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Wins & Insights

Tenant Leasing Illustrated – Sept 2016 – Batman, Robin and Your ROFO Rights

Batman, Robin and Your ROFO Rights

I am more a city/suburban slicker than a backwoodsman.

Yes, I understand your surprise, but it is true. On the call of the wild scale of Woody Allen to ten, I fall pretty close to Alvy Singer of Annie Hall fame.

But this summer I have cheerfully (ahem) gone along with my wife Robin’s wish to have a summer weekend place and we rented a house in the middle of the woods about two hours north of New York City.

I am all good with hiking and biking, and can hit a farmer’s market like nobody’s business. And I have no issue with the deer, foxes, wild turkey and other varmints that we have encountered outside

But one day returning home from dinner with two of our grown sons and some of their friends, we found our living room taken over by a large bat circling overhead doing its best rendition of Top Gun.

Are you kidding me? Just as there is no crying in baseball, there are no bats in commercial leasing!

As some of our party pushed me into the house and closed the door from the outside, and others laughed hysterically while peeking out from the basement beer-pong festivities, I channeled Alvy as best I could, put on my Michael Phelps Kenobi Jedi face, and took on that lobster, er, bat, with a bicycle helmet on my head, broom in one hand and kitchen knife in the other.

Before our PETA inclined readers cancel their subscription, the knife was not for bat shish kabob, but instead to open broken and roped off French doors.

And no doubt the only reason it took so long for me to get the bat out the French doors was that he or she was uncontrollably laughing just looking at me.

Of course, maybe this flying rodent had a bent for commercial leasing and was merely trying to exercise an option on some expansion space.

When tenants look to expand their space, they do not need to fly around my living room. Instead they negotiate expansion options into their lease.

Expansion options generally consist of (x) rights of first offer (ROFOs), in which the landlord provides a “first bite” on particular space (e.g., on an adjacent floor or in a particular elevator bank), (y) rights of first refusal (ROFRs), in which the landlord provides the right to match another agreed upon offer for particular space and (z) specified expansion options, in which a landlord provides the option to add particular space at particular times.

In this issue, we focus on rights of first offer because rights of first refusal are less common (they result in the greatest restriction on a landlord’s flexibility) and specified expansion options are a broad enough topic for a separate issue.

A landlord will offer a tenant a short window to exercise a ROFO on particular terms. The tenant can accept such terms or, if not acceptable, can generally either initiate an arbitration procedure or require that the landlord re-offer the space if it later sweetens the terms.

Landlords resist ROFOs (and other expansion options) since, while providing the tenant with flexibility, they also tie up space within the landlord’s building.

But tenants need and often push for the ability to expand over the course of a long term lease, particularly larger tenants with greater leverage. And landlords would in all likelihood first approach existing tenants regarding contiguous space, so ROFOs really just provide tenants comfort and formalize the process.

All well prepared caped crusaders would be wise to address the following eleven issues in their ROFO options:

  • Address in the term sheet. This is when you have the most leverage and it will be harder to obtain ROFO rights if first raised during lease negotiations.
  • Provide enough time. Your landlord will require quick turnaround, so provide sufficient time to make an organizational decision.
  • Carefully define “default”. ROFOs will not be available while you are in default. This is reasonable for a “continuing” default after the expiration of applicable notice and grace periods, but ideally should be limited to “monetary or material non-monetary” defaults to avoid forfeiting valuable rights for immaterial defaults.
  • Focus on occupancy requirements. It is reasonable for your landlord to require utilization of a minimum percentage of your original space, although 100% occupancy is too restrictive (try for 75% or 80%). Alternatively, you may want to negotiate occupancy of a minimum block of contiguous space, but be mindful of the configuration of the remaining space. You must also be sure to include successor entities, affiliates and “desk space users” within your occupancy.
  • Carefully define “named tenant”. Your ROFO rights may be limited to the original “named tenant”, but this should include successors and affiliates.
  • Agree on availability. ROFOs are generally triggered when the space “becomes available”, i.e., when the prior lease expires, subject only to the right of your landlord to extend the prior tenant.
  • Obtain partial rights. You may only wish to accept a portion of the space offered, although you may have to agree to take minimum amounts (e.g., full floor increments), leaving the balance of the space marketable.
  • Make the ROFO space “co-terminous”. You will want the expiration date of the ROFO space to coincide with the expiration date of your lease. Your landlord may limit your ability to exercise a ROFO unless there is a minimum amount of time left in your term (e.g., three to five years), although in such event provide yourself the right to exercise renewal options necessary to meet this requirement.
  • Provide for a “second bite”. If the offered terms are not acceptable, you need the right to initiate arbitration or require that your landlord re-offer the space to you if the material economic terms improve by more than an agreed upon percentage (e.g., 5%, 7.5%). Otherwise, your landlord could make you a disingenuous offer and then freely market the space, resulting in a (valueless) “right of first discussion.”
  • Condition of space. You should have the right to inspect the premises before making your decision and may wish to provide for certain delivery requirements (e.g., free of hazardous materials, broom clean, vacant, etc.).

Address holdover. If the prior tenant holds over, your landlord should commence summary eviction proceedings (with some leeway allowed to negotiate the surrender before litigating). In some instances, you may be able to negotiate additional free rent and/or a right to rescind the exercise of the option, although this may not always be to your benefit and is hard to obtain.