By Erin K. Tenner, Attorney
How would you feel if you entered into a buy/sell agreement and the manufacturer exercised its right of first refusal? A growing number of buyers and sellers are learning the answer to that question.
Although manufacturer-dealer sales and service agreements routinely include some form of a right of first refusal, it used to be rare to see one exercised. Now, however, a growing number of manufacturers are taking advantage of their right to snatch a dealership from the intended buyer and assign it to a buyer of their choice. If you intend to challenge a manufacturer in this instance, there are some important things you should know.
A manufacturer is not required to determine if the buyer the seller has chosen is qualified to own a dealership. The manufacturer typically merely sends a letter notifying both the buyer and seller that the right of first refusal has been exercised and the rights of the buyer have been assigned to a third party.
Your rights in this case vary from state to state so having counsel in the state in which you are buying is important. Generally speaking, it is only the seller who has the right to sue a manufacturer for not following the law in a buy/sell transaction since the seller is the one who has a contract with the manufacturer. However, some states have statutes to protect buyers. California, for example, requires that the manufacturer reimburse the buyer for legal fees and other expenses if it exercises its right of first refusal.
The buyer’s rights against the seller are also limited. Unless the seller gave a warranty and representation to the buyer that there were no pre-existing rights of first refusal, the buyer would not likely have any basis on which to sue the seller.
There are numerous laws that govern the rights of an innocent purchaser who pays for something without knowing that someone else owns it or has a right to own it.
However, none of them apply to a right of first refusal in a dealer sales and service agreement because manufacturer approval is required prior to purchase. If approval is not obtained, a seller has no liability to a buyer unless there is some other breach of contract that might have made a difference, such as a warranty or representation that no right of first refusal existed.
The seller’s rights are another issue. Sellers generally don’t like having the manufacturer step in and exercise a right of first refusal any more than buyers do. In the end it is the buyer that loses out as the seller must get the benefit of the bargain they made with the buyer, even if a right of first refusal is exercised. For this reason, sellers rarely end up suing a manufacturer for exercise of a right of first refusal.
However, the seller is typically the only one who has standing to sue a manufacturer for unreasonably withholding consent to transfer, provided the state law allows for it, or to sue for improper exercise of a right of first refusal. Generally speaking, a manufacturer will not exercise its right of first refusal if it cannot perform all of the terms of the contract.
For example, in a situation in which the buyer has agreed to purchase multiple franchises, or even a few shares of stock in another franchise that is not the manufacturer’s make, the new buyer would need to step in and do the same. Right of first refusal provisions require the manufacturer to perform on the same terms on which the buyer agreed to perform. If a manufacturer has a right of first refusal with respect to one franchise only, but the purchase agreement includes multiple franchises all being sold to the same buyer, the manufacturer usually will not exercise its right of first refusal because it has no right of first refusal with respect to the other franchises, and so it cannot perform the entire contract.
Provisions can be added to purchase agreements to prevent manufacturers from exercising their right of first refusal. If the manufacturer asks to have the provision removed and tells you they won’t exercise their right of first refusal, don’t be too quick to believe them. The person you are talking to may not be the decision maker.
Sellers also need to know that some dealer sales and service agreements provide that a manufacturer has the right to terminate the franchise if the seller attempts to undermine it by adding language to the purchase agreement to prevent exercise of a right of first refusal. Whether such provisions are enforceable is yet to be seen and will depend largely on how they are written. The bottom line is: Make sure you know your rights regarding rights of first refusal, or they may come back to bite you.
Erin Tenner is a buy/sell attorney in Los Angeles, California. She can be reached at erin@cardealerattorney.com or 818-707-8410.
