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BUYING OR SELLING A DEALERSHIP:
WHAT YOU NEED TO CONSIDER

by Paul Norman

Most dealers are involved in buying or selling a dealership only once or twice in their dealer careers, if ever. Some dealers inherit the dealership and pass it on to their heirs and, therefore, never have to negotiate a buy-sell agreement. Other dealers are regularly involved in buying and sometimes selling dealerships, particularly as the industry moves toward consolidation.

One of the most important things that all dealers need to know about buying or selling a dealership is that it is crucial to have a good team of advisors (legal, accounting and financial) and to involve them early in the process. However, even dealers who rely heavily on advisors should know what issues need to be addressed in putting together a buy-sell agreement and how those issues may affect their interests. The purpose of this guide is to list those issues and provide a summary of some of the alternatives of how those issues can be resolved. This list of issues is not exhaustive because each transaction is unique and may raise issues not typical in most buy-sell transactions. However, hopefully this guide will help dealers work better with their advisors in structuring a buy-sell agreement that protects their interests to the maximum extent possible.

IDENTIFYING AND RESOLVING ISSUES AND CONCERNS RELATING TO SELLER

Structure of Seller

It is important to consider at the outset of selling a dealership the tax status of the Seller. If the Seller is a C Corporation, the revenues that the Seller receives from the sale are potentially taxed twice - once to the Seller and again to the Seller's shareholders when those revenues are distributed to the shareholders. If the Seller is an S Corporation or a limited liability company, its shareholders or members will be taxed directly on the income that the sale produces for the Seller, but such income will only be taxed once. The tax status of the Seller plays a role in structuring the transaction. A C Corporation Seller will potentially benefit from having consideration paid directly to its shareholders in the form of compensation for agreements not to compete with the Buyer, employment or consulting services or even for personal good will. An S Corporation or LLC Seller will have less interest in these types of arrangements.

Agreement Among Seller's Shareholders/Members

Another important issue to resolve at the outset of a buy-sell transaction is whether all of the shareholders or members of the Seller are in agreement that the dealership should be sold and on the essential terms of the sale. If a majority of the ownership interests want to sell on specific terms but a minority do not agree, the dealership probably can still be sold, but the interests of the dissenting shareholders/members will need to be addressed under specific legal rules. Things will go much smoother if all shareholders/members are in agreement from the beginning.

Seller's Legal Issues Affecting Sale

Another question that should be answered at the beginning of buy/sell negotiations is whether any legal issues exist that may affect the sale. What litigation is pending against the Seller? Are there any threatened legal claims? Does any of the litigation or claims have the potential to result in liability for the Buyer after the Closing? Are there outstanding warranty or service contract or other customer obligations that, while not binding on the Buyer under normal circumstances, have the potential of damaging the customer good will of the dealership if not satisfied post-Closing?

Seller's Labor and Employment Agreements

If Seller is a party to any collective bargaining agreements, these need to be examined by both the Seller's and Buyer's attorneys to determine if they impose any obligation on the Seller to ensure that they are honored by the Buyer post-Closing. Absent an express agreement by the Buyer to assume a union contract, will it potentially be obligated to assume the obligations as a "successor" to the Seller? Does the Seller face any liability for early withdrawal from the union pension fund if Buyer does not assume the Seller's union contract and continue participation in the fund?

Individual employment agreements generally are not assumed by the Buyer or subject to successor liability. However, just as Seller's unfulfilled obligations to its customers can damage the Buyer's customer good will post-closing, the Seller's unfulfilled obligations to its employees may damage the Buyer's relationship with the former employees of Seller who the Buyer retains. Therefore, the Buyer generally will want to ensure that those obligations are fulfilled, including compensation for any accrued but unused vacation pay.

Seller's Employee Benefit Plans

Generally, a Buyer will not be liable for any obligations relating to Seller's employee benefit plans unless Buyer agrees to assume those obligations. However, if the Seller does not maintain its health benefit plan after the Closing, the Buyer may be required to allow any former employees of the Seller who are not retained by Buyer to participate in the Buyer's plan if they exercise their COBRA rights. For purposes of maintaining employee good will, Buyer will also want to make sure that the Seller fulfills its obligations to its employees (especially those retained by Buyer) under its employee benefit plans.

