Mr Lynn told News Ltd that he would resign after the party's state executive refused his demand to reopen nominations in Fairfield, in southwest Sydney, before council elections in September.
Mr Lynn objects to the presence of property developers on the Liberal ticket, including serving councillor Joe Molluso.
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News Ltd reports that rather than reopen nominations, the executive opted on Friday that for the right not to endorse a ticket.
Mr Lynn believes this move will allow Mr Molluso and several other developers to win seats.
Mr O'Farrell said Mr Lynn hadn't resigned yet and he was waiting to speak with him in person.
"He's in Papua New Guinea, I'm about to go to China," Mr O'Farrell told reporters in Sydney on Saturday.
"I'll wait to see what Mr Lynn says when he returns."
Mr O'Farrell acknowledged that there were concerns about Liberal branches in southwest Sydney.
"The Liberal Party has made clear that we are concerned about what's been happening in branches out there."
Mr Lynn has said that the developers won't represent party values.
"I have a set of values that I've stood by all my life," Mr Lynn told News Ltd.
"The developers out there have a different set of values and the state executive have decided that they subscribe to the values of the developers who run the Fairfield area."
The O'Farrell Government currently only has 12 upper house seats to Labor's 14 and the balance rests with minor parties.
Mr Lynn said he will sit on the crossbenches until his term expires in 2015.
