Using 'Bundled' Sales to Circumvent a Tenant's Right of First Refusal
While it normally doesn’t disrupt the lease, the sale of leased property can be disconcerting to tenants. That’s why some tenants negotiate for first refusal rights giving them the option to purchase the property at the same price and terms the landlord accepts from a third-party purchaser in the event it decides to put the property on the market.
But while providing tenants a measure of security and flexibility, first refusal rights also limit the landlord’s room for maneuver. Worse, if not properly planned, first refusal rights can also substantially reduce the property’s value and purchase price.
As a result, landlords may try to include the property as part of a larger sale, forcing the tenant either to abandon its first refusal rights or purchase the additional assets that the rights don’t cover. However, there are limits to how far landlords can go to use “bundling” to defeat a tenant’s right of first refusal.
A tenant signs separate leases for restaurant space in adjoining downtown historic buildings located across the street from the convention center. The first is a small, one-story structure (1,540 square feet) that was erected in the 19th century called the Annex; the second lease covers the first floor of a 5,940 square foot mixed-use property known as the Char Building.
Both leases give the tenant the right of first refusal “to purchase the demised premises at the same price and upon the same terms and conditions as those offered by any prospective purchaser tendering a bona fide offer to Lessor, which offer Lessor intends to accept.”
The once languid properties assume a new luster when the convention center and neighborhood undergo redevelopment. The landlord finds a buyer willing to take both properties for $1.3 million, including $100,000 for the Annex and $1.2 million for the Char Building.
The tenant then asserts its first refusal rights and tenders $100,000 in earnest money to purchase the Annex, while declining to do so on the Char Building. The landlord cries foul, insisting that the sale is a package deal and that the tenant can’t purchase one of the properties without also purchasing the other.
Can the tenant exercise its first refusal rights on just the one property and not the other?
A. Yes, because the landlord acted in bad faith to frustrate the tenant’s refusal rights
B. No, because the properties are clearly more valuable when sold together
C. Yes, because the bundled sale doesn’t defeat the tenant’s right to exercise its first refusal rights on the individual properties being sold
D. No, because the purchase price doesn’t reflect the true value of either property
C. The tenant can exercise its first refusal rights on just the Annex and not the Char Building even though the landlord was planning to sell the properties together.
This scenario, which is based on a recent Ohio case called Gordon Rests., Inc. v. W.S. Carlile & Sons Co. (2021 Ohio Misc. LEXIS 679), illustrates what’s known as the “bundling doctrine,” which holds that once a landlord gives a tenant first refusal rights on a property, it can’t defeat those rights by selling the property to a third party as part of a larger sale involving unrelated property. Courts have described the bundling tactic as “contractual sabotage” designed to force the holder to decide between giving up its legitimate first refusal rights or purchase additional property that the rights don’t cover.
Accordingly, the tenant in this case could exercise its first refusal rights under the Annex lease and purchase the property for $100,000 without having to also purchase the Char Building. So, C is the right answer.
WHY WRONG ANSWERS ARE WRONG
A is wrong even though it’s true that courts in some states, including New York, do look at whether the seller acted in bad faith when applying the bundling doctrine. But as the Gordon Rests. ruling explains, “rather than focusing on motivations, most courts focus on whether a third-party offer is made honestly, communicated openly, and not derived from fictional land values or collusion otherwise intended to extinguish a vested right of first refusal.” Moreover, even if bad faith were a factor, there was no evidence to suggest that the landlord in this case acted in bad faith.
B is wrong because even though the properties clearly were more valuable when sold together, the lease terms unambiguously gave the tenant first refusal rights to purchase the leased property at the same terms and conditions and precluded the landlord from bundling them and requiring the tenant to purchase them both. The landlord simply made an unfavorable deal in giving the tenant separate first refusal rights on adjoining properties that would command a higher price when sold together. It’s “not the responsibility or function of a court to rewrite the parties’ contract in order to provide for a more equitable result.”
D is wrong for the same basic reason that B is wrong. Each first refusal right was valid and independent of the other. There’d be no doubts about this had the properties not been adjoining. Besides, the court explained, while more valuable together, “each parcel has value separately.”