Right of First Refusal

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Blog Author :

WallStreetMojo Team

Edited by :

Vageesha Mishra

Reviewed by :

Dheeraj Vaidya, CFA, FRM

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Meaning of Right of First Refusal (ROFR)

Right of first refusal (ROFR) is a right in a contract that offers a party a chance to acquire something beneficial before it is offered to a third party. For instance, a real estate owner offers a potential buyer to purchase his property at a certain price before offering it to others due to the Right of First Refusal clause. ROFR is found in some business contracts, real estate agreements and shareholdings.

Right of First Refusal
Table of contents
  • A right of first refusal is a right in a legal contract that offers certain preferential rights to its holder.
  • These contracts can be found in some business contracts, shareholdings, real estate dealings, and tenant-landlord agreements.
  • A ROFR contract usually obligates a shareholder to offer the company a chance to buy back its shares before the shareholder takes on the offer from a third party or an outsider.
  • ROFR comes with a time frame that gives its holder some time to decide upon the offer before its expiry.

How Does Right of First Refusal Work?

ROFR is a contractual right, offering the holder of this right to have preferential access to some great opportunity. Since it is a little complicated subject, we'll explain the meaning and aspects of the Right of First Refusal contract with a quick example. Mark is a tenant occupying a property. Mark receives a call from his landlord, who says a third party is interested in purchasing his property in which Mark is currently residing. The third party is offering the landlord $100,000.

Since Mark is the Right of First Refusal holder, the landlord is invoking the ROFR clause and is offering to sell the property to him at $100,000. The ROFR clause comes with a time limit. As such, the landlord gives Mark a couple of days to make up his mind and purchase the property at $100,000. If Mark cannot do so before the expiry of the time frame, the landlord will be offering the property to the third party who made the offer.

Mark is under no obligation to make the purchase. However, if he doesn't want to lose the property, he would have to arrange the quoted price to buy it. He is being given some time in which he can look for alternatives, compare the market rates and arrange finances to make a decision. On the bright side, it gives a preferential right to the holder and a certain time to decide.

But on the flip side, many critiques have argued that the ROFR clauses are confusing. In cases of a real estate property, many potential buyers have had to purchase the property at a high price because of the mental pressure they felt at the thought of losing the property to an available interested buyer.

Many jurisdictions have different rules regarding how this contract can be used. This includes laws determining how long this right can last. Generally, these intricacies can be worked out by hiring a lawyer who can draft the contract. For negotiations in terms of the rate at which the landlord was offering the property to Mark, a lawyer could come in handy.

Example

Practical examples of the Right of First Refusal contract can be found in some business contracts, shareholdings, real estate dealings, and tenant-landlord agreements. As part of a business contract, let us take you back to January 2001 when National Broadcasting Company (NBC) and Paramount Studios were renegotiating who would gain the right to broadcast the TV series, Frasier, after the expiry of the existing term. NBC was the holder of ROFR.

The negotiation contract said, If Paramount and NBC did not come to an agreement over the financial terms before the lapse of the ROFR period, Paramount is free to allow the broadcasting license to a third party.

Another example of a ROFR contract could be a shareholder's agreement. A ROFR contract usually obligates a shareholder to offer the company a chance to buy back its shares before the shareholder takes on the offer from a third party or an outsider.

Right of First Refusal (ROFR) in Real Estate

The ROFR contract between a seller and a potential buyer of a real estate property can be beneficial for both, which is why it is popular in property deals. Due to this contract, a seller will offer the property to the potential buyer at a certain rate before offering it to the competing parties. The potential buyer will have certain days to decide upon the offer before its expiry, giving some time to explore the property's condition and the prevailing market trends.

For the contract to be beneficial to both, expertise in real estate is needed. A real estate lawyer is essential in drawing up the contract. Having an expert helping hand ensures that these transactions benefit the buyer and the seller.

However, it is imperative to note that this only works if both the buyer and seller are well represented. If not, the worst-case scenario has one party using it to take advantage of the other party, as happened in some cases where buyers had to pay a higher price from the fear of losing the property to a competitor.

There are many ways of getting into this contract in real estate. In some instances, a real estate firm could approach property owners and convince them to sell their properties using the Right of First Refusal. This is particularly when the property is in high demand.