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What is Right of First Refusal?

2017-05-13T06:37:41+00:00

The term 'Right of First Refusal' is included in the Economics edition of the Financial Dictionary. Get yours now on amazon in ebook or paperback format. Read more here...

Right of First Refusal refers to a right, but not an obligation, to enact a transaction regarding an asset with another party ahead of any competitors. It is similar to possessing a particular call option on the asset in question. Such a contractual right will typically be negotiated after a party to a transaction wishes to first see how its business will go. The participant could easily decide it is better to have the option to become involved in the asset or opportunity later on instead of having to commit to and pay for it in advance.

There are some significant advantages and benefits to having a Right of First Refusal. It represents a true insurance policy for the contract holder to not lose the possibility of later acquiring the valuable asset which may help to build up the business. It is always helpful to consider a concrete example to better understand this. The commercial tenant of a building might wish to lease or re-lease their office space. It might be willing to purchase the space if the alternative was to be thrown out in favor of a new tenant. This is a good instance when a tenant would want to obtain a first right of refusal as part of the lease contract.

At the same time, such a Right of First Refusal is an inconvenience for the owner of the office building and property. This is because it restricts the capability of seeking out buyers for the building or selling it off. The landlord for the building in this example will discover how hard it is to entice buyers for the property when they learn that the present tenant has the right to match any offer which they decide to make on the property. Yet for building owners, getting the right tenant can be worth providing the first right of refusal incentive in order to secure the lease deal.

There are many cases in the business world where such Rights of First Refusal are in evidence. This is especially the case with joint venture scenarios. Joint venture partners will usually have a true Right of First Refusal to buy out their partners’ interests in the venture when the partners wish to exit the business. Private companies also have common scenarios with their stockholder agreements that permit the pre-existing stake holders to buy out the ones who wish for an exit event before any new stock holders are created.

There are a wide range of other cases where these Rights of First Refusal apply in business and entertainment. This goes well beyond the world of corporate deals and boardrooms or even partnerships. In avenues as wide ranging as sports, real estate, or even arts and entertainment they are quite common elements of the business models and contract traditions. There are countless examples of this to consider.

With Real Estate, buyers of land may obtain a first right of refusal from a property holder on the future sale of any adjacent land next to that which they are acquiring. In this case, the property holder would have to offer the original buyer the opportunity to add to their existing holdings by purchasing the adjacent property.

In entertainment, large publishing houses sometimes require a new author to provide them with a Right of First Refusal on additional books they may write and seek to have published. The author would likely have to go along with this, as the publisher could simply refuse to take a chance on the unknown author if he or she is unwilling to accommodate the company. Publishers who put up significant resources into new authors look for this financial incentive of having sequels or additional hit books to help justify their risk.

On the one hand, this likely guarantees the author will have subsequent books published by the same publishing house (unless the first book is a commercial failure). At the same time, the author may not be able to accept a more lucrative competing offer from a rival publishing house. This is because the original publisher will likely not have to meet competitors’ offers as part of the first right of refusal clause.

The term 'Right of First Refusal' is included in the Economics edition of the Financial Dictionary. You can get your copy on amazon in Kindle or Paperback version. See more details here.