Right of first refusal is a contractual right to enter into a business transaction with a person or company before anyone else can. If the entity with the right of first refusal declines to enter into a transaction, the owner of the asset who offered the right is free to open the bidding up to other interested parties.
A right of first refusal can cover almost any sort of asset, including real estate, personal property, a patent license, a screenplay, or an interest in a business.
Typically, right of first refusal is used in share purchase and share acquisition agreements. For example, a shareholder of a company before selling off his shares to an outside third party has to offer them to the promoters first. These clauses also termed as ROFR are generally accompanied by call and put options.
Purpose of Right of First Refusal?
A right of first refusal is usually requested by an individual or company when it wants to see how a business or opportunity will turn out. The right holder may prefer the option to get involved at a later point, rather than make the outlay and commitment up front. Right of first refusal allows them to do this. They don’t need to commit now, but will have the first chance to commit (before others) if they decide to.
Key Terms of Right of First Refusal?
The following are the key terms or variations of a right to first refusal agreement:
- Duration – The right of first refusal only stands for a particular period of time.
- Exception include certain transactions
- Transferability – The right of first refusal is transferable, given that it is not of a personal nature as per the contract.
- Extinguished on First Sale – If the seller sells it to another buyer, after the right of first refusal has already been exercised, the right is extinguished and the buyer may sell it to a third buyer at will.
- Extinguished on Failed Exercise – The right is extinguished if by exercising the right of first refusal the buyer accepts the offer but is unable to fulfill it.
- Persistence – The right of first refusal, in contrast to the above two clauses, may persist with each subsequent buyer as per the terms of the contract.
Drafting of Right of First Refusal?
There are a number of factors to be considered when drafting a right of first refusal:
The commodity or property, subject to the right of first refusal must be clearly defined, and the purchase price or formulae must be determined.
- The right should outline what will happen in the event that the offer does not involve cash, such as in the exchange of property.
- The time limit for exercising the right should be clearly defined.
- The terms should clearly outline the instances in which the holder of the right may transfer it to a third party, if not otherwise prohibited.
- The extent to which the right can be exercised by the holder should be clearly outlined. This must also reflect on the exceptions, such as what happens when an owner dies.
- The draft must clearly define what happens if the owner of a property extends an offer to a holder of a right, and the holder declines it.
Types of Right of First Refusal Agreement
Typically, a right of first refusal is used in the following agreements:
- Shareholder agreements.
- Share purchase agreements.
- Share subscription agreements.
- Joint venture agreements.
- Mergers and acquisitions
- Real estate development agreements.
Benefits of Right of First Refusal Agreement
The right of the first refusal plays to the advantage of the holder. Below are some of its benefits:
- It ensures a third party does not get into a business transaction before the holder gets a chance to do so.
- It is useable by the holder as an insurance policy against losing an assert he may need for his business.
- It may be used by the owner of a property as part of a tenant contract in order to lure the right tenant.
- The holder can use it to obtain a lease expansion.
Cons of Right of First Refusal Agreement
Conversely, the right of first refusal is a hindrance for the property owner since it limits the ability to sell and seek buyers. This may extend to each subsequent buyer as well if the right of refusal clause is one that either persists or is continuous, meaning that each subsequent buyer is also subject to the same terms of the clause as the original one.
A Right of First Refusal agreement is typically drafted to gain the first mover advantage. However, its enforceability still remains a cause for concern. Typically, arbitration is resorted to in the event any disputes arises with respect to right of first refusal agreements.
Sample Right of First Refusal Agreement
A sample of the agreement can be downloaded from below.
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