Favreau said he withdrew from negotiations because Marvel didn't seem to know where the character was going, (or something like that, I can't quite remember exactly what he said).
I suspect it was money that sealed the deal; Favreau wanted more (and justifiably so) and Marvel didn't give it to him. (Marvel's notoriously thrifty!
As for RDJ & JF, they met for a screening and discussion of Iron Man (last year), and they went to dinner or something too, so if there was a fallout, they're over it.
Personally, I was glad when he was left out of IM3 because I felt Favreau was so concerned about his own scenes with SJ, that he neglected the rest of the IM2 movie. HOWEVER, Marvel's just as guilty because it insisted on shoe-horning her into the story.
The thing is, we could speculate on and on about this, but it's not worth it. Imagine if we stopped liking someone just because of a rumor...!

Country Guatemala

Age (opt) 51