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I.Legislative considerations
The right of first refusal enjoyed by a lessee of real property endows the leasehold of real estate with priority in terms of effect over general creditor’s rights. There are doubts about the considerations behind this legislation.
A.Foreign legislations
1.Germany
Section 577 of the German Civil Code provides that a lessee has a right of first refusal: (1) If leased residential premises, apartment ownership of which has been established or is to be established after the lessee has been permitted to use it, is sold to a third party, then the lessee has a right of first refusal with regard to it. This does not apply if the lessor sells the residential premises to a member of his family or a member of his household. To the extent that the following subsections do not lead to a different conclusion, the right of first refusal is governed by the provisions on preemption. (2) The notification of the seller or of the third party on the contents of the purchase agreement is to be supplied together with information to the lessee on his right of first refusal. (3) The right of first refusal is exercised by a written declaration of the lessee to the seller. (4) If the lessee dies, then the purchase option passes to the persons who succeed to the lease under section 563 (1) or (2). (5) A deviating agreement to the disadvantage of the lessee is ineffective. Germany limits the subjects of the right of first refusal to the lessees of “the leased residential premises, apartment ownership of which has been established or is to be established” and treats them as the weak and offer them protection
2. The Taiwan region
Article 104 of the Land Act of the Taiwan region provides that in the case of the sale of a land, the owner of superficies, the dien right holder or the lessee have the right of first refusal under the same terms and conditions. In the case of the sale of a house, the owner of the land has the right of first refusal under the same terms and conditions. The order is determined by the order of registration. Persons with purchase priority as mentioned in the previous Article should respond within 10 days after the receipt of the sale notice, and failure to respond within the specified time limit shall be deemed to have waived that right. The contract entered with a third party by the seller without giving prior notice to the person with the right of first refusal cannot be used against that person. In 1999, Taiwan revised its Civil Code to incorporate the aforesaid provisions into Article 426, providing that in the case that a lessee rent a land to build a house, if the lessor sells the land, the lessee has a right of first refusal under the same terms and conditions. If the lessee sells the house, the owner of the land has a right of first refusal to buy the house under the same terms and conditions. In the previous circumstances, the seller should notify the person with the right of first refusal in writing the terms and conditions of the sale. The person with the right of first refusal should respond in writing within 10 days after the receipt of the written notice and failure to respond within the specified time frame shall be deemed to have waived that right. The registration of the transfer of ownership made by the seller without giving prior written notice to the person with the right of first refusal cannot be used to defend against that person. From the above legal provisions, it can be seen that the Taiwan region first uses the Land Act to regulate the lessee’s right of first refusal, the purpose of which is to avoid the separation of land possession and land use as well as deformed land and the segregation of ownership, to unify land ownership and house ownership and avoid the tendency of complicating legal relationship so as to make full use of the land.1 In the Taiwan region, the land is privately owned. Thus, the land and the house thereon may belong to different persons. To unify land ownership and land use, it is established that a lessee has a right of first refusal. This legislation is not for the purpose of protecting the weak. Nor does it presume the lessee is the poor and disadvantaged of the society in economy.
B. Legislative situation and purpose in China
1.Current laws and judicial interpretations
Article 230 of the Contract Law of the PRC set out provisions on the lessee’s right of first refusal in principle. It merely provides that where the lessor is to sell a dwelling unit under a lease, it shall give the lessee a reasonable advance notice before the sale, and the lessee has the right of first refusal under the same conditions. Article 118 of the Opinions of the Supreme People’s Court on Several Issues concerning the Implementation of the General Principle of Civil Law of the PRC (Trial Implementation) lays down strict provisions with regard to the consequences of the lessor’s violation of a lessee’s right of first refusal. It provides: If a lessor wants to sell his leased house, he shall notify the lessee three months in advance, and the lessee shall have priority to buy the house under the same conditions; if a lessor fails to sell the house based on such conditions, the lessee may claim to the people’s court for declaration of the invalidity of the sale of the house. In 2009, the Supreme People’s Court promulgated the Interpretation on Several Issues concerning the Application of Law in the Trial of Cases about Disputes over Lease Contracts on Urban Buildings. Articles 21 to 24 thereof set forth explicit provisions regarding a lessee’s right of first refusal. Article 21 thereof amended the aforesaid provision and expressly states that the violation of a lessee’s right of first refusal shall not affect the validity of the sales contract, and the lessee can only sue for damages. Article 24 thereof specifically set out the circumstances in which the lessee does not have the right of first refusal. As to the reason why China grants the lessees the right of first refusal, there has been no authoritative interpretation from the legislative and judicial organs.
