The First Right of Refusal

About 35 years ago, my brother and I were looking for a ranch. We had little money, but lots of time and energy.

We heard about a property we might be able to buy at an affordable price. It was listed for sale with a real estate broker with whom I was acquainted. He explained the situation like this.

Two brothers, Frankie and Al, had owned a ranch for many years. They had purchased it primarily as a hunting club. One of the brothers ran the business affairs and the other had made a hobby of making physical improvements like dams and roads. Over time they purchased additional property and the ranch grew to over 1,000 acres. In addition, it was adjacent to two land-locked sections of BLM ground – giving them almost 2,000 acres on which to hunt. The had it almost to themselves.

They had also built a very nice home on the property and they invited family members to hunt. Some of their guests actually paid a fee which allowed them unaccompanied access to the ranch.

Over the years, the brothers agreed that in their old age, they would sell the ranch if they needed money for retirement. Little did they know that Albert would drop dead from a heart attack at about the age of 50. Al was married and his portion of the ranch went to his wife. Having no other means to support herself, Albert’s wife asked Frank to purchase her interest in the property, or (at least) allow her to sell her half.

Although Frank did not agree to purchase her half, he did agree to letting her subdivide and sell subject to Frank having a first right of refusal to purchase.

Their agreement included a division of half the ranch into five 120 acre parcels. The parcels were put on the market for about $100,000 each with seller financing. As offers came in, Frank had the right to either match the offer or let Albert’s wife sell to the buyer.

The price was acceptable, but nobody wanted to be the guinea pig for Frank. It became clear to us that the agent and Albert’s wife were frustrated by their inability to obtain a viable offer.

My agreement with the seller’s agent was that we would split a 10% commission, but I couldn’t see making an offer just to watch Frank take the opportunity away from us. The $100,000 price was a little too rich for Rob and I to handle on our own, so we found a partner who would become  co-owner if the deal came together.

Then I got an idea that made a lot of sense. If the seller wanted to get the property sold, she might need to pay a higher commission. If she were willing to pay 20% and the selling agent was willing to accept 5%, we could pay me 15% even if Frank purchased the property. That would fund a pay out of 5% to me and each of my partners. Once I proposed this idea, my partners were a go. If Frank acted on the first right, we would each be compensated for our efforts.

The seller’s agent and the seller were fine with idea. At this point we made our $100,000 offer and waited to hear from Frank. He acted upon the first right.

There were  four remaining parcels available and we still didn’t know exactly what to expect from Frank, so we made an offer that would repeat itself on each of the remaining parcels with a commission being paid to me (and indirectly my partners) each time Frank acted.

Frank not only exercised his first right, but he became so annoyed that he outright purchased the remainder of the ranch. I received a commission of 15% on all five parcels. My partners and I were disappointed that we couldn’t own the property, but we were compensated for our disappointment.

Some significant information can be gleaned from this story. First of all, it is clear that a first right of refusal has a negative impact on one’s ability to sell property. And, it is clear that the first right decreases the value of the property – in this case about ten percent. In my opinion the actual decrease in value was even higher than that.

What’s a Duck Club Worth?

The value of a duck club is as subjective as any real estate evaluation on earth.

You never own the ducks.

An appraiser would look at duck club sales and compare the price, annual operating costs, taxes and acreage to come up with a value.

A few days ago I got a call from a duck hunter who was evaluating a duck club offering in the delta. He’d checked out my blog and decided that it would be worth his time to give me a call.

He gave me the salient facts. 1,000 acre club, ten partners, $2,500 per acre price for land under a wetlands reserve easement. 100 acre closed area, 7 days per week shooting, $40 per acre per year reclamation fees and a club house that he didn’t intend to use.

He then asked if I thought it would be a good purchase.

This is where things get dicey. Was he a hard-core duck hunter who appreciated quality time in the marsh? Or, was he a trophy duck-club owner who mainly wanted to impress acquaintances with his duck club address?

I assumed he was the former, not the later and told him that the price sounded OK if he could afford it. He said he could and sounded as if he was ready to move on it.

For sake of discussion, my clarity and your benefit, let me review the purchase. It may be helpful down the road to take a closer look at his purchase.

The price was straight forward – $250,000 for 1/10th share of 1,000 acres.

The fixed annual fees are pretty easy to estimate. Reclamation – $4000. Taxes – $2,500. If he’s borrowing the money, he should figure an annual interest cost of about $5,000 – $7,500 per $100,000 borrowed depending upon his borrowing rate. Most duck club buyers either pay cash for this type of property, or the seller provides financing.

