Substantive Legal Content

Murray’s Rant About Rights of First Refusal

Bob, Ted, Carol, and Alice own a company. They have a shareholder’s agreement. The only divorce mechanism is a right of first refusal (“ROFR”).

Bob wants out. He goes to Ted, Carol and Alice and asks them to buy his shares. They refuse. They tell him to use the ROFR.

So Bob goes out and finds Murray. He speaks to Ted, Carol and Alice and says, “Here is Murray. He is a great guy. Could you be so kind as to meet him and hear what he has to say and then consent to me selling my shares to him?”

Ted, Carol, and Alice say, “We are not interested in meeting Murray. Use the ROFR.” (Or maybe they do meet with Murray and drop some suggestions that he is unlikely to be happy as an owner of a minority interest in the company.)

Let’s say that Murray is still interested. And to be charitable to Ted, Carol, and Alice, let’s even assume that they cooperate with Bob in making due diligence materials available and do not stonewall him or threaten to sue Bob for breaching confidentiality.

Bob says to him: “Murray, here is what I need you to do. Hire some accountants and lawyers to do due diligence. Don’t forget to speak to your bank about the financing. Then have your lawyer do a formal agreement to buy the shares and make it conditional on my partners not exercising their right under the ROFR to buy the shares. We can then negotiate the purchase agreement at great expense.”

So Murray goes out and drops some number of thousands of dollars on lawyers and accountants. He enters into the agreement with Bob and puts down a deposit.

One of two things happens then.

Either Bob’s partners exercise their right to buy, in which case Bob offers Murray his most heartfelt thanks for wasting all of that time and money investigating the opportunity.

Or Bob’s partners do not exercise their right to buy, and Murray has won the right to become a partner with those same unreasonable people who made Bob go through all of this nonsense to sell his shares, provided, of course, that he signs the same shareholder’s agreement that did not work so well for Bob.

What do you think the odds are that Bob (or anyone else) is going to be willing to go through all of this?

As you may have guessed by now, I think that rights of first refusal in shareholder’s agreement are generally useless. Perhaps not always, but most of the time. And I would mention in passing, that in my 40 years practicing business law, I never saw a single first right of refusal transaction completed pursuant to a shareholder’s agreement.

So how does one explain why lawyers frequently include them in shareholder’s agreements, sometimes as the only divorce mechanism? I cannot answer that question although I asked it many times during my career. Could it be that many lawyers do not really understand how these provisions are likely to work in practice? Might they be blindly relying on precedents rather than thinking practically? Or am I missing something?

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