In corporate and commercial transactions, the term “right of first refusal” (ROFR) frequently appears in contracts, shareholder agreements, and joint venture arrangements. Though often used interchangeably with other pre-emption rights, the right of first refusal carries distinct implications and should be carefully negotiated and clearly drafted to avoid disputes.
This article provides a detailed overview of the right of first refusal, including how it functions, typical scenarios in which it arises, its application in shareholder and joint venture contexts, and key considerations in negotiating and drafting such rights.
Understanding the Right of First Refusal
A right of first refusal is a contractual right that gives a specified party the option to enter into a transaction before the asset holder offers it to a third party. In practice, this means that if the owner of an asset (such as shares, property, or intellectual property) intends to sell or transfer it, the holder of the ROFR can match the terms of a third-party offer or to purchase the asset on agreed terms before it is offered more widely.
ROFR provisions are widely used as a mechanism to maintain control over who may become a stakeholder in a business or gain access to valuable assets. They act as a safeguard, giving existing investors, shareholders, or strategic partners a chance to prevent undesired third parties from entering a venture.
Key Characteristics of ROFR
While specific terms may vary, ROFRs generally share the following features:
Triggering Event
The ROFR is usually triggered when the seller receives a bona fide third-party offer.
Notice Requirement
The seller must notify the ROFR holder of the offer and provide sufficient detail (including price and material terms).
Exercise Period
The ROFR holder is typically given a fixed time window to decide whether to match the offer.
Transfer Restrictions
If the ROFR holder declines the offer, the seller is then free to proceed with the sale to the third party, usually on the same or better terms.
It’s important to distinguish a ROFR from a right of first offer (ROFO). A ROFO gives the holder the opportunity to make an offer before the asset is marketed to others, whereas a ROFR is reactive and applies after a third-party offer has been received.
ROFR in Shareholder Agreements
In the context of private companies, particularly those with multiple shareholders, ROFR provisions are commonly embedded in shareholder agreements to control the transfer of shares. These rights serve to protect existing shareholders from having unknown or unwanted third parties acquire shares, potentially impacting control or direction of the company.
Typical Clause Structure:
Trigger
A shareholder proposes to sell their shares to a third party.
Offer to Existing Shareholders
The selling shareholder must offer the shares to other shareholders on the same terms as the third-party offer.
Pro Rata Rights
The offer may be extended on a pro-rata basis, allowing each shareholder to purchase a proportionate number of shares based on existing ownership.
Completion
If shareholders decline to purchase, the seller may proceed with the third-party sale, usually within a limited time and on terms not more favourable than those rejected.
This type of arrangement is closely aligned with pre-emption rights, though there is a subtle distinction. Pre-emption rights often refer to rights of existing shareholders to purchase new shares in an issuance (to prevent dilution) and in many agreements, both types of rights co-exist.
ROFR in Joint Ventures
In joint venture (JV) arrangements, the ROFR can be especially important in managing exit strategies and maintaining strategic balance among the partners.
A typical scenario is where one JV party wishes to exit by selling its interest. The ROFR allows the remaining parties the first opportunity to purchase that stake. This ensures that a competitor or non-aligned entity doesn’t acquire a position of influence within the JV.
Some JV agreements go further by including “tag-along” and “drag-along” rights, in conjunction with a ROFR, offering more complex exit mechanics. ROFRs may also interact with broader governance arrangements, such as reserved matters or board composition, making it critical to assess the full commercial context.
Other Common Uses
ROFR provisions also appear in:
Commercial Property Leases
Tenants may have a ROFR to purchase the property if the landlord decides to sell.
Licensing Agreements
In IP-heavy industries, licensors may grant licensees a ROFR over future rights or ownership of the IP.
Supply Agreements
Buyers may seek a ROFR for key components or raw materials in the event of a sale by the supplier.
Negotiating and Drafting ROFR Clauses
Well-drafted ROFR clauses should be clear, unambiguous, and tailored to the specific context of the transaction. Key points to consider include:
1. Scope: Define exactly what asset the ROFR applies to, e.g., ordinary shares only, or all equity interests?
2. Trigger Events: Should the ROFR apply to sales only, or also to gifts, restructures, or transfers within a group?
3. Offer Terms: Should the seller be required to disclose all material terms of the third-party offer, or just the price?
4. Response Time: Allow sufficient time for the ROFR holder to evaluate and arrange funding if necessary.
5. Non-Compliance: What are the consequences if a sale proceeds in breach of the ROFR? Is it void, or does it give rise to damages?
6. Exclusions: Should transfers to affiliates, family members, or trusts be carved out of the ROFR?
It is also important to consider anti-avoidance provisions. For example, preventing parties from circumventing the ROFR by structuring a transaction as an asset sale rather than a share sale.
How we can help
The right of first refusal is a powerful tool in corporate and commercial agreements, but one that requires careful consideration. While it provides protection for existing stakeholders, it can also introduce complexity and potentially hinder third-party transactions.
Whether you are a founder entering into a shareholder agreement or a joint venture partner planning an exit, understanding how ROFRs function (and how they differ from other pre-emption rights) is vital to safeguarding your interests.
If you are considering entering into an agreement involving ROFR provisions, are unsure how they may apply to your business, or would like to create a new agreement, we recommend seeking legal advice early in the negotiation process. At Ronald Fletcher Baker, we have extensive experience drafting and negotiating corporate and commercial agreements across a wide range of sectors and deal types.
For tailored advice, please contact Olivia Crolla (Associate Solicitor) at o.crolla@rfblegal.co.uk
Olivia Crolla
Associate Solicitor
