Options: First Refusal Rights Could Be Thorny
A right of first refusal means that a recipient has the right to meet an outsider’s offer when the seller puts the property up for sale. These rights sound simple and on the surface do not seem to be much of a sacrifice by the optionor, but frequently they are the subjects of litigation.
A recent Maryland appellate court decision held that the optionor may be guilty of bad faith when it contracts to sell property to a third party subject to a condition that has the primary purpose of frustrating the optionee’s rights. That is particularly true when the added condition to the third-party sale would be of little benefit to the optionor. Bramble v. Thomas, 2007 WL 49255 (Md., Jan. 8, 2007).
In that case Bramble, a company mining sand and gravel, had acquired the parcel it was working on for its business. It had also obtained an assignment of a right of first refusal on an adjacent property owned by “Lanes.” The right of first refusal gave Bramble the right to acquire the property by matching any offer that Lanes intended to accept. Lanes were required to tender such an offer to Bramble within thirty days, and Bramble was required in the agreement to match both the price and the terms of the intended sale.
A Bramble of Offers
The dispute revolves around an attempted sale by Lanes of the optioned parcel to a local real estate broker named Thomas for $105,000, and a condition in the proposed sale prohibiting mining on the optioned parcel. When Bramble received the proposed agreement, it accepted the price with one major deviation. It excluded the mining restriction.
After that, without responding to Bramble’s acceptance, Lanes renegotiated with Thomas to sell the property to Thomas for $120,000. Lanes then tendered this contract to Bramble. Bramble indicated that its earlier acceptance of a $105,000 offer constituted a binding contract, and that therefore the renegotiated contract was a nullity that did not affect Bramble’s rights. Bramble then retendered its acceptance of the first offer for a price of $105,000, this time including the mining restriction. This acceptance was more than thirty days after the original tender of the first Thomas offer, and so was technically not in compliance with the right of refusal.
Lanes then asserted that they could not sell to anyone because of the confusion, and attempted to return a deposit that Thomas had paid them. Thomas countered by suing to nullify the first Bramble acceptance because it did not comply with the use right, and also sought to enforce its other rights against Lanes.
The trial court granted summary judgment for Thomas, holding that Bramble’s original acceptance did not comply with the terms of the refusal right, and Bramble then appealed.
In light of the litigation, the right of first refusal, which seems simple on the surface, had become a costly and thorny issue for Bramble. It may not escape the reader that there is a certain Dickensian quality to the name of ”Bramble”, one of the major characters in the somewhat complex plot that has unfolded here.
On appeal, the Maryland Appellate Court reversed the lower court and found that the summary judgment was inappropriate because a genuine issue of fact existed. The issue was whether the first Thomas contract was tendered to Bramble in bad faith because of the insertion of a condition that was of no consequence to the parties except to frustrate Bramble’s rights under the option. Thomas argued that the restriction against mining was material because the property was worth less with the restriction than without it. Therefore, Bramble would be getting a windfall if it would be able to acquire the property for the $105,000 price without the restriction.
The appellate court, in a well-researched opinion, cited conflicting precedents in various jurisdictions about whether this type of option may be exercised if accepted with variations from the triggering offer where the variations “constitute no substantial departure” from the offer. The court held, however, that whether the omission was material was not necessary to its decision in this case. It stated that there was a genuine issue here of whether the Lanes and Thomas inserted “in bad faith,” the no-mining clause as a “poison pill” to discourage Bramble from exercising its right of first refusal. The court characterized the original contract that created the refusal right as a contract, which Lanes had a duty to carry out in “good faith.” It held that the optionor “should not be permitted to engage in a subterfuge or devious means to prevent the other party from performing, and then use that as an excuse for failing to keep its own commitment.”
The court said that when the case goes to trial, Bramble would have the burden to show that the no-mining condition was inserted in bad faith, and then that burden would shift to Thomas and Lanes to counter that. Bramble had argued that the mining restriction was inserted at the request of Thomas, in order to impede the exercise of the refusal right. Thomas was a real estate broker, knew of Bramble’s use of the property, and would have no apparent reason to desire such a restriction on its own rights. Since it seems that the Lanes were selling out all of their property at that location, it is not apparent why they would have any reason to include a restriction on mining. Of course, that restriction might have value, and the Lanes may have been looking to sell that right in the future to Bramble or some other party, which would give them additional income to the $105,000 price for the property.
Frustrating Rights of First Refusal
While options of first refusal seem simple, the Bramble case is just one factual situation indicating how thorny they can be. For example, the court cited an earlier case where the option or included the option parcel in a proposed sale of a larger parcel, and then requested that the optionee match the price for the larger parcel.
It also cited a case where the optionors received an offer from a third party to buy their property for $200,000.00, which consisted of a combination of the offerors’ home stated to be worth $48,000, with the balance to be paid in cash. When the optionee attempted to exercise its right of first refusal, it matched the $200,000 price but conditioned the acceptance with an offer to pay $50,000 of that price with any piece of real estate of the seller’s choice with a value of up to $50,000. In that case the court held that the optionee had not exercised effectively its right of first refusal because the optionors were acting “in good faith” even though the inclusion of “unique consideration” made it impossible for the optionee to match exactly the terms of the triggering offer.
The casebooks are populated with many versions of offers to sell by optionors, which tend to frustrate or defeat options of first refusal. For example, in a Wyoming case, a court barred the optionor from selling the optioned property as part of a larger sale; and in Halyak v. A. Frost, Inc., the Pennsylvania Superior Court held that a landlord could not defeat the right of a tenant which had been given the right of first refusal to lease other space in the building. In that case, the landlord had offered another tenant a lease for new space, conditioned on the other tenant’s obligation to surrender its occupied space. The landlord claimed that the designated space it had demanded in return was a key component to the transaction, because the landlord could lease that surrendered space at a much higher rental. Since the optionee could not possibly surrender the other space he did not occupy, he could not meet that part of the offer. See OMINSKY, REAL ESTATE LORE, PP. 329-331 (AMERICAN BAR ASSOCIATION, 2005).
Some of these issues may be headed off by proper drafting of rights of first refusal. However, for cases where that has not worked, the Bramble decision is trying to strike a balance between two clashing concepts. One requires an optionee to “match exactly the terms of a triggering offer (i.e., a lack of materiality of the omitted terms is no defense).” On the other hand, the bad-faith rule prohibits adding “bad faith terms to the triggering offer which are intended to nullify the right of first refusal.”
This should prove to be a difficult balance for future courts to implement in dealing with rights of first refusal, particularly because a proper ruling seems to depend on getting into the head of the optionor.
The American Bar Association has recently published Mr. Ominsky’s new book, Real Estate Lore, Modern Techniques and Everyday Tips for the Practitioner. This article originally appeared in the ABA Section of Real Property, Probate and Trust Law's RPPT eReport.