Leveraging the Right of First Refusal: A Strategic Blueprint for High-Impact Negotiations

The addition of a right of first refusal in your commercial transaction can transform an ordinary deal into a strategic, value-added proposition. To optimize this tool, an astute negotiation of the particulars is non-negotiable.

A ‘right of first refusal’ (RoFR), often referred to as a matching right or right of first offer, is an instrumental clause in business contracts that, if carefully utilized, can bring about significant benefit to both parties. Elucidated by Professor Guhan Subramanian of Harvard Business School and Harvard Law School, an RoFR confers upon one contractual party the privilege to equal any subsequent offer that the other party receives for the item or subject in question.

Consider a property owner negotiating a lease agreement with a potential tenant. The landlord wishes to retain the future option to sell the property, while the tenant seeks to secure a long-term rental agreement. In this scenario, granting the tenant an RoFR – the opportunity to match any genuine third-party offer for the property – serves both parties’ interests. The tenant avoids the inconvenience of relocation, and the landlord retains the flexibility to sell to the highest bidder.

In this context, RoFR emerges as a potentially synergistic instrument, a powerful addition to your negotiation arsenal. However, to actualize its mutual benefits, it is imperative to meticulously delineate the parameters of the agreement.

The Devil is in the Details

Unfortunately, many contracts containing an RoFR clause suffer from ambiguity concerning the process to be followed when a right holder exercises their privilege. Subramanian advises clarity on what ensues when the right holder matches a competing bid. Will this signify the end of the competition, or initiate a bidding war?

Additionally, it’s critical to define the timeframe for deciding to match an offer. An unclear duration can be exploited by a third party through an ‘exploding offer’ – a bid with a tight deadline – potentially preventing a successful match. Ensure you negotiate a generous response period.

Different Flavors of First Refusal

Typically, the holder of an RoFR only needs to match the highest bid without partaking in the auction. However, a variant commonly seen in real estate and entertainment markets requires the right holder to either accept or reject the seller’s price before other potential buyers are approached. If rejected, the right holder forfeits their opportunity to match any future offers.

Researchers Brit Grosskopf and Alvin Roth caution that such a clause could transform an apparent boon into a liability. They posit a situation where you hold an RoFR for a property valued at $500,000. If required to match high bids, you might secure a bargain in a weak market, possibly reacquiring the property for $400,000. However, if you must respond before the market is tested, a demand of $475,000 could compel you to pay near your maximum while risking the loss of the property to a higher bid. Essentially, this scenario pits you against yourself in a bid.

Consequently, ensure that the specific terms of the RoFR will not unexpectedly disadvantage you later.

A Word of Caution for Third Parties

Potential bidders face a conundrum if their offer triggers an RoFR. On one hand, if the right holder exercises their privilege, you may waste time performing due diligence and negotiating. On the other hand, if they do not, you may have overpaid, given that the right holder likely possesses superior knowledge of the asset’s intrinsic value. For this reason, many prefer to eschew deals that invoke an RoFR.

However, certain conditions can alleviate these apprehensions. For instance, the right holder may be unable to match your offer due to liquidity constraints, or you may possess comparable