The Importance of Honoring the Right of First Refusal in Contract Law

G.R. No. 111538, February 26, 1997

Imagine you’ve been leasing a property for years, investing in improvements, with the understanding that if the owner ever decides to sell, you’ll have the first chance to buy it. Then, one day, you discover the property has been sold to someone else without you even being given the opportunity to make an offer. This scenario highlights the importance of the legal concept known as the right of first refusal.

This case, Parañaque Kings Enterprises, Incorporated vs. Court of Appeals, delves into the intricacies of this right, exploring what constitutes a valid cause of action when it’s violated and the remedies available to the aggrieved party. It underscores the significance of adhering to contractual obligations and the potential legal ramifications of failing to do so.

Understanding the Right of First Refusal

A right of first refusal is a contractual right, often found in lease agreements, that gives a party the first opportunity to purchase a property if the owner decides to sell. It doesn’t compel the owner to sell, but if they do, they must first offer it to the party holding the right, typically on the same terms offered to a third party.

This right is designed to protect the interests of the party who has invested time, money, or effort into a property, giving them the chance to reap the benefits of their investment. The Civil Code of the Philippines governs contractual obligations. Article 1159 states: “Obligations arising from contracts have the force of law between the contracting parties and should be complied with in good faith.” This principle is central to understanding the enforceability of a right of first refusal.

Prior cases like Guzman, Bocaling & Co. vs. Bonnevie (206 SCRA 668, March 2, 1992) have clarified that the holder of the right of first refusal must be offered the property on the same terms as any other potential buyer. Only if the holder declines can the owner proceed to sell to a third party. The case of Equatorial Realty vs. Mayfair Theater, Inc. further emphasizes that the right holder should be given every opportunity to negotiate within a reasonable period. Failure to do so constitutes bad faith and can lead to rescission of the sale.

The Case of Parañaque Kings Enterprises

Parañaque Kings Enterprises (PKE) leased a property from Catalina Santos, with a clause in the lease agreement granting PKE the “first option or priority to buy” the property if Santos decided to sell. Santos initially sold the property to David Raymundo without offering it to PKE. After PKE complained, Santos repurchased the property and offered it to PKE for P15 million, which PKE rejected as overpriced. Santos then sold the property to Raymundo again, this time for P9 million, without offering it to PKE at that price.

PKE filed a complaint seeking to annul the sale to Raymundo and compel Santos to sell the property to them for P5 million, the original price Raymundo paid. The trial court dismissed the complaint for lack of a valid cause of action, arguing that Santos had complied with the right of first refusal by offering the property to PKE, even though the price was higher. The Court of Appeals affirmed this decision.

The Supreme Court reversed the lower courts, holding that the complaint stated a valid cause of action. The Court emphasized that the right of first refusal required Santos to offer the property to PKE at the same price and terms as those offered to Raymundo. Here are key points from the Court’s reasoning:

• “In order to have full compliance with the contractual right granting petitioner the first option to purchase, the sale of the properties for the amount of P9 million, the price for which they were finally sold to respondent Raymundo, should have likewise been first offered to petitioner.”
• “From the foregoing, the basis of the right of the first refusal must be the current offer to sell of the seller or offer to purchase of any prospective buyer. Only after the grantee fails to exercise its right of first priority under the same terms and within the period contemplated, could the owner validly offer to sell the property to a third person, again, under the same terms as offered to the grantee.”

The Supreme Court found that the lower courts erred in dismissing the complaint, as PKE had sufficiently alleged a breach of contract. The case was remanded to the trial court for further proceedings.

Practical Implications of the Ruling

This case serves as a reminder of the binding nature of contractual obligations, particularly the right of first refusal. Property owners must understand that granting this right creates a legal obligation to offer the property to the right holder on the same terms as any other potential buyer.

For businesses and individuals holding a right of first refusal, this case reinforces their ability to enforce that right through legal action. It clarifies that a mere offer at an inflated price does not satisfy the obligation; the offer must reflect the actual terms of the sale to a third party.

Key Lessons:

• Honor Contractual Obligations: Always comply with the terms of contracts, especially those granting rights of first refusal.
• Offer the Same Terms: If you decide to sell, offer the property to the right holder on the same terms and conditions as any other potential buyer.
• Document Everything: Keep detailed records of all offers, negotiations, and communications related to the sale of the property.

Hypothetical Example:

Suppose a company leases office space with a right of first refusal. The landlord receives an offer from another company to buy the building for P20 million. The landlord must first offer the existing tenant the opportunity to purchase the building for P20 million. If the tenant declines, only then can the landlord proceed with the sale to the other company.

Frequently Asked Questions

Q: What is a right of first refusal?

A: It is a contractual right that gives a party the first opportunity to purchase a property if the owner decides to sell.

Q: Does a right of first refusal force the owner to sell?

A: No, it doesn’t compel the owner to sell, but if they do, they must first offer it to the party holding the right.

Q: What happens if the owner sells the property to someone else without offering it to the right holder?

A: The right holder can sue for breach of contract and seek remedies such as specific performance (compelling the owner to sell to them) or damages.

Q: Does the owner have to offer the property at the same price?

A: Yes, the owner must offer the property to the right holder on the same terms and conditions as those offered to a third party.

Q: What should I do if I believe my right of first refusal has been violated?

A: Consult with an attorney to review your contract and discuss your legal options.

Q: Can a right of first refusal be assigned to someone else?

A: Yes, the right can be assigned, unless the contract specifically prohibits it.

ASG Law specializes in real estate law and contract disputes. Contact us or email hello@asglawpartners.com to schedule a consultation.