What Is a Right Of First Refusal?

Right of first refusal (ROFR), also known as first right of refusal, is a contractual right to enter into a business transaction with a person or company before anyone else can. If the party with this right declines to enter into a transaction, the obligor is free to entertain other offers. This is a popular clause among lessees of real estate because it gives them preference to the properties in which they occupy. However, it may limit what the owner could receive from interested parties competing for the property.

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Right of First Refusal

How a Right Of First Refusal Works

Rights of first refusal clauses are similar to options contracts as the holder has the right, but not the obligation, to enter into a transaction that generally involves an asset. The person with this right has the opportunity to establish a contract or an agreement on an asset before others can. 

Rights of first refusal are usually requested by individuals or companies who want to see how a business or opportunity will turn out. The rights holder may prefer to get involved at a later point, rather than make the outlay and commitment right away, and a right of first refusal allows them to do so.

Right of first refusal clauses can be customized to create variations of the standard agreement. As such, the parties can incorporate changes, such as specifying how long the right is valid or allowing a third-party nominated by the buyer to make the purchase. Typically, right of first refusal agreements are bound by time. After the period expires, the seller is free to pursue other buyers.

Key Takeaways

  • A right of first refusal is a contractual right giving its holder the option to transact with the other contracting party before others can.
  • The ROFR assures the holder that they will not lose their rights to an asset if others express interest.
  • The right of first refusal can limit the owner's potential profits as they are restricted from negotiating third-party offers before the rights' holder.

Advantages and Disadvantages of Rights of First Refusal

For the entitled party, a right of first refusal is sort of an insurance policy, assuring that they will not lose rights to an asset that they want or need. For example, a commercial tenant may prefer to lease a location; however, he may buy the premises if it meant that he would be evicted if the property sold to a new owner. In such a case, the tenant would negotiate to have a right of first refusal clause incorporated into his lease. This way, if leasing becomes impossible, he would have the option to buy the property before others have the chance. 

Conversely, the right of first refusal is a hindrance for the property owner since it limits the ability to negotiate with multiple buyers, who in a bidding war could drive up the price. In the example above, the landlord may have a difficult time attracting buyers if they know that the current tenant is always first in line to buy. However, if attracting the right tenant necessitates a right of first refusal, the property owner might still do it.

Special Considerations

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 who leave the venture. Similarly, a ROFO gives non-selling shareholders in a shareholder agreement the right to purchase shares of selling shareholders before they are offered to the public.

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 new author.