Understanding Effects of Competing Tenant Exercising Option
If, under your lease, you have a right of first refusal at a certain year to buy the space you rent at a shopping center if a third party makes an offer to buy it from the owner of the property, it might seem pretty straightforward. But if your right of first refusal is subject to another long-standing tenant’s right to buy the space, it could be confusing—and potentially an issue for you. If that tenant passes up the offer, then you can certainly exercise your right once you reach the designated year of the lease at which point you can do so. But what if the other tenant’s right extends to the whole property as well? If the owner receives an offer for the property, the other tenant buys it and continues leasing to you, can the other tenant then use its right of first refusal again for your space to stop you from buying it? Or is its option extinguished if it “uses” it on the property as a whole, leaving you with an unfettered right of first refusal?
If you’re worried about this, a recent Massachusetts case with similar facts should ease your mind. There, two tenants leased space at a property. The first tenant had a right of first refusal to buy the entire property, including the second tenant’s space, if a third party made an offer. The second tenant had the option to buy its own space at a certain year in its lease term. But that was subject to the first tenant’s right of first refusal—that is, if the first tenant were offered the opportunity to buy the second tenant’s space that year; if it did not want to do so, the second tenant was free to buy it. At some point before the second tenant’s opportunity to buy its space came up, a third party made an offer to buy the entire property. The first tenant exercised its option, buying the entire property. It continued to occupy its own space and to lease space to the second tenant. The first tenant also created a limited liability company and transferred ownership of the property to it.
When the second tenant’s option to buy its space came up under the terms of its lease, it attempted to exercise that right, but was told by the limited liability company that the first tenant still had the right of first refusal, that the first tenant would exercise that right, and the second tenant wouldn’t be able to purchase its space as a result.
The first tenant sought a declaration that its right of first refusal remains in existence, even after its exercise, as it is still a tenant, and that the second tenant’s option is therefore still subject to the right of first refusal. It asked that a trial court rule in its favor without a trial, declaring that the right of first refusal is available for use.
A Massachusetts trial court declared that the right of first refusal is of no further force and effect; the second tenant’s option to purchase is no longer subject to it. The second tenant argued that the right of first refusal, having been exercised, no longer existed, leaving it free to exercise its own option to buy its space. The court noted that the issue was the continuing validity of rights of first refusal. The first tenant argued that after it exercised the right of first refusal when it made the offer on the property, it did not take title to the property. Rather, it created a separate entity, which took title and to which both leases were assigned. Thus, both leases remain in force as written despite the transfer of title, including their terms creating the right of first refusal and the second tenant’s option to buy, according to the first tenant.
It pointed out that in its lease, the second tenant’s option is expressly made “subject to [the first tenant’s] right of first refusal. If the second tenant can now exercise its option to claim title to the premises, its right of first refusal will be made ineffectual, the first tenant asserted.
The second tenant argued that the first tenant already exercised its option to trump the offer from the third party, which meant that it, in effect, purchased the property, only creating the limited liability company to take title. Therefore, when it exercised the right of first refusal to acquire title, “the right of first refusal was extinguished, and it cannot be revived by the expedient of putting title to the property in a separate legal entity,” said the second tenant.
The question, said the court, was whether a right of first refusal in a lease is extinguished once it is exercised, or whether it may continue in existence if the holder of the right does not take title to the property itself, but creates a separate legal entity that takes title after the exercise and is assigned the lease that contains the right of first refusal.
The court said that the fact that the first tenant assigned its rights under the purchase and sale after exercising its option, thereby remaining a tenant, does not mean the right of first refusal survives and will be triggered by a new offer or the exercise of the second tenant’s option. The assignment of its rights to the limited liability company and the limited liability company taking title to the property did not undo the exercise of the option. The second tenant was free to purchase its space [Froio Mgmt. Grp. v. Bargain Disc. Mkts., Inc., March 2017].