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How Does a Right of First Refusal Work?

by Jayne Thompson

The terminology might be confusing, but a right of first refusal (RFR) is a great opportunity for a potential buyer to purchase a house ahead of the competition. Put simply, a person with an RFR has the first right to buy a property (technically, refuse to buy it) before the property is offered for sale on the open market. RFR's vary in scope. They can be informal and no more binding than a handshake, or they can be contained within a legal agreement and capable of legal challenge if things go wrong.

Option

The most effective way of securing an RFR is by option agreement. An option is a legal contract that offers to sell the property to the buyer, known as the option holder. However, the offer to sell is contingent on a future event, typically the homeowner wishing to sell his home. When the trigger event happens, the option holder has a set amount of time to opt whether or not to buy the property. The option agreement might specify a sale price, or it might not. If the parties know when they agree to the RFR that the trigger event will not happen for some time, the option will typically not name a price, but instead spell out the procedure for agreeing to a sale price akin to market value at or around the trigger date, with opportunities for either party to back out of the deal if they cannot agree.

Right to Match

A "right to match" RFR gives the potential buyer the opportunity to match the seller's best offer for the property. The buyer can choose to match the offer or not, but will typically have to act within a specified time period. This is likely to be quite short, to ensure that the seller does not lose his other potential buyers. If the holder exercises his right to match, the seller is obligated to sell the property to him.

Right of First Offer

As its name suggests, a right of first offer (ROFO) gives the potential buyer the right to make an offer to purchase the property as soon as it is listed, or is about to be listed for sale. A ROFO obligates the parties to negotiate terms for sale, but rarely binds them to reach an agreement. In this respect a ROFO gives no more certainty than a general real estate negotiation. The difference is that both parties commit to acting in good faith in attempting to conclude a deal.

Advantages

An RFR has advantages to both parties. The seller gains the security of an interested party willing to pay, or at least to negotiate, a realistic price for his home. In a rising market the RFR holder has the chance to secure property ahead of his competition; in a falling market, he may be able to secure a favorable price.

Things to Consider

RFR's are drafted as legal contracts and recorded, so anyone interested in the property has notice of the holder's rights. RFR's are tricky to document: They spell out the conditions of a property sale that might not happen for a number of months, or even years; on terms that the parties have yet to agree; to take effect in a future property market that could be radically different from the one that existed when the agreement was initially signed. It is not a transaction to attempt without legal advice.

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