What is the legal nature of a right of first refusal?

By Ray Mikkola ·

Law360 Canada (January 24, 2024, 9:38 AM EST) --
Ray Mikkola
Ray Mikkola
The first part of this article dealt with the recent decision of Justice Charles Hackland in McMullen v. Dilawri Property Holdings Ltd. 2023 ONSC 599, in which he held that a right of first refusal (ROFR) terminates upon its exercise. Justice Hackland did not consider, because it was not necessary to do so in that case, several important and interesting issues involving the nature of a ROFR, its exercise, and its termination.

What is the legal nature of a ROFR? As with the creation of most obligations, a properly formulated ROFR requires consideration in order to be effective. That consideration may be provided either by way of the payment of money or by its inclusion as part of a contract, such as an agreement of purchase and sale or a lease. But does an ROFR create an interest in land? While courts have sometimes struggled with this issue, it seems that a ROFR will typically be interpreted as creating personal contractual rights rather than a right in land, at least until it is exercised, whereupon it becomes an agreement of purchase and sale. Although a ROFR is unlikely to qualify as a restrictive covenant given in particular the statutory requirements imposed on such covenants by s. 119 of the Land Titles Act, including the requirement to specify the dominant tenement lands benefitting from such covenant, it plainly imposes on a ROFR grantor a covenant not to dispose of its ownership rights without giving notice to the ROFR holder, which covenant is negative in nature.

The personal right in a ROFR is not an absolute right to purchase. Rather, its exercise is entirely dependent on the seller electing to sell, and receiving an acceptable offer, neither of which may ever happen. Typically, the holder of the ROFR cannot require the seller to convey the land in the absence of the contingencies, the satisfaction of which are entirely in the control of the seller. It is the absence of this right that appears to be fatal to an argument that the ROFR constitutes a right in land.

However, it seems that the characterization of the ROFR as a mere personal right does not preclude the ROFR holder from obtaining an order for specific performance. The Supreme Court of Canada in Irving Industries (Irving Wire Products Division) Ltd. v. Canadian Long Island Petroleums Ltd. [1975] 2 S.C.R. 715 had before it a case in which a ROFR exchanged between co-owners of property had been ignored by a co-owner, and that co-owner had completed a sale of that co-owner’s property interest to a third-party purchaser. A 30-day right to match the offer was contained in clause 13 of an agreement which constituted the ROFR. The third-party purchaser took the position that the ROFR ran afoul of the rule against perpetuities.

The court agreed that if the ROFR created a property interest then that that interest would be void as it would offend the rule, but the court held that the ROFR did not create a property interest but merely a personal interest. The court emphasized that the ROFR did not give the ROFR holder any present right to require a conveyance of the ROFR grantor’s undivided one-half interest in the land, as it was not specifically enforceable at the time the ROFR was executed. The ROFR holder was not given any right to take away the seller’s interest without its consent. The right was a contractual right consisting of the covenant of the owner that if it was prepared to accept an offer to sell its interest, the ROFR holder would then, and only then, have a 30-day right, if exercised, to purchase on the same terms as the offer. The contingency in the ROFR could be resolved solely upon the decision of the owner to sell.

However, notwithstanding that the ROFR created a mere personal right, the court reasoned that had the ROFR holder applied for an injunction to prevent the seller from disposing of the land without complying with its obligations under the ROFR, the ROFR holder would have qualified for an injunction and the third-party purchaser would have been bound by the order. The court ordered that the ROFR holder was to become the owner, notwithstanding that the transfer of title to the third-party purchaser had already been completed.

Central to the court’s decision in Long Island was the fact that the third-party purchaser took title with “full knowledge” of the ROFR. The court held that the purchaser’s position could not be made stronger because the seller had actually breached the ROFR by conveying the land to the purchaser. The purchaser could therefore be made a party to the proceedings by reason of the “equitable ground of his conscience being affected by notice” of the ROFR. It is unclear if the court would have made the specific performance order had the purchaser been unaware of the pre-existing ROFR. It appears therefore that actual knowledge or notice of the ROFR by a third-party purchaser will be necessary in order for the ROFR holder to enforce its ROFR acquisition right against the purchaser.

In the McMullen case, the seller was required to proceed to court by reason of the registration of the ROFR on its title, the purchaser thereby being deemed to be affected by notice of the ROFR by reason of s. 71(2) of the Land Titles Act (although a purchase could be fixed with actual notice to the same effect even absent such registration of course). Absent such actual notice by a purchaser, it seems that a ROFR holder would be limited to damages against the ROFR grantor as former owner only, where the transaction in breach of the ROFR comes to the attention of the ROFR holder after closing to a purchaser for value without notice. In Ontario, the registration of a ROFR is specifically permitted pursuant to the provisions of s. 71 of the Land Titles Act.

Section 71 allows the registration of notice on land by a person to protect that person’s unregistered “estates, rights, interests, or equities” which are authorized by the Act or by the Director of Titles. The Director of Titles has expressly permitted the registration of a notice of a ROFR (see page 187 of version 12 of the Electronic Registration Procedures Guide). British Columbia has provided in s. 9 of its Property Law Act that a ROFR constitutes an estate in land.

The Long Island case also makes it clear that the ROFR must be exercised strictly in accordance with its contractual requirements. This involves not merely the delivery of timely notice, but compliance with the manner in which notices are to be given and the contents of the notice. But the court will not easily allow a party to avoid its ROFR obligations where such avoidance suggests bad faith. In Long Island, it was actually the seller that approached a prospective purchaser and made an offer to sell the land interest, which the purchaser then accepted. The purchaser and ROFR holder therefore took the position that the ROFR had not been triggered because the facts involved a seller’s offer, rather than a purchaser’s offer to the seller.

The Manitoba Court of Appeal concluded that “any reasonable appraisal of the intent of the clause would negate the effect of any attempt to evade its effect by the subterfuge of making the ‘offer’ come from [the seller] rather than the proposed purchaser.” This case involved a circumstance wherein business partners involved in the joint operation and development of certain oil producing properties (and the co-ownership of those properties) did not want to be forced to accept a different partner and co-owner, so the court held that the seller should not be able to avoid or defeat this purpose by “juggling with words.” The Supreme Court of Canada confirmed its agreement with this holding.

This case also noted the importance of an ROFR holder matching exactly the terms of the third-party offer. The ROFR holder delivered a notice in which it agreed to purchase the interest of the seller on the very same terms as set out in the third-party offer, but included a sentence that the purchase price would be paid by a specific date.

There was no closing date specified in the third-party offer, but the court found that the closing should have occurred within a reasonable time. Nevertheless, the ROFR holder and purchaser argued that the introduction of the date in the ROFR acceptance meant that the ROFR had not been properly exercised given that it included a term that was not identical to the third-party offer. The court held that the insertion of the date was not material and did not affect the validity of the exercise of the ROFR. But the court suggested that had the insertion of the date been inconsistent with the third-party offer, it would have resulted in the failure of the ROFR acceptance to comply with the ROFR requirement.
 
This is part two of a two-part series. Part one: Right of first refusal terminates once exercised, says court.
  
Ray Mikkola is a partner with the firm of Pallett Valo LLP. The author would like to thank Pulkit Sahi, student-at-law, for his assistance in the preparation of this paper.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the author's firm, its clients, Law360 Canada, LexisNexis Canada, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
 
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