The two most common types of lease expansion options are rights of first refusal and rights of first offer. When negotiating these expansion rights, landlords and tenants should understand the factors involved.
What’s the Difference? A right of first refusal provides that when the landlord receives an acceptable offer from a third party for certain space, then the landlord must offer such space to the tenant on the same business terms. A right of first of offer requires the landlord to offer any “available” space covered by the right to the tenant before the landlord offers the space to the market generally.
Some of the factors that are common to both types of rights are as follows:
- Both rights should cover a finite area, although it is possible to have these rights apply to an entire building or project. The lease should specify what space is covered by the right. Use a diagram or other clear method of defining the space. Beware that the configurations of a suite can change over time, so suite numbers can be problematic.
- Both types of rights are encumbrances on the landlord’s ability to lease the space. Landlords need to track and monitor these rights carefully to avoid violations. The landlord’s failure to honor a tenant’s right can result in the landlord incurring liability.
- Landlords should try to protect the right to negotiate extensions of existing leases with other tenants of the encumbered space without triggering the right, even if those other tenants do not have a renewal right.
- Once the landlord makes the offer to the tenant, and if the tenant declines, does the tenant have an ongoing right to further offers? Or is it a one-time right?
Factors particular to rights of first refusal are:
- Because there is a third‑party offer involved, the tenant can be reasonably assured that the business terms of the offer approximate the fair market value for the space.
- Because the landlord has to identify a prospective tenant and negotiate a deal before making an offer to the tenant, these rights are more cumbersome for the landlord’s management of its property.
- Consider whether the existing tenant has to accept the agreed-upon deal, or does the tenant have the right to adjust the offer to be more similar to the terms of the tenant’s lease? For instance, the term of the offer may be shortened or extended to be “coterminous” with the tenant’s lease term. Landlord’s should try to avoid any requirement to modify the agreed-upon deal.
Factors particular to rights of first offer are:
- Rights of first offer are easier for the landlord to manage because it can offer the space to the existing tenant before negotiating with any other potential tenant.
- A right of first offer is less attractive to tenants because it can be difficult to know if the landlord’s offer is fair. On the other hand, the offer that can be easier to customize to the existing tenant’s needs, such as requiring a coterminous term or the same rental rate as the tenant’s existing space.
- When is the space “available” and therefore subject to being offered by the landlord? Is it available when the space is actually vacated? Or, when the occupant of the encumbered space is otherwise obligated to vacate the space? Landlords will want to preserve flexibility in case the existing occupant wants to renew its lease, or if the occupant holds over in the encumbered space.
- How can the tenant know the offer is fair? One method is to require that the landlord “re-offer” the space to the tenant if the landlord actually offers materially more favorable terms to a third party (and the parties should agree on what the phrase “materially more favorable terms” means). Also, if a certain period of time elapses after the offer and the landlord has not found a tenant, then the landlord may be required to re-offer the space.
Whatever the parties decide to do, they should be aware of the various issues involved in right of first refusal and right of first offer.