Options v Pre-emptive Rights in Sale Transactions

Owners, agents and property professionals are often confronted with the legal terms ‘option’ to purchase and ‘pre-emptive right’ or a ‘right of first refusal’. So what is the difference between an option to buy property and a right of first refusal, and under which circumstances should each term be utilised in practice?

Owners, agents and property professionals are often confronted with the legal terms ‘option’ to purchase and ‘pre-emptive right’ or a ‘right of first refusal’. So what is the difference between an option to buy property and a right of first refusal, and under which circumstances should each term be utilised in practice?

The option to purchase is often utilised by property developers. For example, a property developer wishes to build a shopping centre on an identified site. By obtaining an option to purchase from the owner of the land, the property developer secures a window period to approach an anchor tenant (often a grocery chain) and thereafter convinces a financier to finance the development on the basis of the future rental income that will flow from leases to be signed by the anchor and ancillary tenants at the centre. The option is exercised and the property is purchased at the pre-determined price as agreed upon in the option contract if and when all the essential role players have committed to the business plan presented by the property developer.

A right of first refusal, in contrast, if often a right sought by a tenant that may for various reasons wish to obtain a first right to purchase property that he is currently renting but possibly cannot afford to purchase at present or where the property has not yet been marketed for sale by the owner.

From the above one can determine that an option is a contract where the owner of property agrees with another person that he shall have the right to buy property at a fixed price and a specific time is fixed within which this option to purchase must be exercised. This means that the seller (the grantor of the option) is bound to sell if and when the option holder (i.e. the purchaser) decides to exercise his right to purchase in terms of the option and complies with any option requirements set. Conversely, the option lapses if the option holder does not exercise the option within the specific agreed upon time.

The option mostly favours the purchaser as the seller is effectively barred from marketing his property to the public at large during the option period. The grantor of an option, in exchange for this exclusivity, often requires the person requesting the option, to pay for this option. This in turns poses some risk for the potential purchaser that requested the option that he could lose this payment if he decides not to exercise the option.

In contrast to an option agreement, the right of first refusal does not compel the owner (grantor) to sell, but compels him to give the potential purchaser (grantee) preference if and when the owner decides to sell during the existence of the right of first refusal. The right of first refusal does not impose an enforceable obligation to sell upon the owner, but restrains him from selling the property to a third party without first affording the holder of the right of first refusal the right to purchase or not to purchase. This implies that the grantor must provide the grantee an opportunity of purchasing the property or turning down the invitation. The invitation to purchase is usually triggered by a desire to sell or where the owner receives an offer to purchase from a third party. The holder of the right of first refusal is generally only afforded the right to purchase at a price determined by the seller and is not usually afforded a right to pre-determine the purchase price as in the case of an option agreement.

A right of first refusal must be in writing and signed by both parties and this right can also be registered against the title deed of the property. Conversely, an option agreement cannot be registered against the title deed of the property.

The owner that grants a right of first refusal is not restricted from marketing his property (as in the instance of an option agreement) as the property can be marketed for sale subject to the holder of the right being invited to purchase.

To Summarize:

Option agreements are usually employed by property developers that require a fixed option period in which they can obtain financing and secure rental incomes before formally exercising the option to purchase. The right of first refusal on the other hand is predominantly used in lease agreements where a lessee intends to purchase the property if and when the owner wishes to sell. Owners of immovable property, when requested to grant either an option or a right of first refusal, should be careful regarding the consequences, wording and the restrictions that may be imposed upon the granting of such rights and should consult a property specialist before an option to purchase or a right of first refusal is granted.

May 15, 2012
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