National Association of Dealer Counsel
March 1, 2017
By Joseph S. Aboyoun
The automotive franchisor’s right of first refusal ("ROFR") under its dealer agreement has become a major component in buy-sell transactions today. The frequency of ROFR exercises has significantly increased in recent years. The exercise presents both missed opportunities for some and perceived benefits to others. No matter on what side of the field you sit, you are cautioned to fully understand the law governing ROFRs and how its exercise might affect your position in the buy-sell. Let’s explore some of the concerns that may arise and how your position can be maximized.
The playing field in this context is actually triangular (if you disregard the manufacturer’s position). On one side is the selling dealer. For the most part, a ROFR exercise can be neutral or even beneficial to the seller. However, there arc certain instances where the exercise can present serious concerns which should be avoided. On another side is the contract buyer, who obviously seeks to avoid the ROFR exercise at all costs. On the third side is the assignee buyer designated by the franchisor. The ROFR deal may, at first blush, appear to be the proverbial "gift horse" for the assignee. However, there are several aspects of the "flip" transaction that can be troublesome and costly to this party.
II. The ROFR
To better understand how to address the ROFR exercise from your particular position in the deal, it is imperative to understand the precise language and terms of the ROFR under the dealer (franchise) agreement in play. While there are many common features in ROFR provisions throughout the spectrum of various dealer agreements, there are important variations which must be addressed in the particular case.
The following are some of the typical ROFR provisions:
- Exercise Period/Deadline. Most dealer agreements establish a time period within which a franchisor must exercise the ROFR. This typically ranges from fifteen (15) business days to forty-five (45) calendar days.
- Trigger Event. One of the more significant aspects concerns the timing of a ROFR -exercise and what triggers the right and the commencement of the prescribed time period. The language in this regard is varied in franchise agreements. The common denominator is the time at which the contract buyer has completed and submitted its franchise application. Of course, the submission of the acquisition agreement is also important. Many of the automotive franchise agreements arc surprisingly vague on this critical aspect.
- Reimbursement. Certain franchise agreements provide for the reimbursement of the buyer’s transactional expenses’ if the ROFR is exercised; however, many franchise agreements do not.
- Withdrawal Rights. Some franchise agreements entitle the selling dealer to withdraw a "buy-sell" agreement within a specified time after the ROFR is exercised, although this is nor a common provision.
- Family Transfers. Many dealer agreements contain exemption provisions that do not allow the exercise of the ROFR in transactions involving family members.
The precise ROFR language of the particular dealer agreement must be carefully scrutinized.
III. The ROFR Law
A. Statutory Regulation. As the exercise of the automotive ROFR became more frequent, state legislatures responded with statutory restrictions and limitations on the ROFR. Other state franchise statutes do not explicitly address ROFRs.
Common features of the statutory provisions governing automotive ROFRs include:
- The ROFR cannot be used by the franchisor CO impair or influence the price to be paid for the franchise.
- The franchisor must assume all obligations of the contract buyer as stated in the acquisition agreement.
- The franchisor must reimburse the contract buyer for all transactional costs.
- The franchisor must also purchase or lease the real estate if that component is part of the acquisition.
Many of the ROFR statutes establish a specific timeframe within which the franchisor must exercise the ROFR, which can be in conflict with the time prescribed under the pertinent franchise agreement. The statute will control the timing in such instances.
Other statutes restrict the employment of the ROFR to varying degrees. For example, in Maryland, the ROFR may not be exercised if the proposed transferee meets the manufacturer’s reasonable qualifications and is an existing dealer in good standing." Similarly, in Washington, the ROFR is restricted if the buyer falls within one of the following categories: transferee pre-approved by the franchisor; family member of a dealership owner; a manager-level employee who is qualified as a dealer-operator under the franchisor’s standards; entity controlled by a dealer-owner; or trust established for succession planning by a dealer-owner.
It is noteworthy that there is at least one jurisdiction (Georgia) that grants a motor vehicle franchisor a statutory right of first refusal. There is another (Iowa) that expressly invalidates the ROFR.
A comprehensive chart of the ROFR provisions in various state franchise statutes is included in Appendix A.
B. The Judicial Arena. Legal challenges to ROFRs in the automotive context are numerous. As one might expect, the cases in this arena have increased in recent years as the existence and exercise of ROFRs has become more common. Interestingly, the challenges have come from several directions. Of course, the majority of the challenges come from the aggrieved contract buyer that wants to regain its contract rights. The franchisors have also joined in the challenges where the deal is structured in a manner which impairs, if not precludes, the ROFR exercise. Even the existing franchisee has sought judicial protection where the ROFR exercise creates a perceived negative result.
The ROFR issues that have made their way to the judicial arena include the following:
- Validity — ls the automotive ROFR valid under the particular state franchise statute?
- Standing — Who has legal standing to assert the invalidity of the ROFR? Of particular interest here is whether the contract buyer has the right to challenge the ROFR.
