What Is a Right of First Refusal Provison?
In essence, this right allows the holder to decide on whether to participate in a transaction or not.3 min read
2. Advantages of the Right of First Refusal
3. Procedures of Exercising the Right of First Refusal
4. Other Rights Closely Related to a Right of First Refusal
A right of first refusal provision is a contractual right with predefined terms that its holder the option to enter into a legal business transaction with the owner of something before the owner commits to transacting with a third party. In essence, this right allows the holder to decide on whether to participate in a transaction or not. Basically, when the holder wishes to observe how a business will eventually turn out, he may negotiate the right of first refusal. Upon doing this, he may decide on whether to get involved in the transaction instantly or at a later time.
In a startup business, for example, if you are an investor with the right of first refusal, then you have an opportunity to buy new shares before a third party does. This provision is, however, a right and does not oblige you to take any deal on the table. On the other hand, this right is not a veto power and, therefore, your decision not to engage in a transaction does not bar it from coming into effect.
Provisions for the Right of First Refusal
There are a number of factors to be considered when drafting a right of first refusal.
- The property, or part of the 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.
Even though a well-drafted right of first refusal may consider most of the above factors, many of them are not completely specified. This may render them vague. To prevent this from happening, both the property owner and the holder of the right should express their understanding of what that right means.
Advantages of the Right of First Refusal
Basically, 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.
Procedures of Exercising the Right of First Refusal
- The person who is by contract guaranteed the right of first refusal must be informed any time the owner wishes to conduct a business transaction bound by that right.
- If the transaction involves the sale of an asset, the holder of the right has a chance to offer the best match in order to acquire the asset in question.
- If the transaction involves shares, the holder of the right of first refusal gets the first opportunity to buy the shares before the offer is opened to the public.
Other Rights Closely Related to a Right of First Refusal
- Option to Purchase. This right gives the holder an opportunity to purchase a pre-defined property during the term of the option, irrespective of whether the owner expresses a desire to sell it or not. Under this provision, the holder may force the owner to sell him the property.
- Right of First Offer. This right demands that its holder be given an opportunity by the owner to buy a property once the owner decides to dispose of it. The holder, however, cannot force the owner to sell him the property. Consequently, this right can be used by the holder to obtain a lease expansion.
The above rights, together with the right of first refusal, are clearly elaborated, in the case of Stuart v. D'Ascenz in Colorado Court of Appeal and in that of Cimfel v. Windber of Nebraska Supreme Court.
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