Expansion Rights: Growing as a Tenant
There are many vital considerations business owners have in mind when negotiating a lease agreement. One such consideration is the need for additional space when the business grows. Often enough, landlords include “expansion rights” to induce tenants to enter into a commercial lease agreement. These expansion rights can either impose restrictions on the tenant or the landlord. In today’s post, we will discuss expansion rights and what they mean for tenants.
An expansion right affords the tenant certain preferential rights to certain additional space. There are generally three types of expansion rights: 1) right of first offer, 2) right of first refusal and 3) fixed expansion options.
Right of First Offer (“ROFO”)
Under a ROFO, the landlord would be required to offer certain additional space to the tenant before it markets such additonal space. This right gives the tenant priority to decide whether it wants the extra space and finalize agreement before other interested parties are shown the offer. A disadvantage of the ROFO is that the landlord can request the tenant to pay above the market rate for the additional space or commit to a long lease term. This limitation may leave the tenant in a dilemma where it wants to have such advantage and priority but does not want to overpay for the additional space. There is also no guarantee that the tenant will secure the space. This is because there is a negotiation period, and if both parties cannot agree within that period, the landlord will then make the space available to third parties.
Right of First Refusal (“ROFR”)
This right is the opposite of the ROFO because the landlord goes to the market first and obtains third-party offers for the additional space. After that, the landlord submits such offer to the tenant and the tenant may match the offer and secure the space. This right benefits a tenant such that he can have the option of either matching the third party offer or getting better rates in the property market for other expansion options. Importantly, there is no commitment on the part of the tenant to lease the additional space. A ROFR may be less attractive for a landlord because he may expend resources in getting a third party offer and may end up ruining the relationship it has built with such party whose proposal is still subject to the tenant’s right.
Fixed Expansion Option
Under an option to expand clause, a tenant has a right to reserve the additional space for when it needs it. However, this expansion right must be exercised within a specified period, after which the landlord can make the space available to other interested parties without any encumbrance. This right balances both the tenant and landlord’s respective interests as the option is a for a fix period.
It is important to note that these clauses should be reviewed and drafted carefully to reflect the parties’ intentions. Other important details include the space subject to the expansion rights, the specified period for negotiation and exercising the right, and preconditions.
If you have questions about expansion rights in commercial tenancies, kindly book a free consultation with Northview Law by following this link or contact us at 905-857-4890. We look forward to hearing from you soon.