2.Legislative purpose seen from the debate on keeping or abolishing the right of first refusal
The traditional view is that the lessee of a house is the weak in economy and should be protected to maintain social equity and justice. The right of first refusal is in the final analysis a mere priority in the opportunity of purchase rather than a benefit in economy. The exercise of right of first refusal should not infringe on the seller’s substantive interests and result in unbalance of economic interests between the seller and the person with the right of first refusal.2
The opponent alleges that the traditional view fails to explain such a fact that the validity of a lease contract between a lessee and a seller is not affected by the change of ownership of the lease item. That is, the change in ownership in real property does not affect the contract between landlords and tenants. Even though the lease item at this time had been sold to the buyer, it had nothing to do with the lessee. The lessee’s interests in using the lease item were not affected. Then why is the lessee given the right of first refusal? And how can the lessee be called the weak if he can afford the leased real property? Hence, the system of right of first refusal should be abolished. This system restricts ownership, which not only violates the principle of autonomy of the will of parties and the theory that the law protects ownership but also is not beneficial to the flow of goods and effective operation of the fair competition mechanism in the market economy.3
As I see it, there are fundamental values for the existence of the system of the real estate lessee’s right of first refusal. There are two basic principles in private law: freedom and efficiency. In terms of freedom, it is about how to guarantee and realize an individual’s autonomous space regarding his property. In terms of efficiency, it concerns how to make the property come to persons who can make full use of it. From the perspective of economics, an efficient system should impel the social resources to flow to persons who are the most good at operation and can maximize its efficiency. The system of the lessee’s right of first refusal meets the demand of efficiency value. It endows the lessee with the right of first refusal based on lease relationship. The purpose of such design is to simplify the legal relationship and prompt and achieve the most efficient use of property, which reflects the pursuit of efficiency value. The lessee, through a lease contract, has in advance occupied, used and benefited from the leased house, who is more aware of the attribute of the lease item than the potential buyer, and more experienced in the operation of the lease item, and apparently more confident in its future operation when he intends to make the purchase. From the angle of economics, the continuous use of a property is obviously beneficial to the achievement of the goal of efficiency, i.e., producing more output with the same amount of inputs. Seen from the transaction cost, under the same conditions, the transaction cost in a lease item between the lessor and the lessee is the lowest. The following reasons can explain this. First, the lessor and the lessee know each other and thus a higher level of honesty and credibility can be ensured, which will decrease the time spent on inspection and hesitation. Second, the lessee is familiar with the situation of the lease item and thus there is no need for the lessor to explain, to look for an intermediary agent, which will lower the transaction cost. Third, the lessee has occupied the lease item. Once the transaction is closed, the only thing left to do is to handle the procedure of registration, which will avoid the trouble of delivering the lease item. Though the system of the lessee’s right of first refusal may to a certain extent restrict the lessor’s right in choosing transaction partners, it won’t cause any harm to the lessor’s substantive economic interests; rather, it will spur the third party to bid against the lessee and may probably raise the transaction price. Therefore, the system, seemingly restricting the lessor’s freedom, actually protects the lessor’s fundamental economic interests. In the contest between the lessee and the third party, i.e., the person who can afford to lease a house and the person who can afford to buy a house, the law leans towards the former and gives consideration to the relatively weak, which reflects humanistic care and achieves the goal of justice. Therefore, I insist that there are rationales behind the existence of the system of right of first refusal. This system to a certain degree limits freedom but safeguards interests, and sacrifices the relatively strong but cares for the relatively weak. This system takes into account both efficiency and fairness and realizes the unification of freedom and justice.
II. Restriction on the parties who exercise the right of first refusal
A real estate lessee has a right of first refusal. However, doubts exist regarding the definition of lessee. To the lessor, there exist a lessee and a sub-lessee in the case of lawful sublease. No explicit provisions can be found in China’s laws and judicial interpretations. There are at present three viewpoints in the academic and practical circles:
1. Only lessees have the right of first refusal. Due to the relativity of lease contracts, a sublessee can only claim rights against the lessee rather than against the lessor. This viewpoint, influenced by the viewpoint of the judiciary circles of the Taiwan region, maintains that sublessees cannot claim right of first refusal.
2. Only sublessees enjoy the right of first refusal. In accordance with the legislative intent, the purpose of granting lessees the right of first refusal is to protect the lessees’s interests in using the lease item and guarantee the interests of the disadvantaged. Given this intention, only an actual lessee has the interests in using the lease item. Hence, an actual lessee, no matter whether it is a lessee or sublessee or sub-sublessee, is entitled to the right of first refusal. This viewpoint is held by some people in China’s judicial practice.
3. Both lessees and sublessees have the right of first refusal. In the case of lawful sublease of a lease item, if the lessor sells the lease item, there exist two rights of first refusal, i.e., both the lessee and sublessee have the right of first refusal. Under the same conditions, the right of first refusal should be first given to the sublessee because he is occupying and using the leased house and has more reasons to claim the right of first refusal in comparison with the lessee. In contrast, the lessee, after entering the lease contract with the lessor, subleased the house to make profit, who concerns more about the rents than the actual use of the house. Protecting the right of first refusal of the sublessee, the actual occupant and user of the house, is more in conformity with the legislative intent of the law in establishing the lessee’s right of first refusal. Of course, if the sublessee does not assert the right of first refusal under the same conditions, the lessee should enjoy the right of first refusal in comparison with other transaction parties in the market because the leased house is more connected to the lessee in comparison with others.
