Private Equity

An important aspect of the diligence involved in acquiring a business is identifying any third party rights that could potentially delay, hinder or block the acquisition.  Among those potential third party rights is the dreaded Right of First Refusal (or “ROFR”).  And a recent decision from Iowa, Pistol Limited Co. v. Green Family Flooring, Inc., 2023 WL 2905165 (Iowa App. April 10, 2023), serves as a useful reminder of the difficulties that can arise when a ROFR applies to some particular (and important) asset that is part of the purchased business, as opposed to the entire purchased business.

While ROFRs are commonly triggered by a sale of real estate, they can also be triggered by the sale of membership, partnership or shareholder interests in entities that are the subject matter of the potential acquisition, as well as by the sale of certain product lines or intellectual property comprising the purchased business.  And typically, the acquisition has been priced on the assumption that all of the assets of the entire business will be purchased, without one or more of the assets being picked off by a third party exercising a ROFR.  Moreover, it is rare that an asset subject to a ROFR has been separately valued from the business as a whole and, even when it has, it is not necessarily clear that that valuation will be the applicable valuation for the ROFR, or that the ROFR will be limited to just the asset that is technically burdened by the ROFR.  The law, in fact, is muddled.

Green Family Flooring involved a traditional ROFR contained in a real estate lease agreement.  The landlord, Pistol Limited Company, had leased a portion of a building it owned to the tenant, Green Family Flooring.  The ROFR stated that if the building were ever proposed to be sold by the landlord to a third party, the tenant would be given the opportunity to purchase the building on the same terms as those offered by the landlord to the third party.  But here, the proposed transaction was a package deal whereby the landlord was proposing a sale of the building and a restaurant operated by the landlord in a part of the building not leased to the tenant.  In other words, the sale of the building was conditioned upon the simultaneous sale of the restaurant—unless the buyer purchased both the building and the restaurant, it could have neither. The two packaged transactions did, however, have separate prices.

The landlord’s position was that, in order to exercise the tenant’s ROFR on the building, it had to purchase the restaurant as well, because the landlord was only offering the building for sale as part of a transaction that involved the simultaneous sale of the restaurant.  In the subsequent dispute, the trial court did not adopt the landlord’s position that the tenant had to purchase both the building and the restaurant in order to exercise its ROFR; instead, the trial court held that the ROFR actually had not been triggered at all.  The trial court’s reasoning was that because the ROFR only applied to the building, and there was no indication that the landlord had acted in bad faith in packaging the sale of the building and the restaurant together, the ROFR was simply not applicable to the packaged transaction. 

The Iowa Court of Appeals, however, reversed the trial court, holding that the landlord could not in fact package the transaction, even in good faith, such that the tenant would be effectively deprived of its right to purchase the building as part of any sale that included the building.  Instead, the tenant was apparently entitled to have the building separately priced from the restaurant and its ROFR applied to that separately priced item in the package. 

The approach of the Iowa Court of Appeals, in Green Family Flooring, is not the approach of all courts to the issue of how to enforce a ROFR applicable to a specific asset that has been packaged with other assets.  According to a helpful 1995 law review note, by Bernard Daskal, a then student at Fordham Law School,^[1] there are in fact a variety of approaches that have been applied by courts in the U.S.  Some courts have held, like the trial court did in Green Family Flooring, that a ROFR covering a specific asset that is part of a packaged deal is simply not triggered, because the ROFR only covered a deal involving that specific asset alone.  Other courts have treated the ROFR as expanding to the broader package and requiring the holder of the ROFR to purchase the entire package or nothing at all, because that was, in fact, the only deal the seller was willing to accept from the third party.  Still other courts seem to require a good faith pricing that separates out the asset subject to the ROFR from the assets not subject to the ROFR.

ROFRs obviously can be written to expressly address a packaged sale situation so the courts do not have to determine the outcome the parties apparently intended, but did not expressly state.  But few ROFRs do so.  Thus, for those involved in performing the diligence and determining how to proceed in the face of a ROFR on a specific (but important) asset that is part of a purchase of an entire business, understanding the approach of the courts in the state whose law governs the ROFR is critical.  And Mr. Daskal’s 1995 law review note appears to be the only in depth treatment of the differing approaches employed by the various state courts that continue to be “vexed” by this issue.^[2] 

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