By Leonard A. Bellavia, Esq., Bellavia Blatt & Crossett, P.C.
Our auto dealer clients are being told that the retail landscape as they know it is about to radically change with the advent of self-driving and electric vehicles. Only time will tell. But what has already changed is the way auto manufacturers have re-engineered the process whereby dealerships are transferred.
The problem is that dealers have been slow to react to that re-engineered process, and are entering buy-sell transactions using concepts and provisions from standard contracts that no longer protect them. If dealers are to successfully consummate deals in the form originally negotiated, then they also need to reinvent the buy-sell process.
A new phenomenon known as the manufacturer’s Right of First Refusal (“ROFR”) has evolved from a lawyer’s talking point at dealer association conferences to a full-blown epidemic where unsuspecting dealers are submitting asset purchase agreements for approval only to have them ROFR’ed with increased regularity.
A ROFR is an age old real estate concept where a party to a contract reserves a right to “match the deal” that is entered into with a third-party at arms-length. Auto manufacturers and distributors incorporated this provision into their franchise agreements many decades ago but rarely executed these rights. Legal practitioners could count on one hand how many times they saw it exercised during an entire career.
In the past few years, however, experienced dealer attorneys see these ROFRs exercised several times a month. Usually this in the context of a referral from a dealer who has been ROFR’ed and now wishes to explore his or her rights. If only the dealer had consulted an experienced dealership attorney in the first instance, many of the ROFRs may have been avoided.
Helping buyers and sellers avoid the collapse of their transaction through the exercise of a ROFR is no longer an incidental aspect of discussion. It has become the centerpiece of the negotiation and drafting of the transaction documents.
There was a time when it didn’t matter to the seller if the factory exercised its ROFR because it would still collect its full proceeds. That is no longer true as most sellers are multi-franchise dealers and the exercise of a ROFR by one factory could leave the dealer with unsold franchises and unoccupied real estate.
Auto manufacturers are confronted with dealer franchise statutes in all 50 states that make it extremely difficult to reject a qualified buyer. Rather than subject themselves to litigation over an unreasonable rejection of a proposed buyer, manufacturers are invoking their ROFRs and having favored dealers take over the obligations of the buyer by assigning to him or her the asset purchase agreement and related documents.
Perhaps this satisfies the repayment of a favor owed to a dealer. In some cases, the buyer is qualified but not as desirable to the manufacturer as another dealer. Often, a manufacturer utilizes this tool to help achieve its minority dealer development objectives.
Despite this epidemic, dealers continue to lead with their chin by submitting garden-variety asset purchase agreements drafted by their local attorneys with the usual provisions that make it extraordinarily easy for a factory to exercise its ROFR and for a favored dealer to then perform quick and easy due diligence, all courtesy of the time, expense and negotiating expertise of the buyer.
First and foremost, forget convention. For decades, accountants and attorneys were taught to avoid stock deals for dealership transfers. The amount of work necessary to overcome the risk was able to be eliminated by simply having the buyer form a new entity. That logic was historically sound, but in the current climate it also makes it easy for a manufacturer’s ROFR assignee to enjoy the same comfort to step into the shoes of the buyer.
Why tee up an easy deal to be plucked by a stranger? A stock transfer transaction requires an investment of time and risk that a factory assignee may find unattractive. Also, the short window of time for a ROFR to be executed may not permit an assignee dealer to assemble the team of advisors needed to perform due diligence. Indeed, public companies and many private equity groups are prohibited from purchasing stock.
While a stock deal for a buyer may not be preferred, safeguards can be put into place. Importantly, if it discourages a ROFR, it may be worth the extra time and expense. It is incumbent upon dealer counsel to bring an experienced automotive accountant onto the transaction team early in the process. For a seller with multiple franchises, a stock sale may present far too tangled a web for a ROFR assignee to act within the usual 30-day time frame to close.
Local dealer counsel also seems to be making it too easy for manufacturers to exercise a ROFR in multi-franchise deals, by expressly allocating blue sky values amongst the various brands. It is likely that the buyer and seller made an aggregate deal for all the franchises together, such that a request by the manufacturer for a breakdown would be an artificial exercise. To be sure, they will demand it, but dealer’s counsel has a powerful argument to advance.
In this same regard, the dealerships’ real estate values may be incorporated as part of the transaction price and, in any event, the lease or sale of the properties should be an integral part of the consideration required to be “matched” in the exercise of a ROFR.
In a multi-franchise transaction, a validly-exercised ROFR can only be implemented when all manufacturers work together and simultaneously approve the proposed assignee, who has agreed to match the aggregate terms. While that may not be a realistic scenario, it is emblematic of real-world buy-sell transactions, where often one entity is buying a large group of dealerships. ROFR clauses were inserted into dealer agreements over 40 years ago and have not been redrafted.
Manufacturers’ arguments urging dealers to extrapolate or segregate complex transactions to comport with antiquated contractual provisions are strained at best and practitioners should not capitulate to such pressure. It is not unreasonable for seller’s counsel to respond to the manufacturers that the proposed assignee “Either match the deal in full in its present form as negotiated as to all manufacturers, or approve the transaction as submitted.”’
Attorneys should also avoid the use of “poison pill” provisions that may appear to be designed solely to frustrate a manufacturers ROFR. This may place the seller in potential breach of the dealer agreement. The inclusion of break-up fees is also inadvisable. Side letters altering the terms of the proposed deal are also not recommended and are not necessary if a more radical approach to structuring deals is utilized.
Sellers should be cautious about being lulled into a false sense of security by working with the factory’s preferred ROFR candidate with respect to the remaining franchises in a buy-sell transaction. The seller has a contractual duty to the buyer and may expose him or herself to liability to the buyer for breach of contract or for conspiracy with the factors under a tortious interference theory.
There are 5 states that prohibit manufacturers from exercising their ROFR rights. Until all 50 states enact similar provisions — for which dealers must strenuously lobby — attorneys representing buyers and sellers should discard the old play book and reinvent their approach to advising dealers on these transactions.
Leonard Bellavia is a senior partner with Bellavia Blatt & Crossett PC, with offices in New York, New Jersey, and Connecticut. He can be reached at 1-516-873-3000 or email@example.com.