Rights of First Refusal in Commercial Contracts

In Short

• A right of first refusal grants one party the opportunity to enter into a contract on the same terms before the other party contracts with a third party.
• While it secures priority access to opportunities, it can limit flexibility for businesses.
• Carefully drafted clauses are essential to avoid disputes and ensure the right functions as intended.

Tips for Businesses
When offering a right of first refusal, clearly define the scope of agreements it covers and the process for triggering it. Consider the trade-off between securing strategic opportunities and limiting your flexibility to contract freely. Ensure the clause is specific, including response times and communication requirements, and seek legal advice to tailor the clause to your business needs.

Summary
This article explains how a right of first refusal clause works in commercial contracts, offering priority access to future transactions in exchange for specific obligations. Prepared by LegalVision, a commercial law firm specialising in contract drafting and negotiations, it highlights the benefits and restrictions of these clauses, offering guidance on how to draft them effectively and align with your broader business strategy.

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On this page

• The Importance of Strong and Tailored Contracts 
• What Is a Right of First Refusal?
• How Does The Right Generally Work?
• What Is the Impact of this Right? 
• How Can These Rights Be Used Practically?
• How Should the Clause Be Drafted?
• Why Should You Take Legal Advice?
• Key Takeaways 
• Frequently Asked Questions

When you enter into a commercial contract, it is important to consider both your current needs and future opportunities. A right of first refusal, sometimes known as a contractual right of pre-emption, is a clause that requires one party to offer specified contract terms to another party before entering a contract with a third party on those same material terms. 

Businesses can use this type of clause as a strategy to preserve business relationships and protect access to valuable opportunities. This article explains how a right of first refusal clause works and provides suggestions for drafting it effectively in your commercial contracts.

The Importance of Strong and Tailored Contracts 

Before considering this specific type of clause, you should understand why strong commercial contracts are important for your business. Commercial contracts can create important, clear and enforceable rules when they are well-drafted and entered into correctly. 

They can be useful to set out your rights and obligations, and thereby prevent a mismatched understanding, which could lead to disputes. They can also help you manage risk in various ways, by recording key commercial terms to help projects progress smoothly and limit your liability if things go wrong. 

What Is a Right of First Refusal?

A right of first refusal gives a party (the grantee) the first opportunity to enter into a contract on specific terms before the grantor may conclude a contract with a third party on those same terms.

In other words, if the grantor wants to enter into a particular agreement with someone else, it must first give the grantee the opportunity to accept those terms.  

Generally, the grantor can only proceed with a third party if the grantee: 

• fails to respond within the agreed period; or 
• the parties do not conclude a contract within that period.

However, the grantor will typically be restricted from concluding a contract with the third party on terms that are more favourable than what they offered the grantee. 

How Does The Right Generally Work?

If the grantor makes or receives an offer from a third party that it wants to accept, the right of first refusal clause kicks in. 

The grantor must then send the grantee a notice setting out the material terms of the proposed third-party agreement. There will usually be a defined period (this can often be called the exercise period) to decide whether to accept those terms.

If the grantee accepts within that period, the grantor must seek to conclude a binding contract with the grantee on the terms offered. 

The grantor may conclude a contract with the third party if the grantee: 

• refuses; 
• does not respond in time; or 
• cannot conclude a binding contract within the exercise period.

What Is the Impact of this Right? 

A right of first refusal creates a structured process for handling certain types of future transactions. It seeks to make sure that the grantee party has a genuine opportunity to match a proposed third-party deal. It is important to carefully understand this right and its implications in your contracts. 

If you receive the right, you can essentially gain priority access to specified opportunities. 

If you grant the right, you need to accept additional procedural steps and restrictions before you can conclude certain third-party contracts.

How Can These Rights Be Used Practically?

You may seek to include rights of first refusal in important contracts, such as: 

• supply;
• distribution; or 
• franchise agreements. 

For example, if you manufacture products, you might give an existing distributor the first opportunity to distribute a new product range. 

These clauses can help to reduce uncertainty about future access to important commercial opportunities. They can thereby strengthen long-term relationships and protect your strategic position.

However, they also limit flexibility. If you grant this right, you must follow the agreed process before completing certain transactions. As such, you should consider whether the benefit of this type of priority access right truly outweighs the restriction on your freedom to contract.

How Should the Clause Be Drafted?

You must draft this type of clause carefully and understand its implications, in particular:

• Define precisely what type of third-party agreement the clause covers. If you describe it too broadly, you may restrict yourself more than you intend;
• Clearly define what triggers the obligation. The obligation may begin when you decide to accept a third-party offer; and
• State how long the grantee has to respond and how it must communicate acceptance.

These are examples of common drafting considerations; your specific contract wording can define exactly how you want this right to look in practice. 

Why Should You Take Legal Advice?

The implications that this type of clause has depend on how you draft it. A commercial solicitor can help to: 

• understand your commercial intentions;
• draft correct wording accordingly;
• clarify trigger events;
• ensure that you define the material terms clearly; and 
• make sure the clause aligns with the rest of your contract.

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Key Takeaways 

A right of first refusal is a contractual clause giving one party the first opportunity to enter into a transaction before the other party contracts with a third party. Whilst useful, they can restrict a party’s freedom to contract and must be carefully defined to avoid uncertainty or disputes. Businesses should therefore take legal advice before granting or accepting a right of first refusal, particularly in high-value or long-term arrangements.

If you need help in drafting your commercial contracts, LegalVision provides ongoing legal support for all businesses through our fixed-fee legal membership. Our experienced commercial contract lawyers help businesses across industries manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 0808 196 8584 or visit our membership page.

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