'I Thought I'd Seen It All with Rights of First Refusal, But I Was Mistaken'

Tenant shall have the pre-emptive right during the term of this Lease to purchase said premises on the same terms and conditions as those of any bona fide offer received by and acceptable to Landlord, and Landlord, before making any sale or any agreement to sell, shall notify Tenant in writing of the amount of the proposed purchase price, a copy of the purchase contract and all other terms and conditions of such offer.

Tenant had received a letter from Landlord stating that Landlord had accepted an offer to sell the property, that the purchase agreement enclosed with such letter (the “Original Agreement”) contained the material terms of the proposed acquisition, and that such letter satisfied Landlord's right-of-first-refusal notice requirements under the lease. The Original Agreement was signed by Landlord and the prospective purchaser, initialed by the parties on each page, and was contingent only on Tenant's waiver of its right of first refusal. The purchase price for the property set forth in the Original Agreement was $1,085,000.

Within the time period required by the lease, Tenant exercised the right of first refusal and accepted Landlord's offer on the same terms and conditions as contained in the Original Agreement. In the letter notifying Landlord of Tenant's acceptance, Tenant recited that the purchase price for the property was $1,085,000. Within a week following Tenant's exercise of the right of first refusal, Landlord prepared and delivered to Tenant its draft of the purchase agreement for the property. While Landlord's draft of the purchase agreement failed to include all of the same terms and conditions of the Original Agreement, it did state that the purchase price was $1,085,000. After exchanging multiple drafts of the purchase agreement, Tenant and Landlord finally agreed to the form of the agreement and executed a purchase agreement (the “New Agreement”).

At all times during the parties' negotiations, the purchase price in the drafts of the purchase agreement remained $1,085,000. In the weeks that followed, Tenant completed its due diligence with respect to the property and prepared for closing.

With the closing date that the parties had agreed to less than two weeks away, Landlord contacted Tenant stating that it had “discovered a material error” and that the purchase price set forth in the Original Agreement should have been $100,000 more (i.e., $1,185,000). Landlord explained that prior email communications between Landlord and the prospective purchaser were clear that Landlord would not have accepted a purchase price less than $1,185,000. Based on these communications between Landlord and the prospective purchaser, Landlord asserted that, at best, a mutual mistake between Landlord and the prospective purchaser had occurred or, at worst, the prospective purchaser had employed an underhanded tactic by changing the terms of the Original Agreement before signing and submitting such contract to Landlord and not highlighting such change to Landlord. In either event, claimed Landlord, the New Agreement should be reformed to include the higher purchase price.

We proceeded to send a formal demand that Landlord honor the terms of the New Agreement as written, and proceed to closing in accordance with the terms of the New Agreement or be subject to all remedies available to Tenant, including specific performance and attorneys' fees, as permitted by the New Agreement, but Landlord would not waver. Instead, Landlord continued to allege that there was a mutual mistake in the Original Agreement, that in exercising the right of first refusal, Tenant had “stepped into the shoes” of the prospective purchaser, and that the mutual mistake was a basis for rescinding the New Agreement. Landlord argued that if Tenant and Landlord could not come to a mutual agreement (i.e., Tenant agreeing to pay a higher purchase price), then there was no agreement between the parties, and the parties were excused from performance under the New Agreement.

Mutual Mistake vs. Unilateral Mistake

A mutual mistake, when properly shown, may be a basis for rescission or reformation of an agreement. Here, we argued, there was no mutual mistake between Landlord and Tenant as to the purchase price set forth in the New Agreement. A mutual mistake is “one common to both parties or all parties, wherein each labors under the same misconception respecting a material fact, the terms of the agreement, or the provision of a written agreement designed to embody such an agreement.” Simpson v. Curtis, 351 S.W. 3d 374, 378-379 (Tex.App.-Tyler 2010) (internal citations omitted). Because Tenant understood the purchase price stated in the original offer, the Original Agreement and the New Agreement to be correct, Tenant was not operating under any misconception.

In our research, we found a case directly on point. In Vonada v. Long, 852 A.2d 331 (Pa. Super. 2004), landowners received an offer from a prospective buyer (the son of one of the landowners) to purchase certain real property, and such landowners subsequently offered the property to their neighbor pursuant to a right of first refusal held by such neighbor. The neighbor exercised its right of first refusal and accepted the offer. After such acceptance, the landowners realized they had made a mistake. They had failed to recognize that the express terms of the right of first refusal permitted a sale of the property to certain relatives of the landowners (which would have included the prospective buyer) without triggering the neighbor's right of first refusal. Once they recognized their mistake, the landowners attempted to rescind their offer to the neighbor. The neighbor then sued the landowners for specific performance. The landowners argued that there had been a mutual mistake subjecting the agreement to rescission.

