A right of first refusal (“ROFR”) provision as found in shareholder agreements requires a shareholder intending to sell their shares to first offer them to their fellow shareholders or to the corporation. ROFRs are beneficial because they permit shareholders to sell their shareholdings, while allowing other shareholders the option of buying out the selling shareholder before an unwanted third party has the opportunity to join the company. For that reason, ROFRs are commonly incorporated into shareholder agreements. ROFRs are also commonly found in commercial agreements, including in regard to rights of a party to purchase assets before third parties have an opportunity.
The question of whether a party has complied with the terms of a ROFR is a common source of contention, and the Courts have mapped out a thorough framework for resolving interpretive questions arising from these disputes.
Principles of Interpretation
Courts will apply basic principles of contractual interpretation when determining the scope of the ROFR and whether it was complied with. Interpreting a ROFR involves finding an interpretation that promotes or advances the true intentions of the parties at the time they entered into the contract.[1] The Alberta Court of Queen’s Bench (“ABQB”) noted that ROFRs are restrictions on a shareholder’s right to deal freely with their property and are therefore strictly construed.[2] The Supreme Court of Canada’s (“SCC”) recent decision in Creston Moly Corp v Sattva Capital Corp (“Sattva”) emphasized that contracts must be interpreted as a whole, using a contextual approach that considers the factual matrix of the surrounding circumstances and dealings between the parties.[3]
Good Faith ROFR Performance
Courts have long recognized an implied duty of good faith in performing ROFR obligations. The Ontario Supreme Court stated that “the grantor of a right of first refusal must act reasonably and in good faith in relation to that right, and must not act in a fashion designed to eviscerate the very right which has been given”.[4] The SCC confirmed the existence of a duty of good faith in commercial contracts in Bhasin v Hyrnew (“Bhasin”), where the duty of honest performance was recognized as a general doctrine of contract law. This duty operates irrespective of the intentions of the parties.[5] Any conduct that falls below the minimum standard of honesty in contractual performance is actionable.
Recent Developments
In a post-Bhasin legal landscape, the question of how ROFR obligations will be interpreted in light of the newly recognized duty of honest performance in contract law was addressed in the Saskatchewan Court of Appeal (“SKCA”) case of Northrock Resources v ExxonMobil Canada Energy, 2017 SKCA 60 (“Northrock”). The SKCA considered whether ExxonMobil Canada Energy (“ExxonMobil”) breached its ROFR obligations owed to Northrock Resources (“Northrock”) when it chose to transfer certain assets to a wholly-owned subsidiary, and then sell the shares of that subsidiary to a third party, rather than selling the assets directly to the third party. The ROFR provision in question specifically provided that transfers to ExxonMobil subsidiaries would not trigger a ROFR, so the transaction undertaken by ExxonMobil did not offend the ROFR on its face.
Northrock sued ExxonMobil, its subsidiaries, and the third party, alleging that the transfer by ExxonMobil to its subsidiaries was in breach of the principle established in GATXCorp v Hawker Siddeley Canada Inc (“GATX”) that a seller acts in bad faith if a transaction is structured so as to avoid ROFR obligations. Northrock’s argument was rejected by the Court of Queen’s Bench, which held that ExxonMobil had negotiated the right to transfer assets to subsidiaries and was motivated by tax considerations, rather than a desire to frustrate the ROFR, when it made the decision to transfer the assets to its subsidiary. The trial judge held that the plain language of the ROFR clearly permitted dispositions of assets to subsidiaries. If Northrock intended for the ROFR to trigger on dispositions to subsidiaries, then it could have negotiated the provision to reflect that intention.
Northrock appealed the Queen’s Bench decision, but the SKCA rejected Northrock’s position that ROFRs have a general purpose, being a general right of first refusal of the disposition of certain assets. The SKCA stated that ROFRs are restrictions on a property-owner’s right to sell that only exist because they are bargained for and reduced to a written contract. There were no reasons for the SKCA to impute into the ROFR any additional restrictions on ExxonMobil’s ownership rights beyond what was bargained for.
Northrock also argued that the trial judge’s interpretation of the ROFR position would yield a commercially unreasonable result. The SKCA also dismissed that argument, holding that there was nothing “commercially unreasonable” about holding parties to the clear terms of their agreement.
The SKCA lastly considered whether ExxonMobil chose to transfer the assets to its subsidiary in bad faith, and noted that the principle of good faith from Bhasin asks for a context-specific understanding of what honesty and reasonableness in performance require. The SKCA borrowed from GATX and other cases and identified six principles to consider in the context of good faith performance of ROFR obligations:
- the grantor of a ROFR must act reasonably and in good faith in relation to that right;
- the grantor must not act in a fashion designed to eviscerate the very right which has been given;
- the grantor of a ROFR has a duty to exercise its right in such a manner to ensure that the other party’s rights are not rendered meaningless;
- the duty of reasonableness and good faith is not discharged if the essential purpose of the sale to the third party is to frustrate the ROFR;
- unless the whole transaction is structured to do indirectly that which triggers the ROFR, the ROFR does not apply; and
- the grantor of the ROFR is not entitled to frustrate a ROFR by conveying property in such a way as to avoid having to give the right in the first place.
In closing, the SKCA cautioned that “the duty of good faith must not be used to circumvent the plain language of a contract because that would result in ad hoc judicial moralism and undermine the principle of certainty in contract”.[6]
Invitation for Discussion:
If you would like to discuss this article in greater detail, or any other business law matter, please do not hesitate to contact one of the lawyers in the Litigation Group at Linmac LLP.
Disclaimer:
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.
[1]GATX Corp v Hawker Siddeley Canada Inc., 1996 CanLII 8286 (ON SC) at para 38 [GATX].
[2]Zust Bachmeier International Air Cargo, Inc. v. Klapatiuk, 2006 ABQB 633 (CanLII), at para 17 [Zust].
[3]Sattva Capital Corp. v Creston Moly Corp., [2014] 2 SCR 633, 2014 SCC 53 (CanLII), at para 50 [Sattva].
[4]GATX at para 71.
[5]Bhasin v Hrynew, [2014] 3 SCR 494, 2014 SCC 71 (CanLII), at para 74 [Bhasin].
[6]Northrock Resources v ExxonMobil Canada Energy, 2017 SKCA 60 (“Northrock”), at para 47 [Northrock].