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As a business owner, you may find a right of last refusal term contained in your commercial contracts. This article will explain how a right of last refusal operates. It will also discuss how it differs from a right of first refusal. Finally, this article will explain what you should look out for when agreeing to such a term. 

Right of Last Refusal

A right of last refusal is a preemptive right to receive a particular benefit in preference to any other party. A right of last refusal is embedded into earlier contracts between parties, and gives one party the right to match an offer made by a third party when considering any future transactions. 

For example, imagine that you are a manufacturer of car parts. Imagine also that you have previously entered into an agreement with XYZ Motors to manufacture and supply them with 100 units of an exhaust at $1.50 per unit. Your agreement with XYZ Motors contains a right of last refusal for any future orders relating to that same exhaust. XYZ Motors are now in the market for another 150 units of the same exhaust, and have received an offer from ABC Manufacturers to manufacture the exhaust for $1.30 per unit. As you have the right of last refusal granted to you as a continuing obligation from your previous contract, XYZ Motors must present the offer from ABC Manufacturers to you. By doing so, XYZ Motors effectively gives you the opportunity to match that offer and they must refuse the offer from ABC Manufacturers. As a result, XYZ Motors must instead contract with you for the supply of these additional units. Indeed, only if you refuse to match the offer received from ABC Manufacturers can XYZ Motors enter into a contract with them. 

How Does This Differ From a Right of First Refusal?

In contrast, a right of first refusal requires that the party receiving the benefit of the right be given the first option to enter into a particular transaction. Only if this party chooses not to exercise their right can the other party then go to market and seek additional offers. You will more likely see a right of first refusal in commercial contracts in comparison to a right of last refusal.

Following on from our previous example, imagine that the contract between you and XYZ Motors contained a right of first refusal. In this case, XYZ Motors would have been obligated to allow you to make an offer first, before seeking offers from third parties. 

You may also see a right of last refusal in shareholders agreements. A shareholder wishing to sell their shares must first offer those shares to the other shareholders in the business. If those other shareholders choose not to exercise their option to purchase these shares, only then can the original shareholder look for other offers. 

Advantages of a Right of Last Refusal

A right of last refusal can be quite beneficial to the holder of that right. This is because you have a right to match an offer made by a third party in relation to a business transaction. As a result, this allows you the opportunity to understand the market before making your offer. Additionally, it also gives you time to think about the offer you will make, with a guarantee that the contract won’t be awarded to someone else if you don’t promptly respond. 

Disadvantages of a Right of Last Refusal

On the other hand, a third party may become aware that another party has a right of last refusal over a transaction they are currently negotiating. In this case, the third party may decide not to proceed with the negotiations. This is because the risk of the transaction falling through may not be worth investing time into the negotiations and the due diligence process. Moreover, this may cause issues for the party that has granted the right of last refusal. THis is because it could mean there are fewer parties showing an interest in the transaction, and therefore less bargaining power. 

Key Terms of a Right of Last Refusal

When including a right of last refusal in your contract, it is important to think about the practical effects of the right. Some important things to consider include:

  • Timeframe: Does the party receiving the benefit of the right have to exercise their right within a particular time frame? The time frame should be sufficient to give the party some time to assess the situation and make an informed decision, however it shouldn’t be too long in that it results in you potentially missing out on other opportunities. 
  • Commercials: Is the right holder allowed to simply match the offer made by the third party, or do they need to beat the offer in some manner? 
  • Restrictions: Are there any other restrictions that will be placed on either party or the future transaction? Taking another look at the example of the shareholders agreement above, if the other shareholders chose not to exercise their right of last refusal, they may still have the opportunity to reject the sale of the shares to another third party if they believe that third party is unsuitable to hold those shares. Similarly, will the holder of the right of last refusal have any other rights under this provision? 

Key Takeaways

A right of last refusal is a preemptive right that gives the holder of the right the opportunity to make an offer in ongoing negotiations between the other party and a third party. If the party holding the right of last refusal is able to match the offer made by the third party, depending on the terms of the right of last refusal, the other party may be obliged to accept that offer rather than continuing negotiations with the third party. A right of last refusal needs to be carefully considered to ensure it has some benefit to both parties involved. 

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