First Offers, First Refusals, and Shotguns: Knowing Your Rights And Obligations As A Share Vendor Or Purchaser

If drafted well, shareholders’ agreements or other key business contracts (e.g. limited partnership or joint venture agreements) will set out protocols in the event that one or more interest-holders want to sell their holdings. These protocols may include items such as rights of first offer (“RFOs”), rights of first refusal (“RFRs”), and/or ‘shotgun’ buy/sell provisions. Having a good grasp of what these mechanisms are – as well as how they differ from each other – may help prevent unnecessary disputes or costly litigation.

First offers vs. first refusals

The difference between RFOs and RFRs can be summed up as follows:

  • RFOs set out what a vendor ought to do before soliciting any third party offers; whereas,
  • RFRs set out what a vendor ought to do after she has received a good faith offer from a third party.

Under an RFO, once a shareholder decides to sell her interest in a company, she must notify her co-signatories to the shareholders’ agreement and allow them to make a first bid for her shares. For an RFO to be triggered, a shareholder must actively be intending to sell.

Conversely, an RFR provision will typically set out that as soon as a shareholder receives a good-faith offer from a third party which she would be willing to accept, she must immediately notify her co-shareholders and give them a chance to match the offer.

Although RFRs and RFOs have often been lumped together, they are distinguishable in terms of i) their timing and ii) the amount of third party involvement. For instance, if shareholder “B” owes shareholder “C” first-refusal privileges, B could still negotiate back and forth – or conditionally come to terms – with a third party (“A”), subject to C’s rights. This conditional scenario wouldn’t count as a breach of obligation by B. The same scenario would not be allowed under an RFO provision, however, as A and B would not be allowed to communicate until C has tabled an offer.

In terms of underlying rationales, both RFRs and RFOs are ‘pre-emptive’ tools intended to protect parties’ interests, i.e. so that current shareholders, partners, or joint owners will not have unwanted strangers foisted on them as new business associates.

It is also important to note that RFOs and RFRs are contractual rights governed by strict rules of interpretation. (For example: If an RFO provides interested co-shareholders with 15 calendar days to make a first offer, courts will not look kindly on an impatient vendor who begins ‘shopping’ for outside offers on Day 14).

Do third parties have rights with respect to first offers and refusals?

Since RFRs and RFOs are contractual matters between fellow shareholders and/or stakeholders, third parties generally cannot enforce or otherwise rely on them. The case of GolfNorth Properties v Rebel Land Holdings Inc. (“GolfNorth”) helps to illustrate this point, although there are certain exceptions (e.g. like in Benzie v Kunin).

In GolfNorth, a third party offeror challenged the validity of a shareholder’s matching offer, alleging that its own initial bid – which had triggered the RFR – did not in fact count as a triggering “offer” as defined in the relevant shareholders’ agreement.

The Superior Court of Justice rejected this argument based on privity of contract, since the third party had no actual stake in the agreement it sought to enforce. GolfNorth therefore suggests that non-parties to an agreement possess no rights flowing from first-refusal or first-offer provisions within said agreement, unless a contrary intention is shown by the parties’ conduct or in the words of the contract itself.

Benzie v Kunin, however, presents an interesting exception to the above. In this case, a father left a farm to one of his daughters (“M”), subject to the condition that if M should ever sell it, she would notify her siblings (“B” and “K”) who could then exercise first-offer and refusal rights.

When M, B, and K reached their sixties, it was unclear what should happen to B’s and K’s pre-emptive rights once the siblings passed away. On one hand, M argued that her children should not be encumbered with her obligations, which may have been consistent with a narrow approach based purely on contractual privity. On the other hand, B and K argued that their respective children should inherit their rights, relying on an ‘enurement clause’ which implied that the agreement was intended to outlast its original signatories:

  • “The Agreement shall ‘enure to the benefit of and be binding upon the parties hereto and their respective heirs, administrators, executors, successors and assigns’…”.[20]

The Superior Court of Justice agreed with – and the Court of Appeal affirmed – B and K’s reading of the agreement, such that its first-offer and first-refusal provisions were essentially deemed transferrable to M, B, and K’s adult children.

Breakdowns in business relationships – who stays and who goes?

Alongside RFOs and RFRs, another mechanism known as a ‘buy/sell’ provision – a.k.a. a ‘shotgun’ provision – may be used to kickstart negotiations where business partners have fallings-out and/or are considering exiting the business.

