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The Last Word On First Rights

Rights of first refusal (RFR) and rights of first offer (ROFO), though deceptively easy to negotiate, can wreak havoc on a leasing program.

Right of First Refusal Under the RFR, the grantor is required to notify the grantee (in a lease, the landlord and tenant, respectively) that a third party has made an offer to lease the RFR space. The RFR space must then be presented to the tenant, who may either accept or reject the space on terms offered by the third party.

As one may ascertain, granting an RFR severely impairs the marketability of the affected space. Prospective third-party tenants will not be enthusiastic about spending time and money examining space and negotiating lease terms, only to have their final product offered to the first-right holder. Taking this into consideration, prospective tenants will likely make only "low-ball" offers. In addition, brokers may be unwilling to market property subject to an RFR unless they receive a commission even if the right-holder exercises its right and takes the space.

Right of First Offer (or Opportunity) Under the ROFO, the landlord is required to offer the ROFO space to the tenant, including all key terms, before it can offer that space to a third party. Frequently, the parties agree in advance that the rent will be pegged at fair rental value (presumably, the prevailing rental rate at the shopping center). If the tenant rejects the offer, the landlord is free to openly market and lease the ROFO space, but at no better terms than those set forth in the initial offer to the ROFO holder.

Minimizing Risks If required to grant an RFR or ROFO, a landlord should take great care to deal with all foreseeable contingencies - and should realize that some contingencies are inevitably overlooked. As a testament to this fact, space options account for a disproportionately high number of commercial real estate disputes. To minimize the risks of overlooking a future contingency:

* Clearly calendar and map any and all space options granted for the shopping center or other project (including renewal and expansion options).

* If the option space is currently leased, then specify that the grant is subordinate to a) the current tenant's right to renew its lease or expand its premises, and b) any renewal or expansion agreements that may be reached in the future with the current tenant. (Very few renewal options are consummated as drafted.)

* Specify that the grant is subordinate to all other rights (including RFR and ROFO rights) granted to other tenants of the shopping center with respect to the option space prior to the date of the grant. (The tenant should request full disclosure of all such rights to which it is subordinating.)

* Condition the tenant's exercises of the option in one or more of the following: a) no event of default by the tenant beyond the expiration of applicable notice and cure periods; b) no lease assignment by the tenant, i.e., the option is "personal" to the named tenant (and perhaps its affiliates); c) the tenant (as distinguished from subtenants) being in occupancy of all or substantially all of its space; and d) the tenant's providing an additional security deposit, the amount of which should be pre-negotiated.

* Keep the time by which the tenant must decide to accept or reject the offer as short as possible. Moreover, specifically address the issue of when the landlord is required to re-offer the space to the grantee. For example, if a tenant rejects an offer, allow the landlord to vary the economic terms of the offer by, perhaps, 5 percent without being required to resubmit the offer to such tenant. If an ROFO is based upon a fair market rental rate, require the tenant to accept the offer while objecting to the rental terms through binding arbitration. Specify whether the right is a "one time" right. If the tenant fails to exercise that right and the landlord leases the space subject to the right, does the tenant have another right after the third-party-lease expires?

* Retain flexibility to market blocks of space that are larger than the space covered by the space option. For example, require the tenant to lease (at landlord's option) either the larger block of space or the space covered by the space option.

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