Farm Leases: Is Your Right of First Refusal Drafted Correctly?

May 26, 2015

Landowners often enter into lease agreements with farmers to farm their land. These lease agreements often include a right of first refusal provision or an option provision. A right of first refusal provision gives the tenant a contractual right to be first in line for the opportunity to purchase or lease the property in the future. An option provision gives the tenant the ability to force the landowner to sell the property on specific terms within a specified window of time. Both types of contract provisions allow a tenant the first opportunity to take possession of land while providing the landowner some amount of cash for not selling to someone else first. Typically, a right of first refusal or option provision are a win-win for both parties; however, sometimes fights break out over these provisions.

The Wisconsin Supreme Court recently addressed a lawsuit between a landowner and a leasing farmer in MS Real Estate Holdings, LLC v. Donald P. Fox Family Trust. In its decision, the Supreme Court provided guidance on the legal difference between a right of first refusal and an option and how to draft a legally enforceable right of first refusal. With this new guidance, landowners and farmers should ask: Is my right of first refusal drafted correctly?

The Background Facts

MS Real Estate operated a dairy farm in Outagamie County. Its dairy farm was next door to 450 acres of farmland owned by the Foxes. MS Real Estate contracted with the Foxes for a right of first refusal to purchase or lease the Fox Land.

The right of first refusal to purchase or lease the Fox Land set a step-by-step procedure. First, if the Foxes decided they wanted to lease or sell the Fox Land, they had to deliver to MS Real Estate a written copy of a third-party offer to lease or purchase the land. MS Real Estate then would have 15 days to decide whether it wanted to accept or reject the offer to lease or purchase on the identical terms included in the offer. If MS Real Estate rejected the offer, then the Foxes were allowed to complete the lease or sale with the third-party that made the initial offer. If the proposed lease or sale did not happen for any reason, then MS Real Estate’s right of first refusal would be put back into effect.

The contract between MS Real Estate and the Foxes also included a continuing rights provision, meaning the agreement would remain in place until the Fox Land was sold or MS Real Estate gave up its rights. The agreement was also binding on the parties’ heirs and successors.

MS Real Estate leased the Fox Land through 2012. The Foxes notified MS Real Estate that its lease agreement would soon expire and requested a bid to lease for the 2012 crop year. The Foxes also solicited offers from other potential lessees and received two. The first offer was to lease the property at $200 per acre, and the second offer was to lease the property at $225 per acre. The Foxes presented both offers to MS Real Estate. The Foxes attempted to terminate the agreement, but MS Real Estate sued to force the Foxes to lease the property based on the lower priced offer.

In court, the Foxes argued the whole right of first refusal provision should be thrown out and deemed legally invalid because it was indefinite and hypothetically went on forever. The trial court agreed and indicated that there was no guarantee that the Fox Land would ever be sold or that MS Real Estate would ever voluntarily give up its right of first refusal. Because the contract could go on forever, it was an indefinite contract and was unenforceable. For this reason, the trial court allowed the Foxes to terminate the contract. MS Real Estate eventually appealed to the Wisconsin Supreme Court.

The Supreme Court’s Decision

On appeal, the Supreme Court disagreed with the trial court and held a right of first refusal contract is definite as to duration (and is enforceable) when it specifies an event that triggers the right and requires the other party to act within a specified time. In its decision, the Court gave some helpful guidance on the difference between a right of first refusal and an option and how to draft an enforceable right of first refusal contract provision.

The Court explained a right of first refusal is a contractual right to be first in line should the opportunity to purchase or lease the property arise. The opportunity only arises, however, if the landowner decides to lease or sell in the first place. The holder of an option agreement, on the other hand, can force the landowner to sell, even if the landowner changes his or her mind later. An option agreement only lasts for a pre-determined amount of time, whereas a right of first refusal can last until the landowner decides to sell or lease.

The Supreme Court relied on this understanding to conclude a right of first refusal is not indefinite because it does not contain a time limit. Instead, a right of first refusal relies on the triggering event, normally the decision to lease or sell the property and an offer to do so. The Court wrote that “MS Real Estate’s opportunity to exercise its right of first refusal is completely dependent upon the actions of the Foxes. The Foxes hold all the cards because they are not required to sell or lease their land, and they may use their land however they wish.” “In the event an offer for sale or lease is made that they are willing to accept, all that is required is that they give MS Real Estate the opportunity to accept or reject the terms of the offer that they find acceptable.”

The Bottom Line

After the Court’s decision in MS Real Estate, landowners and farmers considering right of first refusal agreements should remember the following points:

  • A right of first refusal agreement is not indefinite if it is based on an explicit trigger event, such as an acceptable offer to lease or sell the land. Be sure to include explicit trigger events in the contract document so that there is no confusion about how the right of first refusal is triggered.
  • The holder of the right of first refusal should be given a reasonable period of time to respond to the offer. The contract should explain how much time, preferably in days, the holder has to respond to the offer.
  • The agreement should include a clear step-by-step procedure for making and responding to the offer.
  • The agreement should plan ahead for what happens in the offer is not accepted.

Right of first refusal and option agreements are tricky and require careful planning. Landowners and farmers should review their agreements and determine if they are drafted correctly.

MS Real Estate Holdings, LLC v. Donald P. Fox Family Trust, 2015 WI 49.


 

For more information about "Farm Leases: Is Your Right of First Refusal Drafted Correctly?," contact Buck V. Sweeney at csweeney@axley.com or 608.283.6743 or Tyler K. Wilkinson at twilkinson@axley.com or 608.283.6783.