Under a basic buy/sell clause, an offeror will choose a unit price and then give the offeree a time-limited choice between either:

  • Buying all of the offeror’s shares at the unit price; or,
  • Selling all of the offeree’s shares to the offeror at the unit price.

In other words, the initiating shareholder will generally need to start by proffering her shares first in a buy/sell negotiation. Provided that the offeree has had a chance to consider his options first, the offeror may then proceed with a purchase offer.

As may happen from time to time, however, two shareholders could face such irreconcilable differences that neither is willing to sell to the other. If each party insists on a right to buy out the other, how might a court decide who must yield their rights first?

That type of worst-case scenario was litigated in Jansezian v Hotoyan, which concerned two brothers-in-law holding 40% and 60% stakes in a numbered company, respectively. In this case, the court turned to an assessment of each party’s “reasonable expectations” as to their rights to each other’s shares. In assessing their expectations, the court also paid close attention to the terms of their shareholders’ agreement, as well as their levels of involvement with the day-to-day operation of the business.

Despite Hotoyan’s majority holding being a clear factor in his favour, the court found in favour of Jansezian’s priority-right to purchase under a buy/sell provision. This ruling reflected the court’s view that a) Jansezian had a far higher level of direct involvement in the business, as well as b) a disproportionate degree of dependence on the business for his livelihood. On a final note, this case appears to suggest that where contractual tools (e.g. default ‘shotgun’ provisions) fail to yield suitable compromises, courts may well step in and make decisions for disputants based on what they deem to be fair and reasonable.

Questions? We can help!

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Disclaimer: This article is for informational purposes only and does not provide legal advice, nor does it create a solicitor-client relationship with you or any other reader.

[1] See Christopher C. Nicholls, “Lock-Ups, Squeeze-outs, and Canadian Takeover Bid Law: A Curious Interplay of Public and Private Interests” (2006) 51-2 McGill LJ 407 at 410.

[2] See 1605041 Ontario Limited v 2424033 Ontario Ltd., 2018 ONSC 7119 at para 40 [1605 Ontario].

[3] See Harris v McNeely, [2000] OJ No 472 (QL), 2000 CanLII 5649 (ON CA) at para 16 [Harris v McNeely].

[4] See Christopher C. Nicholls, supra note 1 at 410.

[5] See 2056668 Ontario Inc. v Fernbrook Homes (Majormac North) Ltd., [2007] OJ No. 2755, 2007 CanLII 27334 (ON SC) at paras 12-13 [Fernbrook Homes].

[6] See Fernbrook Homes, ibid at paras 12-13.

[7] See GATX Corp. v Hawker Siddeley Canada Inc., [1996] OJ No 1462, 1996 CanLII 8286 (ON SC) at paras 36, 40.

[8] See 1605 Ontario, supra note 2 at para 40.

[9] See GolfNorth Properties Inc. v Rebel Land Holdings Inc., 2019 ONSC 3479 at paras 75-76, 106 [GolfNorth].

[10] See GolfNorth, ibid at para 46.

[11] See GolfNorth, ibid.

[12] See GolfNorth, ibid at paras 105-106.

[13] See GolfNorth, ibid at paras 74-76.

[14] See GolfNorth, ibid at paras 102-106,

[15] See GolfNorth, ibid at paras 91-92.

[16] See Benzie et. al. v Kunin et. al., 2012 ONSC 976 at paras 4-10 [Benzie v Kunin].

[17] See Benzie v Kunin, ibid at para 14.

[18] See Benzie v Kunin, ibid at paras 16, 19.

[19] See Benzie v Kunin, ibid at para 17.

[20] See Benzie v Kunin, ibid at para 10.

[21] See Benzie v Kunin, ibid at para 19.

[22] See Benzie v Hania, 2012 ONCA 766 at paras 51, 85.

[23] See Jansezian v Hotoyan, 1998 CanLII 14816 (ON SC) at para 7 [Jansezian v Hotoyan].

[24] See 2235512 Ontario Inc. v 2235541 Ontario Inc., 2016 ONSC 7812 at para 17.

[25] See Jansezian v Hotoyan, supra note 23 at paras 1-2.

[26] See Jansezian v Hotoyan, ibid at paras 7-9.

[27] See Jansezian v Hotoyan, ibid at paras 9, 12.

[28] See Jansezian v Hotoyan, ibid at para 12.

[29] See Jansezian v Hotoyan, ibid.

[30] See Jansezian v Hotoyan, ibid at paras 9, 12.

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