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Eversheds Sutherland property column: October 2019

  • United Kingdom
  • Real estate

11-10-2019

Chris Mullings of Eversheds Sutherland discusses the different contractual arrangements for options, pre-emptions and rights of first offer, and considers which might best suit particular circumstances and whether the parties really meant what they said.

Does your tenant have FOMO? Give them a ROFO!

They have different names, but options, pre-emptions and rights of first offer (ROFOs) are all methods of securing the possibility of expansion space for a tenant. All three are becoming more common and, despite the terminology being used interchangeably in the market, each offers something slightly different. These rights are often added as a last thought to heads of terms as a sweetener for a tenant, but it is important not to underestimate the potential significance or complexity of these mechanisms and the additional costs that may flow from their negotiation.

As a result of being one of the last items to appear on heads of terms, detail is usually light. More often than not, lawyers will produce something that looks like what has been agreed in the heads of terms, when the parties actually meant something completely different.

For whose benefit?

A standard option to renew an existing lease might benefit successors to the original tenant but options, preemptions and ROFOs might be personal to the original tenant; there is no hard and fast rule. A landlord will always push for the right to be personal to a named tenant, so it can maintain greater control.

Consider how the right will be documented. If it’s contained in the lease, the option/pre-emption/ROFO will run with the reversion. Even if the right is made personal in the lease, other potential tenants might discover that existing tenants have been granted such rights by accessing the leases through HM Land Registry. Frequently, landlords request to document this right separately.

How long?

A landlord would be tying up its space if it granted an option over empty floors, and would be delaying the letting process if it granted a pre-emption or a ROFO.

So consider whether:

  • The right to the further space should last for the full term of the current lease, or only until all the other floors are first let.
  • The right should only begin based on a future trigger (such as another tenant exercising a break right or not renewing its contracted out lease).
  • The right should only apply whilst the benefiting party is in actual occupation.

What should trigger the tenant’s right?

Option: should a tenant’s call option be conditional? A landlord may insist that the tenant has to be up to date on its rent and not be in breach of its lease covenants to have the right to take another floor. From a landlord’s perspective, they don’t want a badly behaved tenant taking more space in their building; but from a tenant’s point of view, its precious right to expansion space should not be frustrated due to a genuine dispute over service charge payment.

Pre-emption: should the tenant’s pre-emption right arise before or after the landlord has lined up another prospective tenant? If it’s before, the tenant will have a strong argument to ask for a lease of the extra space on the same terms as its existing lease. If it’s after, the landlord will more likely ask the tenant to take a lease on the same terms agreed with the prospective tenant. This trigger does not just affect the landlord and current tenant: any prospective tenant may be put off from negotiations knowing that an existing tenant is waiting in the wings to take the space should the deal be right.

ROFO: examples we have seen in the market include "when floor [x] of the Building becomes available to let on the open market"; when "the tenant of floor [x] serves a break notice"; "when practical completion takes place"; or even as extreme as "if and when the landlord builds a new office building next door". The rights become even more complicated when the building has not even been designed as yet, let alone built.

Timing

All three rights add potential delays to lettings for landlords, and empty space means lost income; but the tenant will need time to consider whether or not it wants to take the extra space and then (for a pre-emption) consider whether the terms offered are suitable or (for a ROFO) put its own offer together.

If no agreed form documents form part of the document granting the right, then a further time period will be needed to agree documentation. Worse still, if the landlord and tenant cannot come to an agreement, there will need to be a further time period to refer to expert determination. Before you know it, six months has gone by and the space remains unlet.

Complications

Over-engineering: we have recently seen a set of heads of terms whereby a tenant has an option for a year to take the floor below, or either half of it, and then for a further 18 months after this option expires a right of pre-emption over the remaining amount of floor that it hasn’t taken … in "quarters". While this can be described in a wordy sentence or two, it represents a substantial amount of "what-if" drafting and additional agreed form documents that may never be used.

Drafting nuances: a classic phrase such as "available for letting on the open market" can mean a number of things: is that when the floor is actually vacant, or when the current tenant serves its break notice? Be wary of triggers that are based on conditional break rights should the landlord not be able to waive any breaches of those conditions.

Multiple rights: if there are different tenants of the same building with potentially competing "rights of first offer", the second of such rights will need to take into  account the other’s existence. A landlord will also need to consider whether it builds its own pre-emption right into its leases so that it has the ability to take the premises back and administer accordingly.

Good faith: while seems desirable for both parties to "act in good faith", beware that it could have some unintended consequences. For example, if the current lease of the expansion space is within the security of tenure provisions of the Landlord and Tenant Act 1954 and the present tenant holds over, can the landlord postpone the right arising by not serving a section 25 notice on the present tenant?

Conclusion

Many more issues exist in the "expansion right world" and this is by no means an exhaustive list. However, when the phrase "Tenant to have right of first offer and option to take space when it becomes available in the building" appears in the heads of terms, first be very sure what your client is trying to achieve!

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