Right of First Refusal (ROFR)

A right of first refusal gives one party a priority right to buy something if, and only if, the owner decides to sell it and finds a buyer. Until then, the holder has no right to buy at all. The owner decides when to sell and negotiates with outsiders; the holder decides whether to step into the deal on the outsider's terms.

The usual sequence:

1. The owner receives a genuine written offer from an arm's length third party that it is prepared to accept.
2. The owner gives the holder notice of the offer and its full terms.
3. The holder has a fixed period to match.
4. If the holder matches, it buys on those terms. If not, the owner may sell to the third party within a set window, at no lower price and on terms no more favourable to the buyer than those offered to the holder.

A ROFR concerns the sale of something that already exists. The separate right to buy a share of newly issued shares, so as to keep the same ownership percentage, is a pre-emptive right.

A right of first offer (ROFO) reverses the order. Before going to market, the owner must first offer the asset to the holder, usually at a price the owner names. If the holder declines, the owner may sell to others for a set period, but only at or above that price and on terms no better for the buyer.

Sellers prefer a ROFO because outside buyers know the holder has already declined. Holders prefer a ROFR because they see a real market price before deciding.

In a private corporation, a ROFR is one of the most common contractual limits on a shareholder's ability to sell to an outsider. It normally works alongside the restriction in the articles that requires board or shareholder consent to any share transfer. That restriction also helps the corporation rely on the private issuer exemption under securities law, as our guide to share structure for a new Ontario corporation explains.

Key drafting points in a shareholder agreement:

• Pro rata allocation. The other shareholders can buy in proportion to their holdings, with oversubscription rights if some decline.
• All or nothing. The holders must usually buy all the offered shares, so the seller is not left with an unsold remainder.
• Permitted transfers. Transfers to a holding company, family trust or estate are normally exempt, provided the transferee signs on to the agreement.
• Conditions on the outsider. The third-party buyer must sign a joinder and take the shares subject to the agreement.

Order matters. The ROFR normally runs before any drag-along and tag-along rights, and an approved sale of the whole company is usually carved out of it. Lamba Law's free shareholder agreement builder includes a right of first refusal among its share transfer terms.

Franchises. Many franchise agreements give the franchisor a ROFR when a franchisee sells its business: the franchisor can buy the business on the terms the buyer has offered. The Arthur Wishart Act (Franchise Disclosure), 2000 does not regulate the terms of a ROFR, but its disclosure regulation, Ontario Regulation 581/00, requires the franchise disclosure document to describe all restrictions and conditions in the franchise agreement on transfer of the franchise. Section 3 of the Act also imposes on each party a duty of fair dealing in the performance and enforcement of the franchise agreement, which includes acting in good faith and in accordance with reasonable commercial standards. A franchisee should know the ROFR notice period and transfer terms in its franchise agreement before listing the business. Our guide to franchise renewal, transfer and exit in Ontario explains how the right affects a sale, along with consent requirements and transfer fees.

Commercial leases. A tenant may negotiate a ROFR to lease adjacent space when it comes free, or to buy the building if the landlord sells. A purchase ROFR raises extra questions: what happens if the building is sold in a portfolio with other properties, how non-cash consideration is matched, and whether the right binds a new owner. Tenants often ask to register notice of the right on title so a purchaser takes with notice of it, while landlords often limit the right to the original tenant so it lapses on an assignment; see lease assignment vs. sublease.

Most ROFR disputes come from gaps in the clause rather than bad faith:

• Non-cash or package offers. If the third party offers shares, an earn-out or one price for a bundle of assets, the holder may not be able to match like for like. The clause should allow a cash equivalent or provide a way to value the non-cash part.
• Staged offers. Requiring a genuine, arm's length written offer, with evidence of financing, stops an owner from inventing a high offer to scare the holder off.
• Strict exercise. Notices and acceptances should follow the clause's timing and form exactly. A late or conditional acceptance risks being ineffective, and a sale that skips the ROFR can lead to a claim for an injunction or damages.
• Chilling effect. A long matching period deters serious buyers. A period of a few weeks is easier to market around than several months.
• Changes after a waiver. If the price drops or the terms improve for the buyer after the holder declines, the clause should require the owner to go back to the holder.

A well-drafted ROFR states the trigger, the notice contents, the matching period, the closing deadline and the consequence of a sale made in breach.

Karim Haddad and Elena Petrova each hold 40% of the shares of a Vaughan HVAC parts distributor, and Tom Nguyen holds 20%. Their shareholder agreement gives the other shareholders a 30-day right of first refusal, pro rata to their holdings, with oversubscription rights, and requires them to buy all the offered shares or none. If they decline, the seller has 90 days to close with the third party at no lower price and on no better terms, and the buyer must sign a joinder.

Tom receives a written offer from an outside buyer to purchase his 20% for $700,000 in cash, closing in 60 days. He delivers a transfer notice with a copy of the offer. Elena declines. Karim elects to buy his pro rata half and, through the oversubscription right, Elena's half too.

Karim pays Tom $700,000 and closes within the 60 days, taking his stake to 60%. Because the right was all or nothing, Tom was never left holding an unsold 10%, and the company did not take on a shareholder the other owners had not chosen.