In June 2018 issue of the Journal, I published an article - Ruff! Ruff! ROFR!1 - analyzing a case in which the holder of a right of first refusal (ROFR) cried foul and alleged bad faith on the part of the property owner in circumventing his ROFR. The holder of the ROFR ("ROFR Holder") claimed that the property owner ("Seller") had agreed to sell the property to another party, whom I referred to as "Interloper," under a contract that included a provision that Interloper intended and knew, and that Seller also knew, would serve no purpose whatsoever other than to make it untenable for ROFR Holder to buy the property on the same terms as in the proposed sale, as required under the ROFR.
The Case and the Appeal
Seller and Interloper prevailed at trial in Clifton Land Co. v. Magic Car Wash, LLC.2 The trial court held that any allegation of bad faith was speculative. In Ruff! Ruff! ROFR! I demonstrated, based on the limited facts that were included in the trial court's opinion, that that holding was indefensible. This past October, the Appellate Division, Third Department, unanimously reversed the trial court and concluded, in even more unambiguous terms, that Seller's behavior constituted bad faith as a matter of law.3
In vindicating the rights of ROFR Holder, the Appellate opinion also marshaled and recited some new factual material (which one must assume was part of the record below) that showed the machinations of Seller and Interloper and demonstrated a backdrop of bad faith. In particular, an email from Interloper referred to the ROFR as "a serious sticking point" because Interloper did not want to spend a lot of time on negotiations and then have ROFR Holder step in front of him.4 Interloper indicated that he had "already spent a lot of money with [his] attorney discussing how to structure [an agreement] as a 'poison pill' for [the ROFR Holder] and . . . they planned to do[ ] very unusual things with deed restrictions to accomplish this."5
To review the salient facts:
• Seller owned and operated a car wash on the subject property.
• ROFR Holder was another a car wash operator who had procured the ROFR from Seller in the hope of eventually buying and operating the car wash on the property, if and when Seller was interested in selling the property.
• Interloper owned a competing car wash across the street from the property.
• Interloper wanted to buy the property to develop it, not to operate a car wash.
• The so-called poison pill was a covenant that a car wash could not be operated on the property.
What Was So Bad About This Covenant?
The covenant plainly benefited Interloper, in that it would give Interloper's car wash across the street protection from competition, and on that basis one might ask why it was inappropriate. The answer, as I pointed out previously, is that any such benefit should be disregarded because it did not have to be included in the sales contract. Rather, if Interloper had been successful in buying the property, Interloper would have been free to close the car wash and even to add a covenant in the event he wanted to resell the property. The act of including the covenant in the sales contract (consistently with Interloper's colorful "poison pill" description) served only to destroy the value of the ROFR to ROFR Holder.6 The Appellate Division therefore correctly focused on the latter effect as violating Seller's duty of good faith toward ROFR Holder and rightly held that Seller acted in bad faith in adding this covenant to the sales contract in order to accommodate Interloper.
The Appellate Division also noted that Seller presented ROFR Holder with a completed purchase contract rather than a mere offer, observing that had the Seller acted sooner and presented merely an offer to ROFR Holder, the latter might have made a counteroffer. The court took that sequence of events as further proof of bad faith on the part of Seller and Interloper.7
These ugly revelations about the covenant collectively are a smoking cannon, not just a mere gun, but, troublingly, they were not discussed or even mentioned in the trial judge's opinion. Indeed, a key portion of the trial opinion stated:
[ROFR Holder] has not provided evidence that the 2016 Purchase and Sale agreement was the result of any collusion between the defendants. [ROFR Holder] is merely speculating that it was done in bad faith or the result of wrongful conduct.8
It is hard to see how the trial judge could have justified that statement. There plainly was collusion in that Seller added an unnecessary covenant that served only to defeat ROFR Holder's bargain.
The Core Function of a ROFR: What Is or Is Not Entailed?
One might infer that the trial judge was miffed at ROFR Holder, from the opinion's citation of a fact which ROFR Holder did not contradict:
[Seller] asserts that she sought to engage [ROFR Holder] in discussions for purchase of the property in 2016 and received no response, so she began to explore other opportunities.9
That observation may be true, but it injects an irrelevant issue. When a property is subject to a typical ROFR (as opposed to a "right of first offer"10 and as opposed to a ROFR modified as I suggest below), the owner wishing to sell need not approach the ROFR Holder first. Even if the owner does approach the ROFR Holder, the latter has every right to sit back smugly on his verandah sipping mint juleps waiting for another offer to materialize and has no contractual or good-faith duty to engage in purchase negotiations independently of any other offers. That is the point of a ROFR: it confers no rights or responsibilities on either party unless and until there is another offer on the table in place of the bottle of bourbon, and at that point it becomes no more or less than an option in the hands of the ROFR Holder to purchase the property on the same terms as are on the table.
