What is the Right of First Refusal?

A right of first refusal (ROFR) is an important contractual right that can impact your business and future opportunities.

The right of first refusal (ROFR) is a contractual right that can impact your business and future opportunities. Simply put, the ROFR gives the holder of the right the option to enter into a transaction before anyone else. However, the extent of the right, and when it is triggered, depends on the language of the contract.

How Does the Right of First Refusal Work?

The right of first refusal is created by a contract between two parties. One party owns property, such as real estate or a business, and the other party holds the ROFR. The contract provides that if the property owner wants to enter into a transaction with anyone else, like deciding to sell a business, the owner of the ROFR must be given the same opportunity to enter that transaction on the same terms. The property owner may only go forward with the business transaction with the third party should the ROFR holder decline the opportunity.

The ROFR may be used for different kinds of property and is most commonly found in contracts concerning real estate and business assets. Many operating agreements for LLCs include a ROFR clause, which provides that if one of the owners of the LLC decides to sell his share of the business, he must first give the other owners the opportunity to buy his share before bringing in a third party.

How to Create a Right of First Refusal

For the ROFR to be effective, there must be a valid contract. You will often see this right as part of another contract, such as a rental lease or an operating agreement. However, it can also be a standalone contract.

In either case, the contract itself must be legally enforceable. Depending on the type of property and length of the contract, it typically must be in writing, signed, and include a description of the property. All contracts must have valid consideration, meaning there is an exchange of something of value between each party. While one party is granted the ROFR, the other party must also receive something of value, such as an amount of money.

Variations of the Right to First Refusal

The specifics of the right will be dependent on the actual contract. Here the parties have the opportunity to create an agreement that suits their situation. It can be helpful to consult with an attorney to ensure your contract reflects the needs of your business and addresses potential issues that can arise. Some of the common variations include:

Exclusions: The contract may state that the right does not apply to certain situations, like transactions with family members.

Transactions that trigger the ROFR: The contract should specify when the ROFR is triggered. For example, it may only arise if the property owner wants to sell the property, but not by giving a lien on the property to secure a loan.

Duration: The ROFR may expire after a certain amount of time or after an event occurs, such as the expiration of a lease. After the specified time, the property owner may enter into a transaction without notifying the holder of the ROFR.

Time to respond: Similarly, the contract may specify that the party only has a limited amount of time to decide whether or not to act on the offer, after which the property owner may go forward with the transaction with the third party.

Transferability: The parties may decide whether or not they want the ROFR to be transferable to another party. The ROFR may transfer with the property, meaning that if the property owner sells the business or real estate, the new owner must continue to give the holder the right to refuse any new transactions.

Alternatives to the Right of First Refusal

An alternative to the ROFR is the right of first negotiation, also known as the right of first offer. This is more limited in that the holder of the right is not given the opportunity to accept the transaction on the same terms, but is simply given the right to make his own offer. The other party is not obligated to accept that offer and may enter into a business transaction with a third party on different terms.

Penalties for Violating Contract Terms

Because the ROFR is a contractual right, the penalties for violating the terms are based on contract law. If not given the right to refuse, the harmed party may sue for money damages or specific damages, but typically not both.

Specific performance means the party is ordered to perform under the contract. For example, if a party was not offered the ROFR before the third party entered the business transaction, the ROFR holder must be given the opportunity to purchase the property based on the same terms, such as buying the stock of the company.

If specific performance is not an option, either because of the circumstances or state law, the harmed party may instead pursue money damages. The amount serves to compensate the harmed party for the loss of opportunity.

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