When transferring property, sellers sometimes insist on rights of first refusal – the chance to be first in line to repurchase the property if their buyer later decides to sell. Rights of first refusal can be obvious advantages if your financial circumstances later change. If you’re keeping adjoining land, you may wish to protect yourself against the risk of something unattractive being built next door.
But Brit Grosskopf of Texas A&M University and Alvin Roth of Harvard University have both identified a little-recognized distinction in legal drafting that can turn this apparent blessing into a curse.
One type of first-refusal right gives the former owner the ability to regain the property by matching competing bids. Rights holders only have to equal the high bid without engaging in the auction themselves. But another form of rights of first refusal (common in certain real-estate and entertainment markets) requires the right holder to accept or reject the seller’s demand before other potential buyers are offered the same deal. If the right holder refuses the price, she forfeits the chance to match other offers.
As illustration, suppose you hold the right of first refusal for a piece of property you value at $500,000. If you only have to match prior bids, you may get a bargain if the market is weak, perhaps buying back the parcel for $400,000. But supposed you have to respond before the market has been tested. If the owner demands $475,000, you may be pushed close to your limit yet feel reluctant to risk losing the property to a higher bidder. In essence, the second type of right leaves you bidding against yourself.
As this example suggests, when the right of first refusal is on the table, make sure the specific terms won’t turn around and bite you later.
Renee Lloyd /
Rights of first refusal are thrown around quite liberally (and vaguely) in deals by business teams who often have little understanding of the mechanics of such clauses. Accordingly, this post does a nice job of highlighting one of the more problematic issues for the inattentive deal-maker. That said, it is also critical to highlight that the time-frame of a Right of First Refusal generally is important to track as well, lest the parties be held 'hostage' by a term for an indefinite period of time. Good deal makers understand that taking time up front to address critical detail saves time (and lots of $$) in the long run.
jeff brown /
The first type of right of first refusal may make the property essentially unmarketable--in a sale of a property encumbered by such a right, one then has to negotiate with a buyer, reach a price and then tell the buyer to hold that thought while someone else decides whether or not they want to take advantage of the deal the buyer has struck. Many potential buyers are reluctant to enter that game--the lower the price they negotiate, the more likely they are to lose.
Genghiz /
Hello Jeff, One would assume that before the property goes to market the seller would have already negotiate he right of refusal withy the potential buyer. Am I wrong here? Genghiz
Anne-Sophie Sayman /
Dear friends, I believe right of refusal is an extraordinary asset IF you really want to regain access to the property, for example. More for an emotional or practical reason as a business move it is not necessarily the smartest since you are already showing the future potential buyer your level in interest... extremely high. You have very little leverage. In the case that you do not compete against yourself, you compete against others, which is as dangerous since bluffing (false potential buyer with high offer) can push you to make a stronger offer.... In conclusion, I would say that if you want it that bad, in the end, you will probably pay it more, unless the asset you want is UNWANTED by anyone else....