Terminate Lease if Tenant Doesn't Exercise Refusal Right to Buy Space for Development

May 31, 2006

You may own a property that you know is ripe for development or redevelopment—say, underutilized land, a parking lot, or a run-down office building or shopping center. When renting the property to a strong tenant, the tenant may demand a right of first refusal to buy the property. This right typically gives the tenant two options if a prospective buyer makes an offer to buy the property.

You may own a property that you know is ripe for development or redevelopment—say, underutilized land, a parking lot, or a run-down office building or shopping center. When renting the property to a strong tenant, the tenant may demand a right of first refusal to buy the property. This right typically gives the tenant two options if a prospective buyer makes an offer to buy the property. The tenant can either: 1) exercise its right of first refusal and buy the property on terms substantially similar to the prospective buyer's terms or 2) not exercise its right of first refusal and continue as a tenant under its lease.

This right of first refusal can cause problems, though, if a third party makes you a great offer to buy. The prospective buyer will probably demand that it get the space free of all tenants and their leases. But the lease has this loophole: Nothing in the lease lets you kick out the tenant if it doesn't exercise its right of first refusal. So you may be forced to either fork over lots of money to buy out the tenant's lease or risk losing the deal.

New York City Owner Gets Burned by Loophole

New York City attorney A. Barry Levine is seeing the effects of this loophole. His client has begun renting a very well-located parking lot under a long-term lease. A prospective buyer wants to develop the parking lot and has offered a huge sum of money to the New York City owner for it. The lease gave the tenant a right of first refusal to buy the lot, but the tenant chose not to exercise its right because it didn't have enough money to match the prospective buyer's offer. The owner now faces a big problem: The prospective buyer doesn't want to buy the parking lot if any tenant—especially one with a long-term lease—will come with it. Because of the loophole, the owner has no way under the lease to kick out the tenant. So, Levine's client is now in an enviable position. Either the owner must come up with enough money to tempt it to give up its lease or the lease will continue and the third-party deal will most likely fall through.

Plug Loophole by Getting Lease Termination Right

If a space is so valuable that a third party would want to buy it for the purpose of developing (or redeveloping) it and the tenant wants a right of first refusal to buy the space, there's an easy way to plug the loophole, says Levine. In return for agreeing to give the tenant a right of first refusal, get the right to terminate the tenant's lease if the tenant doesn't exercise its right of first refusal, he says. That way, you can deliver a space to the buyer that's unencumbered by the tenant, he says.

Don't Terminate Lease Until Five Conditions Are Met

Because only a strong tenant will get a right of first refusal, expect the tenant to demand—and get—certain limits on your lease termination right, which will mean you can't easily kick it out of its space, notes Levine. For instance, the tenant will likely demand that the lease not terminate unless the third-party deal actually closes. Otherwise, the tenant will fear that you'll abuse the termination right by inducing a third party to make a bogus offer to buy the space for a large sum that the tenant couldn't match, so that you can kick the tenant out of its space when it doesn't exercise its right of first refusal, he explains.

To persuade the tenant to accept your lease termination right, you can agree not to terminate the tenant's lease unless these five conditions are met, says Levine:

  • A prospective buyer offers to buy the tenant's space;

  • The tenant fails to exercise its right of first refusal on time;

  • Your contract of sale with the prospective buyer is signed and valid, and you've given a copy of it to the tenant;

  • The prospective buyer's and your right to cancel the contract of sale for any reason has lapsed (otherwise, you or the prospective buyer could easily cancel the contract after you terminate the lease); and

  • You've given the tenant enough advance written notice—say, 90 days' prior written notice—of the lease's termination.

When those five conditions are met, the tenant must give back the space to you on or before the termination date, free and clear of all leases, tenants, and occupants, explains Levine. Then you can deliver the unencumbered space to the buyer, he says.

To get this lease termination right, add the following language to your lease's right of first refusal clause, says Levine: CLLI0116

Model Lease Language

(x) If Tenant does not timely exercise its right of first refusal in accordance with the terms of this Clause [insert #], and further provided that Landlord shall have entered into a bona fide contract of sale upon terms and conditions substantially similar to those offered to Tenant with a third-party buyer, a copy of which shall be given to Tenant with the termination notice (“Contract of Sale”), and all cancellation options relating to, or rights to terminate, the Contract of Sale held by both or either party have forever lapsed, Landlord, upon at least [insert #, e.g., ninety (90)] days' prior written notice to Tenant, may elect to terminate the term of this Lease as of a date provided in Landlord's written termination notice (the “Termination Date”) and Tenant shall surrender full and complete vacant possession of the Premises to Landlord on or before the Termination Date, as if the Termination Date was the expiration date originally provided in this Lease, free and clear of all leases, tenancies, and rights of occupancy of anyone claiming by or through Tenant.

Give Tenant Second Chance if Buyer Revises Offer

After you've submitted the prospective buyer's original offer terms to a tenant with a right of first refusal, if you and/or the prospective buyer revise the offer terms, the tenant will want to get the revised terms, notes Levine. Plus, it will want enough time to review the revised offer terms and decide whether to exercise its right of first refusal with respect to those revised terms, he adds. But in agreeing to this demand, make it clear that if the tenant decides not to exercise its right of first refusal with respect to those revised terms, you still have the right to terminate its lease, he says.

To do that, add the following language to the Model Lease Language above, says Levine:

Model Lease Language

(y) If there is a material change in the essential terms and conditions of the Contract of Sale which differ from the terms and conditions initially offered to Tenant, Landlord shall again submit the third-party offer to Tenant, with the changed terms and conditions, and Tenant shall again have [insert #, e.g., thirty (30)] days to accept such offer in accordance with the terms and conditions of this Clause, and the provisions of Paragraph (x) hereof shall apply if Tenant does not timely exercise its right of first refusal in accordance with the terms of this Clause [insert #].

Practical Pointer: If the tenant agrees to give you the lease termination right in return for getting a right of first refusal to buy its space, expect it to demand that, in return, you pay it the unamortized cost of its improvements when you terminate its lease because it didn't exercise its right of first refusal, says Levine. That's a reasonable demand to give in to, he says.

CLLI Source

A. Barry Levine, Esq.: 320 E 23rd St., New York, NY 10010-4713; (212) 477-5118; blevine2@nyc.rr.com.

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