As the competition to clear vacancies escalates in many office leasing markets, more prospective tenants are able to extract concessions that were once only the province of larger users. This article will focus on one of those concessions - the “right of first offer” or “ROFO”.
A ROFO is an expansion right. It gives a tenant a “first look” at leasing other space that becomes “available” during the tenant’s lease term before the landlord takes the space to the overall market. Tenants like ROFOs because they provide an opportunity to bid on desirable space before the market can drive up the rent for such space, without requiring that the tenant make an upfront commitment at lease execution. From the landlord perspective, a ROFO is seen as the least harmful method for a landlord to accommodate a tenant’s future expansion needs without overly encumbering its building. Because the ROFO rights are triggered early in the leasing process for the “available” space, the ROFO can be addressed with minimal disruption to overall leasing efforts.
However, a broadly defined ROFO provision can significantly limit the landlord’s flexibility in accommodating the needs of the current occupant of the ROFO space, and thus can frustrate a landlord’s overall leasing plan for the building. This article will focus on drafting the ROFO provision narrowly in order to preserve this flexibility. As discussed below, the keys are (1) limiting the number of overall times that a tenant’s ROFO is triggered and (2) narrowly defining what constitutes “available” space for the purpose of triggering the ROFO.
(1) Limiting Overall Occurrences of the ROFO
Most ROFO provisions have clear conditions that must remain satisfied for a ROFO beneficiary’s right to vest at the time the applicable space becomes available. These generally include that the tenant is not in default, that a minimum term still remains under the ROFO beneficiary’s lease, and that the ROFO beneficiary not have subleased a substantial portion of its own space. Because the granting of a ROFO is predicated on the ROFO beneficiary being in good standing and in a growth mode, these conditions are not problematic.
A common step is to minimize the number of times that particular space is subject to the ROFO. In particular, a landlord may expressly state that the ROFO is a “one-time” right as to each particular block of space that becomes available. This means that such space will no longer be considered “available” later in the term if the ROFO beneficiary previously passed on the space, even if it becomes vacant a second time during the term of the ROFO beneficiary’s lease. For example, assume that Tenant A enters into a 10 year lease for space on the 6th floor that contains a ROFO on any other space that becomes available on the 6th floor. Two years later a 6th floor suite becomes vacant. Tenant A is offered the space under its ROFO and Tenant A declines to lease same. Landlord subsequently enters into a 3 year lease for such suite with Tenant B. When and if Tenant B’s 3 year lease rolls over, must landlord offer the same space again to Tenant A? Not if the ROFO provision was clear that Tenant A’s ROFO right was “one-time”, and extinguished as to particular space when Tenant was initially offered the space and declined.1
Limiting the application to the ROFO to a “one-time” right is often readily agreed to by smaller tenants, or by tenants with shorter lease terms that lack extension options. Because there is less likelihood that the same space will become available more than once during its term, one bite of the apple is often enough. However, for tenants with sufficient bargaining power, a landlord may need to accept a recurring ROFO (i.e., one that will apply each time the space becomes available during the ROFO beneficiary’s lease term). Given this reality, narrowly defining “availability” is helpful in achieving a workable ROFO provision.
(2) Defining Availability
Perspectives on whether ROFO space is truly “available” to be leased by the ROFO beneficiary can differ greatly. To a landlord, ROFO space is not “available” if the current occupant of such space is interested in extending its occupancy, regardless of the then status of that occupant’s express rights to extend. However, in the view of many ROFO beneficiaries, if the landlord and the current occupant of the ROFO space want to enter into a new arrangement with respect to such space that is subsequent in time to the date that the ROFO was granted, the ROFO should take precedence. Under many ROFO provisions, the tenant’s argument would prevail. This can put the landlord in the unfortunate position of not being able to fully negotiate an extension or expansion of the relationship with the occupant of the ROFO-encumbered space without first going through the ROFO process. Because of this conflict, a landlord needs to draft “availability” narrowly, with appropriate exclusions.
