Are factories exercising rights of first refusal more frequently now than they did 10 or 15 years ago? Dealer attorneys I ask say yes and I agree. No single reason explains the increase, but factories now seem more familiar and comfortable with the right of first refusal process. Many have honed their ability to locate a willing assignee – an existing dealer ready and willing to purchase and operate the dealership after the factory exercises the right of refusal.  This increased frequency and other developments in the buy-sell arena merit a review of California’s comprehensive statutory scheme governing rights of first refusal, which itself is now over 5 years old.

In 2008 (effective January 1, 2009), AB 2707 was enacted to modernize a number of California motor vehicle dealer franchise protection laws.  Buy-sells were a central focus of the bill. Among a host of other features, the law inserted a buy-sell timeline of sorts into the dealer protection statutes, establishing deadlines for factory action on approving or disapproving a buyer’s application to become a dealer pursuant to a buy-sell, and on exercising a right of first refusal. The bill made it harder for factories to justify buy-sell turn downs by requiring the reasonableness of the turn down to be evaluated based on a consideration of  “all the existing circumstances” as opposed to prior law, which suggested one below-par mark on the buyer’s record could justify a turn down.

Prior to enactment of AB 2707, California’s dealer protection laws did not specifically address rights of first refusal.  At that time, many manufacturers were adding rights of first refusal to their standard form dealer agreements for the first time. Some lawyers thought that rights of first refusal might, as a matter of law, be inconsistent with the then (and still) existing statutory prohibition against factory efforts to “prevent or require, by contract or otherwise” the sale of any interest in the dealer to any other person or persons (See Vehicle Code Section 11713.3(d)(1)) or the requirement that factory consent to buy-sells not be unreasonably withheld. Courts in other states sometimes reached that conclusion. See Bayview Buick-GMC Truck, Inc. v. General Motors Corporation, 597 So.2d 887, 890 (Fla.Dist.Ct.App.1992).

But AB 2707 cut off questions as to the legality of rights of first refusal by tacitly approving of them by subjecting them to the requirements added to the Vehicle Code by the bill. (See Vehicle Code Section 11713.3(t).)  Those requirements include the following:

  1. A contractual right of first refusal must be contained in the franchise agreement.
  2. The manufacturer must give written notice of exercise of the right of first refusal within 45 days after receipt of an application for approval of the buy-sell;
  3. The proposed sale, transfer, or assignment must relate to not less than all or substantially all of the assets of the franchised business, or to a controlling interest in the franchised business.
  4. The right of first refusal cannot be exercised if the transferee is family member of an owner or if the transferee is a managerial employee of the dealership owning 15% or more of the franchised business, or a corporation, partnership or other legal entity owned by the existing owners of the franchised business.
  5. “[T]he consideration paid by the franchisor to the franchisee and owners of the franchised business shall equal or exceed all consideration that each of them were to have received under the terms of, or in connection with, the proposed sale, assignment, or transfer, and the franchisor shall comply with all the terms and conditions of the agreement or agreements to sell, transfer, or assign the franchised business.” (Emphasis added.)
  6. The franchisor must reimburse the proposed transferee for any reasonable expenses paid or incurred by the proposed transferee in evaluating, investigating, and negotiating the proposed transfer.

The most important of these provisions, both when the bill was passed and now, is item 5 (see Vehicle Code section 11713.3(t)(5).  This provision makes it illegal for a manufacturer to exercise a right of first refusal unless all of the consideration that the buyer would have received if the buy-sell closed as originally planned is paid to the buyer. It also requires the franchisor to comply with all terms and conditions of the agreement or agreements for sale of the business applicable to the buyer. In other words, the law requires the factory to take the “same deal” as the deal between the buyer and seller.  The statute can certainly be read to support this statement: if it is not possible for the factory to take the same deal, the right of first refusal simply cannot be exercised legally. When enacted, commentators suggested that this same-deal provision would provide certainty regarding the real estate aspects of a buy-sell: if the buyer were committed to purchase or lease real estate, then the factory would have to do so too if it exercised the right of first refusal.  As a result, the Seller did not need to worry that a right of first refusal might upset a real estate deal carefully crafted as part of a buy-sell. In my experience, this has worked out well in practice. Most manufacturers realize that they or their assignee need to step into the shoes of the original buyer not only as to the assets of the dealership, but as to the real estate as well. One remaining area of friction, however, is whether a manufacturer (as opposed to its assignee) must provide its own guarantee of all ongoing obligations under a lease or other long-term commitment associated with the buy-sell in cases where the original buyer was required to provide such a guarantee.  However, the statute clearly requires a franchisor who exercises a right of first refusal to assume all terms and conditions of all agreements for the sale of the dealership, making it difficult for the factory to argue it is not fully obligated on any lease or other long-term agreement.

