Get 10 Legal Protections When Giving Tenants a Right of First Offer
Offering ROFOs is a great way to attract flourishing businesses. But it comes at a price.
Moving to a different building can be costly and disruptive. Accordingly, tenants that are growing rapidly may seek rights to expand within the building in case they run out of space. One way to accommodate this need is to grant what’s called a Right of First Offer (ROFO) giving the tenant dibs on space that becomes available in the building.
Offering ROFOs is a great way to attract and retain flourishing businesses. But it comes at a price. In essence, you can’t lease the space covered by the ROFO to a third party until you first “offer” it to the tenant. Because it constitutes a significant encumbrance on the property, the ROFO is not given freely or often. And when it is given, it’s crucial for landlords to incorporate appropriate safeguards to ensure that tenants use it for only legitimate and limited expansion needs and don’t seek to abuse it as a source of profit.
While there’s no such thing as a one-size-fits-all provision, our Model Lease Clause: Protect Yourself When Giving Tenants an ROFO Expansion Right, which comes from a seasoned New York City real estate attorney, includes the 10 legal protections you need when granting an ROFO.
1. Limit Option Duration
First, limit the duration of the ROFO so that it’s not a perpetual encumbrance on the property. Make it a one-time option only. Limit its shelf life to a specific number of years after the lease commencement date. “If the tenant's lease has only a year or two to run, the landlord shouldn’t have to offer the space for only a short-term expansion,” explains the attorney who drafted the clause. “Most ROFO clauses omit this important condition” [Clause, Sec. 1].
2. Bar Exercise If Tenant in Default
As you would with a right of first refusal, specify that the tenant may exercise the ROFO only if it hasn’t breached any lease term or provision and is currently “in occupancy of the entire demised premises" as of the "Inclusion Date," that is, the date you notify the tenant of the space’s availability [Clause, Sec. 1].
3. Carve Out Space in Units Under Lease
Include a definition of the “Option Space” subject to the ROFO and ensure that it excludes any space within another unit that is being leased by, or that the landlord proposes to lease to, another party [Clause, Sec. 1].
4. Establish Procedure for Exercising ROFO
Establish a clear procedure for the tenant to follow to exercise the ROFO. Our clause requires the tenant to provide the landlord written notice within five days of the Inclusion Date with late or lack of notice being treated as rejection of the option, thereby discharging the landlord from further liability under the ROFO [Clause, Sec. 1].
5. Make Tenant Accept Space “As Is”
To head off disputes over the Option Space condition, require the tenant to accept the space in “as is” physical condition as of the Inclusion Date with no obligation of the landlord “to pay any allowance, give any contribution or credit therefor, or do any work or perform any services therein” [Clause, Sec. 1].
6. Ban Tenant Sublease of Option Space
The ROFO clause should bar the tenant from acquiring the encumbered space for the sole purpose of subleasing it at a profit to a third party. Don’t let the tenant convert the ROFO into a profit-making venture, the drafting attorney warns. “The only legitimate rationale for need of the ROFO is so that the tenant may satisfy its growth needs within the building” [Clause, Sec. 1].
7. Require “Market Rent” for Option Space
Require the tenant to pay “Market Rent” for the Option Space, which our Model Clause defines as the fair market rent for the Option Space as of the Inclusion Date based on the rents for comparable office space in the area in which the building is located, determined on a “gross” basis [Clause, Secs. 2 and 3].
8. Require Tenant to Pay Higher Operating Expenses
Because the tenant is assuming more space in the building, provide for increasing its Percentage Share by a fraction representing the number of rentable square feet in the Option Space divided by the applicable square footage set forth in the applicable part of the lease. (Use CAM if the Option Space is in a shopping center.) Tenants who exercise ROFO rights should also post additional security and pay a larger share of the property taxes [Clause, Secs. 3 and 5].
9. Set Procedure for Resolving Disputes over “Market Rent”
A tenant strong enough to command ROFO rights is unlikely to agree to accept a landlord’s definition of “Market Rent” without some pushback. Accordingly, establish a procedure for tenants to disagree on “Market Rent.” The Model Clause requires the landlord to provide written notice of what it deems to be “Market Rent” on the Option Space on the Inclusion Date. The tenant then has 10 days to provide written notice of disagreement, with failure to do so deemed as constituting acceptance of the landlord’s rate. Each side then has 30 days to appoint an appraiser with the two appraisers (or, if they can’t agree, a county judge) to appoint a third appraiser, for a final, binding determination of “Market Rent,” which becomes effective as of the Inclusion Date. The landlord and tenant each pay for their own appraiser and split the fees for the third appraiser 50/50 [Clause, Sec. 4].
10. Provide for Option Space’s Lack of Availability
Last but not least, explain what will happen if the prior tenant holds over or the Option Space is otherwise unavailable for occupancy on the Inclusion Date. Get the tenant to agree that such lack of availability won’t:
- Impact the validity of the lease;
- Affect inclusion of the Option Space within the demised premises as of the date the landlord delivers vacant possession of the Option Space to the tenant; or
- Be construed as in any way extending the term of the lease [Clause, Sec. 5].
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