Dealing with Dealers During COVID-19: Performance

Manufacturers and suppliers face a struggling dealership sales network as the effects of the coronavirus pandemic continue to ripple across the United States.  The pandemic will likely cause an uptick in dealer terminations, forcing manufacturers and suppliers to navigate state dealership laws in the process. Part of a series, this article focuses on the issue of dealer performance. 

In recent years, both courts and regulatory bodies have made it increasingly difficult to terminate a dealership on the sole basis of poor performance. The pandemic will exacerbate this trend, and it is important for manufacturers and suppliers to anticipate these obstacles when seeking to terminate dealerships for poor performance.

If your company manufactures products and sells them to a network of authorized third-party retail dealers, most states regulate your relationship with those dealers. The motor vehicle industry hosts the most extensive set of dealer regulations, with similar regulations applicable to the construction equipment, agricultural equipment, powersports equipment and outdoor power equipment industries. State dealer regulations typically contain anti-waiver provisions, ensuring application to dealer relationships notwithstanding the contractual terms of any dealership agreement. 

Dealer laws regulate the manner and method of terminating a dealer. For example, many states require a supplier to give advance notice prior to terminating a dealer, after which a dealer can “protest” the noticed termination. If a dealer objects to termination, state dealer laws compel manufacturers and suppliers to prove “good cause” to terminate the dealer. 

In the motor vehicle industry, many states direct these disputes to “boards” — consisting of industry insiders favorable to dealers — to adjudicate the dispute.  In other regulated industries, state dealer laws typically grant standing to dealers to file suit to challenge the termination.

In recent years, the motor vehicle industry has drastically limited the ability of manufacturers to terminate dealers for inadequate performance. This trend is likely to continue, and expand to other industries such as construction, agriculture, powersports and outdoor power equipment.  As a result, manufacturers and suppliers will need to tread carefully when addressing dealer performance amid the coronavirus pandemic.

Dealer Termination

In two landmark cases, General Motors (GM) was prohibited from terminating Chevrolet dealerships in New York and California, even though it had amassed data demonstrating the struggling performance of the dealers. Notwithstanding the wealth of data put forward by GM, courts and industry boards alike held that the data was not sufficiently granular, and failed to account for local and regional differences in consumer preferences and habits. Together, the cases illustrate an increasingly high bar for dealer terminations for performance alone.

In Beck Chevrolet Co., Inc. v. General Motors LLC, 845 F.3d 68 (2d Cir. 2016), after input from New York’s highest court, the United States Court of Appeals for the Second Circuit held that GM’s industry standard sales metrics, called its “Retail Sales Index” or “RSI,” could not support a dealer’s termination because the data used statewide averages and did not factor-in “local market forces.” The court concluded performance benchmarks that reflect a market different from the dealer’s sales area cannot be “reasonable” or “fair.”  Following that decision, the New York DMV ruled that GM could not utilize its sales effectiveness metric or RSI in a termination proceeding.  (Case No. 34452, NY DMV May 31, 2016.) 

Two years later, the California New Motor Vehicle Board followed the reasoning in Beck Chevrolet. In Folsom Chevrolet, Inc. v. General Motors, LLC, California New Motor Vehicle Board, Protest No. PR-2483-16 (Aug. 13, 2018), the Board held that GM’s use of its Retail Sales Index to support termination violates California’s Vehicle Code. That Code enumerates several “good cause” factors that can be used to support a dealer’s termination, including the “[a]mount of business transacted by the franchisee, as compared to the business available to the franchisee.”  Cal. Veh. Code § 3061(a).

The Board held that GM’s “RSI fails to account for the impact of circumstances unique to Folsom Chevrolet’s market (other than segment popularity), including but not limited to demographics, geography and brand preferences.” The Board cited the Second Circuit’s decision in Beck Chevrolet as instructive. The Board continued:

“Neither in calculating the size of the market nor in calculating the RSI for any particular market does General Motors consider what would cause a customer to purchase a certain car or a certain brand. … The RSI does not consider the following: demographics in the dealer’s area of responsibility, geographical and market characteristics in the dealer’s area of responsibility (market competitiveness); the availability and allocation of vehicles and parts inventory; local and statewide economic circumstances; or historical sales, service, and customer service performance of the line-make within the dealer’s area of responsibility, including vehicle brand preferences of consumers in the dealer’s area of responsibility.” 

The Board concluded that “General Motors has not established that Folsom Chevrolet is not conducting an adequate amount of business as compared to the business available to it.”

Economic Circumstances and Dealer Performance

A phrase in the above passage that will jump out to readers is the reference to “local and statewide economic circumstances.”  That concept takes on an entirely new meaning with COVID-19 and the patchwork of “Stay Home” or “Shelter-In-Place” orders. Today’s “economic circumstances” have no modern-day precedent, and that will give dealers tremendous cover when defending against claims of poor performance. Interpreting metrics like industry “averages” will become increasingly difficult due to the varying responses to the pandemic by individual states.

The construction, agricultural, powersports and outdoor power equipment industries do not have an extensive set of jurisprudence interpreting their respective industry dealer laws.  Courts handling dealer disputes in these industries often turn to the more heavily litigated motor vehicle industry for guidance. Thus, the GM decisions are the proverbial canary in the coalmine, putting other industries on notice that poor dealer performance is an increasingly difficult path to dealer termination.

It is important to recall the context in which these regulations arose, in order to understand the impact of the current pandemic on dealer disputes. State dealer laws were written to protect dealers from a perceived imbalance in bargaining power. As a result, the regulations meddle in arm’s length contracting to purposefully tip the playing field to favor dealers. 

One express purpose of these laws and regulations is to make it difficult to terminate underperforming dealers out of a desire to protect a dealer’s investment in its dealership. The pandemic will fuel policy arguments by dealers challenging termination, invoking the protectionist nature of the regulatory scheme. Manufacturers seeking to terminate poor performing dealers need to distinguish between a lack of performance resulting from COVID-19 and related shutdown orders, versus a performance deficiency that was preexisting or driven by other non-pandemic factors.

Altogether, manufacturers and suppliers will face an increasingly hostile landscape for the foreseeable future when seeking to terminate dealerships for poor performance. If poor performance is to be a key basis for terminating a dealership, it will be critical that manufacturers and suppliers collect sufficient data to justify those actions, and that the data properly accounts for the economic impact of COVID-19. 

Notices of termination that cite poor performance will likely elicit dealer challenges, who will argue that manufacturers and suppliers are failing to consider “local and statewide economic circumstances,” and that the performance data does not adequately account for “local market forces.” In addition, dealers will likely blame any performance deficiency on the pandemic and — due to the burden-flipping contained in most dealer laws — it will be the burden of manufacturers and suppliers to prove that the performance deficiencies are not the result of the pandemic.

The COVID-19 pandemic will bring an end to a number of commercial relationships across our entire economy, but state dealer laws are inherently protectionist and were not written to accommodate pandemics wreaking havoc on those relationships. Manufacturers and suppliers must be prepared for pushback by dealers and their trade associations as they dig in their heels and leverage state regulations to prevent dealership terminations during the pandemic downturn.

This article was originally published on Manufacturing Best Practices.