Right of first refusal
Encyclopedia
Right of first refusal is a contractual right that gives its holder the option to enter a business transaction with the owner of something, according to specified terms, before the owner is entitled to enter into that transaction with a third party. In brief, the right of first refusal is similar in concept to a call option
.
An ROFR can cover almost any sort of asset
, including real estate
, personal property
, a patent
license, a screenplay
, or an interest in a business. It might also cover business transactions that are not strictly assets, such as the right to enter a joint venture or distribution arrangement. In entertainment, a right of first refusal on a concept or a screenplay
would give the holder the right to make that movie first. Only if the holder turns it down may the owner then shop it around to other parties.
Because an ROFR is a contract right, the holder's remedies for breach are typically limited to recovery of damages
. In other words, if the owner sells the asset to a third party without offering the holder the opportunity to purchase it first, the holder can then sue the owner for damages but may have a difficult time obtaining a court order to stop or reverse the sale. However, in some cases the option becomes a property right that may be used to invalidate an improper sale.
An ROFR differs from a Right of First Offer (ROFO, also known as a Right of First Negotiation) in that the ROFO merely obliges the owner to undergo exclusive good faith
negotiations with the rights holder before negotiating with other parties. A ROFR is an option to enter a transaction on exact or approximate transaction terms. A ROFO is merely an agreement to negotiate.
Many other variations are possible. A fully drafted ROFR addresses all of these types of issues and more, and in the case of valuable or complex transactions is subject to negotiation and review by business transaction attorneys. However, many ROFR are not completely specified. Even the best drafted ROFR agreements suffer a high risk of dispute and litigation because they are anticipating future transactions and contingencies that are unknowable at the time the ROFR originates.
Call option
A call option, often simply labeled a "call", is a financial contract between two parties, the buyer and the seller of this type of option. The buyer of the call option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument from the seller...
.
An ROFR can cover almost any sort of asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
, including real estate
Real estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
, personal property
Property
Property is any physical or intangible entity that is owned by a person or jointly by a group of people or a legal entity like a corporation...
, a patent
Patent
A patent is a form of intellectual property. It consists of a set of exclusive rights granted by a sovereign state to an inventor or their assignee for a limited period of time in exchange for the public disclosure of an invention....
license, a screenplay
Screenplay
A screenplay or script is a written work that is made especially for a film or television program. Screenplays can be original works or adaptations from existing pieces of writing. In them, the movement, actions, expression, and dialogues of the characters are also narrated...
, or an interest in a business. It might also cover business transactions that are not strictly assets, such as the right to enter a joint venture or distribution arrangement. In entertainment, a right of first refusal on a concept or a screenplay
Screenplay
A screenplay or script is a written work that is made especially for a film or television program. Screenplays can be original works or adaptations from existing pieces of writing. In them, the movement, actions, expression, and dialogues of the characters are also narrated...
would give the holder the right to make that movie first. Only if the holder turns it down may the owner then shop it around to other parties.
Because an ROFR is a contract right, the holder's remedies for breach are typically limited to recovery of damages
Damages
In law, damages is an award, typically of money, to be paid to a person as compensation for loss or injury; grammatically, it is a singular noun, not plural.- Compensatory damages :...
. In other words, if the owner sells the asset to a third party without offering the holder the opportunity to purchase it first, the holder can then sue the owner for damages but may have a difficult time obtaining a court order to stop or reverse the sale. However, in some cases the option becomes a property right that may be used to invalidate an improper sale.
An ROFR differs from a Right of First Offer (ROFO, also known as a Right of First Negotiation) in that the ROFO merely obliges the owner to undergo exclusive good faith
Good faith
In philosophy, the concept of Good faith—Latin bona fides “good faith”, bona fide “in good faith”—denotes sincere, honest intention or belief, regardless of the outcome of an action; the opposed concepts are bad faith, mala fides and perfidy...
negotiations with the rights holder before negotiating with other parties. A ROFR is an option to enter a transaction on exact or approximate transaction terms. A ROFO is merely an agreement to negotiate.