I think the first viewpoint is relatively proper. Take for example that A leased a house to B, and B subleased it to C. First, seen from the legislative technique, the lessees protected in the law of various countries are those conforming to certain requirements. If the establishment of right of first refusal is to protect the lessee who is in a vulnerable position, then the lessee is the one who is subject to some restrictions. That is, the lessees protected by law are those who have contractual relationship with the lessors. The parties to a sublease contract are the lessee B and sublessee C. There is no lease relationship between the sublessee C and the lessor A. The sublessee C does not obtain the right to lease the lessor A’s house. The lessee protected by law is the lessor A’s lessee, not the sublessee B’s lessee. Therefore, the sublessee C does not have the right of first refusal. Second, in the case of sublease permitted by the lessor, there might be one, two, ten, and even scores of sublessees. If all sublessees have the right of first refusal, the lessor will bear heavy burden, which is unpredictable, when selling the real estate even if there is the restriction of order. Suppose only the last actual lessee has the right of first refusal, then how can he prove that he is the legal and actual lessee? There is in his hand only the lease contract signed with the prior party. The lease contract between the prior party and the priorprior party is unknown and it is difficult to demand others to cooperate. As a result, in the case of multiple sublease, it is difficult for the actual sublessee to prove to the seller that he is the actual lessee and the seller does not have the duty to investigate this matter. Third, seen from the right of lease, the lessee’s lease right is not only stipulated by a lease contract but also prescribed by law. The lessee may sublease lawfully under the lease contract. However, under the law, there is no space for free transfer because the law sets out special provisions regarding the status of a lessee. Consequently, in the case of the transfer of lease right, i.e., the lessee completely exited from the lease relationship and was replaced by others, and others obtain the right of lease completely and of course enjoy the right of first refusal. In summary, whether it is from the legislative intent, or the actual operation, or the nature of lease right, the right of first refusal can only be enjoyed by the lessee who entered the lease contract with the seller. The lack of express provision in China’s law regarding the right of first refusal results in inconsistent rulings in the judicial practice. The law should be explicit in this issue as early as possible so as to clarify understanding and ensure uniform judicial decisions. Additionally, the German Civil Code provides that in the event that the lessee died, his right of first refusal shall be transferred to the other family members who live together with him, which, in my view, is very necessary and worth learning.
III. Specific issues relating to the exercise of right of first refusal
A. Choice of the way of notice
A legally valid lease contract is one of the requirements for the lessee to enjoy the right of first refusal. If the lease contract does not exist, or is invalid, or is terminated due to expiration, the lessee is not entitled to the right of first refusal. The question is if the lease contract between the lessor and the lessee is indeed legitimate and effective but the lease item has not yet been delivered to the lessee, does the lessee have the right of first refusal?
According to the majority of viewpoints, the premise of obtaining lease right is that the lessee actually occupies the lease item, and the lessee has the right of lease only after he receives the delivery and occupies the lease item, and it is only at this time the lease right has the effect of countervailing force and priority similar to real rights.6 For example, Section 577 of the German Civil Code provides that if leased residential premises, apartment ownership of which has been established or is to be established after the lessee has been permitted to use it, is sold to a third party, then the lessee has a right of preemption with regard to it. China’s law does not set forth provisions with regard to this. I am of view that prior to the actual occupation of the lease item by the lessee, the lessee has only the right to require delivery of the lease item even if a lease contract has been signed. In this sense, he is no different from general creditors. He has not had actual usufruct interests in the lease item. There is no need to provide him with special protection via the right of first refusal. With respect to the third party who plans to buy, in the case of no actual receipt of the delivery and actual occupation by the lessee, there has been totally no opportunity for the third party to know that there exists a right of first refusal. It is unfair to the potential buyer. Hence, the right of first refusal has after all the priority effect of real right and necessary notice should be given before its exercise. In Germany and the Taiwan region, there is no requirement of registration with respect to real property lease. As a consequence, for the right of first refusal to take effect, it is very necessary to require delivery, occupation and notice. However, to my mind, to ensure transaction safety and balance the interests of the third party, it is more appropriate and efficient to give notice by means of registering the real property lease contract.
B. Mandatory provision or optional provision
The system of the right of first refusal endows the rental rights with prior effect over general creditor’s rights. This effect is of real rights type and should be mandatory. It means that the parties to a lease contract cannot make stipulations regarding the effect of the contract against a third party and such stipulations, if any, are invalid to the third party. The lessee’s right of first refusal is specially set by law. The grant of the right of first refusal is to grant a possibility of an action. The rights holder will decide whether to act or not. Thus, the holder of right of first refusal may waive such rights in a lease contract. Section 577 (5) of the German Civil Code provides that a deviating agreement to the disadvantage of the lessee is ineffective. I suggest China should refer to this provision. That is, the lessee’s right of first refusal is directed at the lessor and the buyer of a lease item. If they stipulate that the lessee has no right of first refusal, the stipulation will be deemed invalid, which is a mandatory provision. However, the lessee may waive this right through stipulation with the lessor or the buyer of the lease item.
