By Mark D Johnson; President of MD Johnson, Inc.
What could be better than this if you are a dealer looking to buy dealerships, and a manufacturer looking to get the right dealer in place? You, the dealer, align with the manufacturer and wait for a buy sell to be submitted. The manufacturer shares the terms of the deal, or in some cases the actual document with you and at the last possible moment exercises its Right of First Refusal over the buyer the dealership owner prefers. You are instead the approved buyer.
No tedious negotiations, no hassles over documentation, just wait for the documents (deal flow) to fall in your lap. In some cases, this is a great reward to dealers that have done a great job for the factory. In other cases, this Right of First Refusal, or ROFR, is grossly abused.
Either way if you are the seller, the manufacturer will be required to reimburse all your expenses incurred before the application was rejected. However, little case law exists to solidly identify and describe those expenses. That means you could end up out a lot of money.
It is my information that, due to the volume of ROFR’s occurring in the current lopsided seller’s market, identifying these expenses and the process for repayment are being more clearly defined.
What will be reimbursed is being more clearly defined in buy sell agreements because dealers are more alert to the possibility that ROFR will be exercised. For example, now documents itemize details such as attorney’s fees, due diligence costs, environmental assessment fees, and other expenses incurred when preparing the buy sell agreement. These are expenses that must be reimbursed should ROFR be exercised.
Rather than depending on those clearer definitions, try to avoid facing a ROFR by being a profitable dealer with happy customers. If you do face a ROFR, however, understanding the process is crucial.
Mistakes to avoid in the ROFR process
The buyer and the seller (you) agree on the terms of the sale and enter into one of several agreements. The most important is the asset purchase and sale agreement or APA. This can take from 10 days to 3 months to agree on depending on the parties involved. Then either a lease of the real property(s) is executed or a REPSA (real estate purchase and sale agreement). These documents along with all exhibits are submitted to the manufacturer by the seller with the corresponding letter, the form of which is typically outlined by each state.
Most dealers and many lawyers think that this is when the proverbial “clock starts to tick.” That refers to the law in some states requiring the manufacturer tell the buyer whether the deal is approved or denied within 60 days.
There are many mistakes that can delay the clock’s start, however. These delays can give a manufacturer more time to shop your buy sell agreement around to potential buyers not of your choosing.
- First mistake: Incomplete documentation. The clock starts when the “completed document including all exhibits are submitted”. Don’t send incomplete document packages when you believe a ROFR is or could be looming.
- Second mistake: Amending the buy sell agreement with new partners or new financial information after the document has been submitted. This starts the 60 days over.
- Third mistake: Developing a document designed to thwart or otherwise “frustrate” the manufacturers’ Right of First Refusal. Your dealer agreement in some cases says the manufacturer can assert ROFR for just the assets and not the Blue Sky if such a frustrating tactic occurs.
- Fourth mistake: Thinking that a state prohibition against manufacturers’ right of first refusal changes anything. Don’t depend on it to prevent ROFR from happening.
Tips for a buyer
A potential buyer also loses out if a manufacturer exercises ROFR. Here are a few things a buyer can do to help ward that off.
- Don’t sue the manufacturer. They never get over this.
- Send in a completed document if you are buying a dealership. That includes all exhibits, all signatures. Closely monitor the buyer’s application package and deadlines. Don’t leave anything out. The key is to make sure the 60 day clock actually starts ticking.
- Be proactive. If a manufacturer doesn’t release the application within about 10 days, it is likely shopping the deal for a ROFR. Call for a meeting and state your case.
- Lastly and most importantly, don’t develop or hold side letters. My favorite side letter was “we will put down in the buy sell the blue sky is $15 million but do a side letter for a $5 million dollar adjustment to the good will at closing”. This is how you lose your franchise and your credibility all in one fell swoop.
Also keep in mind that you cannot obligate the manufacturer or any other third party by placing terms upon them in the buy sell. An example of this is “should the manufacturer choose to assert their right of first refusal, the assignee buyer will be required to pay an additional one million dollars.” That is not in the sales and service agreement, so the factory has no obligation to agree to “accept” the buy sell with this term. They simply reject it and rightfully so.
Mark Johnson is the President of MD Johnson Inc., a dealership buy sell advisory firm. He can be reached at mark@mdjohnsoninc.com or 1-360-825-1756.
4 Comments
meg kennedy
Fourth mistake: Thinking that a state prohibition against manufacturers’ right of first refusal changes anything. Don’t depend on it to prevent ROFR from happening.
Can you give me an example of how this would happen?
Mark Johnson
Although some states prohibit the exercise of the factory right of first refusal as outlined in the dealer agreement, the factory will often exercise it anyway. It is the selling dealer (typically) with standing to object. Most sellers dont object as long as all of the terms and dates are adhered to by the ROFR buyer. At the end of the day, sellers want to get their transaction closed. A lot of sellers may start out being concerned with who the buyer is but often at the end of the process, getting the transaction closed becomes more important than with whom. If you need additional information feel free to call me.
Mark Johnson
Lynnda Jordon
What if the non-ROFR buyer (Comp. X) inserts a penalty clause into the contract. ie: if ROFR is enacted then Seller pays Comp. X $50,000 for expenses. Any way around this?, Any suggestions?
Mark Johnson
Hi Lynnda
This is more of a legal question based on your franchise agreement and the specific franchise law of that state. Generally I see that most factories compensate the non rofr buyer for their expenses but not usually at the level necessary to cover all the actual expenses. As long as the penalty or fees are paid by a party to the agreement anything that is lawful is likely permitted.