Today, the same-deal provision finds renewed currency in this era of multi-line dealer and dealer group buy-sells. Sometimes referred to as “package deals,” many buy-sells today involve agreements calling for a single unified transaction for the sale of a “mega dealership” with multiple line makes or a dealer group with multiple locations and line-makes.  Manufacturers seeking to exercise a right of first refusal in these circumstances sometimes claim that it is impossible or at least unfair to expect the manufacturer to step fully into the shoes of the buyer and acquire multiple dealerships and/or operations involving unrelated line-makes.

Some franchisors take the position that even in the face of a package deal law, like California’s, the franchisor can exercise the right of first refusal as to just the dealerships representing that franchisor. Under this argument, the seller is purportedly bound to convey to the franchisor or its assignee the assets related to the franchisor’s brand in exchange for an allocated portion of the package deal purchase price, with the fate of the remaining dealerships and assets being left to the seller and original buyer to work out.  Alternatively, franchisors argue that even if they cannot technically exercise a right of first refusal as to just a portion of a package deal, allowing a package deal to close would unfairly deprive the franchisor of its right of first refusal, such that a court should enjoin the closing, at least until some way is worked out for the franchisor to have a right of first refusal as to only the dealerships of that franchisor’s line-make. Under this scenario, the prospect of an injunction stopping the entire transaction from moving forward becomes a powerful inducement for the franchisee to bow to the franchisor’s demands in order to save a very significant transaction from ruin. 

Mercedes-Benz convinced a federal district court in Georgia to issue such an injunction a few years ago in a case involving the purchase and sale of multiple franchises contained in one asset purchase agreement. Mercedes-Benz USA, LLC v. Star Automobile Co., et al., No. 3-11-cv-73, 2011 U.S. Dist. LEXIS 59258, 2011 WL 2175037; 2011 U.S. Dist. LEXIS 76648, 2011 WL 2791076 (M.D. Ga. 2011).  The decision in Star Automobile rested on common law principles developed principally in the context of real estate and non-automotive businesses transactions.  The general law regarding rights of first refusal and how it can be applied to package deals has been reviewed. See, e.g., Bernard Daskal, Note, The Right of First Refusal and the Package Deal, 22 Fordham Urban Law Journal 461 (1995). 

Of course real estate and non-dealership business transactions do not involve dealer protection statutes.  And although mention of the Georgia dealer franchise laws was made in Star Automobile, the court simply concluded that a right of first refusal is not inherently inconsistent with dealer protection statutes governing the buy-sell approval process. Additionally, although Georgia’s statute governing rights of first refusal contains a same-deal provision, it is not as detailed and specific as the provision in California law discussed above.  Thus, irrespective of Star Automobile and the common law, a very good case can be made that, under California law, a franchisor seeking to exercise a right of first refusal in the case of a package deal would need to exercise it as to the entire package and purchase the entire package.

Requiring a franchisor to exercise and perform its right of first refusal as to the entire package is neither unreasonable nor unworkable. For a variety of reasons, franchisors are loathed to actually purchase and operate dealerships and therefore seek to assign the right to purchase to an assignee.  The assignee should, of course, be properly matched to the dealership by being capable of handling the brand, location, and size of the dealership.  Similarly, an assignee can be properly matched to a package deal transaction with ability to own and operate the entire packaged deal.  If the original buyer found it appropriate to enter into the package deal, the franchisor should be able to find an assignee that also sees the value of doing so.  If such an assignee cannot be found, the franchisor can make arrangements to split up (or to have the assignee split up) the assets to multiple buyers after closing, leaving the franchisor or assignee with the assets they desire. In any event, in many if not most instances, a package deal provides a premium purchase price to the buyer over the price that would have been received in selling the assets in a series of singe-point transactions. The entire purchase price, including any package deal premium, constitutes value that the seller created through monetary investment, innovation, long hours, goodwill, and hard work.  The law should not and, in my view, does not permit a franchisor to curtail or reduce the dealer’s right to realize on that investment generally, and certainly a franchisor should not be permitted to do so simply by invoking a right of first refusal. But disputes over rights of first refusal usually happen within days of the scheduled closing of the buy-sell transaction making it difficult if not impossible to fully and completely assert these legal rights in a manner that does not delay or otherwise jeopardize the entire transaction. For this reason, it may be worth considering the possibility of legislation that would clarify that this is indeed the intent of the law in this area of growing importance.

Originally posted in Driven, a newsletter by the California New Car Dealers Association.