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From Lawletter No. 184 Beware of franchisor assignment of first refusal rights Under California law, your franchisor has a right of first refusal on any assignment of a franchise. We have previously warned in these pages against understating the purchase price in your notification to the company. You may be tempted to do this in order to avoid a large transfer fee, or for other reasons. In a number of cases, the majors have exercised their first-refusal rights. During the last few years, they have also come up with a new tactic--assigning the first refusal-right to a preferred dealer. We believe that the use of such a practice significantly increases the chances the franchisor will exercise its first refusal right on any given sale. Those situations where the company might take the deal are no longer limited to situations where it wants to company-op. the station. Advantages to oil company: By assigning its first refusal right to dealer it prefers, the refiner gains several advantages. First, it gets the dealer it wants. Second, it puts up no money. Third, it can still collect any applicable transfer fee. California assignment law: Business & Professions Code section 21148 states that notwithstanding the terms of any service station franchise agreement, the dealer has the right to transfer or assign his franchise, that is his lease and supply contract, if: (1) The buyer meets the company's current, uniformly applied standards for new dealers; (2) The seller grants the company a 30-day right of first refusal; and (3) The parties pay any transfer fee that the franchisor charges. Practical effect of right-of-first-refusal: Some dealers may be tempted to take a substantial part of the purchase price under the table when the business is sold, either to avoid paying the full transfer fee or to accommodate a buyer who does not want to have to explain to the IRS where he got the money. Apart from potential violation of the tax laws, the seller runs a serious risk if the company elects to exercise its right-of-first refusal. The selling dealer who expected to receive additional under the table compensation from the buyer will hardly be in a position to reveal the secret part of the deal after the franchisor has exercised its first refusal right. To do so would at best subject the dealer to termination of his franchise for fraud. Furthermore, on any transaction in which the purchase price appears to be a bargain, the refiner may very well be tempted to exercise its right to take the deal. Canceling the deal: If the company were to elect to be aggressive in such a situation, it might very well be able to prevent the seller from canceling the transaction after learning of the oil company's intention to buy the business at the formally disclosed purchase price. The California assignment law purports to give the refiner a right of first refusal. It would provide little or no protection for the seller and buyer to provide in their contract that the sale is canceled if the franchisor exercises its right of first refusal. Such a clause is an obvious red flag, i.e., an indication that the parties may not have made full disclosure of the purchase price. Furthermore, the presence of such a clause would very likely relieve the company of any legal obligation to approve the sale under California law. Recommended procedures: We therefore recommend the following procedures for the dealer who intends to sell his business: 1. Use written agreement: Have the buyer sign a written contract of sale as soon as you have reached an agreement. Make the contract subject to the franchisor's approval of the assignment, so you take no risks. 2. Accurate disclosure of purchase price: Keep in mind that if you understate the purchase price, and the refiner exercises its right of first refusal, you may very well be stuck with accepting the purchase price from the oil company that you state in the written contract. 3. Avoiding first refusal right: If for any reason you do not want the franchisor to take the deal, bring this fact up when you first consult your lawyer about the deal. It may be possible in some cases to at least reduce the chances that the oil company will try to transfer its first refusal right to another party by careful planning. ©1999 Automotive Trade Organizations of California and Carroll, Gilbert & Bachor |
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