C. Interpretation of the “selling of rental house”
Under China’s Contract Law, the premise that the lessee excises his right of first refusal is the selling of the leased housing by the lessor. Then how do we interpret the issue “selling of the rental house”? Real property includes housing and land. In China, lease exists in the secondary market rather than in the primary market of the state-owned land. Namely, those who obtain the right to use the state-owned land through such form as transfer or appropriation may let the land to others. Of course, the lease agreement signed at this time is, to be exact, not the lease of real property but of rights because the lessor has no right to dispose of the land. Thus, there is no possibility that the lessor sells the leased land. Accordingly, in China, with respect to the lease of state-owned land, there is no condition for the exercise of right of first refusal. With respect to the collectively-owned rural land, China’s land law expressly states that it cannot be directly used for leasing. In China, there is no condition for the lessee of a land to exercise the right of first refusal. Hence, it is correct to limit the subject matter to houses, which inevitably involves the issue of interpreting “houses”. In accordance with the provisions regarding the measures for the administration of house leasing promulgated by some cities, the “leased houses” can be interpreted to include: (1) temporary houses and factory buildings built under law; (2) business sites, counters, stalls of a house as well as underground facilities. The meaning of “sell” is worth weighing. The word “sell”originates from buying and selling. In a sales contract, the seller’s act is called selling. Hence, the right of first refusal does not apply to cases where the change of ownership of the leased house is due to gift, bequest and inheritance. However, if the house is of the nature of half selling and half giving, i.e., a mixed gift, does the right of first refusal apply? As I see it, a mixed gift is a gift given with pay and since gift exists, the emphasis is on personal relations and degree of trust, and it differs from pure buying and selling. Thus, in the case of a mixed gift, right of first refusal does not apply. Some local administrative regulations in China interpret it broadly and define house sales to include house transfer with compensation, exchange of house ownership, fake investment with a house, rebuilding or expanding one’s own house in cooperation with others, paying off debt with a house.7 This broad interpretation in practice should be treated differently and strictly based on specific situations. Paying off debt with a house and transferring a house with compensation should be deemed selling of the house. However, house exchange, investment with houses, cooperatively building and expanding of houses are different. Though the house ownership at this time has changed, the purpose of the house seller is not to obtain the market price of the house but for other purposes beyond the market price. Can the lessee exercise right of first refusal if he can provide the “same” condition as the third party did? In my view, where the ownership of a house changes in the form of exchange, if the exchanged objects are nondefined objects, it is possible for the third party to offer the same condition; however, if the exchanged objects are defined objects, the third party is unlikely to provide the same condition. For example, exchanging housing with gold is the exchange of non-defined objects; exchanging housing with housing is the exchange of defined objects. The former is actually no different from sales. As long as the lessee can provide the same condition, he should be allowed to exercise the right of first refusal. Article 22 of the Interpretation of the Supreme People’s Court on Several Issues concerning the Application of Law in the Trial of Cases about Disputes over Lease Contracts on Urban Buildings expands the scope of housing sales to include the situation where “the lessor negotiated with the mortgage holder to reduce price and sell the leased house to pay off debt.”
D. The meaning of “the same condition”
The lessee has the right of first refusal under “the same condition” as offered to the buyer. With respect to “the same condition”, people’s understanding varies. Some believe that it refers to the same price; some maintain that apart from the same price, it should also include payment method; still others argue that it should include all matters related to selling such as price, payment method. I am of the view that the purpose of requiring the condition offered to the lessee and the third party be the same is to protect the seller’s interests. Such protection is very important because the design of right of first refusal deprives the seller of his right to choose the buyer. Thus, “the same condition” should be interpreted from the perspective of maintaining the seller’s interests, which should be handled strictly but not too rigidly.“The same condition” means that not only the price but also the payment method is the same. That is, if a third party can pay in a lump sum, the lessee should also do the same rather than making payment by installments. If the seller agrees that the third party pays in installments, the lessee can also pay in installments. However, the lessee’s payment in installments cannot be treated as the same as that of the third party because the credit and ability to pay vary from person to person. The lessor trusts the third party’s capacity to pay in installments. Yet, the lessee may not necessarily win the same trust from the lessor. Therefore, the lessee needs to provide collateral to win the lessor’s trust.8 With respect to payment term, the lessee’s payment term should be no later than the third party’s.
E. The way of exercising the right of first refusal and its legal effect
1.The way of exercising the right of first refusal
Article 230 of the Contract Law of the PRC merely provides that a lessor shall give the lessee a reasonable advance notice before the sale of its leased real property. The Opinions of the Supreme People’s Court on Several Issues concerning the Implementation of the General Principle of Civil Law of the PRC (Trial Implementation) states that a lessor who wants to sell its leased house shall notify the lessee three months in advance. Article 24 of the Interpretation of the Supreme People’s Court on Several Issues concerning the Application of Law in the Trial of Cases about Disputes over Lease Contracts on Urban Buildings provides that where a lessee failed to indicate unequivocally an intention to buy after the lessor fulfilled its obligations of advance notice, the people’s court shall not uphold the lessee’s claim of right of first refusal. It is a loophole in law that China’s law and judicial interpretations fail to set out provisions on the manner of notice by the seller and the way of reply by the lessee. The German Civil Code provides that the notice must be in writing. The United Kingdom also requires notice regarding priority right should be in written form. In my opinion, China’s legislation should perfect the following provisions: First, the seller’s notice should be served in the form of writing and be accompanied by a statement about the lessee’s right of first refusal. Second, if a notice meeting the requirement is sent by the lessee to a potential buyer, it shall be deemed a notice from the seller. Third, the seller’s notice should include at least the price and condition of sale for the real property. Fourth, the lessee should exercise its right of first refusal in written form and shall be deemed to have waived that right if he fails to respond within 15 days after the receipt of the written notice.
2. The legal effect of exercising the right of first refusal
Once a lessee exercised its right of first refusal, a contract was created between the lessee and the seller, which contains the same condition as offered to potential buyers.9 The specific content of the contract should be taken into account in combination with its specific characteristics and “the same condition” should not be applied mechanically. For example, pursuant to the contractual stipulation between a lessor and a third party, if the time period for the third party to make payment has expired, the stipulation regarding payment term as prescribed in “the same condition” is not binding on the lessee; otherwise, there will inevitably be delay in performance on the part of the lessee once the lessee exercises its right of first refusal. In this case, the lessee should be given proper time to make payment.
