A pre-emption right gives someone the right to be offered the chance to buy land before the landowner offers it to another party. They are often used when an estate owner sells land (perhaps to a family member) but wants to keep his hand in for the future.
Sounds simple enough, but there are a number of points to consider at the outset, not least to avoid them becoming bones of contention between lawyers at a later stage.
How do pre-emption rights work?
A pre-emption right gives rise to a contractual relationship between the parties. If the landowner decides not to sell, the pre-emption right may never be exercised. To ensure that a pre-emption right is more than just a vague promise, the arrangement has to be properly documented and it is essential that it is protected by registration (with a restriction) at the Land Registry.
There are a few broad types of pre-emption right.
- A right of first refusal: this enables the holder of the pre-emption right to acquire an interest at a price proposed by the landowner. If not accepted, the landowner is entitled to sell the property to any other party within a defined time period after non-acceptance of the offer on terms that are no more favourable to another party than those offered.
- A right of last refusal: the holder of the pre-emption has a right to match an offer made by a third party to purchase from the landowner, which the landowner intends to accept.
- A right to acquire the property at a price to be determined by a third party.
When drafting a pre-emption agreement, the parties must make clear how and when the preemption right arises and the procedure that must be followed for the right to take effect.
What triggers the landowner’s obligation to offer the property to the holder of the preemption right? This is typically determined by the definition of ‘disposal’; the holder of the pre-emption right should take care to ensure that the landowner cannot structure a disposal in a way that avoids triggering the pre-emption right. To alleviate this risk, a blanket prohibition on all dispositions of the property or an exhaustive list of prohibited transactions should be included in the agreement. You may also wish to give thought to how a disposal of part can be accommodated or whether the pre-emption right is still triggered if the landowner intends to make a disposal not for money, for example as a gift or a property exchange.
A right of pre-emption only arises when the landowner chooses to sell the land during the pre-emption period. Both parties will usually have a timeline in mind and the length of the pre-emption period is a critical issue in negotiations.
Timing provisions should be carefully considered from the point of view of practicality. If the landowner decides to dispose of the property during the pre-emption period, it must serve an offer notice to the holder of the pre-emption right within a specified period. There will then be a period within which the holder of the pre-emption right can serve an acceptance notice.
If the landowner’s offer is rejected by the holder of the pre-emption right, either:
- The pre-emption period comes to an end and the landowner can offer to another party; or
- The landowner has a ‘disposal period’ in which to sell the property to a third party (if the landowner fails to dispose of the property during the disposal period then the landowner again becomes subject to the pre-emption right until they have successfully disposed of the property or the pre-emption period ends).
The holder of the pre-emption right is likely to ask for a reasonable length of time in which to consider and either accept or reject the landowner’s offer. This must be balanced against the potential disadvantage to the landowner if the acceptance period is prolonged and the property is exposed to market volatility.
It is important to be clear at what point the obligation to sell/buy at a particular price becomes binding on the parties and this (and other points) are often worth discussing with a solicitor at heads of terms stage.
If a model involving third party determination of the price has been chosen, you will want to give careful consideration to the valuation assumptions to be used. In particular, should a special purchaser premium be taken into account?
If a right of first refusal has been agreed, it is in the landowner’s interest to reserve the right to accept an offer from a third party at slightly less than the original offer made by the holder of the pre-emption right. This will enable the landowner the flexibility to accept an offer by a third party that is, say, 95% of the initial offer, without needing to revert back to the holder of the pre-emption right to give them the opportunity to accept a marginally lower price. Plainly, the holder of the pre-emption right is likely to resist such a provision.
The landowner should be aware that a prospective purchaser may be deterred from investing in due diligence on the land if they are informed that another party has a preemption right (which will be obvious from the Land Registry documents). To remedy this, the landowner could provide prospective purchasers with a vendor due diligence report.
In sum, pre-emption rights can be tricky to negotiate but, if clearly and comprehensively drafted, can offer a mutually beneficial arrangement.
If you require further information about anything covered in this briefing, please contact Edmund Fetherston-Dilke, or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, July 2019