- Third-party beneficiary — Can the contract buyer can nullify the ROFR exercise as a purported third-party beneficiary of the franchise agreement?
- Tortious interference — Will the exercise of a ROFR can constitute tortious interference?
- Time limitation — When is the ROFR exercise period triggered under the franchise agreement or applicable law? This seemingly simple concept can become complex in certain instances. What is the notice requirement?
- Structural issues — What happens when a sale transaction is structured, whether wittingly or unwittingly, in a manner which effectively averts or frustrates the exercise of the ROFR? A typical example is the sale of several dealerships or a variety of franchises in an integrated transaction.
C. Covenant of Good Faith and Fair Dealing — Does the doctrine of the covenant of good faith and fair dealing have a bearing on the exercise of the ROFR? Does the Automobile Dealers Franchise Act (ADFA) play a role in this regard?"
IV. Representing the Seller
For the most part, a ROFR exercise presents no major concern to the selling dealer. The manufacturer’s money is just as green as the buyer’s. In many instances, the manufacturer may pay the price in lump sum even where seller financing is provided in the buy-sell agreement. However, the ROFR can present serious concerns in certain transactions. Some of these include the following:
- The deal includes several franchises — the so-called packaged deal. In this instance, the exercise of the ROFR with respect to one of the franchises (perhaps the most significant dealership in the platform to be acquired) may prompt the buyer to cancel the acquisition. Indeed, in many buy-cell’s, the acquisition of the entire package or, at minimum, certain high-performing franchises, is a condition precedent.
- The sale contemplates a post-closing equity position for one or more of the owners. The seller will obviously feel more comfortable in this position with a known entity (i.e., the contract buyer), but not with a stranger or, worse, one of his or her competitors or even a business enemy.
- The same concern is present with regard to post-closing employment.
- The lease of the dealership facility to the buyer may create similar concerns. This is complicated by a personal guaranty under the lease. Fortunately, the ROFR exercise imposes a requirement that the manufacturer must guaranty the lease.
- Other situations may also render a ROFR exercise as undesirable to a seller, such as a contingent consideration — e.g., a deferred purchase price in the form of the vehicles sold by the buyer in the first few years of the acquisition.
Each of these potential scenarios must be carefully scrutinized and addressed in the buy-sell negotiations and the ultimate language of the acquisition agreement.
V. Representing the Contract Buyer
The contract buyer is clearly the party most victimized by the ROFR exercise. It is obviously the buyer’s goal to avoid or preclude the exercise to the largest extent possible. There are many ways that a buy-sell can be structured that can assist in this regard. However, there is a fine line between what will be considered legitimate deal structuring and a transparent attempt to thwart the ROFR. The latter is potentially subject CO attack under prevalent case law. The art of the deal is to accomplish the former when representing the buyer.
The art of negotiation with the manufacturer should not be overlooked in this situation. No matter how the deal is structured and the buy-sell crafted, your client, as the proposed buyer, and you as its advocate, must be persuasive and effective with the manufacturer when processing your application for franchise approval. In my experience, this concept is amazingly absent from many deals and realized far too late in the game. A rapport with the factory must start immediately upon the submission of the buy-sell. A face-to-face conference with the regional manager of the manufacturer is encouraged as soon as this can be arranged.
A correlating issue that arises in this context is whether the contract buyer should challenge the ROFR exercise, even if there is a perceived legal basis to do so. Even the most scorned buyer should consider the consequences of a challenge. The impact on the franchisor relationship, especially one involving a significant franchise, can be immeasurable. Just because one can attack the ROFR exercise does not mean chat one should. This will not be an easy decision and will require your sage advice.
VI. Representing the Assignee Buyer
Representing the alternate buyer designated by the manufacturer can be extremely challenging. ‘What may appear, at first blush, to be major opportunity for your client may slowly transform into a problematic deal. Most of the issues that arise are the reality of stepping into a deal at the twelfth hour. Due diligence is complete; closing is around the corner; the pressure to close is enormous. This situation must be scrutinized very carefully before your client decides to attempt this "opportunity". The legal format of this acceptance is an assignment and assumption agreement drafted by the franchisor in its typical one-sided fashion. This is where the war is lost or won. This is the time when you must address all apparent concerns regarding the acquisition.
The following are some of the usual problems that can be encountered:
- Since due diligence is already completed by the time your client steps into the deal, great care must be taken in scrutinizing the usual concerns, including environmental, facility, and franchise/ business issues, which in most instances, can take weeks, if not months, to properly evaluate.
- What if the dealership has a union and your client’s other stores do not? How does this play out?
- Can your client line up financing in time, whether in the form of acquisition or working capital funding, or the requisite floor plan?
- Do you have sufficient time to analyze and/or line up required management and employee staff?
The exercise of a ROFR impacts every party in the transaction in one way or another. It is up to you, as the experienced automotive professional, to navigate your client through the minefield presented by the ROFR. The failure and/or inability to do this can result in significant injury and consequences. To accomplish this effectively for your client can be most rewarding for the both of you.