Word Rights and Options Provisions Carefully to Avoid Contract Confusion

By Carol C. Honigberg, JD, and Ellen Farrell Sharpe, JD

Avoiding imprecise language is immensely important when drafting documents for property sales or leases. This especially is true when dealing with options to purchase, rights of first offer, and rights of first refusal. While most real estate professionals understand the practical distinctions among these provisions, many do not perceive the differences in the legal language that defines them.

Too often, rights of first offer and rights of first refusal are discussed as interchangeable provisions or are confused with options to purchase. The failure of parties to use the correct language to grant the desired options or rights in contracts or leases can lead to disastrous consequences.

Clarifying the Concepts Although the language used to define them is similar, an option to purchase, a right of first offer, and a right of first refusal are distinctly different legal concepts.

Option to Purchase. This provision grants the holder the right to purchase an indicated property during the term of the option without respect to the owner's desire to sell. In other words, the holder can force the owner to sell the property by exerting the option. Options to purchase often include specific terms such as a purchase price; however, inclusion of such terms does not necessarily mean that an option to purchase exists.

Right of First Offer. Sometimes referred to as a right of first opportunity or first right to purchase, this provision requires the owner to give the holder the first chance to buy a property after the owner decides to sell. Unlike the option to purchase, the holder cannot force the owner to sell.

Right of First Refusal. This provision grants the holder the right to see any bona fide third-party offers the owner has received on a property. The holder can match the terms of the third-party deal and purchase the property or pass on the deal. Rights of first refusal tend to be the most problematic for owners. Third parties easily are discouraged from considering a purchase because the holder can buy the property under the terms that the third party put together.

Unlike options to purchase, rights of first offer and rights of first refusal also can be used to obtain lease expansions or other rights not involving property sales.

Cases in Point Three recent court cases illustrate the need for precision in drafting and administering these three provisions: the Colorado Court of Appeals case of Stuart v. D'Ascenz, the Nebraska Supreme Court case of Winberg v. Cimfel, and the Texas Court of Civil Appeals case of Sanchez v. Dickinson.

In Stuart, the parties entered into a commercial property lease with a clause granting a “first right of refusal on the property” and identified a purchase price of $160,000 upon exercise of that right.

Stuart, the lessee, sued D'Ascenz to force him to sell her the property pursuant to this provision. D'Ascenz countered that the provision simply was a right of first refusal, which only required him to give her an opportunity to match any bona fide third-party offer received.

The trial court ruled that the lease granted Stuart an option to purchase because it contained a purchase price. However, the Court of Appeals reversed the ruling, stating that the lease provision granted only a right of first refusal, reasoning that the inclusion of a purchase price did not alter the “unequivocal right of refusal” in the lease.

Conflicting language in the lease that incorporated elements of both a right of first refusal and an option to purchase resulted in a protracted legal battle, and Stuart failed to obtain the purchase option she had anticipated.

The discussion in Winberg focused on whether or not the owner granted a first right to purchase.

The Winbergs purchased a four-acre portion of the Cimfels' 280-acre farm. The purchase contract included a provision granting the Winbergs “first rights to purchase above four acres or any part thereof if [the Cimfels] desire to sell.” Several years after the purchase, the Cimfels informed the Winbergs that the remaining property was for sale. The Winbergs inquired about the price, and the Cimfels responded in writing.

Three days later, without receiving a response from the Winbergs, the Cimfels entered into a contract to sell the property to a third party at the price quoted to the Winbergs. The Winbergs responded that they wished to purchase the property, but the Cimfels refused and sold the property to the third party.

The Winbergs sued the Cimfels contending that they failed to honor the first rights to purchase provision in their sales contract. The court concluded that the language did not grant an option to purchase, because “nothing in the agreement indicated that the Winbergs had an absolute right to demand conveyance of the property at any time prior to the Cimfels' decision to sell it.” Rather, the court determined that the contract's language compelled the Cimfels to offer the property to the Winbergs only after they had decided to sell. Because the Cimfels clearly had decided to sell the property, they had an obligation to permit the Winbergs to purchase it first.

Although this case was remanded to the trial level to determine whether or not the Winbergs adequately exercised their first right of purchase, the court inferred that the sale to the third party should be voided if the trial court ruled in favor of the Winbergs.

Finally, the Sanchez case in Texas highlights how imprecise language regarding purchase rights can lead to serious consequences.

In this case, the owner of a large commercial parcel entered into a contract containing a “first option” to purchase 200 acres of a larger tract “when and if the seller decides to convey.” The contract further stated that the option would last for 90 days after the owner decided to sell, but it failed to identify a purchase price.

In the intervening years between the contract's execution and the resulting actions, the owner granted various oil and mineral rights on the property to third parties. However, the contract holder sued to cancel the third-party oil and mineral rights, stating that they were made in contravention of the right of first refusal in the contract. The oil and mineral rights holders responded that this contract provision was not a right of first refusal but an invalid option to purchase, because it did not include a purchase price.

The court concluded that the oil and mineral rights holders incorrectly referred to the purchase right as an option to purchase; rather, the contract clearly granted a “valid and binding first refusal right to purchase.” The court upheld the trial court's order requiring the oil and mineral rights holders to convey their interests to the holder of the right of first refusal.

Carol C. Honigberg, JD, is a partner and Ellen Farrell Sharpe, JD, is an associate in the real estate group at Reed Smith LLP in Falls Church, Va. Contact them at (703) 461-4200 or chonigberg@reedsmith.com and esharpe@reedsmith.com.

The discussion of legal issues in this column is for informational purposes only. Results may vary depending on state laws and individual circumstances.