Let’s assume he pays cash. That means he’s out at least $6,500 per year. But that’s not the end of the story. Duck clubs have other costs associated with operations. Insurance for one and that can vary depending upon the owners and the type of ownership entity.

A duck club should have an operating entity that creates an annual budget, pays bills and takes care of business. Somebody will be in charge and that person will probably want to be paid. Usually these fees are not large, but in this case I would estimate that the individual managing this club will want at least $200 per month. The insurance will probably be $1,000 per year. That adds up to another $340 per partner. Add in electricity and we can call it $400 per partner.

Duck clubs need to be maintained. That means they must be mowed, plowed and or sprayed. To plow the club one time around may cost $10 per acre – just a guess. Therefore I would estimate that the annual cost of maintaining the ponds would be about double that or $2,000 per share – including irrigation management, water control maintenance etc.

That puts the annual cost at about $9,000 for each owner. You can add to that a few other costs personal in nature.

The good news is the only time a buyer evaluates the cost of a duck club is when he’s making the decision to purchase. Once you own a club, you will just blindly pay until you either die, go broke, quit hunting or decide to purchase a new club.

It’s easy to divide up the cost of ownership. The tricky part of a duck club purchase is dividing up the hunting. That depends upon the individual member’s allowance of time, flexibility and desire.

A scenario that includes hunting every day tends to create a problem that’s hard to resolve –  competition between owners.

Having a system to give each owner a fair chance to enjoy the benefits of ownership is as critical to the success of a duck club as the availability of water.

Creating a Partnership that Lasts

Friends Fred, Steve, Gary and Ralph with limits

 

I recently received the following email. The question was so appropriate that I decided to make a post on the topic. 

Good morning Rich, 

          I bought a 100 acre property here in Ontario, Canada in January with three partners. We have known each other for over 25 years and have hunted together forever. We are starting to build our new camp this spring. I have been doing research on the net to find a document we can use and all agree on and sign for our camp. I am looking for something that may cover a member’s sudden death, buy outs, passing shares on to spouses or children, divorce and anything else that may pop up. I joined a few hunting forums to try and get some advise and possibly a copy of an other camps document, but all I seem to get is the old “be careful” speeches and not much more. A lot of people seem to have partnership agreements, but no one seems to want to share them with me. We have contacted a lawyer to draft an official document, but he told us if we could get a document already completed and just modify it to our situation it would be a lot cheaper. Rich, would you have a copy of a partnership agreement that you could share with me?  

Dear Ontario: It would not be appropriate, or much true help, for me to give you a partnership agreement from California. Penny wise and pound foolish would be an applicable phrase. 

I am not the best source to provide you with such a document. I am a real estate broker in California and I do have some experience with partnerships. I also have a copy of a partnership agreement around that I could provide. A lawyer is an expert in the law and also trained at producing clear agreements without ambiguity. Many of the clauses you need for your agreement have stood the test of time and an attorney understands how they apply. I do not do legal work. 

Undoubtedly the laws of Ontario Canada are different from the laws of California, both from a real estate and a partnership prospective. I could be accepting some liability by going so far as to provide a document – and it makes no sense to me to create liability as a blog writer. However, I do have a layman’s experience and I am willing to pass along some guidance – guidance that a lawyer may not provide. 

You must think of the partnership relationship you and your partners want to create. I believe that the best partnerships are created amongst groups that have commonality of goals and also similar starting points. As partnerships age, often the group splits as each individual moves in their own direction.  

Having a common starting point also creates a degree of equality among partners, making it difficult for one person to dominate. And, it creates the basis for common goals. 

Sometimes partnerships create limitations on the ability of partners to sell their interest. For example, partnerships sometimes allow partners to sell out only for their initial cost, plus some accrued interest. This type of partnership creates a situation where partners have little or no profit. Accordingly, there is no motivation to ever sell and little investment incentive. These agreements typically have a first right of refusal agreement built-in so the group or remaining partners have the first opportunity to purchase when an individual partner decides to sell. 

First right agreements tend to devalue each partnership interest. Typically the logic is that control over the membership is necessary to protect that group from exposure to undesirable individuals who could ruin the quite enjoyment of each of the group members. This is understandable. 

However, I am not a fan of this type of agreement. I prefer an agreement that follows typical real estate investment strategies where each individual has a right to sell their interest in the partnership at fair market value. I believe this model produces a better investment incentive for people who have limited funds. Partners are able to withdraw their funds and reinvest when necessary. 

If money is no consideration for any of the partners, or a degree of benevolence is present for some of the partners, the “no profit” concept can work, but this is not typically a healthy partnership situation from my prospective. 

An alternative method of protecting both the real estate business interests of the group and also the quite enjoyment of the hunt club is to create two entities. One group holds title to the property and the other leases the property from the real estate group. The two groups may be exactly the same people or they can be different. 

