A right of first refusal is a contractual right to purchase property that arises when the owner decides to sell.  The holder of a right of first refusal has a preference to purchase the property over other purchasers.

As with all other contracts, courts lean toward enforcing a right of first refusal, even if its language is “uncertain” to some degree.

A decision recently published by California’s Fifth Appellate District — J & A Mash & Barrel, LLC v. Superior Court (Tower Theater Properties) — illustrates the point.

Facts: commercial tenant’s exercise of right of first refusal stymied by owner

Tenant J & A Mash & Barrel, LLC (“J&A”) owned and operated a restaurant and brewery (Sequoia Brewing) on a portion of commercial property in Fresno pursuant to a lease with the owner, Tower Theater Properties, Inc. (“Tower”).  The lease covered a stand-alone commercial building (the brewery premises), but the building was just one part of a larger parcel of real estate owned by Tower covering nearly an entire city block.

The lease contained a right of first refusal allowing J&A to purchase the brewery premises if Tower received an offer to sell the premises to a third party.

After J&A heard rumors of a potential sale of the entire Tower parcel, Tower belatedly reached out to J&A, announcing a sale was set to close in three days and asking J&A to waive the right of first refusal.  Two days later, Tower sent J&A a letter giving notice of a sale, but did not state the price that would apply to the brewery premises, and provided no information regarding the sale price of the entire Tower parcel.

When counsel for Tower and J&A spoke by phone, Tower counsel represented the sale price of the Tower parcel was $6.8 million, and Tower was willing to sell J&A the brewery premises for $2.5 million.  J&A declined, stating the price was “ludicrously high.”

J&A sued to stop the sale and enforce its right of first refusal.

During the litigation, Tower offered to sell the brewery premises to J&A for $1,268,000.  J&A responded that it was entitled to buy the brewery premises for a price matching the third party’s offer, and couldn’t evaluate Tower’s proposed price without knowing the sale price of the entire Tower parcel that Tower had agreed to with the third party buyer.

Trial court: lis pendens expunged; right of first refusal too “uncertain” to enforce

At the outset of the litigation, J&A recorded a lis pendens on the property.  A lis pendens gives public notice of the litigation and prevents any sale or encumbrance until the litigation is resolved or until the lis pendens is expunged.

Tower filed a motion to expunge J&A’s lis pendens, which the trial court granted.

The trial court found that J&A had not shown a probability of prevailing on its claims.  Specifically, the trial court ruled that the contractual language of the right of first refusal was “too vague to be legally enforceable” because it did not specify a method for determining the value of the brewery premises in the event of an offer for the entire Tower parcel, and because the language included provisions addressing a potential parcel split for the brewery premises to create a separate legal parcel that could be sold.

J&A filed a petition for writ of mandate in the Court of Appeal.

Court of Appeal: writ granted; right of first refusal was fully enforceable and could not be dodged by “uncertainty” or bad faith conduct

The Court of Appeal issued the writ and reversed the trial court’s order.  The court held that the language of the right of first refusal was not too “uncertain” to enforce.

As to price, the contract language stated the price would be “on terms equaling or more favorable to Landlord than terms offered by a third party which offer Landlord intends to accept.”  The court noted that not specifying an exact purchase price is common in rights of first refusal, observing “the price and terms become definite and ascertainable upon the occurrence of a later event, such as a bona fide offer by a third person, which is sufficient to make the preemptive right definite and enforceable at that time.”

Further, the fact that the brewery premises was “only a portion” of the Tower parcel was no obstacle — “courts generally have found rights of first refusal to remain enforceable even if the sale involves a larger parcel.”  In such cases, the court held, the owner must comply with the implied covenant of good faith and fair dealing and make a “reasonable allocation,” or the court will determine fair market value.  The court noted the availability of several options for determining fair market value.  J&A presented several methods as well during the trial court proceedings, with valuations of the brewery premises ranging from $585,000 to $1.040 million.

Likewise, the court held that the contract provisions addressing a potential parcel split were not too uncertain to enforce.  The court noted that the parties were unlikely to include these provisions if they believed a parcel split was unlikely, and pointed to J&A’s evidence indicating the parcel split was feasible.

Finally, the court pointed to Tower’s bad faith.  For months, Tower failed to disclose to J&A that it was in escrow to sell the Tower parcel.  Even after J&A became aware of the pending sale, Tower “engaged in a pattern of overstating the price of the brewery premises while withholding the actual sale price” of the Tower parcel.

This evidence showed that J&A was likely to prevail on its claims that Tower breached the lease’s right of first refusal.  As such, the trial court should have denied Tower’s motion to expunge and left J&A’s lis pendens intact.

Lesson

Courts lean toward enforcing contractual rights of first refusal, even if they are “uncertain” to some degree with respect to the price or other mechanics of sale.

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