A "right of first refusal" is a contractual right on the part of a potential buyer to purchase real property within a specified period of time after another potential purchaser submits a purchase offer. The holder of the right of first refusal agrees to purchase on the same terms and conditions as may be contained in the competing offer.
What is an Option?
The right of first refusal must be distinguished from an "option." An option is an agreement to keep a specific offer open for a certain period. In an option, the seller and the potential buyer execute a complete purchase contract with all terms and conditions set forth and agreed upon. In exchange for an agreed amount paid to the seller for the option, the buyer has the right to purchase the property for a specific period of time on the previously agreed contract terms and conditions.
In an option, all of the terms are specified in advance, and the potential buyer's exercise of the option must ordinarily be identical to the terms of the offer itself. On the other hand, in a right of first refusal, the terms of the transaction are unknown until a bona fide offer to purchase is submitted to the seller, at which time the holder of the right can elect whether to exercise it and purchase the property on the terms of the competing offer.
Differences Between Option and Right of First Refusal
One critical difference between an option and a right of first refusal is that the exercise of a right need not be identical to the terms of the competing purchase offer.
This principle was graphically demonstrated in the recent California appellate court decision in Arden Group Inc. v. Burk. In that case, the Burks purchased a Shell Oil gas station in 1973 and signed a lease with the Owner for the real property on which the gas station was located. The Burks could extend the duration of the lease for up to twenty years and also had a right of first refusal to purchase the property if the Owner decided to sell. The Burks extended their lease and operated their gas station on the property for the full duration of the lease.
In 1992, the Arden Group Inc., operator of a grocery store chain, became interested in purchasing Owner's property for use as a parking lot adjacent to one of its stores. Following a period of negotiations, Arden made a formal offer to purchase the property, and the Owner accepted, subject to the Burks' right of first refusal.
Arden and the Burks were concerned about soil contamination, because the property had been used as a gas station for about 50 years. Accordingly, their agreement provided for soil testing and certification that the property was free of toxic contamination, that the Owner would remove the gas tanks and related improvements and clean up any contamination, and that the Owner would remain responsible for contamination discovered after the sale.
Burk Exercised Right of First Refusal
The Owner gave the Burks notice of the proposed sale, as was required under the lease, and the Burks' attorney timely responded by giving the Owner a written notice of the Burks' exercise of their right of first refusal. A written "Modification of Contract" was later signed, which, in substance, permitted escrow to close without removal of the tanks (because the Burks intended to continue operation of the gas station) and eliminated any requirement of soil testing and responsibility on the part of the Owner for removing the tanks.
Thereafter, Arden filed a lawsuit against the Burks and the Owner, seeking "declaratory relief" (a court ruling identifying the rights and duties of all parties), claiming that the Burks had not properly exercised their right of first refusal because their offer was not identical to the offer submitted by Arden to purchase the property. The trial court agreed with Arden's position and entered judgment for Arden.
Trial Court Found for Arden -- Appellate Court Reversed
The Court of Appeal reversed. The Court commenced its analysis by stating that "resolution of this case begins and ends with an understanding of the difference between an option agreement and a right of first refusal" (described above). The Court also confirmed the law that "a right of first refusal may be exercised without a literal matching of terms. Because the party exercising a right of first refusal is stepping into a contract made by a third party, the court must consider commercial realities and allow modifications consistent with the intent of the parties whose contract created the right of first refusal."
The language of the appellate decision was stinging. The Court chastised the trial court for failing to apply governing law or to recognize the plain realities of the transaction. The Court also tersely described Arden's arguments as "absurd" and "self-serving nonsense." In doing so, the Court found a legal basis for awarding to the Burks full compensation for the damages they had sustained as a result of this lawsuit, including the attorney's fees and costs they had incurred.
In Conclusion
As complicated as real property transactions can sometimes be, it is heartening to see the Courts of Appeal reaching the legally correct outcome and, at the same time, compelling a just result in favor of the Burks, who were, in my opinion, subjected to inappropriate litigation by Arden. This case thus serves not only as a "primer" on options and rights of first refusal but also as a good illustration of the power of the Courts of Appeal to vindicate the rights of injured parties such as the Burks.
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