Certain exclusions as to what constitutes “available space” are generally not controversial. For example, space is typically not “available” under a ROFO if the space was vacant at the time the ROFO was granted. Similarly, there is general agreement that space is not “available” for the purposes of the ROFO until the lapse or expiration of all express renewal or expansion rights held by the occupant of the ROFO space, so long as such rights existed at the time the ROFO was granted. As there is nothing a landlord can really do about other tenant rights that predate the ROFO and occupancy of the ROFO beneficiary, ROFO beneficiaries are content to “wait out” these existing extension terms and expansion rights.
A trickier situation arises if the landlord and the occupant of ROFO-encumbered space want to enter into a new or modified arrangement after the ROFO was granted. For example, assume that Tenant C is granted a ROFO today on space currently occupied by Tenant D. Tenant D currently has no express renewal rights, or perhaps only has an existing 5 year extension. Later, Landlord and Tenant D decide that it is advantageous to extend Tenant D’s term by way of subsequently granting another 5 year renewal term; or, maybe they want to extend for only 1-2 years rather than pursuant to the existing 5 year option. Under many ROFO provisions, which are subordinate only to “such extension rights as are in effect on the effective date of the granting of the ROFO”, the landlord could not enter into either of these arrangements with Tenant D without first offering the space to Tenant C. These situations significantly limit the landlord’s flexibility to address the needs of Tenant D.2
Or, assume Tenant C has a recurring ROFO on the 6th floor. A 6th floor suite becomes vacant, Tenant C declines, and Landlord enters into a short term lease with Tenant D for a suite on the 6th floor, without extension options. But then Tenant D grows, wants space on another floor, which only makes sense for the landlord if the lease term is simultaneously extended for Tenant D’s initial 6th floor suite. Can the landlord enter into such an extension without implicating Tenant C’s ROFO? When tenants insist on recurring ROFO’s, they will usually readily agree that their rights to the space on a second go-around are subordinate to any renewal or extension rights that may have been granted in such subsequent tenant’s initial lease. But that would not help the landlord in our example - because at the time of Tenant D’s lease, Tenant D may not have warranted an extension term, and thus such right was not in its “initial lease”. But Tenant D’s circumstances changed, and Landlord wanted the flexibility to expand that relationship without implicating Tenant C.
So, from the Landlord’s standpoint, it is helpful to define “availability” in a way that permits the landlord to grant extension periods and renewal rights to occupants of ROFO encumbered space. For example, if the ROFO had clear language that Tenant C’s ROFO is subordinate to “any renewal or extension rights that may be granted to any current occupant of [ROFO Space] at any time”, the issue described above is obviated. By carving out the ability to enter into extensions or renewal rights with the occupant at any time, landlord has preserved the flexibility of maintaining and expanding a relationship with Tenant D without implicating Tenant C.
But carving out the ability to renew or extend leases with current occupants does not cover every scenario for the landlord. What if space on the 6th floor that is subject to a ROFO is occupied by a tenant that has some space under a prime lease and some under a sublease, and when the sublease expires the landlord prefers to enter into a direct lease with the subtenant rather than involve the holder of a ROFO? When the sublease expires, is the space “available” to trigger the ROFO? Under most ROFO provisions, the answer is probably yes. If the landlord wished to preserve flexibility in this scenario, landlord needs to define “available” in a manner that excludes any new lease arrangement with any “occupant” in that space.
A final drafting note. Even the most elegantly drafted and administered ROFO provision can become victim to uncertainty as to whether the landlord actually adhered to the provision and offered the space when obligated. Notices of offers can get misplaced after being sent, or there can be some disagreement after the fact whether an offer was required. In order to mitigate these situations, landlords may wish to add an estoppel requirement to the ROFO provision, wherein the landlord would have the right to require that the tenant confirm that the ROFO was declined, waived, or not applicable, as appropriate for the particular situation. The landlord may also want to include language that if same is not executed or disputed in good faith within a particular time period, tenant will be deemed to have confirmed the relevant facts. This provides a landlord with an efficient means to “clear the decks” before entering into a lease or other transaction that could otherwise lead to an argument that another tenant’s ROFO was breached.
In conclusion, ROFOs have become a fact of life for many office landlords. Through some tight drafting and forward thinking, the landlord should be able to agree on its ROFO provision that provides the tenant with expansion potential without overly restricting the landlord’s ability to manage and expand its relationships with other building occupants.