Rights of pre-emption and rights of refusal can be used in
corporate and commercial contracts to give one party
(preferred party) rights to buy or sell just about
anything from the party granting the rights
(grantor). In shareholders agreements for example,
they are often used in favour of shareholders where one shareholder
proposes to transfer its shares.
There is a danger in overlooking the exact nature of these kinds
of rights. Subtle differences in approach can materially impact on
the way in which the grantor is able to deal with an underlying
asset or more generally conduct its business.
Taking the example of a shareholder intending to sell shares,
pre-emption rights can be viewed as falling within one of the
following three categories:
a right of first look, giving the preferred party the
opportunity to offer terms, including as to the purchase price to
buy the seller's shares. If the seller rejects that offer, it
will not be permitted to sell those shares to a third party at a
price less than the offer price or on other terms more favourable
to the third party than the terms of the rejected offer;
a right of first refusal, being similar to a right
of first look, except that the preferred party has the
opportunity to accept or reject terms offered by the seller for the
sale of the shares, rather than the opportunity to offer terms to
the seller; and
a right of last refusal, giving the preferred party
the opportunity to accept or reject terms conditionally agreed
between the seller and a third party for the sale of the
If the process is properly documented, specified time periods
will be applicable to each step. For example if the parties do not
agree a share sale pursuant to the pre-emption right, there is
usually a subsequent time period in which the seller may sell the
shares to a third party, failing which it must again comply with
the pre-emption process in order to transfer its shares. In
addition, the process may provide for a formula or mechanism to
appoint an independent person to value the shares.
A right of first look is the most favourable to the
grantor, as it does not have to show its hand, letting the
preferred party make the first move instead. A right of last
refusal is the most favourable to the preferred party, as the
grantor must not only test the market, but must bring to the
preferred party a negotiated deal. However, as a practical matter,
a third party may be deterred by a right of last refusal,
knowing that the time it invests in assessing the opportunity to
make an offer will only result in its offer price being
'shopped' back to the preferred party. Moreover, the
preferred party usually has a specified time period to consider the
third party offer, time that may seem to the third party like
unnecessary delay. If the terms of the contract containing the
pre-emption right are confidential, the grantor will find it
difficult to explain to the third party the reason for the delay.
If the pre-emption right is wide reaching in the context of the
grantor's business, for example it relates to major supply
items, it may impact the grantor's ability to engage with its
marketplace and remain competitive.
As suggested above, price is often one of many considerations in
commerce, and the offer terms of pre-emption rights will often
contemplate other factors relevant to the underlying goods or
services, such as quality, delivery times, technical
specifications, payment terms and counterparty credit risk. In this
case, the offer against which the pre-emption right operates can be
the terms of the offer viewed as a whole, or some balanced score of
those terms. This can introduce a degree of judgment, giving the
grantor scope to justify rejecting the preferred party in order to
deal with a third party. Nevertheless, grantors should be aware
that the pre-emption process itself may mean that in reality the
preferred party is the only game in town.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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