As a matter of practicality and efficiency, of course, it will often behoove a property owner who is interested in selling to approach the ROFR Holder first, in order to gauge interest, before investing any time or effort looking for another buyer. By the same token, a ROFR Holder can advance his case commercially by keeping in touch with the owner to make sure to be able to commence serious discussions as soon as he catches a whiff of the owner's interest in selling. In many cases, those approaches could result in a completed contract of sale between two happy parties. But, on the other hand, the owner has no responsibility to approach the ROFR Holder, and even if the owner does and ROFR Holder refuses to negotiate at that point, the owner has no recourse and the ROFR Holder retains all rights under the ROFR.
The practical lesson is that an owner of property is often better off granting only a right of first offer or, if he grants a ROFR, including in it a provision under which the ROFR Holder agrees to provide some indication of interest, or to negotiate in good faith, if approached even before there is another offer on the table. The purchaser of a ROFR, on the other hand, may resist those additional terms because the value of a ROFR, in part, inheres in being able to match an offer and not to have to negotiate with oneself before others have clarified the contours of the market.
Resolving the Tension Between Good Faith and Freedom to Exploit Property
There may also be a very thin line between actions that violate the property owner's duty of good faith toward a ROFR Holder (including the inclusion of a particular term in a proposed sale with another party) and actions that do not violate that duty of good faith.
Consider that Interloper also was a car wash operator and had a facility across the street. This circumstance temptingly presents a facially reasonable basis, as noted above, for Interloper's desiring the covenant, namely to reduce competition.11 But, as I also noted above, accepting that conclusion obscures the sequence of events and the fact that Seller had a duty of good faith toward ROFR Holder personally, which should have precluded adding the covenant when its only effect was to eviscerate the value of the ROFR to ROFR Holder. This duty of good faith becomes clearer if one simply observes that any would-be third party buyer who had no interest whatsoever in car washes, but who did not want his negotiation efforts to go for naught, might have inserted the same covenant to make the exercise of the ROFR far less likely.
More generally, I do not believe that the duty of good faith that attends the grant of a ROFR imposes an absolute limitation on what the property owner may do with the property that is not connected or associated with a sale or potential sale.
For example, suppose that the property owner had not been looking to dispose of the property, but instead had been approached by a nearby car wash operator with an offer of a large sum of money in exchange for shutting down the existing car wash and agreeing to a covenant not to operate a car wash on that property. Or suppose that a developer was looking to build an upscale hotel or theater in the neighborhood and thought that the presence of a car wash was inconsistent with that and therefore had offered the property owner money to close down the car wash and agree to the restrictive covenant.
Arguably, it would have been permissible for the property owner to accept offers like those. Two things distinguish those offers from the situation in the actual case. First, the property owner would be getting a benefit as a property owner and not as a seller, as a quid pro quo for voluntarily reducing the value of property it still was holding, as opposed to either getting no benefit or, at best, trying to create an incentive for a third party buyer by defeating the "drag" of the ROFR. Second, any challenge by the ROFR Holder would truly have been speculative unless and until there was a purchase offer on the table, or unless, possibly, there was already some expectation that there would be a purchase offer in the future during the term of the ROFR.12
In some cases, even proximate to an intended sale, the circumstances that lead to the addition of the covenant might actually raise the overall value of the subject property even though the originally intended use would be prohibited. In a situation like that, the ROFR Holder might be able to buy the property with no ability to use it as originally intended but with the opportunity to flip it for more. If the profit opportunity is high enough, the measure of damages for eliminating the originally intended use could be zero or close to it.
So when a ROFR is being considered and negotiated, what are the parties and the attorneys to do? The market and contract law provide the answers. Dust off those boilerplate forms, read and reread them with a critical eye and revise them as appropriate in plain English. Use hoary terms of art only when they have crystal-clear meanings, and avoid jargon that could be misunderstood or that admits of multiple interpretations.13 Set out what the property owner may or may not do, or restrict doing, with the property during the term of the ROFR and what additional rights and responsibilities attach to the ROFR itself - all with a healthy appreciation of what it is over which the parties are bargaining, what is important, what is not important and what might be lurking around the corner.