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When dealing with other businesses, being given exclusive access or a first offer often eliminates a lot of competition. This is why things like a right of refusal are common in commercial relationships.
Holding the right of first refusal means the person with the right is entitled to a particular offer before anyone else. The right of first refusal plays out in many ways in business. For example, it can determine whether a franchisee is able to sell their business to the public first or who shareholders can sell their shares to before they leave a company.
Overall, the right of first refusal can establish security and be an incentive to enter into a contractual relationship. However, like many other contractual clauses, it should be drafted and reviewed by a legal professional to ensure you’ve covered all key risks.
In this article, we’ll go through what a right of first refusal involves and how it can help your business’ transactions and activities.
What Is A Right Of First Refusal?
The right of first refusal is usually not an implied right, therefore, it must be expressly stated in an agreement. In other words, it should be made crystal clear in the contract.
When a right of first refusal has been granted, the party who has granted the right will not be able to sell a particular asset or product to anyone else unless they have offered it to the individual or organisation that possesses the right.
Once an offer is made to the respective party, they are at their own liberty to either accept or refuse it. If the party declines the offer, then the seller can look into finding other purchasers.
Some important things to know about a right of first refusal are:
- The right establishes an obligation on one party to offer the sale of a particular good to another party first, if they ever decide to sell it
- It’s a contractual clause and must be worded carefully
- As it is a contractual obligation, a right of first refusal is legally enforceable
- Right of first refusals differ greatly from exclusivity clauses
How Does First Right Of Refusal Work?
A right of first refusal can differ depending on the exact business context you’re using it in. Let’s go through an example to better understand how it works in practice.
| Example Hannah has been operating a cosmetics franchise for six years now but feels that it’s time to move on to other ventures. She plans on selling the franchise however, according to the terms of the contract, she must make an offer to the franchise owner before anyone else. Therefore, Hannah informs Monty, the owner of the franchise, of her intention to sell as well as her asking price. Monty likes the idea of owning one of his business franchises and accepts Hannah’s offer. If Monty had not accepted Hannah’s offer, she would have had the right to open her sale up to the public afterwards. |
What Does First Right Of Refusal Look Like In A Contract?
A right of first refusal clause in a contract will depend on the type of commercial relationship it is based on. For example, the franchise scenario above will have a slightly different clause to one tailored to shareholders selling their shares.
This could include the wording of the clause, the number of people with the right of first refusal and any relevant limitations on the offer of sale. Nonetheless, most right of first refusal clauses should contain these key elements:
- Specifying who will receive the right of first refusal
- A reasonable time for the offer to stand
- Any processes regarding the valuation of the product that is on sale
- Dispute resolution or negotiation processes
- The payment for the purchase
The clause should also address other parts of the contract it coincides with.
To ensure you’ve covered all key aspects, it’s important to seek help from a legal professional.
Butchart & Anor v Sinnamon & Ors [2021]
An example of the importance of wording in right of refusal clauses can be seen in the case of Butchart & Anor v Sinnamon & Ors [2021].
In the case of Butchart & Anor v Sinnamon & Ors [2021], Mr Sinnamon owned two properties, namely, Lot 30 and Lot 31. Mr Sinnamon had sold Mr Butchart Lot 31. Their agreement stated that when Mr Sinnamon sells Lot 30 as well in the future, Mr Butchart would have the right of first refusal.
Mr Sinnamon ended up selling the property to another buyer which led Mr Butchart to claim that the clause had been breached. Mr Sinnamon argued that he had in fact offered the property to Mr Butchart at first, who claimed he could not afford it unless there was a 12 month settlement.
Mr Sinnamon took this as a decline of his offer and carried on with the sale of Lot 30. The court sided with Mr Sinnamon, claiming nowhere in the clause was there a provision granting a payment plan that could allow Mr Butchart to rightfully purchase the property through a 12 month settlement.
Butchart & Anor v Sinnamon & Ors [2021] demonstrated the confusion and loss that can occur if right of first refusal clauses are not drafted with care.
How To Enforce A First Right Of Refusal
The right of first refusal is part of a contractual agreement, therefore, it is a legally enforceable clause. The clause, however, is not enacted until the sale or possibility of a transaction arises.
In Shareholders Agreement, the right of first refusal can be used to ensure that if an existing shareholder wishes to part with their shares, they must first offer it to the current shareholder prior to the general public. If they fail to follow this clause, they can be considered in breach of their contractual obligations.
| Example Blake is one of eight shareholders of a production company. Blake decides he wants to sell his shares at the production company. However, his Shareholders Agreement stipulates that the other seven shareholders are entitled to the right of first refusal. He chats with a good friend, Tina, where they discuss his exit. When Blake tells her, Tina offers to buy the shares from him. Since the right of first refusal is clearly set out in his agreement, Blake turns down the offer, otherwise he would be in breach of the contract. |
How Is This Different To An Exclusivity Clause?
An Exclusivity Clause is very different from a right of first refusal.
The key difference is that an exclusivity clause will prevent a business from engaging in certain commercial interactions, so that their transactions are exclusive to one business or client. For example, if a supplier is bound to an exclusivity clause with one of their clients, they can either:
- Only sell products to that client, or
- Only sell products in certain geographical locations
A right of first refusal clause, on the other hand, involves exclusive access to an offer of sale, rather than the transaction itself. This means the person or business who possesses that right can choose to accept or decline the offer. They have the right to choose to purchase, and is only enforceable upon that offer.
Furthermore, exclusivity clauses exist from the signing of the document until the termination of that contract, and is based on an existing business relationship. However, a right of first refusal is enacted upon the opportunity for a sale.
Key Takeaways
Right of first refusal clauses can work to keep the interest of all parties in mind, when it is used correctly. The key takeaways are as follows:
- Right of first refusal clauses allow a party to receive an offer of a sale first
- If they decline this offer, the seller can seek another purchaser elsewhere
- Right of first refusals are contractual clauses that should be drafted attentively by an expert to prevent potential legal troubles
- It’s important to distinguish these from exclusivity clauses, which work in a different business context
If you have any further queries regarding right of first refusal clauses, or need any legal help drafting contracts generally, reach out to us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.
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