Seller's Sales Tax Obligations

If Seller has an unpaid sales tax obligation to the State of Wisconsin, the Buyer can be liable for that obligation as the Seller's "successor." Buyer will want to make sure that this obligation is taken care of by the Seller. If there is doubt about the Seller's ability to do so, the Buyer will want to insist that a portion of the purchase price be escrowed until the Wisconsin Department of Revenue certifies the amount of the Seller's remaining sales tax obligation, with the escrowed funds then being used to pay the obligation or distributed to Seller once it provides verification that the outstanding obligation has been satisfied.

Seller's Secured Debts

The buy-sell agreement will require the Seller to deliver title to the purchased assets free and clear of all liens and encumbrances. Prior to the Closing, the Buyer will want to identify what perfected security interests, if any, exist with respect to the purchased assets and make sure that those security interests are terminated or released at or prior to the Closing.

Seller's General Debts

Generally, the Buyer of dealership assets (as opposed to dealership stock) will not be liable for the general debts or obligations of the Seller, whether or not the Seller pays them after the Closing. However, Wisconsin is one of the few states that still has a Bulk Sales Act which makes the physical assets transferred by a Seller to the Buyer subject to the claims of the Seller's general creditors if they have not been given notice of the transfer at least 10 days prior to the Closing. If there is doubt as to the Seller's ability to pay all of its general creditors, the Buyer may want to insist on complying with the Bulk Sales Act notice requirements.

Seller's WARN ("Plant Closing") Obligations

If the Seller has more than a certain number of employees (generally 50 or more for purposes of the state law and 100 or more for purposes of the federal law; however, there is a need to consider part-time employees and employees of affiliated companies), it may be required by the state or federal WARN or "plant closing" laws to give advance notice of the Closing and fact that it is going out of business to those employees, unless the Buyer has made a commitment to rehire the bulk of the Seller's work force.

Seller's Non-Cancelable Contracts

It is important for the Seller to identify the contracts it has that cannot be canceled at the Closing and determine whether the Buyer is willing to assume those contracts and whether any third party consents are required in order for those contracts to be assigned.

DETERMINING THE PURCHASE PRICE AND OTHER PAYMENTS TO SELLER

New Vehicles

Generally, Seller's inventory of new vehicles of the current model year as of the Closing date will be transferred to the Buyer for their invoice price less any holdbacks, allowances or other credits that reduce the Seller's actual cost for those vehicles. In pricing new vehicles, the value of any dealer-installed options and the impact of any repaired or unrepaired damage needs also be taken into account. Floor plan interest credits are often split based on the amounts that apply to the periods before and after the Closing. New and unused vehicles for model years prior to the current year often create a negotiable issue that Seller and Buyer need to resolve.

Demonstrators/Drivers Ed Vehicles

Buyers are sometimes reluctant to buy any or all of the Seller's demonstrators or drivers ed vehicles or will insist on a mileage limit and/or mileage credit for those vehicles that they do buy.

Used Vehicles

Often the Seller's used vehicles are excluded from the transaction except to the extent that Seller and Buyer separately agree on the purchase price for specific vehicles. Seller generally has to wholesale any used vehicles which are not purchased by Buyer. When used vehicles are made part of the transaction, the purchase price is usually based on some recognized valuation guide.

Parts and Accessories

The Buyer generally is willing to purchase the genuine OEM parts and accessories that are in the Seller's inventory at the time of Closing, especially if they are returnable to the factory. The purchase price for such items is generally based on the manufacturer's current dealer price lists and is determined by an inventory taken immediately before the closing either by the parties themselves or by an independent parts inventory service, for which the parties share the cost. In order to be returnable, a part or accessory usually must be listed on the manufacturer's current price list and be undamaged and in its original packaging. The Buyer generally will want the Seller to assign any parts return rights to it.

Rebuilt OEM parts and accessories are sometimes included in the description of parts and accessories that will be purchased. Standard parts (nuts, bolts, etc.) are also often included and priced at the Seller's original cost.

Miscellaneous Inventories

Miscellaneous inventories such as gas, oil, paint, reconditioning materials and unopened cans of paint are often included in the transaction at the Seller's cost for such items.

