Right of First Refusal - Explained
What is a Right of First Refusal?
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Table of ContentsWhat is a Right of First Refusal?How is a Right of Last Refusal Used? Examples Variations In venture capital Academic Research on Right of First Refusal
What is a Right of First Refusal?
Right of first refusal, or ROFR, grants the rights and terms of a business transaction to its holder, that is, the holder of ROFR has the right to do a business transaction with the owner of a property before any other person or the third party does.
In the right of first refusal contractual agreement, three parties must be involved, the parties are; the owner of a property, the holder of ROFR and a third party or buyer. This contractual right stipulates that the owner of a property must first offer transaction rights to ROFR holder before any other buyer.
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How is a Right of Last Refusal Used?
Rights of First Refusal mostly occur in real estate, asset transactions and Limited Liability Company (LLC) Operating agreements. This transaction right can also be used for non-asset business transactions. This right gives its holder the right to make the first move with a property owner in a business transaction.
Per adventure, the holder of ROFR is denied the right to transactions before a third party, recovery of damages can be claimed. This means that if the owner offers or sells assets to a buyer without offering them to ROFR holder first, the owner can be sued for damages. However, ROFR differs from ROFO (Right of First Offer) since the owner is only obliged to negotiate with a ROFO holder before other buyers.
The difference between ROFR and ROFO can be better understood with the examples cited below: Example 1 (ROFR): Gold has a property and he is offered $3million by a third buyer. Before he sells it to the buyer, he must first contact Smith who holds the right of first refusal to purchase the property. If Smith is ready to pay the $3million offered to Gold by the third party, he owns the property, if otherwise, Gold can go back to the third party to sell the property. Example 2: (ROFO):If Smith holds a ROFO, Gold must first negotiate price with Smith, if Smith is willing to go by Golds transaction terms, he claims the property. But if Smith declines, Gold can go to another buyer and start negotiation afresh.
There are certain differences that are noticeable in a basic Right of first refusal (ROFR). These variations are highlighted below;
- Duration of ROFR: This right has the time-limit of five years. The owner of a property is only obliged to first offer business transactions to ROFR holder only in the first five years. Afterwards, the ROFR outlives its validity.
- ROFR elapses on declined offers; If Smith declines to buy a property at the amount offered by Gold, Gold has no obligation to offer the property to smith again.
- An owner has a period of 60 days to close a business transaction with a ROFR holder after decline.
- ROFR can be transferred between parties.
- Gold might decided not to sell his property himself, he can transfer the property to another person who is then subjected to the ROFR being held by Smith.
- ROFR allows a substitute purchaser but no pending transaction is allowed.
Aside from the variations listed above, ROFR still has some other variations.
In venture capital
ROFR in venture capital deals operates in a peculiar way, in venture capital deals ROFR allows investors in a firm to either accept or decline the purchase of the company's equity shares. If the investors decline, the company then has the right to offer the shares or external investors or private buyers.
ROFR benefits investors such that it prevents stock or equity adulteration as the company develops. If company owners offer equity shares to third parties before investors, there will be a dilution of the company's ownership and stocks. However, the provision of ROFR in venture capital deals is limited to certain shares.
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