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If you are negotiating a commercial lease and want flexible expansion rights you will want a right of first refusal (ROFR). Since expansion rights are to the benefit of tenants (and not landlords), they will not be offered in the landlord's commercial lease template, so you must ensure that you include it in your letter of intent.
A right to expand is an agreed to clause in a commercial lease between the landlord and tenant. It covers the tenant's ability to acquire additional space to lease.
Landlords will typically not volunteer to provide any rights to expand, as they become cumbersome to administer.
For example, if every tenant in a building had a right to expand, it requires the landlord to know which tenant has the first right, who has the second right, etc.
It depends. It really comes down to negotiating leverage.
A large, creditworthy tenant in a soft market with a small landlord will have much more bargaining power than a small tenant, with a big landlord in a tight market.
The specifics of the right will also matter, as some expansion rights are much more onerous on the landlord than others.
A right of first offer (ROFO) has the least amount of value for the tenant.
It requires the landlord to offer the space to the tenant before the general public.
Typically there is no set price or length of lease term attached to the offer.
The clause is normally just worded to obligate the landlord to offer the space to the tenant before the rest of the marketplace.
The tenant typically has a defined period of time to indicate they are willing to lease the expansion premises...failing which, the landlord shall be entitled to lease the space to a third party.
Typically neither party has any rights or obligations - the landlord just has the duty of letting the tenant know the space is available, and if both parties can work out a lease during the defined time period, then great.
This is up for negotiation, but typically a landlord would want a tenant to make a decision within five business days.
It is unlikely that you could extend this to more than ten business days.
Expansion rights normally cover three areas:
1) Contiguous space (any space touching your existing premises)
2) Other space on the same floor as your suite, or
3) Any space that becomes available anywhere else in the building.
It can also apply to spaces of certain sizes (for instance, any space under 2,000 square feet, or any space over 2,000 square feet).
A sample clause for a right of first offer might look like this (found in a recent office lease we reviewed from San Diego, California):
The Tenant shall have a right of first offer to lease any premises that becomes available on the 2nd floor of the building. The landlord shall notify the tenant of the availability of said premises and the tenant shall have five (5) business days to inform the landlord of their desire to lease the premises. The failure by tenant to notify the landlord shall result in the exhaustion of this right and the landlord shall be free to lease the premises to a third party.
Note that this is broad and generic wording, and that is what is used in most cases.
Here are elements that were missing: is the rental rate the same as the lease, or at market rates?
Since this is not defined, the landlord could simply be unreasonable, and then after five business days be free to lease the premises to any other tenant.
Does the lease have to be extended?
Can the tenant receive a tenant improvement allowance as part of the deal?
Can the tenant take the space on a co-terminus basis as the existing expiry?
Does the negotiation have to be completed by a certain time?
The clause just states the notice has to be provided.
Unfortunately most rights of first offers are constructed by a tenant's broker, they are poorly worded and if a landlord accepts, he knows it has enough problems that the landlord can effectively dodge the obligation to live up to the right.
It is more advantageous for the tenant to have a clause that clearly states that the rent will be consistent with what they are paying and that the main lease does not have to be extended.
A right of first refusal is much more powerful for the tenant.
Rather than being given a short period of time to agree to lease expansion space, a right of first refusal allows a tenant to wait for a space to be leased and then has an opportunity to match that offer.
This allows a tenant to sit back and wait.
Once the space in question becomes conditionally leased, the landlord approaches the tenant with the deal and the tenant has the opportunity to "steal" that deal.
The value is in the tenant's right to sit back and wait.
You do not need to know the space is even available for lease, since the landlord will just come to you with a conditional deal in hand that you can match.
Of course, since this is so advantageous for the tenant, it is a clause that is despised by landlords.
It really hinders their ability to lease space - once any prospective tenants learn they could negotiate on a space only to have it scooped on them, they typically turn their attention elsewhere.
While much more powerful than a right of first offer, typically a right of first refusal has less flexible terms.
For instance, in the case of a tenant with 2 years remaining on a lease:
1) if that tenant had a right of first offer, most landlords would be satisfied leasing the expansion space to the tenant on a 2 year, co-terminus basis.
2) if that tenant instead had a right of first refusal and another tenant came in with a 10 year lease proposal, then the existing tenant would need to match all the terms of that proposal, and would have to agree to the 10 year term.
A landlord who violates a right of first refusal has not lived up to the terms of the contract and therefore would be in default of the lease.
