HEADS OR TAILS- TWO SIDES OF THE SAME COIN: THE DIFFERENCES BETWEEN AN OPTION AND A RIGHT OF FIRST REFUSAL

An option and a right of first refusal have certain common characteristics, yet there are fundamental differences between the two.

Both entail:

• an asset or right belonging to one party; and
• the right to acquire it being granted to another party.

It is who has the choice to invoke that right where the fundamental difference lies.


In an option the party in whose favour the option is granted decides if and when to exercise the option. A practical example would be a party (Party A) granting to another party (Party B) a right to purchase something which belongs to him, for example his shares in a particular company. So, the choice whether to purchase the shares vests in Party B. Once the option is granted, it is solely up to Party B to choose whether to purchase the shares or not. The right to effectively control the sale of the shares is lost at the time Party A grants the option.


Using the same example and applying it to a right of first refusal, Party B does not automatically have the right to purchase the shares once the right of first refusal is granted. The right only arises if Party A decides he wants to sell his shares. The right to purchase therefore only transfers to Party B if Party A decides he wants to sell, not at the time the right of first refusal is actually granted. The choice on the sale therefore remains with Party A until such time as he decides he wishes to sell.


The power to effect transfer of the shares in an option accordingly vests in Party B, and in the case of a right of first refusal this power vests in Party A.


So, given the fact that these rights most usually occur in a sale and purchase situation, it is fair to say that generally in an option the purchaser is in the controlling position and in a right of first refusal it is the seller.


In any situation where rights to acquire something are being considered, whether an option or right of first refusal is the correct contractual instrument will very much depend on the circumstances of the particular case and whether you are the seller or purchaser.

It should be borne in mind that an option is a more definitive arrangement in so far as the terms on which the asset will be sold and the essential terms of the sale are generally recorded at the time of the granting of the option. For example, the price (or mechanism in terms of which the price will be calculated). An option is also usually granted for a specified period and the mechanism on how it should be exercised is usually agreed upon at the time it is granted. It is also not unusual for the party in whose favour the option is granted to pay the party who grants it for the option.


Generally speaking, a right of first refusal

• is for an unlimited time;
• does not contain a purchase price or mechanism in terms of which this is calculated; and
• is not paid for by the person in whose favour it is granted.

Although these two rights are similar in nature and can often be confused, the differences can have a significant impact and when agreeing to grant, or be the recipient of, either an option or a right of first refusal, legal advice should be obtained to ensure that the rights granted (or received) are the most appropriate in the circumstances.