If a hunting partner wants to sell his real estate interest, he can do so and the protection of the recreational aspect will be provided by the operating agreement between the lessees. And, the lease provides some annual income to create a degree of investment incentive for the investor-owners. 

In other words, create two partnerships. This also adds flexibility to the group. If an individual owner moves away for a while, the group may be able to find somebody to be a lease partner until the real estate owner returns. When he returns he can assume his place in the hunting lodge again. 

If one of the owners gets into a financial bind, he may be able to sell his interest to a non-hunting owner and continue to hunt even though he can no longer afford to be an owner. The purchaser may decide it’s a worthwhile investment based upon the lease income. 

When a property has multiple uses, it’s possible to have hunting and non-hunter partners for other reasons as well. Diversity is often a  good thing. 

The makeup of the partnerships in which I’ve been involved has changed over time, but eventually we  seemed to find the “right” guys and subsequently have remained together for quite a while, despite the fact that each of us has our own unique style. 

It’s quite a bit like marriage. Oh my…..

Partition – Ending Co-tenancy

The situation

Ten parcels of ranch property owned by one partnership with about 25 members, one LLC with three members, a family trust with 20 heirs and four individuals including one who was deceased and still on title.

 

That was the status of our ranch in year 2003. We owned an undivided interest equivalent to 949 of the 2,540 acres and we owned different portions of each parcel. It was a mess.

 

Our first attorney couldn’t even get out of the box before he admitted we needed somebody else. Our second attorney got us half way there and decided to retire. Our third attorney took over and completed the job.

 

Now it’s over. All that’s left is to sign a few deeds. The judge signed a stipulated judgment (what all the parties agreed to through mediation) and  that agreement is on its way to the Alameda County Recorder’s office.

 

Why choose the partition route?

Partition is the last thing one must do to resolve untenable property ownership. All other options should be explored first. For ten years we attempted to work out an arrangement to have co-petitioners in a partition suit so we wouldn’t have to take everybody on by ourselves, but that attempt failed and in the end we were forced to go alone.

 

What’s the legal basis?

In general, every co-owner of property who owns property in co-tenancy and doesn’t have some type of partnership agreement has the right to sue for partition. If the property can be subdivided and distributed to co-owners (in kind distribution) the law says that’s the best resolution. If the property cannot be divided up into appropriate parcels, the law says you sell and divide up the money proportionate to each ownership interest.

 

We evaluated our situation. Although some said it could be done, we decided that there was no way to subdivide the ranch. The parcels ranged in size from 20 acres to 640 acres. Zoning laws did not allow parcels to be split. Ownership interests couldn’t be fit into the existing parcels without major ownership changes.

 

We held firm that the ranch would have to be sold.

 

Why didn’t we leave things the way they were?

One family group owned 5% of the ranch. They had at least five people hunting and each could kill two bucks. They showed no interest in conservation of the deer herd. If all the owners killed deer at a proportionate rate we would be taking more than 100 bucks per season. The ranch didn’t have 100 deer on it, let alone 100 bucks. Similar issues existed with at least one other owner.

 

The ranch was (and still is) suffering from disrepair. Since nobody claimed the ranch as their own, nobody took responsibility for doing the little maintenance things that are necessary to keep things working properly. Ponds dams needed work, fences were patched with temporary fixes, gates were held together with bailing wire etc. The few buildings on the property were ready to fall down.

 

Once we initiated the action, all the partners had to respond to the law suit or default on the action. If they defaulted, they would have no say in the outcome and would be forced to accept the judge’s decision.

 

Just getting the case ready for and in front of a judge took about two years. Once we got a court hearing, we then went through a year of delays as attorneys for the defendants sought extensions for any or no reason during the first few court dates.

 

Finally, mediation was scheduled for the spring of 2007. Getting meetings arranged took a few months, but the mediator was efficient and knowledgeable. He made it clear to each owner that if a mediation solution could not be reached that the ranch would be put up for sale. At least one of our co-owners was so angry with us that we thought the mediation might not be successful.

 

However, ultimately everybody realized that there was a solution to fit all. We bought out two owners of a total of 400 acres. Another co-owner bought about 250 acres. We agreed to take four parcels that approximated our ownership share and others did the same. We gave some property to another co-owner.

 

One year after completion of the mediation, the suit is over. After about four or five years of effort, the ranch will have four ownership entities. Everybody is better off. The guy who owned 94 acres and hunted on 2,540 may not have as good a hunting scenario, but he now owns 160 acres by himself and he got it without paying anything for the additional acreage.

