Right of First Refusal; What Does It Mean?

Often times, business owners want to include a provision for a right of first refusal to buy or sale a portion of a business interest or asset.  There can be many variables of provisions for the right of first refusal to consider.  In the recent North Carolina Court of Appeals case, Taylor v. Miller, the Court held that rights of first refusal may be enforceable, even if such provisions contain fixed price options.

According to the facts in Taylor, Mr. Taylor and Ms. Miller were married in 1982 and separated in 1993.  In 1994, they both executed a warranty deed to Mr. Taylor for a piece of property in Morehead City, NC which contained a provision giving Ms. Miller the right to repurchase the land should Mr. Taylor sell it.   More specifically, the provision gave Ms. Miller the right to repurchase the property: (1) on the same terms and conditions as another bona fide offer; or (2) for the sum of $41,500 plus the costs of repairs and improvements made since the execution of the deed.  In 2009, Mr. Taylor and his current wife filed a complaint seeking a declaration of rights under the deed and a determination of whether the 1994 warranty deed’s right of first refusal was enforceable.

The term “right of first refusal” means that before a piece of property is sold, it must be offered to the person holding the right of first refusal.  While rights of first refusal fall under the category of restraints on alienation (which are generally disfavored by the Court), rights of first refusal are not automatically void per se.  However, to be enforceable, the right of first refusal must be shown to be reasonable.  In making such a “reasonable” finding, the Court considers: (1) the duration of the right; and (2) the provisions for determining the price of exercising the right.

In Taylor, Mr. Taylor argued that the right of first refusal failed the reasonableness test’s second prong, for the right of first refusal’s fixed price of $41,500 showed no relation to the property’s fair market value or what Mr. Taylor would have accepted from another buyer.

The Court addressed this argument by holding that in determining whether a fixed price is reasonable, all circumstances that existed at the time the contract was entered into should be examined.  In this instance, the 1994 warranty deed was actually part of Mr. Taylor and Ms. Miller’s separation agreement.  As such, the $41,500 could be deemed a bargained for amount in relation to the terms of their separation, making the right of first refusal price reasonable and enforceable.

This case helps us understand some of the issues to consider when drafting rights of first refusal.  Many times, business owners include similar provisions.  Knowing how a Court interprets this type of provision should be helpful.  If you have any questions, please let us know.