Purchase Option or Right of First Refusal – Which One is Right for Your Planning?

In planning for the succession of the family farm or ranch, we often use a purchase option or a right of first refusal to lock in certain rights. While these terms are often used interchangeably, in reality they are two very distinct rights with very different consequences. A right of first refusal is a right in a contract where the seller of property must give the other party the chance to match the offer that a third party has given to buy the property. An option to purchase, by contrast, is the granting of a right to a potential purchaser to be able to buy the property at a certain price during a certain time period.Consider the following example: John and Sue own a 500 acre farm in southeast Idaho. In their trust they have given their son, Tom, a right of first refusal to purchase the farm following their death. After John and Sue both die, the Trustee of their trust enters into a contract to sell the farm for $1 million to a neighbor. The sale is a cash sale with no financing contingency. In a true right of first refusal, Tom will have a certain number of days as specified in the right of first refusal to match the accepted offer on the same terms and conditions. While Tom could certainly negotiate a purchase of the farm without a third-party offer if the Trustee was willing, he has no “right” to compel the trust to sell him the farm apart from his right to match other acceptable offers.Contrast that example with the example of an option. If instead of a right of first refusal, Tom and Judy had instead stated that upon their death Tom would have the option to purchase the farm for $500,000. Tom could compel the trust to sell him the farm according to the terms and conditions of the option, even if the new Trustee preferred not to sell. A very different outcome.Whether you are planning with a right of first refusal or an option it is very important that all of the vital terms are included. The right of first refusal, at a minimum, should indicate how long the holder of the right has to match the offer. If the holder is allowed to vary the terms in any way, such as seller financing for example, these should be clearly stated. In an option it should be clear when the option period begins and ends and how the option is exercised. An option should also be clear on the terms of the sale such as purchase price and financing. If the specific purchase price is not known, a formula for how the purchase price is arrived at is vital – such as fair market value as determined by a qualified appraiser. Finally, in making these decisions consider whether the farmland will have a value that is not in line with Ag prices. For example, if the land is ripe for development, will the option allow the buyer to pay farmland values as opposed to the value of commercial or residential development property?As always, there are a lot of great tools in the tool box of a planner. Knowing how and when to use those tools is the key.