What is a right of first refusal (ROFR)?

ROFR (or first right of refusal) greatly impacts your startup and its future opportunities. The clause is popular in the real estate industry and gives lessees preference to properties they like. As an obligor, you can only entertain other offers when the ROFR holder declines to exercise their right. 

For this reason, it may limit you from receiving greater offers from third parties. Therefore, you should take time to understand everything about ROFR – what it is, how it works, and its impact on your startup. Read on to learn more! 

Right of first refusal (ROFR) meaning

ROFR is an agreement that gives the holder the right to make the first offer or make a transaction with your startup before other interested parties. The clause mostly involves assets, for example, a rental tenant looking to acquire the property they are living in from their landlord.

A property lessee with ROFR has a right to make the first offer on the property – when the owner lists it for sale – before other potential buyers.

If another party shows interest in buying the property, the ROFR holder still has the right to buy the property. The property owner/seller can only accept other offers when the ROFR holder declines to exercise their right.

ROFR mostly serves as an incentive for lessees in buyer's markets. Besides, it is also a powerful estate planning tool that prevents conflicts that result from inheritance among family members. If you are a contingent buyer subject to a kick-out clause, you may benefit significantly from a ROFR.

In summary, a ROFR clause gives the seller an obligation to present the rights holder with the property listing before accepting alternate offers from third parties.

What is the purpose of ROFR?

Most commercial leases come with provisions that give your business more security in case your landlord lists the property you rent for sale or goes bankrupt. As a venture capital investor, you can use the ROFR to acquire the entire company or the best rates on stocks. Unknown to most people, holding a ROFR as you wait for the ideal moment is more profitable than purchasing the asset right away.

Besides, joint venture business partners share the first right of refusal, which keeps third parties from buying shares in the firm when one of them chooses to sell. Shareholder contracts in the private sector work the same way. For instance, a publisher can hold the right of first refusal on a new author's future books.

In cases where no one holds the right of first refusal for your company or property, the seller can grant it to the first buyer – who is also free to ask for it – or use it to attract potential buyers.

How does the right of first refusal work?

The right of first refusal works similarly to option contracts. The holder has the right to transact with your business, mostly on transactions involving assets, before others can do so.

People who request the right of first refusal mostly want to see the outcome of an opportunity or business. They prefer to participate in the transaction later rather than committing right away. In such cases, the right of first refusal offers them an excellent opportunity to achieve their goals.

You can customize the ROFR clauses to include the standard agreement variations. Doing so allows you and the other party to incorporate the necessary changes, including the contract duration and on what grounds the rights holder can nominate a third party to exercise the right.

ROFRs, like other legal clauses, are time-bound, and the seller can pursue other offers upon expiration.

What are the pros and cons of the right of first refusal?

ROFR is an insurance policy for the rights holder, reassuring them that they can't lose rights to the asset they like or want. For instance, a commercial lessee can purchase the property they rent if they are at risk for eviction by a new buyer. 

In such an event, the tenant may negotiate to incorporate the right of first refusal into their lease. Doing so gives them the right to buy the property before other potential buyers when leasing becomes impossible.

On the other hand, the right to first refusal hinders the property owner from negotiating with third-party buyers, who are capable of a competitive price due to the bidding war amongst themselves.

How can you get a right of first refusal?

Drafting a ROFR clause involves contractual legalities, thus demanding your lawyer's presence. The process mostly involves two lawyers, one representing you and the other representing the property owner. During this process, the seller states the selling price and gives both lawyers time to discuss and ensure fairness for both parties involved.

What is the ideal time to use the right of first refusal?

The right of first refusal is a popular clause among renters who may want to buy the property in the future – upon lease expiration when the owner lists it for sale or goes bankrupt. The clause gives the renter the right to make the first offer on the property before the owner proceeds to other offers.

ROFR prevents chaos and conflicts among family members dealing with inheritance. 

What are alternatives to the first right of refusal?

The right of first offer, also known as the right of first negotiation, is the most effective alternative to the ROFR. The former carries more limitations for the rights holder as they – the holder – are given the privilege to make their offer instead of accepting the transaction on the same terms. The obligor, on the other hand, is free to accept or refuse the offer and can proceed to transact with a third party on different terms. 

What are the consequences of violating ROFR contract terms?

Since ROFR is a legal agreement, its violation carries some consequences depending on the contract law. If the holder doesn't get the right to refuse, they may sue the seller for either specific or financial damages.

Specific performance forces the violating party to act according to the contract. For instance, if the holder did not get their right before the third party entered the transaction, they regain the opportunity to exercise their rights, which may be buying the property on the same terms.

In cases where specific performance isn't an option due to state law or circumstances, the holder may pursue monetary damages. The money is meant to compensate them for the inconvenience of the loss of opportunity. 

Right of first refusal (ROFR): Key takeaways

A right of first refusal is a legal agreement that gives the holder the privilege to do business with the other party before anyone else does. It is an assurance that you won't lose your rights in the future when the other party chooses to sell their asset of interest. However, ROFR may limit the asset owner's possible profits as they sell off their right to transact with third parties unless the rights holder declines to exercise their right. 

As a business owner renting a property, you are likely to significantly benefit from the clause. But the case isn't the same when it comes to selling your company's stock.

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Disclaimer: LTSE is neither a law firm nor provides legal advice. Before making decisions on matters covered by this post, readers should consult their legal adviser.