If there are material damages, such as your business not being able to expand and accommodate growth, then you would have a legal claim to be made with your landlord, but that is beyond the context of this article.
Here is a sample law case (Phipps v CW Leasing Inc.) in which a landlord is liable for damages by not following the right of first refusal steps.
Note that there can be room for ambiguities in a right of first refusal clause.
For instance, in the case of Equinox Engineering v. Lavalin L.P. Investment Corp (Equinox), Equinox had a right of first refusal for any offer on any floor of their building.
The landlord received an offer for multiple floors, and Equinox wanted to exercise their right of first offer on one of those floors.
The judge ruled that their right in this case does not apply, since the offer was for multiple floors.
Typically landlords will preface expansion rights with "Subject to expansion rights of other tenants..." so that they don't always have to remember at the time of a negotiation which tenants have expansion rights.
Be very careful about how your right of first refusal clause is worded.
In most cases a landlord will intentionally ensure that the right is extinguished upon the first opportunity...regardless of whether you decide to exercise or decline.
In order to overcome such a cancellation of the ROFR right, you would need the right to be continuous, and the clause would need to be clear that in the event you decline your option, that your right shall live on.
For example, what if the tenant who leases the expansion space goes out of business or completes a short term lease?
Or if you have a right on space for the entire building - you would want a continuous right of first refusal, which would apply to any space that becomes available, at any time...not just the first time.
Unless otherwise stated in the lease, it would be normal for right of first refusal to be assignable to any subtenants, successors or assigns, but it is not uncommon for landlords to specifically state in the lease that such a right is not transferable.
There is no standard template for exercising a right of first refusal.
It must be done in writing, and most landlords will accept email.
Here is an example template from a recent restaurant client in Los Angeles, California, provided in an email to the landlord:
Thank you for notifying us of the conditional letter of intent you have for suite 301. Further to clause 17 of our lease (right of first refusal), please take this as our notice to formally invoke our right of first refusal right, subject to one condition below.
As the lease term of the letter of intent does not match ours (5 years on their offer, versus 6 years on our remaining term), we would be pleased to offer a 6th year on suite 301 at the same rate as the offer for year 5 (keeping the base rent at $24 per square foot per annum).
Please confirm that you are fine with this modification and we look forward to our continued tenancy.
It depends on what the lease says.
Most prudent landlords would have as a condition to an expansion right "Provided the Tenant is not in default of the lease".
Some leases will take away the expansion right if you are currently in default, while others will extend to any default during the term of the lease.
There likely will be unforeseen situations that come up with respect to your expansion right.
For instance, what happens if the landlord offers you expansion space but you have 2 years left on your lease and the landlord could achieve a 5 or 10 year term from another tenant?
Also, what happens if the space requires a large tenant improvement allowance?
Should you be forced to a 5 year term, or can you do a 2 year, co-terminus deal?
What about amortization of the tenant improvement allowance?
These cases require a broad proration clause.
For instance (from a recent lease in Chicago, Illinois):
"If tenant exercise its right of first refusal in the last two (2) years of the lease, and the third party offer is for more than two (2) years, then the Tenant shall match the term, and extend the term on the existing premises to match. Landlord and Tenant to agree to a fair market rent for the existing premises."
Here is a sample continuous right of first refusal lease template clause from a recent restaurant lease we reviewed in Jacksonville, Florida:
The Tenant shall have the right, on a continuous basis, of first refusal to lease any premises that becomes available in the building during the Term of the Lease and any renewals thereof. When the Landlord completes a conditional offer to lease with a bona fide third-party tenant, Landlord shall present said offer to Tenant. Tenant shall have five (5) business days to accept said terms and conditions, except for length of lease term and inducements, which shall be prorated to be co-terminus with Tenant's Lease Expiry Date. Failing notice by tenant with said five (5) business day period, Landlord shall have the right to finalize a lease with the third party. For further clarity, this right shall be continuous and failure to execute this right shall not extinguish the right for the Tenant.
Expansion rights are not easily obtained and much of it comes down to negotiating leverage...how desirable of a tenant are you and how soft are the market conditions.
A continuous right of first refusal for any space in a building is the gold standard of expansion rights, but most tenants who are able to negotiate for expansion rights end up with a one time right of first offer.
For more information on how our team analyzes rights of first refusal on behalf of retail, office and industrial tenants, check out this super serious video :-)