Summary
- A right of first refusal gives one party the opportunity to accept an offer before it is made available to anyone else.
- If the holder declines, the owner can then offer the opportunity to third parties, usually on the same terms.
- It is commonly used in shareholders’ agreements, leases and commercial contracts to control who can enter a transaction.
- This guide explains the right of first refusal for Australian business owners, including how it operates in commercial arrangements.
- It is prepared by LegalVision’s business lawyers, a commercial law firm that specialises in advising clients on commercial contracts.
Tips for Businesses
Clearly define when the right is triggered, the notice process and response timeframe. Ensure terms offered to the holder match any third-party offer. Consider whether the clause restricts your ability to negotiate freely, and tailor it to balance flexibility with control over key transactions.
A right of first refusal is a contractual right that gives one party the opportunity to accept or match an offer before it is made available to anyone else. It is commonly used in commercial agreements to ensure that the holder does not miss a key opportunity, such as buying shares or assets, by requiring the owner to offer the opportunity to them first on the same terms. This article explains what a right of first refusal is, how it works in practice, and the key terms to consider when including it in your contracts.
What is the Right of First Refusal?
A holder of a right of first refusal, which is found within an agreement or deed, has the option to accept a particular offer or opportunity before any other person. This contractual right arises in many contexts, including transactions involving the sale of business, consumer goods and real estate, which we have set out below.
What Types of Contracts Include a Right of First Refusal?
There are a variety of types of contracts which may include a right of first refusal clause, including:
| Shareholders Agreement or Constitutions | If a company is issuing new shares or where an existing shareholder is disposing of their shares, they may be required under the shareholders agreement or constitution to offer them to existing shareholders before offering them to third parties. This benefits the existing shareholders by ensuring that they have the chance to ensure against their shareholding being diluted and continue to maintain the same level of control of the company and decision-making. |
| Franchise Agreement | Leases may grant tenants the first right to purchase a property when the lease comes to an end or where otherwise, the landlord intends to sell the property. This gives the tenant the opportunity to expand their asset base at a premises that they have come to enjoy while saving the landlord agency and advertising fees in searching for a buyer. |
| Lease | Leases may grant tenants the first right to purchase a property when the lease comes to an end or where otherwise, the landlord intends to sell the property. This gives the tenant the opportunity to expand their asset base at a premises that they have come to enjoy, while saving the landlord agency and advertising fees in searching for a buyer. |
| General commercial contracts | If a company is issuing new shares or where an existing shareholder is disposing of their shares, they may be required under the shareholders agreement or constitution to offer them to existing shareholders before offering them to third parties. This benefits the existing shareholders by ensuring that they have the chance to ensure against their shareholding being diluted and continue to maintain the same level of control of the company and decision-making. |
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What Are Key Terms in a Right of First Refusal?
The table below outlines the key terms in a right of first refusal clause.
| Timeframe and Notice | The clause should specify a timeframe in which a party can exercise their right of first refusal. Without a timeframe, the right may be open-ended and restrict the other party’s ability to deal with third parties. However, the specified time frame should not be overly short. For example, a franchisor should have sufficient opportunity to conduct due diligence before purchasing a franchise business. It will also specify how the exercise of the right may be made – which is normally in writing, to the notice addresses set out in the agreement. |
| Commercial Terms | The clause should indicate what the commercial terms are for the relevant offer or opportunity which will be taken up. For example, the franchisee and franchisor could decide on the sale price of the franchisee’s business upfront, the terms relating to how that price will be paid, and what standard form of sale agreement will be used in the transaction. Sometimes it will be difficult to fully flesh out all the commercial terms, as it often refers to a time in the future when circumstances may be different. In this case, the clause may need to require the parties to agree to negotiate in good faith the terms of any subsequent or new agreement relating to the opportunity or offer. |
| Selling to others | It is normally the case that if a party does not take up their right of first refusal, then it is a requirement of the other party not to offer the relevant opportunity (for example, the sale of an asset) on commercial terms that are no more advantages as that offered or negotiated with the first party. |
What is the Right of Last Refusal?
The right of last refusal operates differently. This right is typically activated in the interim period between a contract being negotiated and a contract being signed. If you have this right, this enables you to compete with a third party to retain your current business opportunity.
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Key Takeaways
A right of first refusal is commonly used in commercial contracts to the benefit of both parties. However, both parties should analyse the operation of the clause to determine whether it operates to their advantage. As such, before including a right of first refusal clause in your contract, you should consider a number of factors. You should consider whether you are granting or receiving the right of refusal. Additionally, you need to determine if the contract provides specific and sufficient time frames and defines commercial terms. Further, you should also determine if you require a valuation clause. Lastly, you should consider if you or the other party require additional rights, such as a right of last refusal.
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Frequently Asked Questions
A person holding a right of first refusal has the option to accept a business offer before anyone else. For example, shareholders leaving a company may be obligated to first offer their shares to the existing shareholders of the company in accordance with the company’s shareholders agreement. If this offer is not taken, the leaving shareholder may then offer the shares for sale on the market to third parties.
Yes, the right of first refusal can be waived if the parties benefiting from the right do so. An example would be where the existing shareholders of the company waive their pre-emptive rights on the issue of shares as a part of the share issue process.
The owner must first offer the asset to the holder on the same terms as a third-party offer. If the holder declines, the owner can proceed with the third party.
It helps protect existing stakeholders by giving them priority to acquire assets and maintain control before they are transferred to an external party.
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