The right of first refusal enjoyed by a lessee of real property endows the leasehold of real estate with priority in terms of effect over general creditor’s rights. There are doubts about the considerations behind this legislation.
A.Foreign legislations
1.Germany
Section 577 of the German Civil Code provides that a lessee has a right of first refusal: (1) If leased residential premises, apartment ownership of which has been established or is to be established after the lessee has been permitted to use it, is sold to a third party, then the lessee has a right of first refusal with regard to it. This does not apply if the lessor sells the residential premises to a member of his family or a member of his household. To the extent that the following subsections do not lead to a different conclusion, the right of first refusal is governed by the provisions on preemption. (2) The notification of the seller or of the third party on the contents of the purchase agreement is to be supplied together with information to the lessee on his right of first refusal. (3) The right of first refusal is exercised by a written declaration of the lessee to the seller. (4) If the lessee dies, then the purchase option passes to the persons who succeed to the lease under section 563 (1) or (2). (5) A deviating agreement to the disadvantage of the lessee is ineffective. Germany limits the subjects of the right of first refusal to the lessees of “the leased residential premises, apartment ownership of which has been established or is to be established” and treats them as the weak and offer them protection
2. The Taiwan region
Article 104 of the Land Act of the Taiwan region provides that in the case of the sale of a land, the owner of superficies, the dien right holder or the lessee have the right of first refusal under the same terms and conditions. In the case of the sale of a house, the owner of the land has the right of first refusal under the same terms and conditions. The order is determined by the order of registration. Persons with purchase priority as mentioned in the previous Article should respond within 10 days after the receipt of the sale notice, and failure to respond within the specified time limit shall be deemed to have waived that right. The contract entered with a third party by the seller without giving prior notice to the person with the right of first refusal cannot be used against that person. In 1999, Taiwan revised its Civil Code to incorporate the aforesaid provisions into Article 426, providing that in the case that a lessee rent a land to build a house, if the lessor sells the land, the lessee has a right of first refusal under the same terms and conditions. If the lessee sells the house, the owner of the land has a right of first refusal to buy the house under the same terms and conditions. In the previous circumstances, the seller should notify the person with the right of first refusal in writing the terms and conditions of the sale. The person with the right of first refusal should respond in writing within 10 days after the receipt of the written notice and failure to respond within the specified time frame shall be deemed to have waived that right. The registration of the transfer of ownership made by the seller without giving prior written notice to the person with the right of first refusal cannot be used to defend against that person. From the above legal provisions, it can be seen that the Taiwan region first uses the Land Act to regulate the lessee’s right of first refusal, the purpose of which is to avoid the separation of land possession and land use as well as deformed land and the segregation of ownership, to unify land ownership and house ownership and avoid the tendency of complicating legal relationship so as to make full use of the land.1 In the Taiwan region, the land is privately owned. Thus, the land and the house thereon may belong to different persons. To unify land ownership and land use, it is established that a lessee has a right of first refusal. This legislation is not for the purpose of protecting the weak. Nor does it presume the lessee is the poor and disadvantaged of the society in economy.
B. Legislative situation and purpose in China
1.Current laws and judicial interpretations
Article 230 of the Contract Law of the PRC set out provisions on the lessee’s right of first refusal in principle. It merely provides that where the lessor is to sell a dwelling unit under a lease, it shall give the lessee a reasonable advance notice before the sale, and the lessee has the right of first refusal under the same conditions. Article 118 of the Opinions of the Supreme People’s Court on Several Issues concerning the Implementation of the General Principle of Civil Law of the PRC (Trial Implementation) lays down strict provisions with regard to the consequences of the lessor’s violation of a lessee’s right of first refusal. It provides: If a lessor wants to sell his leased house, he shall notify the lessee three months in advance, and the lessee shall have priority to buy the house under the same conditions; if a lessor fails to sell the house based on such conditions, the lessee may claim to the people’s court for declaration of the invalidity of the sale of the house. In 2009, the Supreme People’s Court promulgated the Interpretation on Several Issues concerning the Application of Law in the Trial of Cases about Disputes over Lease Contracts on Urban Buildings. Articles 21 to 24 thereof set forth explicit provisions regarding a lessee’s right of first refusal. Article 21 thereof amended the aforesaid provision and expressly states that the violation of a lessee’s right of first refusal shall not affect the validity of the sales contract, and the lessee can only sue for damages. Article 24 thereof specifically set out the circumstances in which the lessee does not have the right of first refusal. As to the reason why China grants the lessees the right of first refusal, there has been no authoritative interpretation from the legislative and judicial organs.
