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Right of first refusal

September 11, 2022

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This article is written by Jyoti Sharma. This article has been edited by Ojuswi (Associate, Lawsikho).

This article has been published by Sneha Mahawar.

Table of Contents

Introduction

Right of first refusal is a contract between Two Parties wherein the second party (Holder) has the contractual first right or first opportunity (Granter) to accept or decline an offer. There is no obligation on the second party to accept the offer. This clause legally binds both parties. Right of first refusal is a very general and common clause of contracts. Right of first refusal is the right of every Investor and partner. To agree all-inclusive and comprehensive Right of first refusal clause is being incorporated in the contracts like Share Purchase Agreement, Franchise Agreement, Lease Agreement, etc. This clause provides certain powers and rights to the parties. This article will insight all the requirements of The right of first refusal.

What is the right of first refusal

Right of first refusal is a contractual right, but not an obligation, to enter into a business transaction with a person or company before anyone else can.

Parties – Grantor & Holder; Grantor Owns an Asset that the holder may, on a future date, want to purchase

Right of first refusal ensures that when a third-party approaches Granter for the Asset, The Grantor must first make an offer to the Holder for the same price and conditions.

Features of the right of first refusal:

Contractual Right
No Obligation
Right of the Investor / Partner
Future transaction
Opportunity

Contractual right

Contractual rights defines as a guaranteed set of Rights given to all the parties whenever they execute a contract. All the parties of the contract have to oblige that as it is mentioned in the agreement to avoid any future disputes. Right to first refusal contracts requires parties to define their contractual rights whereby the first party must offer the second party before engaging in any transaction with the third party for which an agreement has already been executed.

No obligations

The meaning of obligation is any act that is done by any force or pressure.

In the case of the Right, the Second party can refuse the offer and are free to take a decision. First Party can’t make pressure on the second party. If the second party declines to accept the offer the obligor or first party is free to make an offer to others.

Right of the investor/partner

When an Agreement is executed between parties, it is the privilege or right of the other party or second party to get an offer before it will open to or offer to the Third Party.

Future transaction

Right of first refusal always specifies the future date. An agreement or contract executes on the current date but this clause always talks about future certainty.

Opportunity

The right of the refusal clause of an agreement always allows a seconding party to accept or reject the offer. After second party choice, the transaction can lead to other people in general.

Right of first refusal clause in an agreement

Given below are the major points to consider while drafting the Right of first refusal clause in an Agreement –

Deadlines
Time to respond
Extinguish
Exceptions
Transferability
Breach remedies
Transactions that trigger the right of first refusal
Definitions

Deadlines / Time period

In any contract, the time/tenure right of first refusal clause should be specifically mentioned. Like in a lease agreement if the time of the lease expires, after the specified time then the property owner can enter into other transactions without intimating the holder of the right of first refusal. Provision about timing should be clear.

Time to respond

The contract should contain a Limited period in which the party had to respond to accept or reject the offer after the time lapse property owner may enter the transaction with a third party.

Extinguish

The contract should state under which transaction right of first refusal will extinguish or terminated. If a holder of the right of the first refusal accepts the offer but does not complete it, the right will be extinguished. There could be differences or issues if these conditions are not specified in the contract.

Exceptions

A contract should clearly state under which transaction right of first refusal will not apply. Ex – transaction enter between family members or Trust, it can also happen if an owner dies.

Transferability

The parties may decide whether the right of first refusal will be transferable to another party or not. The contract should make clarity on this that if a property is transferred to someone else whether the new owner will continue to give the same Right or not.

Breach remedies

As the right of first refusal is a contractual right and In case any party breach the contract the harmed party may sue the other party for the damages or may ask for some specific performance.

Transactions that trigger the right of first refusal

In the contract, it should be specified at what point the right of first refusal will arise. For example – when the owner wants to sell a property. In that situation, the impact of this clause will arise.

Definitions

The contract should define all the definitions related to the transaction. For example – property, Assets, and Consideration. If details of property and Assets are not clearly defined they may be detrimental to the owner as well to the holder of refusal of first right.

Advantages of the right of first refusal

Modification in the clause of the Agreement

The term of the clause can be amended or modified as per the party’s mutual understanding. If both parties grantor and holder eager to amend any terms and conditions for this respective clause then both of them with mutual consent can do that.

Future deal

ROFR clause speaks about the choice that can be made on a future date, the parties can agree to a transaction at any time for future transactions. This Clause permits to buy of the asset or property later on.

Expedite process

The ROFR clause help to close the transaction soon as the grantor is already aware of that who would be the first buyer and he can directly approach him for an offer. Sale can be expedited by customizing this clause in the Agreement.

No competition for buyer

The holder won’t have any competitors in the market as grantors directly approach him for the transaction. Once the holder opposes the offer only the grantor has the right to make an offer to others. So accordingly this close restricts the competition.

Disadvantages of the right of first refusal

Litigation

The right of first refusal is a source of litigation. As this clause leads to future transactions and the future doesn’t have certainty, there might be chances wherein the holder and grantor not agreed on the executed clause of the agreement.