Fixed Assets

Fixed assets are usually included in the sale of dealership assets. These assets include furniture, furnishings, equipment, tools, service vehicles and leasehold improvements (unless the improvements are considered in determining the real estate purchase price). It is useful if the Seller or the parties collectively prepare a list of all fixed assets at the outset of the negotiation both for purposes of determining a purchase price for them and to create a record of what is included in the sale. The Seller may want to exclude certain fixed assets from the sale, particularly if they have unique personal value to the Seller's owners. If so, these assets should be specifically identified and listed as being excluded.

Unlike inventories, there is no specific formula or routine method for setting the purchase price for fixed assets. Because of depreciation, they usually are no longer worth what the Seller paid for them, but they are probably worth more than the depreciated value at which they are listed on the Seller's financial statement. This is often an area where Seller and Buyer have to work hard in negotiating a deal and usually ends up requiring compromise by both sides to make the deal work. Sometimes the parties agree to let the purchase price be based on an appraised value after the buy-sell agreement has been signed. In fixing a purchase price for the fixed assets in the buy-sell agreement, it should be remembered that the Seller may be required to purchase certain special tools or equipment from the manufacturer between the time the buy-sell agreement is signed and the date of the Closing, and that this is a potential issue that should be addressed to avoid a dispute as to whether the Buyer gets those subsequently acquired items for the agreed upon fixed asset price.

If the dealership premises are being sold to the Buyer, the question of whether the fixtures and leasehold improvements are included in the agreed purchase price for the real estate, or need to be considered in determining the purchase price of the fixed assets, needs to be addressed and resolved.

Another issue relating to fixed assets, apart from identifying them and determining the purchase price for them, is whether the Seller is warranting their condition. Some Sellers will insist that the Buyer inspect the fixed assets before the buy/sell agreement is signed and then will warrant only that they will be in the same condition at the time of Closing. Other Sellers will, if the Buyer insists, warrant that the fixed assets will be in good working condition at the time of Closing, except for reasonable wear and tear.

Prepaid Expenses

Seller will sometimes have prepaid expenses prior to the Closing that benefit the Buyer subsequently. The parties will sometimes address reimbursement of the Seller for the amount of prepaid expenses that benefit Buyer.

Franchise/Goodwill/Customer Records

The purchase price that is often the hardest to reach agreement on is the price for the dealership's intangible assets, which include the Seller's franchise rights, the dealership's goodwill and customer records. The price for these assets is often referred to as the "blue sky." There is no precise formula for determining the "blue sky" for a dealership. Valuation experts sometimes arrive at a "blue sky" value by determining the annual net earnings potential for the dealership and applying a multiplier based on the value of the franchise and other factors. However, determining annual net earnings potential and the appropriate multiplier is an art, not a science. Ultimately, the "blue sky" price is what the parties agree upon and may be affected by whether there is more than one potential buyer attempting to buy the dealership.

Non-Compete Agreement

In almost every situation, the Buyer will want the Seller and its owners (to the extent they have been actively involved in the business) to agree that they won't compete with the dealership within a certain geographic area and for a certain number of years following the Closing. Courts will generally enforce non-compete agreements entered into in connection with the sale of dealership assets or stock in recognition that the Seller and its owners could significantly damage the value that the dealership has to the Buyer if they were to enter into competition with it within short period after the Closing. Because a non-compete agreement preserves the "blue sky" value of the dealership to the Buyer, a portion of the "blue sky" price is often allocated to the non-compete agreement. This is particularly important to the Seller and its owners where Seller is a Subchapter C corporation and, therefore, direct payment to the Seller's owners will help avoid double taxation on the revenues that the Buyer is paying for the dealership assets.

Consulting/Employment Agreement

In some cases, the Buyer will want, or will agree, to employ the principal owner(s) of the Seller following the Closing either as a full or part-time employee or as an independent consultant. Sometimes the payments that will be made to the Seller's owner(s) under an employment or consulting agreement will be deducted from the "blue sky" value that has been agreed upon because the owner's continuing availability to assist and consult with the Buyer regarding the business helps to preserve that value.