2.Legislative purpose seen from the debate on keeping or abolishing the right of first refusal
The traditional view is that the lessee of a house is the weak in economy and should be protected to maintain social equity and justice. The right of first refusal is in the final analysis a mere priority in the opportunity of purchase rather than a benefit in economy. The exercise of right of first refusal should not infringe on the seller’s substantive interests and result in unbalance of economic interests between the seller and the person with the right of first refusal.2
The opponent alleges that the traditional view fails to explain such a fact that the validity of a lease contract between a lessee and a seller is not affected by the change of ownership of the lease item. That is, the change in ownership in real property does not affect the contract between landlords and tenants. Even though the lease item at this time had been sold to the buyer, it had nothing to do with the lessee. The lessee’s interests in using the lease item were not affected. Then why is the lessee given the right of first refusal? And how can the lessee be called the weak if he can afford the leased real property? Hence, the system of right of first refusal should be abolished. This system restricts ownership, which not only violates the principle of autonomy of the will of parties and the theory that the law protects ownership but also is not beneficial to the flow of goods and effective operation of the fair competition mechanism in the market economy.3
As I see it, there are fundamental values for the existence of the system of the real estate lessee’s right of first refusal. There are two basic principles in private law: freedom and efficiency. In terms of freedom, it is about how to guarantee and realize an individual’s autonomous space regarding his property. In terms of efficiency, it concerns how to make the property come to persons who can make full use of it. From the perspective of economics, an efficient system should impel the social resources to flow to persons who are the most good at operation and can maximize its efficiency. The system of the lessee’s right of first refusal meets the demand of efficiency value. It endows the lessee with the right of first refusal based on lease relationship. The purpose of such design is to simplify the legal relationship and prompt and achieve the most efficient use of property, which reflects the pursuit of efficiency value. The lessee, through a lease contract, has in advance occupied, used and benefited from the leased house, who is more aware of the attribute of the lease item than the potential buyer, and more experienced in the operation of the lease item, and apparently more confident in its future operation when he intends to make the purchase. From the angle of economics, the continuous use of a property is obviously beneficial to the achievement of the goal of efficiency, i.e., producing more output with the same amount of inputs. Seen from the transaction cost, under the same conditions, the transaction cost in a lease item between the lessor and the lessee is the lowest. The following reasons can explain this. First, the lessor and the lessee know each other and thus a higher level of honesty and credibility can be ensured, which will decrease the time spent on inspection and hesitation. Second, the lessee is familiar with the situation of the lease item and thus there is no need for the lessor to explain, to look for an intermediary agent, which will lower the transaction cost. Third, the lessee has occupied the lease item. Once the transaction is closed, the only thing left to do is to handle the procedure of registration, which will avoid the trouble of delivering the lease item. Though the system of the lessee’s right of first refusal may to a certain extent restrict the lessor’s right in choosing transaction partners, it won’t cause any harm to the lessor’s substantive economic interests; rather, it will spur the third party to bid against the lessee and may probably raise the transaction price. Therefore, the system, seemingly restricting the lessor’s freedom, actually protects the lessor’s fundamental economic interests. In the contest between the lessee and the third party, i.e., the person who can afford to lease a house and the person who can afford to buy a house, the law leans towards the former and gives consideration to the relatively weak, which reflects humanistic care and achieves the goal of justice. Therefore, I insist that there are rationales behind the existence of the system of right of first refusal. This system to a certain degree limits freedom but safeguards interests, and sacrifices the relatively strong but cares for the relatively weak. This system takes into account both efficiency and fairness and realizes the unification of freedom and justice.
II. Restriction on the parties who exercise the right of first refusal
A real estate lessee has a right of first refusal. However, doubts exist regarding the definition of lessee. To the lessor, there exist a lessee and a sub-lessee in the case of lawful sublease. No explicit provisions can be found in China’s laws and judicial interpretations. There are at present three viewpoints in the academic and practical circles:
1. Only lessees have the right of first refusal. Due to the relativity of lease contracts, a sublessee can only claim rights against the lessee rather than against the lessor. This viewpoint, influenced by the viewpoint of the judiciary circles of the Taiwan region, maintains that sublessees cannot claim right of first refusal.
2. Only sublessees enjoy the right of first refusal. In accordance with the legislative intent, the purpose of granting lessees the right of first refusal is to protect the lessees’s interests in using the lease item and guarantee the interests of the disadvantaged. Given this intention, only an actual lessee has the interests in using the lease item. Hence, an actual lessee, no matter whether it is a lessee or sublessee or sub-sublessee, is entitled to the right of first refusal. This viewpoint is held by some people in China’s judicial practice.
3. Both lessees and sublessees have the right of first refusal. In the case of lawful sublease of a lease item, if the lessor sells the lease item, there exist two rights of first refusal, i.e., both the lessee and sublessee have the right of first refusal. Under the same conditions, the right of first refusal should be first given to the sublessee because he is occupying and using the leased house and has more reasons to claim the right of first refusal in comparison with the lessee. In contrast, the lessee, after entering the lease contract with the lessor, subleased the house to make profit, who concerns more about the rents than the actual use of the house. Protecting the right of first refusal of the sublessee, the actual occupant and user of the house, is more in conformity with the legislative intent of the law in establishing the lessee’s right of first refusal. Of course, if the sublessee does not assert the right of first refusal under the same conditions, the lessee should enjoy the right of first refusal in comparison with other transaction parties in the market because the leased house is more connected to the lessee in comparison with others.
