Expansion Options, ROFO and ROFR: What Is the Difference?

Growing companies ask for "expansion rights" as if they were one thing. In a lease they are three distinct mechanisms, and a letter of intent that uses the terms loosely can leave you with much less than you thought you negotiated.

The useful way to tell them apart is to ask two questions of each. Who decides when the right can be used, you or the landlord? And who sets the terms on which you take the space?

• Expansion option: you decide, within a window written into the lease, and the terms are set by the lease.
• Right of first offer (ROFO): the landlord decides when the space becomes available, and the landlord proposes the terms to you first.
• Right of first refusal (ROFR): a third party's interest triggers the right, and that third party's deal sets the terms you must match.

An expansion option names a specific space, or a floor or area from which the landlord will designate space, and gives you the right to lease it by giving notice within a defined window. The landlord must make sure the space is available then, which usually means leasing it to someone else only for a term that ends before your window opens.

That obligation is why landlords grant fixed options sparingly. It restricts how they can lease part of the building. They are more willing when you are a large tenant in the building, when the option space is hard to lease on its own, or when the market gives tenants the upper hand.

Points to settle in the lease language:

• The exact space, shown on a floor plan, and whether the landlord may substitute comparable space.
• The window for giving notice and the window in which the landlord must deliver the space. Landlords ask for a delivery range because they cannot control exactly when a prior occupant leaves.
• How rent is set: the same rate you are paying, a stated rate, or fair market rent determined when you exercise.
• What improvement allowance and free rent, if any, apply to the added space.
• Whether the term for the new space ends on the same day as your existing lease.

A related structure is must-take space, in which you commit now to add specific space on a future date. It gives the landlord certainty, which can earn better terms, but it is an obligation. Use it only for growth you are confident in.

Under a ROFO, when defined space becomes available or is about to, the landlord must notify you and offer it to you before leasing it to anyone else. You have a set period to accept. If you decline or do not respond, the landlord may lease it to others.

A ROFO costs the landlord little, since it only has to make one offer before going to market, so it is the expansion right most often granted. Its weakness is that it guarantees nothing about timing. The space may come available before you need it, long after, or never during your term.

The details that determine its value:

• What triggers it. "Available" should be defined, and you should know whether the existing occupant's renewal, or a renewal the landlord chooses to negotiate, keeps the space from ever being offered.
• What terms the landlord must offer. A good clause requires the terms the landlord intends to offer the market, or ties rent to fair market value, so the offer cannot be set artificially high.
• Protection after you decline. Ask that the landlord may not then lease the space to someone else on materially better terms without first coming back to you.
• One-time or continuing. A one-time ROFO ends the first time you pass on the space. A continuing ROFO revives each time the space becomes available again.
• How long you have to respond. The period must be long enough for a real decision, including any board approval, and short enough that the landlord will agree to it.

Under a ROFR, when the landlord receives an offer it is prepared to accept from another party for the defined space, it must give you the chance to take the space on those same terms. You never pay more than a real third party was willing to pay, which is the appeal.

Landlords resist ROFRs for a practical reason. A prospective tenant that learns its negotiated deal can be taken by someone else may not spend the time and money to negotiate at all, which makes the space harder to lease. Expect pushback, a short response period, or a counteroffer of a ROFO.

A ROFR also has drawbacks for you. You do not control the timing. You must decide quickly. And matching means matching: if the third party offered a long term, a different size or a configuration that suits it and not you, those are the terms on the table. Negotiate how mismatches are handled, for example that the term for the added space will run with your existing lease and the economics will be adjusted to fit.

Ask for evidence too. The lease should require the landlord to provide the material terms of a genuine third-party proposal, so the right is triggered by a real deal.

From the tenant's side, the usual ranking is as follows.

1. Expansion option. Strongest, because space must be available in a known window on terms set in advance.
2. Right of first refusal. You can always match a real deal, but only if and when one appears.
3. Right of first offer. You get the first look, on the landlord's proposed terms, if and when space becomes available.

The ranking is a generalization. A carefully drafted continuing ROFO with fair pricing and protection against a better later deal can serve you better than a ROFR with a very short response period. And any of the three is weakened by a factor that sits outside the clause itself: other tenants' rights.

Ask the landlord to disclose in writing every existing right other tenants hold on the space you are targeting. Rights granted earlier generally come first, and a right that is fourth in line is close to no right.

Rights can also be combined. A common package for a growing tenant is a fixed option on one adjacent suite and a continuing ROFO on the rest of the floor.

Landlord forms attach conditions to expansion rights. Each is reasonable in moderation and harmful if it goes unnoticed.

• ✓Is the right personal to us, or does it pass to a permitted assignee or a successor after an acquisition?
• ✓Does the right lapse if we have sublet part of our space, and if so, how much?
• ✓Does a past default, already cured, cancel the right, or only a default that exists when we exercise?
• ✓Is there a minimum remaining term required to exercise, and can we extend our term to satisfy it?
• ✓Does the right end on a set date well before the lease expires?
• ✓Is the right subordinate to existing tenants' rights, and do we have a list of them?
• ✓Are the notice method and deadline clear enough that we cannot miss them by accident?

These clauses are short, and each word matters. Have your attorney review the final language, and record every response period and deadline where your finance and operations leads will see it.

Tenant Advisory Group negotiates expansion rights at the letter of intent stage, when landlords are still competing for the tenancy, and we ask for the building's existing encumbrances before a client relies on any of them.