First Right of Refusal is contractual clause that provides a “right” to a specific party. The “right holder” is granted an option to take action when an event is triggered. What the right holder has the first right to depends on the transaction, but in many cases it is the right to purchase an asset first before other potential buyers.
First Right of Refusals are used in contracts for both commercial real estate
and business assets including patents, stock of the company, sensitive documents, etc. These agreements are legally binding and provide the parameters which the parties must abide by and the right
may be passed to heirs, assignees, and administrators.
Due to the various forms and language included in these agreements careful attention should be used when entering a business transaction that involves a First Right of Refusal.
When a business owner decides to sell their company, if there is a previous
agreement that includes a First Right of Refusal clause, then the right holder must be provided the opportunity to match any offers the seller receives. The First Right of Refusal clause comes into
effect when an offer has been provided that the business owner would like to act upon.
The right holder has the option to sit back and wait while the potential buyer
and seller hammer out the details. When a final offer has been negotiated, the right holder can then step in and offer to meet the conditions of purchase or let the transaction
On the surface this may seem an acceptable arrangement. However, depending on
the language in the contract, the right holder may delay the process aggravating the potential buyer to the point they walk away. The right holder may have moved and cannot be located in an
acceptable time period, or may decide to neither respond nor waive their right.
A buyer must consider carefully a deal that includes the uncertainty of a right holder. Negotiations can be lengthy, expensive, and include attorneys, accountants, appraisals, business valuations, etc. Knowing that the deal may be stripped away from them may dampen a buyer’s desire to even start the process. It may also hinder a funding source from making a commitment to fund the transaction.
Business owners should be aware that when investors, lien holders, or
franchisors hold a First Right of Refusal they may also have access to the company’s financial statements and sensitive information. This provides a disadvantage to the company’s stockholders who want to sell the business at its maximum
If the potential buyer provides a low ball offer, the right holder who has access to the company’s data, may seize upon this opportunity to acquire the firm at below market value. The right holder only is only responsible for matching an offer and is not obligated to get into a bidding war that will drive the price higher.
Contracts containing First Right of Refusal clauses should be carefully negotiated.
1. A transaction may be legally invalidated if a seller attempts to circumvent a First Right of Refusal. Make sure you get legal advice.
2. Before revealing the First Right of Refusal some sellers will first negotiate the best deal possible. This might be advantageous to the seller, but the buyer and banker may not like the results.
3. This type of agreement can be used in franchises so that the Franchisor can control who is using their brand. Franchise Agreements containing this clause can stop the seller from completing a transaction with someone of the seller prefers.
4. Confidentiality agreements and non disclosure statements that potential buyer require, may provide challenges to the seller who has an obligation to disclose to the right holder.
5. To stop the right holder from obtaining the asset at a below market value, the seller may demand a higher purchase price from the potential buyer. A take it or leave it type of scenario.
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