in connection with a right of first refusal that a landlord should carefully consider before granting the right.

The “refusal” aspect of a right of first refusal requires, by definition, that there be specific terms and conditions offered by a third party, that the tenant holding the right of first refusal has the sole right to either agree or “refuse” to match. This may create a serious marketing problem for the landlord and its leasing agents, in that before the landlord can accept an offer from a third party, the landlord must first allow its tenant holding the right of first refusal to exercise such a right, and if it is exercised, the landlord must then decline the third party offer. Typically, the holder of the right of first refusal has some specified period of time stated in their lease to either exercise or decline to exercise their right following notification of the third party offer, which requires the landlord to put the potential third party tenant “on hold,” and may result in the tenant walking away.

Even more issues can arise if the right of first refusal is not to lease other space, but instead to purchase the property in which the leased premises are located. For example, if the proposed purchase by a third party is for all cash, does that preclude the holder of the right of first refusal from financing a portion of the purchase price? Can the right of first refusal be transferred to others, either voluntarily or following the death of the holder of such right? Does the right of first refusal terminate if it is not exercised and the third party sale is not consummated, or does the first right of refusal become exercisable when a new potential sale arises? All of these issues, and more, must be specifically addressed in the lease or contract creating the right of first refusal, in order to avoid disputes that could result in costly litigation.

David Allen, a partner in the Phoenix law firm of Jaburg & Wilk, has been representing clients in both transactional and litigation real estate and business related matters for over thirty years.  He is licensed as an attorney in both Arizona and California, and is also a licensed Arizona real estate broker. David can be reached at 602-248-1082 or by email at dla@jaburgwilk.com.

This article is not intended to provide legal advice and only relates to Arizona law.  It does not consider the scope of laws in states other than Arizona.  Always consult an attorney for legal advice for your particular situation.