January 11, 2024

By Brian Babcock

A right of first refusal (ROFR) may be a valuable aspect of a business agreement. No wonder that there are often disputes about the meaning of the rights, or their enforceability.

THE CASE

Some of the principles are reviewed by an Ontario Superior court judge in McMullen v. Dilawri Property Holdings Ltd.

The facts are somewhat unusual, in that the ROFR was exercised, but then the purchaser failed to close.

THE ISSUE

The issue was whether or not the right holder still had the right to match a subsequent offer, or whether, having entered a contract but failed to close, the right was exhausted. It appeared that there was no Ontario case that answered the question, so the judge started at the basics: “If a right of first refusal is not exercised by its holder when a bona fide offer is made by a third party to purchase the property, it is spent and has no continuing force and effect.”

Also:

Similarly, a right of first refusal is extinguished once it is exercised, even if the grantee later declines to purchase the property. Once extinguished, the grantor is not required to submit a subsequent third-party offer for the property to the grantee. On the other hand, it is open to the parties to a ROFR to depart from the common law rules by providing that a right of first refusal can be a continuing right in specified circumstances. However, the words of the ROFR must provide for such a result.

So, in the absence of words indicating an intent to vary the rules in the particular deal, why should the right holder be in a better position if they exercise that right then fail to close?

Ultimately, the case turned on the wording of the ROFR clause. Testimony as to the subjective intent of the parties was not relevant. The correct approach to interpretation is the same as any other contract, as set out in Sattva Capital Corp v. Creston Moly Corp:

1.            The purpose of the interpretation of a contract is to determine the intent of the parties and the scope of their understanding. To do so, a decision-maker must read the contract as a whole, giving the words used their ordinary and grammatical meaning, consistent with the surrounding circumstances known to the parties at the time of formation of the contract.
2.            While the surrounding circumstances will be considered in interpreting the terms of a contract, they must never be allowed to overwhelm the words of that agreement. The interpretation of a written contractual provision must always be grounded in the text and read in light of the entire contract. While the surrounding circumstances are relied upon in the interpretive process, courts cannot use them to deviate from the text such that the court effectively creates a new agreement.
3.            The nature of the evidence relied upon as surrounding circumstances should consist only of objective evidence of the background facts at the time of the execution of the contract, that is, knowledge that was or reasonably ought to have been within the knowledge of both parties at or before the date of contracting.
4.            These surrounding circumstances cannot violate the parol evidence rule which precludes admission of evidence outside the words of the written contract that would add to, subtract from, vary, or contradict a contract that has been wholly reduced to writing. To this end, the rule precludes, among other things, evidence of the subjective intentions of the parties.
5.            Courts should avoid interpretations of a contract that would result in an absurdity, repugnancy, or inconsistency which reasonable people could not have contemplated, under the circumstances.

After going through this exercise, the judge concludes that the ROFR is NOT reinstated by the failure to close the original transaction, because the wording  was silent on that point. It would be commercially unreasonable to allow repeated exercises of the ROFR frustrating the owner’s efforts to sell to a third party.

As the judge points out, this is also an example of the application of the principle of good faith and honest performance of contracts, as developed in prior decisions.

TAKEAWAYS

• if you want your ROFR to NOT be subject to the default rules, it must explicitly say so.
• under the default rules, the ROFR is extinguished once it is exercised once.
• The intention examined is the objective intent, not what either party claims was their subjective intention.
• The Sattva rules apply.
• Common sense and commercial reasonableness support this interpretation.
• The principles of good faith and honest performance continue to be extended to different fact situations.

WHAT WEILERS LLP CAN DO TO HELP YOU

The corporate team at Weilers LLP is experienced in drafting to express your true intention, and not to simply adopt boilerplate wording which might not suit you. This includes customizing rights of first refusal where appropriate.

If you do end up in a right of first refusal dispute, the litigation team at Weilers LLP may be the right lawyers for you.