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What is a 'Right Of First Refusal'

A right of first refusal is a contractual right of an entity to be given the opportunity to enter into a business transaction with a person or company before anyone else can. If the entity with the right of first refusal declines to enter into a transaction, the owner of the asset is free to open the bidding up to other interested parties.

BREAKING DOWN 'Right Of First Refusal'

Since an entity with the right of first refusal has the right, but not the obligation, to enter into a transaction that generally involves an asset, it is akin to a having a call option on the asset.

A right of first refusal is usually negotiated by a party when it wants to see how a business will turn out. The party may prefer to hold the option to get involved at a later point, rather than make the outlay and commitment up front.

Advantages and Inconveniences of Rights of First Refusal

For the person holding it, a right of first refusal is an insurance policy that he will not lose an asset that he may need for his business. For example, a commercial tenant may prefer to lease premises but would actually buy the premises if not doing so meant that he would be evicted by a new owner. In such a case, the tenant would negotiate to have a right of first refusal incorporated into his lease.

Conversely, the right of first refusal is a hindrance for the property owner since it does, in fact, limit his ability to sell and seek buyers. In the same example as above, the landlord may have a difficult time attracting buyers if they know that the current tenant will likely meet any offer they make. However, if attracting the right tenant necessitates a right of first refusal, the property owner might still do it.

Common Uses of Rights of First Refusal

In the business world, rights of first refusal are commonly seen in joint venture situations. The partners in a joint venture generally possess the right of first refusal on buying out the stakes held by other partners, should the latter wish to leave the joint venture. Similarly, in private companies, shareholder agreements commonly allow existing shareholders to purchase those who wish to leave before any new shareholders are brought in.

Rights of first refusal are a common feature in many other areas, from real estate to sports and entertainment. For example, a publishing house may ask for the right of first refusal on future books by a relatively new author.

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