Operating Agreements and Ownership/Control Agreements
THE BEGINNINGS OF A MARRIAGE
By Andrew G. Thomas
As part of two or more individuals (each an investor) forming a new legal entity to own and operate a franchised dealership, it is important that the investors devote time to the negotiation and preparation of an ownership agreement, such as an operating agreement (in the case of a limited liability company), limited partnership agreement (in the case of a limited partnership) or shareholder agreement (in the case of a corporation). One often overlooked, but very important feature, of any ownership agreement is an “escape hatch.” An “escape hatch” is a specific provision that details how one or more investors may voluntarily exit, or be removed from, the legal entity. These provisions are important because in their absence, it may become an arduous, expensive, and complicated process to remove an investor, or for an investor to leave the business entity. If an entity’s ownership agreement does not include terms for removal, buyout, or other form of investor separation, the entity and remaining investors are limited to whatever remedies and standards at law or equity are available in the jurisdiction governing the entity, which are often unclear, absent, or difficult to meet.
When multiple investors enter into an ownership agreement, they bind themselves together for a specific purpose or set of transactions, often without a formal end date, other than the termination or dissolution of the entity. While one investor might believe their co-investor(s) are compatible, the harsh reality is that sometimes things may go awry. It could be a simple disagreement, a deadlock or impasse on a critical company decision where there is no individual with a majority, or one investor simply wanting to retire or liquidate their investment.
But what happens if an investor’s relationship with one or more other investors turns sour or ends abruptly? That depends. If there is no escape hatch in the entity’s ownership agreement, in the absence of an amicable resolution of the investors’ differences, a dispute may arise with little predictability of an outcome because the ownership agreement failed to provide a mechanism for resolving the removal of an investor. This could result in prolonged litigation or even a sale or dissolution of the legal entity. While an escape hatch may not always prevent litigation, an ownership agreement that addresses in detail how investors may exit or be removed should resolve or drastically narrow the issues in such a dispute.
In the motor vehicle dealer entity context, investors should pay special attention to the terms of an OEM required control agreement included with a dealer agreement, and its treatment of entity control or governance. It is not uncommon for OEMs to require designation of a single individual as the dealership’s decision-maker; OEMs want a single person to have authority over the day-to-day operations of the dealership specifically to prevent deadlocks on operational decisions. This may be sensible when there is no single investor with majority control.
Notably, however, if a dealership entity has executed an OEM control agreement, it may complicate or undermine the bargained for benefits of an “escape hatch” provision in the investor’s ownership agreement to the extent that the designated individual under the OEM control agreement attempts to exit the dealership entity, or co-investors wish to remove the “controlling” investor. This is because a typical OEM control agreement may require the OEM’s preapproval of a change in the investor designated under a control agreement as the decision-maker for the dealership.
There are also instances of control agreements drafted to designate an investor, regardless of percentage of ownership, with full authority to make nearly any decision on behalf of the dealership entity, rather than limited to day-to-day operational authority. Such unfettered authority is concerning, as an OEM may contend the investor designated with control may change the ownership or even sell the dealership without the input of other investors. While state franchise laws may prohibit certain impositions by the OEM, the interplay between these agreements, the ownership agreement and the dealer agreement are nuanced and complex. Thus, it is best to evaluate those on the front-end with the help of your experienced dealer franchise attorney than to be left to sort them out when things go awry.
To avoid the scenarios outlined above or minimize other potential conflicts with the OEM, OEM control agreements must be considered and evaluated in view of the bargained for provisions of ownership agreements, especially regarding the disposition of investor ownership interests (escape hatches) and entity control and governance authority.
Due to the importance of OEM control agreements and investor ownership agreements, we strongly recommend that you consult an experienced dealer franchise attorney prior to executing agreements such as these.
If you have any questions or concerns about relating to a dealership ownership agreement or any kind of OEM control agreement, you should contact an experienced dealer franchise attorney.