Right of First Refusal in Lease Agreements: What Lessees Should Know

The Philippine Supreme Court has long protected the rights of lessees who invest heavily in leased properties. In a significant 2010 ruling, the Court affirmed that a right of first refusal granted to a lessee is a binding contractual obligation that a lessor cannot ignore — even when the property is being sold to a government entity. The case of Polytechnic University of the Philippines v. Golden Horizon Realty Corporation (G.R. No. 183612, March 15, 2010) clarifies the scope and enforceability of this right, offering important lessons for both lessors and lessees.

The Facts of the Case

National Development Company (NDC), a government-owned corporation, leased portions of its property in Sta. Mesa, Manila to Golden Horizon Realty Corporation (GHRC) under two separate lease contracts executed in 1977 and 1978. The second contract contained an option clause allowing GHRC to purchase the leased area, with the price to be negotiated at the time the option was exercised.

GHRC invested approximately P5 million to construct buildings and improvements on the property, which it then subleased to various businesses. Before the lease expired in 1988, GHRC wrote to NDC twice — in June and August 1988 — expressing its desire to renew the lease and requesting priority to negotiate for purchase should NDC decide to sell. NDC never responded but continued accepting rental payments.

Unknown to GHRC, NDC had already been negotiating the sale of the entire property to the Polytechnic University of the Philippines (PUP) as early as July 1988. The sale was formalized through Memorandum Order No. 214 issued in January 1989, transferring the property to PUP at acquisition cost.

The Legal Issue

The central question was whether NDC violated GHRC's right of first refusal when it sold the leased property to PUP without first offering it to GHRC. A related issue was whether this right survived the expiration of the original lease contracts, particularly since NDC argued that the implied renewal of the lease was only month-to-month.

The Supreme Court's Ruling

The Court ruled in favor of GHRC, holding that NDC violated the lessee's right of first refusal. The Court made several key points:

First, the option to purchase clause in the lease contract, which had no definite period and made the price subject to future negotiation, constituted a right of first refusal rather than a traditional option contract. This distinction matters because a right of first refusal gives the lessee the first priority to buy the property when the lessor decides to sell.

Second, the timing of the violation was critical. NDC began negotiating the sale to PUP in July 1988 — while GHRC's lease was still in effect and its right of first refusal was subsisting. The Court found that the reckoning point was not the issuance of Memorandum Order No. 214 in January 1989, but the commencement of sale negotiations months earlier.

Third, the Court rejected NDC's argument that the right of first refusal did not carry over to the impliedly renewed month-to-month lease. Since the violation occurred before the original lease expired, this argument became irrelevant.

Fourth, the Court held that where a lease contract contains a right of first refusal, the lessor has a legal duty not to sell the property to anyone until the lessor has first offered it to the lessee. Only after the lessee fails to exercise this right can the lessor sell to others.

Fifth, the Court modified the trial court's price determination. While the RTC had fixed the price at P554.74 per square meter (the price NDC charged PUP), the Supreme Court adjusted it to P1,500.00 per square meter, which was the property's actual market value at the time of sale.

Practical Takeaways

• Right of first refusal is a valuable contractual right. When a lease contains this provision, the lessor must offer the property to the lessee before selling to anyone else. This obligation applies even if the sale is to a government entity.

• Timing matters. A lessor violates the right of first refusal when it begins negotiating a sale to a third party while the lessee's right is still subsisting — even if the actual transfer occurs later.

• Consideration is built into the lease. The right of first refusal is part of the lease contract, and the rental payments serve as consideration for both the lease and the right. A lessor cannot unilaterally withdraw this right.

• The right is enforceable. If violated, the lessee can compel the lessor to comply and may even require the transferee to reconvey the property at the price the lessor should have offered.

• Document your exercise of the right. GHRC's written letters expressing its desire to purchase were crucial evidence. Lessees should always document their exercise of contractual rights in writing.

This article is general information and not legal advice. For your specific situation, consult a lawyer or ask ASG Legal AI.