I think the first viewpoint is relatively proper. Take for example that A leased a house to B, and B subleased it to C. First, seen from the legislative technique, the lessees protected in the law of various countries are those conforming to certain requirements. If the establishment of right of first refusal is to protect the lessee who is in a vulnerable position, then the lessee is the one who is subject to some restrictions. That is, the lessees protected by law are those who have contractual relationship with the lessors. The parties to a sublease contract are the lessee B and sublessee C. There is no lease relationship between the sublessee C and the lessor A. The sublessee C does not obtain the right to lease the lessor A’s house. The lessee protected by law is the lessor A’s lessee, not the sublessee B’s lessee. Therefore, the sublessee C does not have the right of first refusal. Second, in the case of sublease permitted by the lessor, there might be one, two, ten, and even scores of sublessees. If all sublessees have the right of first refusal, the lessor will bear heavy burden, which is unpredictable, when selling the real estate even if there is the restriction of order. Suppose only the last actual lessee has the right of first refusal, then how can he prove that he is the legal and actual lessee? There is in his hand only the lease contract signed with the prior party. The lease contract between the prior party and the priorprior party is unknown and it is difficult to demand others to cooperate. As a result, in the case of multiple sublease, it is difficult for the actual sublessee to prove to the seller that he is the actual lessee and the seller does not have the duty to investigate this matter. Third, seen from the right of lease, the lessee’s lease right is not only stipulated by a lease contract but also prescribed by law. The lessee may sublease lawfully under the lease contract. However, under the law, there is no space for free transfer because the law sets out special provisions regarding the status of a lessee. Consequently, in the case of the transfer of lease right, i.e., the lessee completely exited from the lease relationship and was replaced by others, and others obtain the right of lease completely and of course enjoy the right of first refusal. In summary, whether it is from the legislative intent, or the actual operation, or the nature of lease right, the right of first refusal can only be enjoyed by the lessee who entered the lease contract with the seller. The lack of express provision in China’s law regarding the right of first refusal results in inconsistent rulings in the judicial practice. The law should be explicit in this issue as early as possible so as to clarify understanding and ensure uniform judicial decisions. Additionally, the German Civil Code provides that in the event that the lessee died, his right of first refusal shall be transferred to the other family members who live together with him, which, in my view, is very necessary and worth learning.
III. Specific issues relating to the exercise of right of first refusal
A. Choice of the way of notice
A legally valid lease contract is one of the requirements for the lessee to enjoy the right of first refusal. If the lease contract does not exist, or is invalid, or is terminated due to expiration, the lessee is not entitled to the right of first refusal. The question is if the lease contract between the lessor and the lessee is indeed legitimate and effective but the lease item has not yet been delivered to the lessee, does the lessee have the right of first refusal?
According to the majority of viewpoints, the premise of obtaining lease right is that the lessee actually occupies the lease item, and the lessee has the right of lease only after he receives the delivery and occupies the lease item, and it is only at this time the lease right has the effect of countervailing force and priority similar to real rights.6 For example, Section 577 of the German Civil Code provides that if leased residential premises, apartment ownership of which has been established or is to be established after the lessee has been permitted to use it, is sold to a third party, then the lessee has a right of preemption with regard to it. China’s law does not set forth provisions with regard to this. I am of view that prior to the actual occupation of the lease item by the lessee, the lessee has only the right to require delivery of the lease item even if a lease contract has been signed. In this sense, he is no different from general creditors. He has not had actual usufruct interests in the lease item. There is no need to provide him with special protection via the right of first refusal. With respect to the third party who plans to buy, in the case of no actual receipt of the delivery and actual occupation by the lessee, there has been totally no opportunity for the third party to know that there exists a right of first refusal. It is unfair to the potential buyer. Hence, the right of first refusal has after all the priority effect of real right and necessary notice should be given before its exercise. In Germany and the Taiwan region, there is no requirement of registration with respect to real property lease. As a consequence, for the right of first refusal to take effect, it is very necessary to require delivery, occupation and notice. However, to my mind, to ensure transaction safety and balance the interests of the third party, it is more appropriate and efficient to give notice by means of registering the real property lease contract.
B. Mandatory provision or optional provision
The system of the right of first refusal endows the rental rights with prior effect over general creditor’s rights. This effect is of real rights type and should be mandatory. It means that the parties to a lease contract cannot make stipulations regarding the effect of the contract against a third party and such stipulations, if any, are invalid to the third party. The lessee’s right of first refusal is specially set by law. The grant of the right of first refusal is to grant a possibility of an action. The rights holder will decide whether to act or not. Thus, the holder of right of first refusal may waive such rights in a lease contract. Section 577 (5) of the German Civil Code provides that a deviating agreement to the disadvantage of the lessee is ineffective. I suggest China should refer to this provision. That is, the lessee’s right of first refusal is directed at the lessor and the buyer of a lease item. If they stipulate that the lessee has no right of first refusal, the stipulation will be deemed invalid, which is a mandatory provision. However, the lessee may waive this right through stipulation with the lessor or the buyer of the lease item.