In Vonada, the Superior Court of Pennsylvania rejected the landowners' argument, and found that no mutual mistake existed. Instead, the court, like the Texas court above, found that a
“[m]utual mistake exists … only where both parties to a contract are mistaken as to existing facts at the time of execution.” Vonada, 852 A.2d at 337 (internal citations omitted). The court explained that since the holder of the right of first refusal was unaware of the familial relationship between the prospective buyer and the landowners, any mistake was attributable to the landowners only, and thus the mistake was unilateral.

The court opined, “If a mistake is not mutual but unilateral and is not due to the fault of the party not mistaken, but to the negligence of the one who acted under the mistake, it affords no basis for relief in rescinding the contract.” Id. at 338. The court continued: “Had [the landowners] made inquiry into the identity of the prospective buyer before offering the realty to [the neighbor], the present controversy could have been avoided. Nonetheless, we fail to detect how this nonfeasance by [the landowners] can be assigned to [the neighbor] to create a 'mutual' mistake invalidating the binding effect of the offer to purchase the reality [sic] in dispute.” Id. Finally, “the error was attributable to the negligence of the party acting under the mistake, which underscores the integrity of the acceptance by [the neighbor], which bound the parties.” Id.

Similar to the facts in Vonada, in our case, it was Landlord's negligence in failing to confirm the purchase price at any time before Landlord: 1) initialed the Original Agreement; or 2) signed the Original Agreement; or 3) offered the subject property to Tenant; or 4) sent the draft of the New Agreement to Tenant; or 5) signed the New Agreement, that created the issue.

These facts demonstrate that if there was any mistake, it was a unilateral mistake by Landlord. Since Tenant had not been a party to any discussions between Landlord and the prospective purchaser in arriving at the Original Agreement, Tenant could not have known that the purchase price offered by Landlord in the notice of right of first refusal or in the draft of the New Agreement was incorrect. Therefore, only one party — Landlord — labored under a misconception, and no mutual mistake between Landlord and Tenant existed.

Stepping into the Shoes of a Prospective Purchaser

Perhaps aware of its flawed argument that a mutual mistake could exist between Tenant and Landlord given the events described above, Landlord also argued that the prospective purchaser's knowledge should be attributed to Tenant because in exercising the right of first refusal, Tenant “stepped into the shoes” of the prospective purchaser.

However, an exercise of a right of first refusal is not an assignment. Instead, as described in one case, a right of first refusal is “merely a dormant set of rights” that does not entitle the holder of such rights to take any action until it receives a bona fide offer. Urban Hotel Mgmt. Corp. v. Main & Washington Joint Venture, 494 N.E.2d 334, 337 (Ind. Ct. App. 1986). In Urban Hotel, the holder of the right of first refusal properly exercised an option to lease a hotel, but subsequent to exercising the right, no lease was ever entered into between the owner and the exercising party because of the parties' disagreement over the interpretation of a particular term. The original prospective tenant then brought suit for either specific performance of the lease or damages. In upholding the lower court's award of summary judgment in favor of the owner and against the prospective tenant, the court explained that once the holder of a right of first refusal receives such offer, the right of first refusal is transformed into an option “which is distinctly different from a right of first refusal [in that it] is a continuing offer whose duration and method of exercise is strictly controlled by the agreement that created it.” Id.

Once a right of first refusal becomes an option, the only question is whether the holder properly exercised such option by strict adherence to the agreement that created such right. Id. Upon the holder taking the action required by the agreement creating such right to exercise such option, the right of first refusal is properly exercised and the original offeror's rights to the property are “completely cut off.” Id. (internal citations omitted).

Accordingly, once Tenant exercised its option pursuant to and in compliance with the terms of the right of first refusal, the right of first refusal was properly exercised (which proper exercise Landlord never disputed) and the rights of the prospective purchaser were cut off. In other words, there were no shoes to step into — tenant could not be viewed as an assignee of the prospective purchaser's rights in the subject property because such party no longer had any rights. Instead, Tenant and Landlord entered into their own agreement that contained the terms of such purchase, including the purchase price of $1,085,000.

Conclusion

Given the amount in controversy, you will not be surprised to learn that the parties ultimately settled their dispute out of court. In any event, the above facts and case law illustrate that, much to our clients dismay, even routine transactions can have unanticipated perils. Practitioners should take note that, given the number of articles on rights of first refusal published by this newsletter and similar publications over the years, it appears that rights of first refusal may have more opportunity for these perils than other transactions.

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Marisa L. Byram, a member of <I>Commercial Leasing Law & Strategy's</I> Board of Editors, is a member of Lewis Rice LLC. She thanks firm colleagues Andrea M. Patton and Matthew J. Haas, for their assistance with this article.