What is a Right of First Refusal?
When buying or selling a house, you may hear unfamiliar terms. One of them is a first right of refusal, also known as a right of first refusal (ROFR).
A right of first refusal (ROFR) is a contractual agreement that allows one party to purchase or lease a property or asset before offering it to any other party. Essentially, a ROFR gives the first refusal to the party with the right to exercise it.
For example, let's say you own a property and have a tenant with a ROFR clause in their lease agreement. If you decide to sell the property, you must first offer it to your tenant at the same price and terms you offer to other potential buyers.
If the tenants exercise their ROFR, they can purchase the property instead of other potential buyers.
ROFRs are common in various business transactions, including real estate, partnerships, and intellectual property.
They can also be used in employment contracts, especially for high-level executives or key employees with access to sensitive information or proprietary technology.
First Right of Refusal in Real Estate
In real estate transactions, the first right of refusal is typically granted to a tenant, neighbor, or other interested party. This right allows the holder to match any offer made for the property.
For example, if a landlord decides to sell a rental property, they may grant the first right of refusal to the current tenants. If a potential buyer makes an offer on the property, the tenants would have the opportunity to match that offer and purchase the property before the sale.
The first right of refusal can also be used in other real estate situations. For example, if a developer wants to purchase a property zoned for commercial use, but the local community wants to preserve it for residential use, the community may be granted the first right of refusal.
Making the purchase would allow them to purchase and preserve the property for residential use.
Potential buyers could covet a property for many reasons, including the location, perfect house size, amenities, or endless additional possibilities.
How a Right of First Refusal Works
ROFR allows one party to purchase or lease a property or asset before offering it to any other party. Here's how it typically works:
- The ROFR is established: This is done through a contractual agreement between two parties. The party with the ROFR typically has a contract clause granting them the right to purchase or lease the property or asset.
- A seller receives an offer: When the owner of the property or asset decides to sell or lease it, they will receive an offer from a potential buyer or lessee.
- The owner notifies the party of the ROFR: If a party has a ROFR clause in their contract, the owner must notify them of the offer they have received, along with the price and terms.
- The party with the ROFR decides whether to exercise their rights: The party with the ROFR will have a specified amount of time, usually 30-60 days, to decide whether to exercise their right to purchase or lease the property or asset. If they decide, they must agree to the same price and contract terms as the potential buyer or lessee.
- If the party with the ROFR declines, the owner can sell to others: If one of the parties declines to exercise their right, the owner is free to sell or lease the property or asset to the potential buyer or lessee who made the initial offer, or to any other party.
How Do You Enter a Right of First Refusal Agreement?
Entering a right of first refusal (ROFR) agreement typically involves negotiating and drafting a contract outlining the agreement's terms and conditions.
Here's how you can enter into a ROFR agreement:
- Identify the parties: The first step is identifying the parties involved in the agreement. The party with the ROFR is typically the one who is given the first option to purchase or lease the property or asset.
- Define the property: The next step is to define the property or asset subject to the ROFR. This may include a specific piece of real estate, a business or partnership interest, or intellectual property.
- Establish the terms: The terms of the ROFR should be clearly defined in the contract. This may include the duration of the ROFR, the circumstances under which it can be exercised, the price and terms of any potential sale or lease, and the time frame within which the party with the ROFR must decide.
- Negotiate the contract: The terms of the ROFR should be negotiated between the parties involved. It's important to have legal counsel review the contract to ensure that it complies with applicable laws and protects the interests of both parties.
- Sign the contract: The parties should sign the contract once the terms have been agreed upon. The signed contract serves as the legal agreement between the parties and outlines the terms and conditions of the ROFR.
Entering into a ROFR agreement can be complex, and working with an experienced real estate attorney is essential to ensure that the agreement is drafted properly and protects your interests.
Additionally, it's important to review the terms of the ROFR agreement periodically to ensure that it continues to meet the needs of the parties involved.
The Benefits and Drawbacks of the Right of First Refusal
Before entering into a right of first refusal agreement in a real estate transaction, it is essential to consider the advantages and disadvantages of this legal arrangement.
While it can offer security for property owners and provide an opportunity for interested parties, it can also limit the property owner's flexibility and potentially delay the typical closing time frame.
Here are the advantages and disadvantages of the right of first refusal agreement.
Pros of Right of First Refusal:
- Provides security for the property owner: Property owners can know that the property will only be sold to someone qualified to own it and who has the financial means to make the purchase.
- Preserves property usage: The right of first refusal can ensure that a property is used for a specific purpose, such as residential use, rather than purchased by a developer who intends to use it for commercial use.
- Opportunity for interested parties: The right of first refusal can allow tenants, neighbors, or other interested parties to purchase a property they are interested in.
- Fair purchase price: The right holder must match any offer made by a third party, which can help ensure the property is priced fairly.
Cons of Right of First Refusal:
- Limits the property owner's flexibility: Property owners may be limited in selling the property quickly or at the best possible price, as they must notify the holder of the right before accepting an offer from a third party.
- Time constraints: Holders of the right typically have a limited time to decide whether to exercise their right, which can be stressful.
- Can delay the sale: The right of first refusal can potentially delay the sale of a property, as the holder has a specified amount of time to decide.
Right of First Refusal (ROFR) vs. Right of First Offer (ROFO)
A right of first offer (ROFO) and a right of first refusal (ROFR) are legal arrangements that give one party the right to purchase an asset before the owner offers it to others.
However, there are some key differences between the two:
- Timing: The primary difference between ROFO and ROFR is the timing of the offer. With a ROFO, the owner must offer the asset to the party with the right to purchase it before offering it to any other party. With a ROFR, the owner is free to negotiate with any party but must offer the terms of the sale to the party with the right of first refusal before finalizing any agreement with another party.
- Flexibility: A ROFR is more flexible than a ROFO. With a ROFR, the party with the right to purchase has the option to accept or decline the offer, while with a ROFO, the party with the right to purchase must make an offer to purchase the asset if they wish to do so. This means that the asset owner has more flexibility to negotiate with other parties if the party with the ROFO declines to make an offer.
- Certainty: A ROFO provides more certainty to the asset's owner. Because the party with the ROFO must make an offer to purchase the asset, the owner can be more certain that the asset will be sold at a particular price. With a ROFR, the owner may not know whether the party with the right of first refusal will ultimately decide to purchase the asset.
The right of first refusal is an excellent tool that can be used to ensure that a seller has a say in the future of their property.
While there are some potential drawbacks to this type of agreement, the benefits can be significant, particularly for those who want to maintain control over their property.
Whether you are a buyer or a seller, it is essential to understand the terms of any right of first refusal agreement before entering into it. Additionally, it is crucial to recognize the difference between a right of first offer and a right of first refusal, as they have different implications for both parties.
Considering all these factors, you can make informed decisions and protect your interests in any real estate transaction.