No marketability

Third parties or buyers don’t show interest in such a transaction wherein they are aware about someone else has a ROFR, which leads to the property becomes not marketable and diminishing the value property.

Lengthy process

Due to the right of first refusal transactions won’t close on time and gets delayed. Sometimes Holder takes time to decide due to which the grantor faces unnecessary wastage of time and he needs to wait till the holder’s decision, after that only he can move to other buyers for the offer.

Delay in the sale

The grantor of the Property can not sell the property immediately when an inquiry is made about the property. Grantors require to approach the holder first despite contacting other buyers.

No competition for the seller

Prices are often pre-decided or pre-negotiated, so the seller can’t expect good returns. The grantor is aware of whom he needs to approach so no competition appears where the ROFR clause is there.

Few examples to understand the right of first refusal

Example – 1. Leave And License Agreement

A is the Landlord of property “X” and B is the Tenant of aforesaid property. In the leave and license agreement between A and B, there is a clause wherein it is mentioned that B would have the first Right to purchase or refuse the offer whenever A sells this property. So now, when A is selling this property and has offers from C to buy this property in 2 Crores. So, B has the first right to purchase or refuse this property in 2 Crores. However, there is no obligation on B to purchase this property.

Example – 2. Author Agreement

The agreement between Author and Company. A Company can stop the Author to sell his books to other Companies However The Author may negotiate with the Company on this clause right of first refusal so that he can sell his books to other Companies also with Mutual understanding between both the parties.

Example – 3. Share Transfer Agreement

An investor of a private company can’t sell its shares to any other person who is not an investor of the Company. He needs to make an offer first to other existing investors of the Company. In case other investors of the Company show interest in buying those shares then he had to compulsory sell those shares to that investor. A and B investors of X Company holding shares 95% and 5% respectively. Now if A wants to sell his 10 shares, in that case, he needs to put the first offer to B if B rejects this offer A can sell his shares to C but in case B accepts his offer then A mandatorily have to sell his shares to B.

Case laws to refer to the impact of right of first refusal

Satyanarayana Rathi Vs Annamalayar Textiles (P) Ltd, as reported in 1999 32 CLA 56

In this case, the private company has inserted in its Articles of Association a clause that states that a member of the Company cannot transfer his shares to a third party without offering them to other members at a price determined by the Board of Directors. The appellant(Supplier of Cotton) in this matter was given shares as security for payment by three members of the Company. Unfortunately, the payment was not made on time. The appellant made an application to the Board of Directors to have the shares transferred to him. But as there were members of the Company who were desirous to purchase these shares themselves. The Board rejected the application as the same was a violation of the pre-emption clause included in the AOA. The Company will be bound by the restrictions as imposed under the Articles which are binding on them over and above any other agreements that may be entered into by the members of the company. So shares can’t be transferred to the appellant.

Similar decisions were rendered in a) Cruickshank Co. Ltd Vs Stridewell Leather Pvt. Ltd, (1996) 86 CompCas 439 CLB, b) Tarlok Chand Khanna Vs Raj Kumar Kapoor, (1983) 54 Com. Cas. 12 (Delhi) among others.

PhonePe and Indus OS

This deal is a straightforward transaction where PhonePe wants to acquire 90% of the stake in the company from its present holding of 32%. Since the takeover is a friendly transaction between the companies, Indus OS also wants the same deal which is valued at approximately $60 million by the fintech company. However, the deal is hindered by two of the major minority stakeholders of Indus OS, namely, Affle Global and Ventureast

Affle Global, a minority stakeholder of Indus OS has an approximate stake of 23% in the company. As soon as PhonePe proceeded with the acquisition transaction by the way of executing an alleged term sheet, Affle Global triggered the ROFR rights of their investment agreement with Indus OS. According to the agreement, the shares of the founders of Indus OS have to be first offered to Affle Global after a price has already been negotiated with a third party and Indus OS can proceed only if Affle Global refuses to purchase the shares at the offered price.

Till now, the acquisition is still facing trials in the Singapore Court of law as both the companies have filed legal proceedings against one another, while recently PhonePe has also appealed to the Securities and Exchange Board of India to interfere as according to them there has been a side-dealing by Vneutreast and Affle Global which has been done deliberately in bad faith to scramble the aforementioned acquisition deal of PhonePe and Indus OS.

Conclusion

There must be a valid contract to make the right of first refusal clause effective. However, it’s tough to finalize the transaction at the initial stage for a future date. It’s always easy to negotiate or discuss when the parties are in an actual situation. right of first refusal clause impact a lot on the transaction. Most of the time its restrict due to which litigation arises between the parties. Due to less competition in the market economy, the country will also degrade.

In some agreements, like leave and license agreements, author agreements, share transfers, etc., ROFR clauses are crucial as they require the grantor to sacrifice by which they might gain an advantage in the future. It is advisable to draft this clause with good negotiations between the parties so that none of the parties will suffer. It is a known fact that a boilerplate clause like ROFR might not avoid all the probable future disputes between the founders and the investors but what is known is to draft these clauses with clear, descriptive, and precise use of words and terms.

References

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