Personal Goodwill

Some courts have recognized the concept of personal goodwill, which allows the owner(s) of the Seller to be paid directly for transferring that goodwill to the Buyer. This is a relatively new concept for the motor vehicle industry and not without potential risks.

Work-in-Process

If Seller has uncompleted service work in process at the time of the Closing, the Buyer generally will agree to complete it and to pay the Seller for its labor and parts costs once the bill for the work has been paid.

Sold Orders/Customer Deposits

Generally, the Seller will assign its sold, but undelivered, new vehicle purchase contracts to the Buyer so that the Buyer can deliver the vehicle to the customer once the vehicle is received from the factory. Any customer deposits on such orders are transferred to the Buyer at the Closing. How the profits on the transaction are split between Seller and Buyer is often a subject of negotiation. Buyers sometimes also want protection regarding the trade-in allowance in the deals.

Records

The Buyer usually will want all of the records pertaining to past customer transactions (both sales and service). Generally, these records are transferred for no additional price other than what is paid for "blue sky." The Seller should retain the right to have access to these records in the event that becomes necessary. The Seller's business records generally remain with the Seller, but Buyer may want to have access to those records. Because business and other records are often maintained on computer, Seller may want to negotiate a computer sharing arrangement to have access to the business records it will need in winding up its business affairs.

Employment records are a sensitive issue in these days of privacy concerns. When the dealership assets are transferred (rather than the Seller's stock), the employment relationship between the Seller and its employees comes to an end, and the Buyer becomes the new employer of the former employees of Seller that it wants to retain. Both the Buyer and employee may want the employee's file to go to the Buyer; however, because the file may contain medical and other information that the Seller is legally obligated to maintain as confidential, the Seller should not transfer its employment files to the Buyer without getting written authorizations to do so from the affected employee.

EXCLUDED ASSETS

Typically in dealership asset transfers, the following items are excluded from the sale and retained by the Seller:

• cash/depository accounts

• account receivables, factory receivables, note receivables

• unassumed contracts

• rental vehicles

• life insurance

• securities

• amounts due from finance companies

• intellectual property rights

• any other assets not specifically enumerated as purchased assets

In some cases, the Buyer may agree to purchase the Seller's accounts receivable, but will want some type of protection regarding the collection of those accounts.

REAL ESTATE

If the Buyer intends to operate the dealership location at the same location as the Seller, provisions must be made for the Buyer to either purchase or lease the real estate where Seller's facility is located.

The owner of the real estate may be the Seller, an affiliated entity or a person entirely independent of the Seller. It is important to determine early in the negotiations who owns the real estate and to deal with that person.

If the real estate is owned by a third person, the Buyer may be able to negotiate the right to assume the Seller's current lease or new lease terms. Often when a third person owner is involved, the Buyer's ability to negotiate a satisfactory lease or purchase will need to be made a contingency in the buy-sell agreement. Where the real estate is owned by the Seller or an affiliated entity, the terms of the purchase or lease are generally spelled out in the buy-sell agreement or an attached document.

Whether the real estate is purchased or leased, the agreement will need to address all of the issues that are typically addressed in a real estate sale, including condition disclosures, environmental and other inspections and title insurance. If leasing, the Buyer may want to negotiate an option to purchase the real estate at some time in the future.

Because the Seller or an affiliated entity is likely to incur a substantial capital gain when it sells the dealership real estate that it has owned for a long period of time, it should consider whether deferring the tax on such a gain by investing the sale proceeds in other real estate through a Section 1031 exchange is a feasible strategy.

ALLOCATION OF PURCHASE PRICE

While the purchase price for some assets generally transferred in a typical dealership asset sale are driven by formula, there is quite a bit of discretion in terms of negotiating the purchase price for other assets, such as the blue sky, real estate and fixed assets. How the total purchase price is allocated among various asset categories can affect the tax liability of both the Seller and Buyer in ways that are beyond the scope of this article. The important point to make here is that both the Seller and Buyer need to seek professional advice regarding the tax implications of the transaction before they finalize their negotiations.

