You may have heard about rights of first refusal (ROFRs) and rights of first offer (ROFOs), but what are they exactly? In this blog post, we break down ROFRs and ROFOs, and address some important considerations.
What Are ROFRs And ROFOs?
ROFRs and ROFOs are contract provisions that can be used to enhance the rights of a party to later acquire designated assets owned by their contract counterparty. ROFRs and ROFOs can serve to protect a party's interests by giving the party the opportunity to potentially acquire the asset in question and thus prevent such asset from being sold to a competitor or other party.
The Law Office of Jennifer M. Settles represents clients in commercial contract matters and real estate deals, including negotiating ROFRs and ROFOs. Contact us today for more information. The initial consultation is always FREE.
A ROFR gives a person or entity (referred to in this blog post as the "holder") the right to acquire an asset from a contract counterparty (referred to in this post as the "seller") on terms that match an offer for the same asset made by a third party to the seller. Under a ROFR, the holder has the right to either accept or refuse an offer from the seller after the seller has received an offer on the asset from a third party.
The seller's receipt of a bona fide offer from a third party is required in order for a ROFR to be triggered. When the ROFR is triggered, the seller is required to offer the asset to the holder upon the same terms as offered by the third party, and as defined in the ROFR agreement. Not surprisingly, prospective third party buyers may be reluctant to incur due diligence expenses or spend time negotiating a deal when the asset in question is subject to the superior rights of the holder, pursuant to the ROFR agreement. This uncertainty from the perspective of the third party can lead to lower and fewer offers from third parties, which may ultimately result in the seller not realizing full value for the asset in question.
A ROFO gives the holder the right to make an offer on the asset in question to the seller before the seller can solicit offers from third parties. In contrast to a ROFR, a ROFO places the onus on the holder to make the offer to the seller, and the seller may then accept or reject the offer. If the seller rejects the offer, the seller is then free to sell the asset to a third party, and may do so at any price as agreed by the seller and the third party.
Key Difference Between ROFRs And ROFOs
Thus, the key difference between a ROFR and a ROFO is that ROFRs give the holder the right to match an incoming offer, in which case the seller may be required to sell the asset to the holder. ROFOs, on the other hand, give the holder the right to make the first offer on the designated asset, which offer the seller may accept or reject.
Note that people sometimes use the terms ROFR and ROFO interchangeably. Doing so is a mistake, though, given that there are significant differences between the two concepts, as described above.
When Are ROFRs And ROFOs Used?
ROFRs and ROFOs are commonly used in a variety of contexts, including real estate deals, shareholder agreements, partnerships agreements and LLC operating agreements, intellectual property agreements, and more. A party could hold a ROFR or ROFO with respect to real estate, personal property, equity interests in a legal entity, or other assets.
For example, a limited liability company operating agreement may include a ROFR provision, pursuant to which each LLC member has the right to acquire a selling member's interest in the LLC on terms which match the terms received by the selling member from a third party offeror. By including a ROFR in the operating agreement, the members of the LLC are assured that they will have "first dibs" on their partner's membership interest in the LLC, so long as they match the terms offered by the third party offeror.
As another example, a tenant may have a ROFO in its lease agreement, giving the tenant the right to offer to buy the property they are leasing before the landlord offers the property for sale in the open market or to a third party. By having a ROFO in its lease agreement, the tenant has a level of comfort knowing that in the event the landlord contemplates a sale of the property, the tenant would at least have the opportunity to make the first offer.
Navigating ROFRs And ROFOs
ROFRs and ROFOs can be complicated to navigate. They require careful negotiation and drafting to ensure that they correctly reflect the interests and intentions of the parties. From the seller's perspective, its important to note that ROFRs essentially constitute an encumbrance on the asset in question (albeit, a non-monetary encumbrance), by effectively imposing a limitation on the seller's right to freely sell the asset. An asset encumbered by a ROFR might be viewed as having a lower value than it would have, were it not encumbered by the ROFR. Moreover, a ROFR with broad and/or nebulous terms can be highly disadvantageous to a seller. As a result, sellers must be extremely careful about agreeing to ROFRs and in the drafting of their terms.
Pro Tip: The holder of a ROFR wields considerable power over the seller's ability to sell the asset in question. As a result, a savvy seller should always think twice before granting a ROFR. For example, granting a ROFR to someone the seller knows does not have the credit status or financial wherewithal to in fact close upon the potential future acquisition can be dangerous. Its conceivable that a holder might exercise its ROFR, but then ultimately be unable to secure the necessary financing to acquire the asset. In such a case, the holder may have potentially held up (or even blown up) the seller's would-be sale of the asset to the third party offeror, and frustrated the seller's efforts to sell the asset.
Working with an experience business attorney, such as Prime Legal Freelance, can help ensure that your ROFRs and ROFOs are negotiated and drafted correctly to protect a party's interests. Contact us to discuss your ROFR or ROFO needs. The initial consultation is always FREE.
Deciding Between A ROFR And A ROFO
Once a party has determine that he or she would like the protection of a ROFR or ROFO in her contract, and the seller is amenable to granting it, the next question is "Which to choose, ROFR or ROFO?"
Various factors can play into the question of deciding between a ROFR or ROFO. Among other considerations, relevant factors may include the prospective holder's bargaining strength, investment purpose and strategy, investment time horizon, exit strategy, and management objectives in the business.
A ROFR is considered to favor holders who intend to stay long-term (likely buyers); while sellers generally prefer ROFOs over ROFRs.
Thus, while most sellers tend to dislike their assets being burdened by either a ROFR or a ROFO, from the seller's perspective, a ROFO is generally favored over a ROFR. On the other hand, from the holder's perspective, a ROFR is generally favored over a ROFO.
ROFRs and ROFOs are complex instruments. This is especially true of the ROFR, which is the more impactful and significant of the two concepts. Using a qualified business or real estate attorney for assistance is always a wise choice.
Jennifer M. Settles, Esq. is a corporate lawyer at the Law Office of Jennifer M. Settles. She advises clients on M&A transactions, commercial contracts, real estate matters, financing transactions and corporate law, including advice on ROFRs and ROFOs. To schedule a free consultation with Jennifer, please call 602-617-3938, or email us through our Contact Form.
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