As luck would have it, I have drawn the assignment of
conjuring up a brief piece for our November newsletter. Naturally,
there is only one subject of sufficient gravity that warrants
discussion at this time of year….Thanksgiving Dinner.
Picture if you will your dining room. The table is set with the fine
china, the house has been basted in the smells of the impending feast
and most importantly, the sounds of football resonate out of the den
and past the cooler of beer. It all seems lovely, but there is a
tension lurking. This is your family, it is a festive holiday, and yet
the positioning has begun. A whole year spent recovering from last
year's "stuffing fiasco" (as it has come to be known) and still you can
sense it. There will be conflict. There will be disappointment. One of
the side dishes will run out way too soon.
In this article we will use the Thanksgiving Dinner (largely
autobiographical by the way) as a helpful and familiar tool in
discussing the use of title insurance as protection for real estate
interests such as options, rights of first refusal and rights of first
offer. I bet you didn't see that coming! Think of it this way, everyone
is sitting at the table and the food is being set out. Some dishes are
near you, some are all the way over by your brother in law, Chet. That
means, you have leverage, Chet has leverage.
The point is that this familiar scene bears a resemblance to the deals
that real estate professionals encounter on a regular basis. Options
and rights of first refusal and offer are methods commonly used to
create rights in a developer that can be exercised in the future. While
these rights may only serve to sweeten part of the larger deal, they
also may be crucial to the success of a project. In that case, why
shouldn't some elementary level of diligence be performed and some
steps be taken to protect these interests. A title search and title
insurance may be a cost-effective way to protect these interests.
Let's say you sneak away form the crowd for a few minutes to survey the
spread and plan your gastronomic blitzkrieg, when you notice that there
is only one pumpkin pie. "Damn, Atkins crazed people", you mutter under
your breath. You can't start with Pumpkin Pie, it wouldn't be American,
but you know that it won't last past your seconds.
The pie is like a piece of land that you want. You may not be ready to
take it down now, but you don't want it to slip away in the future
either. What are your options? If you have the cash you can buy it and
hold it. You can take a chance that it will still be there when you are
ready for it. Like the pie, neither of these alternatives are very
attractive. Commonly, what occurs is the negotiation of an option to
purchase the property.
Webster's defines an option as "a continuing offer to sell given by the optionor to the optionee".1
Typically the optionor (landowner) and the optionee (potential buyer)
agree to a price for the grant of option. The buyer is willing to pay
this price to keep the land tied up for some period of time. The
exercise of the option then rests with the optionee. She can choose to
purchase the property in accordance with the terms of the option at
some future date. She may also decide that she does not wish to
exercise the option and thus it would expire by its terms at some
Turing back to the pie
for a second. You think you are going to want that pie, but you aren't
sure there will be room. You certainly want the "option" to have it.
Your Mom, being the generous soul she is, offer to set a piece aside
for a small fee. She says she'll keep it for you until you are ready.
If you don't want it, she'll give it to someone else. And there is your
option. Despite the fact that she charged you for the option
(consideration is a necessary element), she is your Mother and you
trust her not to go back on the deal.
You can't be this certain in the outside world, however. The option,
like any contract, is only as good as your ability to enforce it. In
North Carolina an option has to be recorded in order to be effective
against lien creditors and purchasers for value.3
I have always thought that if you are recording an instrument to
protect an interest, it makes sense to search the record to make sure
that there are no interests that have priority such as other options or
deeds of trust. Additionally, it makes sense to procure title insurance
as an effective assurance about the status of title. Without title
insurance, the optionee would be left to seek recourse against the
optionor. The optionor may be insolvent or otherwise judgment proof. In
any event, it is wise to make sure that the person who grants the
option is in fact the owner of the property and crucial to make sure
that the world is put on notice of the interest. The coverage that can
be obtained will be discussed below.
Just like having
the last piece of the pie, the option can give you leverage. Protecting
the right and insuring its enforceability could be crucial to making a
deal work or to keep out undesirables.
RIGHTS OF FIRST REFUSAL AND FIRST OFFER
While watching the Cowboys take it on the chin, your Uncle Arthur let's
out a long sigh and exclaims that he can't wait to eat and you notice
that he has on his special, expandable waist, "Thanksgiving Pants". Now
that you have successfully negotiated a deal for that piece of pie, you
turn your focus to the main part of the meal. The spectacle becomes
clear in your head. You see the entangled arms, stretching and
straining; the impassioned cries of "More sweet potatoes" and "Pass the
green beans". Perhaps some strategic alliances are in order. So like
Jun from Big Brother, you begin to work the room, looking for friends.
You work a deal with Chet that reads as follows:
Chet agrees that upon receipt of a request to pass the [insert side
dish of your choice] Chet agrees to notify you of such request, whereby
you will have 30 seconds to match said request and to ask for the [side
At its crudest level what you have agreed to is
a right of first refusal. The right of first refusal is found often in
leases, where it binds a landlord to allow a tenant the first right to
lease additional space. Its too close cousin (like yours sitting over
in the corner) is the right of first offer. I am not going to spend
much time breaking down the distinction. The practical difference in
the two is that the first refusal allows the landlord to solicit offers
and then take them to the tenant to see if it wants to match. The first
offer means that the landlord has to offer the property to the tenant
before it can solicit other offers. (Note: The terms tenant and
landlord are used here only for illustration purposes, as these
preemptive rights can also arise in purchase/sale transactions). Both
of these rights can be distinguished from options in that they do not
create an affirmative obligation to sell or lease the property only an
obligation to take certain steps if the owner decides to solicit offers.
Generally, a property owner should grant these types of rights only
after careful consideration of her bargaining power. They tend to make
the marketing of property difficult and really offer little, if any,
benefit to the owner. That being said, such rights may be very
important to a growing business or an adjacent landowner. If there is
this value to the holder, why not protect it. A wary practitioner
should make certain that a memorandum of lease (or other appropriate
document) is recorded and that a search is performed. Title insurance
coverage is available, affordable and can prove very beneficial.
It is important to note that in some states, options and preemptive
rights such as rights of first refusal are not considered real property
interests, but rather mere contract rights. Accordingly, some title
insurers may take the position that they cannot insure these interests.
Without passing on the nature of such interests, this type of coverage
is provided with some regularity in North Carolina. Generally these
interests would be insured through the use of an option endorsement. A
copy of the form endorsement is attached hereto as Exhibit A. This endorsement could be modified in the case of a right of first refusal.
The endorsement insures against loss or damage arising from (i) the
unenforceability of the right to exercise the option; and (ii) the
priority of a lien creditor or purchaser over the option. It is
important to note that these coverages are subject to the insured's
compliance with the terms of the option and any liens or encumbrances
created or suffered by the insured. Additionally, the coverage is
subject to a disaffirmation in bankruptcy, condemnation or other
governmental action and liens imposed by law.
In dealing with options and preemptive rights, the careful practitioner
should think about the most common problems laying in wait to cause the
failure of those rights. Often these rights are crucial to a deal and
as such deserve the same diligence and protection as other property
interest that are acquired. You wouldn't buy a piece of land without
title insurance. So why pay $10,000 for an option with out the same
care. At the dinner table this Thanksgiving look around. Would you
trust those people with your money? You don't even trust them with the
At least consider insuring options and rights of first refusal. And just pray that the gravy holds out!