PAYMENT OF PURCHASE PRICE/SECURITY FOR FUTURE PAYMENTS

The payment of the purchase price is a simple matter when the Buyer is able and willing to pay it all in cash (usually by certified check or wire transfer) at the Closing. However, if the Buyer wants to pay some or all of the purchase price over time or the agreement calls for non-compete or consulting payments over time, the Seller and/or its owners need to be concerned about security for those payments. The same is true with lease payments for the Buyer's use of the dealership facility.

Various methods of securing future payments by Buyer to Seller or its owners include:

• Personal Guarantees

• Letter of Credit

• Security Interest in Dealership Assets (these usually will be pledged to the Buyer's floor plan or other principal lender and, therefore, a security interest in favor of the Seller will be subordinate to the lender's security interest)

• Pledge of the stock of the dealership (foreclosure by the Seller can be problematic because of the terms of the franchise agreement that require that the manufacturer approve any ownership change)

Another issue involving future payments by the Buyer involves whether the Buyer has a right to setoff its obligation to make those payments against purported claims it may have against the Seller arising out of the transaction. The circumstances, if any, under which Buyer has such a right should be spelled out in the agreement or promissory note evidencing the Buyer's payment obligations.

CONTINGENCIES

Typically, the buy-sell agreement will have several contingencies that need to be resolved before the parties will be bound to close the transaction.

Manufacturer Approval(s)

Obviously the Buyer does not want to close until it is assured that the manufacturer(s) under the franchises which the Seller holds will grant those franchises to the Buyer on terms that it finds acceptable. Manufacturer approval is always a contingency when the assets of a new car or truck dealership are being transferred. Most franchise agreements give the manufacturer a right of first refusal if a proposed transfer of dealership assets is submitted by the Seller for the manufacturer's approval and this right is enforceable under the Wisconsin motor vehicle dealer law unless the Buyer is a close family member of the Seller's owner(s) or an established member of the Seller's management team. If a manufacturer withholds its approval of the transaction without exercising its right of first refusal, the Seller has the right to appeal the disapproval to the State of Wisconsin Division of Hearings and Appeals, and force the manufacturer to show good cause why the proposed transfer should not be permitted.

Other Contingencies

• Buyer's Financing

• Buyer's Dealer License

• Environmental Inspection

• Building Inspection

• Other Due Diligence

CLOSING

The buy-sell agreement should specify when and where the Closing will occur. The timing of the Closing usually is tied to when manufacturer approval is expected because that is usually the last contingency that needs to be resolved before the Closing can occur. Other considerations involving timing for the Closing include when it will be most convenient for the parties to conduct pre-Closing inventories and whether closing before a certain date will avoid the Seller having to prepare additional tax or other filings or whether closing after a certain date will reduce the Seller's tax liability.

Generally, the agreement will specify the Closing, once it occurs, is effective as of 12:01a.m. on the Closing Date, which means that any income or losses received or incurred on that date are attributed to the Buyer.

Both parties have an interest in setting a "drop dead" date in the agreement, which is the date after which either party may terminate the transaction without penalty if the Closing has not yet occurred, unless the terminating party's breach is the reason for the Closing not to have occurred.

CLOSING DOCUMENTS

The following is a list of the documents that will or may need to be signed and/or exchanged at the Closing:

• Bill of Sale with attachments describing the sold assets

• Assignment and Assumption Agreement

• Vehicle titles and MSOs

• Lien releases

• Corporate resolutions of both Seller and Buyer evidencing appropriate approval of the transaction

Some transactions call for the lawyers for one or both of the parties to give opinion letters for the purpose of giving the other party comfort that the buy-sell agreement is binding and enforceable.

SELLER’S AND BUYER'S WARRANTIES/REPRESENTATIONS

Although the potential risk that the Buyer will be exposed to obligations of Seller that are not expressly assumed in the buy-sell agreement are not as great in a dealership asset transaction as they are when the Buyer is buying the Seller's stock, the Buyer will still want several warranties and representations from the Seller and also its owner(s) to protect against unforeseen liabilities. Although these warranties and representations should be focused on areas where there is potential successor liability by the Buyer, the Buyer may also want to ensure that circumstances that could cause future damage to the goodwill or employment relations of the business (e.g., customer or employee disputes) don't exist. The scope of the Seller's warranties and representations is a subject of negotiation and the Seller's warranty and representation section is often what makes buy-sell agreements look long and complicated. While both parties naturally want to keep it simple, the Buyer does have the right to be protected by essential warranties and representations of the Seller and its owners.