C. Interpretation of the “selling of rental house”
Under China’s Contract Law, the premise that the lessee excises his right of first refusal is the selling of the leased housing by the lessor. Then how do we interpret the issue “selling of the rental house”? Real property includes housing and land. In China, lease exists in the secondary market rather than in the primary market of the state-owned land. Namely, those who obtain the right to use the state-owned land through such form as transfer or appropriation may let the land to others. Of course, the lease agreement signed at this time is, to be exact, not the lease of real property but of rights because the lessor has no right to dispose of the land. Thus, there is no possibility that the lessor sells the leased land. Accordingly, in China, with respect to the lease of state-owned land, there is no condition for the exercise of right of first refusal. With respect to the collectively-owned rural land, China’s land law expressly states that it cannot be directly used for leasing. In China, there is no condition for the lessee of a land to exercise the right of first refusal. Hence, it is correct to limit the subject matter to houses, which inevitably involves the issue of interpreting “houses”. In accordance with the provisions regarding the measures for the administration of house leasing promulgated by some cities, the “leased houses” can be interpreted to include: (1) temporary houses and factory buildings built under law; (2) business sites, counters, stalls of a house as well as underground facilities. The meaning of “sell” is worth weighing. The word “sell”originates from buying and selling. In a sales contract, the seller’s act is called selling. Hence, the right of first refusal does not apply to cases where the change of ownership of the leased house is due to gift, bequest and inheritance. However, if the house is of the nature of half selling and half giving, i.e., a mixed gift, does the right of first refusal apply? As I see it, a mixed gift is a gift given with pay and since gift exists, the emphasis is on personal relations and degree of trust, and it differs from pure buying and selling. Thus, in the case of a mixed gift, right of first refusal does not apply. Some local administrative regulations in China interpret it broadly and define house sales to include house transfer with compensation, exchange of house ownership, fake investment with a house, rebuilding or expanding one’s own house in cooperation with others, paying off debt with a house.7 This broad interpretation in practice should be treated differently and strictly based on specific situations. Paying off debt with a house and transferring a house with compensation should be deemed selling of the house. However, house exchange, investment with houses, cooperatively building and expanding of houses are different. Though the house ownership at this time has changed, the purpose of the house seller is not to obtain the market price of the house but for other purposes beyond the market price. Can the lessee exercise right of first refusal if he can provide the “same” condition as the third party did? In my view, where the ownership of a house changes in the form of exchange, if the exchanged objects are nondefined objects, it is possible for the third party to offer the same condition; however, if the exchanged objects are defined objects, the third party is unlikely to provide the same condition. For example, exchanging housing with gold is the exchange of non-defined objects; exchanging housing with housing is the exchange of defined objects. The former is actually no different from sales. As long as the lessee can provide the same condition, he should be allowed to exercise the right of first refusal. Article 22 of the Interpretation of the Supreme People’s Court on Several Issues concerning the Application of Law in the Trial of Cases about Disputes over Lease Contracts on Urban Buildings expands the scope of housing sales to include the situation where “the lessor negotiated with the mortgage holder to reduce price and sell the leased house to pay off debt.”
D. The meaning of “the same condition”
The lessee has the right of first refusal under “the same condition” as offered to the buyer. With respect to “the same condition”, people’s understanding varies. Some believe that it refers to the same price; some maintain that apart from the same price, it should also include payment method; still others argue that it should include all matters related to selling such as price, payment method. I am of the view that the purpose of requiring the condition offered to the lessee and the third party be the same is to protect the seller’s interests. Such protection is very important because the design of right of first refusal deprives the seller of his right to choose the buyer. Thus, “the same condition” should be interpreted from the perspective of maintaining the seller’s interests, which should be handled strictly but not too rigidly.“The same condition” means that not only the price but also the payment method is the same. That is, if a third party can pay in a lump sum, the lessee should also do the same rather than making payment by installments. If the seller agrees that the third party pays in installments, the lessee can also pay in installments. However, the lessee’s payment in installments cannot be treated as the same as that of the third party because the credit and ability to pay vary from person to person. The lessor trusts the third party’s capacity to pay in installments. Yet, the lessee may not necessarily win the same trust from the lessor. Therefore, the lessee needs to provide collateral to win the lessor’s trust.8 With respect to payment term, the lessee’s payment term should be no later than the third party’s.
E. The way of exercising the right of first refusal and its legal effect
1.The way of exercising the right of first refusal
Article 230 of the Contract Law of the PRC merely provides that a lessor shall give the lessee a reasonable advance notice before the sale of its leased real property. The Opinions of the Supreme People’s Court on Several Issues concerning the Implementation of the General Principle of Civil Law of the PRC (Trial Implementation) states that a lessor who wants to sell its leased house shall notify the lessee three months in advance. Article 24 of the Interpretation of the Supreme People’s Court on Several Issues concerning the Application of Law in the Trial of Cases about Disputes over Lease Contracts on Urban Buildings provides that where a lessee failed to indicate unequivocally an intention to buy after the lessor fulfilled its obligations of advance notice, the people’s court shall not uphold the lessee’s claim of right of first refusal. It is a loophole in law that China’s law and judicial interpretations fail to set out provisions on the manner of notice by the seller and the way of reply by the lessee. The German Civil Code provides that the notice must be in writing. The United Kingdom also requires notice regarding priority right should be in written form. In my opinion, China’s legislation should perfect the following provisions: First, the seller’s notice should be served in the form of writing and be accompanied by a statement about the lessee’s right of first refusal. Second, if a notice meeting the requirement is sent by the lessee to a potential buyer, it shall be deemed a notice from the seller. Third, the seller’s notice should include at least the price and condition of sale for the real property. Fourth, the lessee should exercise its right of first refusal in written form and shall be deemed to have waived that right if he fails to respond within 15 days after the receipt of the written notice.
2. The legal effect of exercising the right of first refusal
Once a lessee exercised its right of first refusal, a contract was created between the lessee and the seller, which contains the same condition as offered to potential buyers.9 The specific content of the contract should be taken into account in combination with its specific characteristics and “the same condition” should not be applied mechanically. For example, pursuant to the contractual stipulation between a lessor and a third party, if the time period for the third party to make payment has expired, the stipulation regarding payment term as prescribed in “the same condition” is not binding on the lessee; otherwise, there will inevitably be delay in performance on the part of the lessee once the lessee exercises its right of first refusal. In this case, the lessee should be given proper time to make payment.