The Right of First Refusal
A simple assumption unleashes unintended chaos
A right of first refusal is an ancillary or collateral agreement whereby one person binds himself to give preference to another person should he or she decide to sell his property.
Most of us have encountered sale or lease agreements with a right of first refusal. These clauses often come in harmless language such as -
The tenant shall have a right of first refusal to purchase the premises when the lessor intends to sell. The purchase price shall be negotiated when the lessor expresses such an intention.
This was the clause, almost verbatim from the recent case of Mokone v Tassos Properties CC 2017 CC. However, rather than being a simple and standard term of the lease agreement, the parties were embroiled in litigation all the way to the Constitutional Court with the tenant attacking the subsequent transfer of the property by the landlord to a third party.
In light of the above, it is advisable to avoid verbal representations or renewals pertaining to residential or commercial leases and to complete separate agreements should you be inclined to grant rights of first refusals (or any other pre-emptive right) to the other party. In this separate agreement, one should clearly set out the rights, obligations and the termination date in order to avoid confusion at a later stage.
In Mokone the issue was whether a right of first refusal, granted without the signature of both parties, was valid, and if it was valid, whether it could be renewed without expressly mentioning the right of first refusal when renewing the lease. In the case of Mokone, the parties entered into a valid written lease agreement whereby Mokone (the tenant) was authorised to operate a bottle store on the premises. In terms of clause 6, the tenant was granted a right of first refusal. The parties initially extended this lease orally and then subsequently extended it through a written endorsement on the first page of the original lease stating: “Extend till 31/5/2014 monthly rent R5 500”. However in 2009 the lessor sold the premises to a third party, transfer taking place on 1 March 2010, without allowing the tenant to exercise its right of first refusal.
The Constitutional Court held that lay person(s), when renewing a lease on the same terms and conditions, would “regard the contents of a document setting out the terms of their lease and a related pactum de contrahendo[agreement to agree] of whatever nature as their ‘lease’” and therefore a right of first refusal would form part of any renewal and is not considered collateral thereto.
You may be wondering why this is an issue?
Firstly the precedent that has been set by this case is that in the absence of an express intention to the contrary during the renewal of a lease (either oral or written), its collateral parts (including a right of first refusal) are also deemed to have been automatically renewed regardless of form or procedure.
This precedent seems to override an Appellate Division decision in Hirschowitz v Moolman 1985 (A) where Corbett JA held that in order for a contracting party to claim specific performance under a right of first refusal, the right itself should comply with the relevant legal formalities.
Corbett JA made that finding for two important reasons:
the renewal of an agreement should only include the essentialia [essential terms]of that agreement, unless expressly including collateral terms. This is because as explained at the beginning, a right of first refusal is collateral and independent from the agreement; and
should a pre-emption not be exercised and the aggrieved party apply for an order of specific performance, the property may be deemed to have been sold (under the Oryx mechanism explained below) to the aggrieved party without a valid sale agreement in place and as such the sale will occur contrary to the Alienation of Land Act.
The court’s reasoning in Mokone was to give effect to the parties intention and as such because their intention was to include the right of first refusal in the renewal this was sufficient evidence to overrule the first point made by the AD in Moolman.
Thereafter, having found the right of first refusal to be valid, the court could “see no reason why” the notion of the holder of a right of first refusal “stepping into the position of the third-party” could not be achieved in a manner that does not by-pass the requisite formalities as cautioned in point two by the AD in Moolman.
In this regard, it applied a remedy known as the ‘Oryx Mechanism’ (Associated South African Bakeries (Pty) Ltd v Oryx and Vereinigte Bäckereuen (Pty) Ltd 1982 A), which can be described briefly as follows:
Where a seller concludes a contract of sale with a third party in breach of a right of first refusal, the holder of the right may, through a unilateral declaration of intent, step into the shoes of the third party. A contract of sale is then deemed to have been made between the seller and the holder of the right of first refusal.
Two key issues emanate from the above contradiction of Moolman and in the application of the Oryx mechanism.
Firstly a right of first refusal may now be renewed without expressly including it in the renewal document. This occurs as parties can merely write the word “extend” with reference to specific essential terms (such as monthly rental and duration) and upon the Mokone interpretation, the entire agreement will automatically be included in the renewal, including all collateral terms such as a right of first refusal.
The issue with this is that parties must comply with relevant formalities when renewing certain collateral agreements. In this instance the right of first refusal, when exercised, should adhere to the formalities of a sale of immovable property, which includes both parties signing the renewal.
This leads to the second issue, whereby a valid sale of immovable property can therefore occur without adhering to the abovementioned formalities insofar as, via a unilateral declaration of intent, the right of first refusal holder can create a deemed sale agreement (using the Oryx mechanism).
This in turn neglects all the purposes, policy considerations and intentions of the legislature, creating uncertainty and allowing courts over-reaching powers.
The point to be made in this regard is that not only can your right of first refusal be deemed to have been included in a renewal but it can also lead to a valid sale agreement should that right be breached in the future.