Friday, January 20, 2017
It’s not uncommon that a right of refusal is utilized when agricultural land is sold. It could be used to facilitate estate and succession planning objectives, avoid an unwanted co-tenant, give preference to a longstanding farm tenant, or give a neighbor a chance to own an adjacent tract that would fit well into their current farming operation. But, the actual drafting language of the provision can have an important impact. If the drafting language is not precise, it can void the right of refusal as being in violation of the Rule Against Perpetuities. That’s today’s focus – the application of an ancient rule to a modern contract provision that is commonly used in agricultural real estate transactions.
The Rule Against Perpetuities
While some states have repealed it, the vast majority of states retain the Rule Against Perpetuities (RAP). Basically, the rule puts a time limit to a restriction on a conveyance of real estate. Under the common-law rule, the restriction can’t last more than 21 years after a particularly identified person dies. So, you can’t tie up property for too long after the lives of the people living at the time the instrument was drafted creating the conveyance. The RAP dates back to the late 1600s in England, and it is typically difficult to apply (as evidenced by the numerous court decisions that have struggled with it).
So what does the RAP have to do with a right of refusal associated with the sale of farmland? If the right of refusal is not drafted carefully, the RAP could void the conveyance. Whether it does or not largely depends on how great a restriction it puts on the alienability (transferability) of land, so careful drafting is the key to staying out of litigation on the matter. A recent case from Kansas illustrates these points.
In a recent case from Kansas, Trear v. Chamberlain, et al., No. 115,819, 2017 Kan. App. LEXIS 56 (Kan. Ct. App. Jan. 13, 2017), the plaintiff bought some real estate from a married couple in 1986. The purchase contract contained a right of refusal stating that if the defendants (the sellers) offered to sell the land adjoining the land the plaintiff purchased, the plaintiff would be offered a right to buy the land at a price and on terms that the parties mutually agreed upon. The adjoining land contained the couple’s home. The right of refusal was to lapse if the parties could not agree on purchase terms. The purchase contract was also “binding upon the heirs, legal representatives, and assigns of the parties hereto.” That language inadvertently ended up creating an issue with the RAP.
The husband-seller died in 2013 and his surviving wife sought to sell the adjoining tract later that same year. As a result, her lawyer sent a letter to the plaintiff offering to sell it to him for $289,000. The plaintiff did not respond to the offer, and the surviving wife listed the tract with a real estate company for $295,000. The plaintiff did not make an offer on the property. The tract did not sell and was taken off of the market. The surviving wife then sold 64 of the 73 acres of the adjoining tract (not including the house) to her daughter and a third party for $91,125. Upon learning of the sale, the plaintiff sued to enforce the right of refusal and to have the property transferred to himself. The surviving wife, her daughter and the third party motioned for summary judgment. The trial court determined that the right of refusal violated the RAP and was nullified. Another issue not relevant for our discussion here is that the trial court determined that the right of refusal did not violate the Statute of Frauds because the adjoining tract could be identified.
On appeal, the appellate court reversed on the RAP issue, finding that the right of refusal, based on a 1994 Kansas Supreme Court decision, was a personal right to the plaintiff that expired on his death and couldn’t be passed to anyone else. In addition, the court determined that the contract language making the contract binding on the “heirs, legal representatives and assigns” made the contract binding on the seller’s heirs, legal representatives and assigns as long as the plaintiff was living. In addition, the right of refusal was not voided by the plaintiff’s failure to act on the surviving wife’s first offer of the property to the plaintiff. There had not yet been an offer from anyone else for the property at the time it was offered to the plaintiff. Thus, the right of refusal had not been triggered. But, when the surviving wife sold some of the remaining tract to her daughter and a third party, the plaintiff was not given the opportunity to buy it on the same terms as the right of refusal required. Because the price at which it was sold to the daughter and third party was much less than the price at which the full tract was offered to the plaintiff, that raised a fact issue as to good faith resulting in the court denying the summary judgment motion. However, the appellate court upheld the trial court’s determination that the contract satisfied the Statute of Frauds - the contract was in writing, the material terms were stated with reasonable certainty and the adjoining tract could be identified.
As noted earlier, rights of refusal are often used in real estate transactions involving farm and ranch land. So, how can a right of refusal be drafted to avoid questions about its enforceability? A mere de minimis restraint on the alienability of property won’t violate the RAP. So, if a right of refusal arises only when a property owner receives a bona fide offer and the holder of the right chooses not to purchase the property and the owner remains free to sell to the third party, the RAP will likely not be violated. That’s why the right of refusal in the Kansas case didn’t violate the RAP. But, if the right is tied to a fixed price or a long time-period during which the holder can chose to buy the property, then it runs a higher risk of violating the RAP. By not tying the right of refusal to a fixed price the seller can sell the property for market value and will still have an incentive to improve it and offer it for sale.
It’s also probably a good idea for a right of refusal to also clearly specify how notice of the offer to buy is to be sent to the holder of the right. How soon after receiving an offer must the holder be notified? It’s best to allow the holder to have a reasonable time to arrange for financing, conduct surveys and perform due diligence with respect to environmental and USDA regulatory issues. On this point, it can speed the process along if the third-party offeror is required to share information pertinent to the property (such as surveys, etc.) with the holder of the right refusal. Also, in what manner is the holder to be notified? How much time does the holder have to respond to the notice? Must the holder’s response, if the holder want to exercise the option, match precisely the terms and conditions of the third party’s offer? What if there are any non-monetary terms of the offer? In addition, a good contract should specify that the landowner cannot create any restrictions on the property (such as easements, for example) that would run counter to the holder’s known future use of the property.
Another point to consider when drafting a right of refusal is to clearly define what triggers the exercise of the right. Is it triggered only by an offer by a third party? What if the landowner dies and the property is transferred via will? What if it is gifted? What if the owner gets in financial trouble and the property is sold at a foreclosure sale or in bankruptcy? Do those events trigger the exercise of the right of refusal? The question is basically whether those events rise to the level of a bona fide purchase.
A right of refusal is a useful and commonly tool in agricultural land sales. But, language used to create the right is critical to avoiding misunderstandings and benefit both the seller of the property and the holder of the right.