Generally speaking, the need for warranties and representations by the Buyer is far less. If the Buyer is a corporation or other legal entity, the Seller will, of course, want to receive warranty and representations that the Buyer has been duly authorized to enter into the transaction and will be bound by the buy-sell agreement.

OTHER ISSUES

Sales Taxes on Transaction

There should be no sales tax on the transfer of vehicle, parts or miscellaneous inventories to the Buyer because those assets are being purchased for resale. Sales taxes on the fixed assets qualify for the "occasional sale" exemption, provided that the Seller ceases to engage in any retail selling at its business location following the Closing and surrenders its seller's permit. Because the Seller's actions control whether there might be sales tax assessed on the transfer of the fixed assets, buy-sell agreements generally specify that the Seller will be liable for any such taxes.

Pro-ration of Taxes and Other Expenses

Generally, personal property taxes and, where applicable, real estate taxes for the year in which the Closing occurs will be pro-rated and allocated between the parties based on the number of days in the year that precede and fall after the Closing. Utilities and other expenses are also allocated between the parties based on the Closing date.

Unemployment Compensation

In an asset transfer, the agency that administers the Wisconsin unemployment compensation program needs to the notified of the transfer. The Buyer has the option to assume the Seller's unemployment compensation account whether or not the Seller consents.

Seller's Perks

Sometimes buy-sell agreements include provisions that allow the Seller's owners or family members to purchase vehicles from the Buyer at reduced prices for a period of time following the Closing.

Seller's owners also often want to be covered under the Buyer's group health insurance plan. However, unless the owners are going to be bona fide employees of the Buyer, they probably will not eligible to be covered by the Buyer's plan.

Account and Other Receivables

In an asset transfer, the Seller's account and other receivables are generally not transferred, but the Buyer will often assist the Seller in collecting its receivables for a period of time after the Closing. If receivables are transferred, the Buyer will sometimes want the Seller to guarantee their collection or to agree to repurchase any receivables that have not been collected after a certain time.

Confidentiality/Public Announcements

Preventing the transaction from becoming public knowledge before it is assured of Closing is often a paramount concern of the Seller who understandably fears having relationships with its customers and employees adversely affected by the fact that the business is being sold. Sellers should seek a confidentiality agreement from the Buyer at the outset of negotiations and require in the buy-sell agreement that the fact of the transaction will be disclosed outside of the parties only when both parties agree to the disclosure.

Pre-Closing Inspections by Buyer

A buy-sell agreement will often provide that, once it is signed, the Buyer and its representatives will have reasonable access to the Seller's records, assets and premises for the purposes of preparing to do business once the Closing occurs and to verify that certain contingencies and warranties are being fulfilled. The Seller will want any such inspections to be conducted in a way that protects its interest in maintaining the confidentiality of the transaction.

Indemnification

The Buyer will want the Seller and its owners to agree to defend and indemnify against any claims or liabilities that result from Seller's obligations which are not assumed by Buyer or from any breach of the Seller's warranties and representations. Whether there are any dollar restrictions or time limitations on the Seller's indemnification obligations is often an issue for negotiation.

The Seller may want the Buyer to agree to indemnify it against any claims arising from the Buyer's conduct of the business post-Closing.

Assignment

The Buyer initially named in the buy-sell agreement may want to be able to assign his, her or its interest under the agreement to another entity or entities. The Seller may require that the original Buyer remain obligated under the agreement as a condition for the Seller's consent to the assignment.

Earnest Money

In some transactions, the Seller will want the Buyer to deposit a certain amount of money with an escrow agent or in the trust account of one of the parties' attorneys as earnest money to be applied against the purchase price at the Closing. Earnest money is sometimes required to demonstrate the Buyer's interest in closing the deal. Sometimes earnest money provisions are drafted to allow the Seller to keep the earnest money as liquidated damages if the Buyer fails to close after all contingencies have been met or removed.

Brokers

If there is a broker involved in a deal, the buy-sell agreement should clarify which party is responsible for payment of the brokerage fees.