Examples
- ROFR: Abe owns a house that he plans to sell to Bo for $1 million. However, Carl holds a right of first refusal to purchase the house. Therefore, before Abe can sell the house to Bo, he must first offer it to Carl for $1 million. If Carl accepts, he buys the house instead of Bo. If Carl declines, Bo may now buy the house at the proposed $1 million price.
- ROFO: Carl holds a ROFO instead of an ROFR. Before Abe may negotiate a deal with Bo, he must first try to sell the house to Carl. Abe and Carl attempt to reach a deal. If they reach an agreement, Abe sells the house to Carl. However, if they fail, then Abe is free to start fresh negotiations with Bo without any restriction as to price or terms.
Variations
The following are all variations on the basic ROFR.- DurationTimeTime is a part of the measuring system used to sequence events, to compare the durations of events and the intervals between them, and to quantify rates of change such as the motions of objects....
. The ROFR is limited in time. E.g. Abe must only make the offer to Carl for any proposed sale in the first five years. After that the right expires and Abe has no further obligation to Carl. - Exceptions. Certain transactions are exempt. E.g. Abe may sell or transfer the property to a holding company, a trust, family members, etc., without first offering it to Carl. However, the new owners remain subject to the right.
- Transferability. Carl may assign his ROFR to Bo. Abe must now offer Bo an option to purchase the property instead of Carl. Not every ROFR is transferable; some are personal to the original holder.
- Extinguished on first sale. If Abe sells the property to Bo because Carl declines the right, the property is no longer subject to the right. Bo may re-sell it free of the ROFR.
- Extinguished on declined / failed exercise. If Abe proposes to sell the property to Bo and Carl declines, or if Carl accepts but is unable to complete the transaction, the right is extinguished whether or not Abe ultimately sells the property.
- Persistent. In contrast to the above two, in this case the right runs with the property and binds the new purchaser. E.g. Abe sells the property to Bo. Now Bo must offer the property to Carl first, just as Abe did, if Bo wishes to re-sell it.
- Offer and acceptance terms. Specific deadlines, procedures, and forms may be required. For example, Abe must give Carl a "notice of sale." Carl has thirty days to accept or reject, with failure to respond counting as rejection. Carl must then close the transaction within thirty days or else that counts as a failed attempt to exercise.
- Limited time period to close transaction. Abe offers the property to Carl under the ROFR and Carl declines. Abe now has 60 days to close the transaction with Bo. If it cannot close within 60 days Abe must offer it again to Carl before proceeding further with Bo.
- Substitute purchaser allowed. Abe offers the property to Carl, who declines. Abe is then free to sell it to Bo but that transaction fails. Abe may sell the property under the same terms to Erin instead without re-offering it to Carl.
- No pending transaction required. Abe wishes to sell the house for $1 million but has not yet identified a purchaser. He prepares proposed sales terms and offers it to Carl on those terms. If Carl declines, he may then shop around for a purchaser.
- Slight variations allowed in exercise. Abe enters an agreement with Bo calling for Bo to put down a 30% down payment, conduct certain inspections, and close the transaction in 20 days. He offers it to Carl at those terms. Carl accepts but is entitled to insist on a 20% down payment and a 30 day closing period.
- Slight variations allowed in sale. Abe offers the house for $1 million to Carl. Carl declines. Abe then enters a transaction with Bo but during the escrowEscrowAn escrow is:* an arrangement made under contractual provisions between transacting parties, whereby an independent trusted third party receives and disburses money and/or documents for the transacting parties, with the timing of such disbursement by the third party dependent on the fulfillment of...
Bo discovers a flaw in title and several defects. Abe is entitled to discount the price by $20,000 to close the sale with Bo without having to re-offer the house to Carl at $980,000.
Many other variations are possible. A fully drafted ROFR addresses all of these types of issues and more, and in the case of valuable or complex transactions is subject to negotiation and review by business transaction attorneys. However, many ROFR are not completely specified. Even the best drafted ROFR agreements suffer a high risk of dispute and litigation because they are anticipating future transactions and contingencies that are unknowable at the time the ROFR originates.