 

Along the way we had to resolve ownership by one co-owner who was deceased and we gave another individual a five-year right to use one of the cabins on the property. Another individual received five years grazing rights on a section of ground.

 

Instead of 949 acres co-owned and unmanageable, we now have 1,300 acres we can manage as we see fit. I haven’t calculated the legal fees, but we paid attorneys two to three thousand dollars a month for several years. Whatever it cost, it was worth it.

 

Create a functional partnership agreement

The best way to prevent this problem is to enter into a partnership or co-tenant agreement whenever you become co-tenants with anybody. The partnership agreement must describe the process for selling whenever an individual wants to opt out of ownership. Keep in mind that not all partnership agreements are fair and equitable. I’ve seen some agreements that left the co-owners with fewer rights than they would have without an agreement.

 

Please keep in mind that I’m not an attorney and the purpose of this information is to give you the benefit of our experience. However, before you take action on your own, hire an attorney to tell you to resolve your issues. A good attorney may appear to be expensive, but in the long run good legal advise can be invaluable.

 

Partition – How We Ended Co-ownership with a Deceased Person (part 2)

When initiating our partition action, we knew that one of the owners had died unexpectedly, but we didn’t know the rest of the story – that he died intestate (without a will), that he was married and that his estate had not been probated even though he’d be deceased for over ten years.

 

We could not probate his estate because probate must be carried out by somebody who has legal standing and knowledge about the individual. In an attempt to resolve the issue, we researched to find out who his heirs were. That’s when we discovered that he had been married. We also knew his father.

 

Because his wife was of foreign decent, she did not communicate well and also was suspicious of our attempts. She also commented that she did not wish to give the property up because her deceased husband’s ashes were on the property.

 

We were very discouraged by these road blocks. She refused to respond to our notices, letters and direct communications. Because of her failure to respond we were forced to advertise for possible heirs and also post the ten parcels. She defaulted on responding to the suit so the judge’s final decision did not include her input.

 

Our attorney concluded that the only way to resolve the issue was to approach the judge with a plan to determine that our deceased co-owner had died without any known heirs and that the court should take over his estate’s share in ownership of the property.

 

We accomplished the necessary noticing and advertising and the stipulated judgment for partition states that we will receive title to the property and initiate what is called an “interpleader” action and deposit the purchase price with the Court to be held for the heirs or devisees of our deceased co-owner.

 

It is our responsibility to initiate this interpleader action and deposit the necessary funds. After we take the steps necessary to notify the heirs of the deceased partner we will be released from any further participation. In the mean time we have clear title and can wrap up the suit.

 

This mess demonstrates just one of the major issues that can arise from co-ownership without a written partnership agreement. If the heirs of a coowner don’t take the proper legal steps to probate upon death of a co-owner, it will end up being your problem too. This type of legal action is very expensive and very time consuming.

Partition Action – How We Ended Co-ownership with a Deceased Person (part one).

Sometimes you just can’t continue to co-own property with certain individuals. It’s similar to getting a divorce, but you may hardly know the person you’re “divorcing.”

I recently participated in a partition action on a ranch which I own approximately a twenty percent interest. As the petitioners my partners and I named the other co-owners in the suit and away we went.

My partners were my brother and my dad, while all the other owners became defendants. There were eight defendants, who owned an interest in one or more of ten parcels of land. We didn’t even know who all the owners were when we started. In fact, the suit is over and we still aren’t sure who all the owners are, or should I say were.

Here’s why. The defendants included two people who were deceased and when the suit started we didn’t know one of them was on title or that the other had died intestate and married to a wife we didn’t know existed. His estate had never been probated.

Due to administrate errors, one of the deceased owners was still on title long after his heirs thought his affairs had been wrapped up. Because title was not properly conveyed from the deceased to his trust, the trust could not successfully transfer title to the daughter, so when the daughter attempted to convey title to the new owner, the title company caught the glitch. She couldn’t convey because the chain of title had been broken.

Ironically this case could have ended when the title company offered to provide title insurance even though title was obviously flawed. As the future owners of the property in question, we were not willing to take the risk that this obvious flaw in the chain of title would not come back to haunt us at some time in the future so we declined accept the title insurance option and required that the flaw be corrected.

The way to correct the flaw is to ask the court to probate the property which had not been properly conveyed. This is a minor court action which will take some time, a probate appraisal and cost of few dollars in attorney’s fees, but when we’re done, we won’t have to worry about anybody challenging the validity of how we received title. As far as we’re concerned, this “clean up” issue can take place after the suit is over, so long as all the parties agree that it must be done and it is so stated in the final judgment.

The second deceased person was not so easy to deal with. I’ll tell you about that one in part two.