Rights of First Refusal Definition

A contract containing a right of first refusal gives the holder the right to purchase an asset or enter into a business contract before anyone else. 

Right of First Refusal Definition

A right of first refusal is a contract term that allows a specified individual or company the option to enter into a business transaction before anyone else has the opportunity to do so. This term frequently appears in real estate and business contracts. 

Right of First Refusal Examples

There are many uses for a right of first refusal. For example, a building owner might give a tenant a right of first refusal to purchase the property in the event of a sale. They may use such a term to entice appealing tenants who will benefit because they gain the option to buy instead of being evicted if the owner eventually decides to sell the property.

Partners in a joint venture, limited liability company (LLC), or other legal entity might include a right of first refusal in their formation documents. This prevents outsiders from joining the company if one partner decides to sell their share. 

Finally, a trustor may include a term in their trust giving a child a right of first refusal, meaning that child gets the first opportunity to purchase the family home.

Right of First Refusal Benefits

The main advantages of a right of first refusal are that it gives the holder an opportunity to obtain a deal without competition and it can save the seller transaction costs. This contract term also may give a potential investor time to see how well a new business does before deciding to invest.

Right of First Refusal Disadvantages

On the other hand, if a buyer holds a fixed price right of first refusal on a home and the value of the home decreases, then it may not be a benefit. 

Lenders also won’t always give you a mortgage or refinance your existing mortgage if your home is bound by a right of first refusal. This is because your home serves as collateral for the mortgage. The lender will want to obtain the best market price if it has to repossess and sell your home and not be limited to one seller.  

Other Considerations

Of course, the contract term must be valid to be enforceable. It’s important for both parties to have legal counsel when negotiating a right of first refusal. It’s important to specify, among other things:

• Whether the right expires under any circumstances
• How long the holder has to act on the right
• Whether the right is transferable
• How a future sale price will be calculated

Both sides also need to consider the options in case of a breach. When the owner of an asset fails to offer the holder the promised right of first refusal, the remedies are specific performance or monetary damages. Specific performance requires the owner to offer the deal, such as by giving the holder the right to buy a house. But if state law or other circumstances make specific performance impossible, then a court will award monetary damages.

Difference Between a Right of First Refusal and a Right of First Offer

The holder of a right of first offer is entitled to receive advance notice of a deal and have time to make the first offer. Unlike with a right of first refusal, the offeror doesn’t have to accept the offer. They’re free to reject the offer or to negotiate in light of subsequent offers from other potential buyers. 

Summary

A right of first refusal can be a useful tool for buyers and sellers in doing business and dealing in real estate. But it’s important to have a lawyer negotiate the terms for you.

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We Can Help

If you’re a small business owner just starting out, we can help you form your LLC. You can include a right of first refusal in favor of your partners in your operating agreement. Our Operating Agreement Template will get you started.