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FORUM (FORUM & FOCUS) • Jul. 20, 2009

Auto Dealers' Uphill Battle


By Aaron Jacoby

The auto industry has been consolidating of late, with car dealers pushed along in the process by GM and Chrysler through the court approved mass rejection of 3,200 franchise agreements in the manufacturers' bankruptcy proceedings pending in the U.S. Bankruptcy Court for the Southern District of New York. Industries typically face consolidation and attrition as a natural, evolutionary course in the business cycle. It is unusual, however, for businesses to suffer shutdowns of the magnitude faced by GM and Chrysler dealers.

Thousands of dealers, including many in California, whether or not their business was failing, are now forced to close their doors. Dealers, who are major advertisers, sponsors of Little League, philanthropists and major campaign contributors with political muscle are not going quietly. Main Street U.S.A. is taking notice, feeling the effect of the sudden elimination of so many jobs and the significant reduction in sales tax revenue. The U.S. Congress and the California State Senate are taking notice as well, with newly proposed legislation designed to address dealer termination. The federal law seeks to restore franchise rights taken away in the bankruptcy proceedings while the California law would mandate repurchase obligations in the event of termination, allowing dealers to recoup some of the losses suffered.

While the House bill has good intentions, the ultimate reversal of the bankruptcy process seems impractical, potentially unlawful and, therefore, unlikely. Dealers will need to rely on the passage of California's enhanced protections to recoup losses suffered in termination of their franchise rights.

How did we even get here? As part of the bailout and bankruptcy process, President Obama's Auto Industry Task Force sought the winnowing of the GM and Chrysler dealer bodies as a key element of the restructuring of the two giant manufacturers. The stated goal was that a reduced dealer count, in line with competitors such as Toyota and Honda, would enhance efficiency, save money and allow us to rebuild the American car industry. The task force directive, however, ignores the franchise distribution model, supported by state laws that prohibit manufacturers from direct sales to consumers. In other words, dealers are the only conduits through which manufacturers sell their vehicles. Sudden elimination of dealers erodes market share because dealers are the customers of the manufacturers - producing revenue, not cost.

There is no question that there are more GM and Chrysler dealers than can be supported by current demand. This was not always true. The dealer body grew over time to meet customer demand. State laws inhibited the ability of a manufacturer to terminate its dealer franchisees. Therefore, reduction of the dealer body was typically due to attrition by acquisition, voluntary closure or a dealer's bankruptcy rather than termination.

During this Great Recession, dealer attrition is on the rise as a natural result of weaker vehicle demand. Most accept the fate that a business without customers must fail and those dealers are shutting their doors with heavy hearts but without political protest. But dealers do not accept that GM and Chrysler, companies deemed too large to fail, used the bankruptcy process to override natural economic cycles, shifting dealer attrition into high gear, eliminating more than 3,000 dealers by rejecting their franchise agreements without regard to any of the state laws that would otherwise protect a dealer's significant investment. (See, e.g. California Vehicle Code Section 3061, which sets forth the good cause factors required to support a judicial finding that the termination of a franchise is warranted.)

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