Rumors about motor vehicle manufacturer bankruptcies and mergers have dominated dealership gossip, dealer group meetings, and even general press coverage of the industry. It seems that everyone has an opinion about whether the government should bail out the manufacturers or the effects of bankruptcy. As in many issues of this type, there are a lot of misconceptions and misinformation that “everyone knows”.
Dealers should know the facts on a number of issues critical to them in the event of manufacturer merger or bankruptcy. This is not intended as a discussion about the psychological impact of bankruptcy on dealership employees and customers. It is designed to examine some commonly held beliefs about the legal rights of dealers and the practical implications on them of a merger or bankruptcy of manufacturers.
Everyone knows #1: In the event two manufacturers merge, dealers will lose their rights under franchise agreements.
That is not true. In the event of a merger, the resulting company will have all of the rights and obligations of the companies that merge – including those under the dealer franchise agreements. Dealers will retain all of their rights under their franchise agreements and under state law.
Having said that, serious issues may arise after merger. A merged company will find itself with many more product lines and dealers. How will it deal with those?
It is likely that the manufacturer will eliminate line makes, with a resulting termination of the dealer franchises of those dealers handling those lines. This will lead to situations we saw with Oldsmobile (where there were numerous lawsuits and compensation arrangements) or Plymouth (where there were few lawsuits and no compensation arrangements). Under all of the dealer agreements of the Detroit 3 and under Virginia law, they are required to buy back new vehicles, parts, signs, and special tools in the event of dealer terminations resulting from elimination of a line make. The challenge for dealers at that point will be to make a case for additional compensation for the value of their franchises.
Everyone knows #2: Dealers don’t have to do facility upgrades as agreed with the manufacturer because of the uncertainty.
Not true. Don’t simply ignore your agreements. Any agreement to upgrade is still in force. If there are monetary or other penalties, the manufacturer may still try to enforce those.
Consult a legal advisor about the effect of your agreement. Perhaps it can be renegotiated. There may even be a basis for a legal action to block enforcement or to restructure the agreement if the manufacturer is uncooperative. Don’t assume it is unenforceable, however, just because times are difficult.
Everyone knows #3: In the event of a manufacturer bankruptcy, dealers will lose all of their state franchise law protections.
It’s not quite that simple. While it is true from a legal standpoint that bankruptcy law will probably trump state dealer laws, there are practical implications for any manufacturer bankruptcy that will limit the impact. It is likely that any manufacturer bankruptcy will be an attempt to reorganize. In a reorganization bankruptcy, the bankrupt company seeks to reduce or shed obligations so that it can emerge from the bankruptcy as a viable business.
One aspect of state franchise laws will be critical. Under Virginia law, a manufacturer may not sell new vehicles directly to the public. It must sell through dealers. For a manufacturer to emerge from bankruptcy as a viable entity, it must have “shelf space”. Consequently, in any bankruptcy a manufacturer will have to maintain dealers.
There may, nevertheless, be bad news for some dealers. The manufacturers may choose to strategically seek to thin the dealer herd. And in those cases, the bankruptcy laws will probably prevail. Dealer franchise agreements are executory contracts. Under the bankruptcy laws, a bankruptcy court may restate or eliminate the obligations of the debtor’s executory contracts. Consequently, some dealers may find themselves subject to termination that may be permitted by a bankruptcy court. However, it is not practical for a manufacturer to eliminate a majority of dealers if the manufacturer is to emerge as a healthy company from bankruptcy that can continue to sell vehicles, and a manufacturer may have to justify why it is seeking to terminate some dealers and not others.
Everyone knows #4: During the course of the bankruptcy, dealers will not get payments which are due from the manufacturer.
This is probably not true for a simple, practical reason. While one can expect that payments may be delayed and some money owing when bankruptcy is filed may be caught up in the red tape, for the most part funds owing by the manufacturer based on continuing dealer operations will probably be respected in a reorganization bankruptcy. The goal for a court in dealing with a reorganization bankruptcy is to allow a company to rehabilitate itself so that it can emerge from the bankruptcy. That can’t happen if the manufacturer damages its equity by effectively ceasing business and its dealers fail because the manufacturer does not pay ongoing obligations.
Recent airline reorganization bankruptcies are instructive. Some have been strategic bankruptcies. The airlines filed bankruptcy with a goal to eliminate certain obligations that were limiting their ability to achieve success, and for the most part they restructured those obligations in bankruptcy. However, the courts that oversaw those bankruptcies recognized that for those airlines to emerge as operating companies they would have to adopt a plan to continue to operate and serve customers.
One can expect that a bankrupt manufacturer will work with its creditors through the bankruptcy court to adopt a plan to pay ongoing obligations to dealers. Any bankruptcy will surely damage the image and product desirability of the manufacturer. Stopping all payments so that the manufacturer’s business can’t be revived, however, will crush the company and the dealers it needs to retail and service vehicles. This will prevent the manufacturer from emerging reorganized from bankruptcy.
If a manufacturer cannot emerge and must convert to a liquidating bankruptcy, that will likely stop all cash payments, making the dealers unsecured creditors. Holdback and local advertising contributions will probably be considered fiduciary obligations of the manufacturer with some priority. Other sums owed by the manufacturers to dealers, however, will probably be general, unsecured debts in a liquidating bankruptcy.
Everybody knows #5: If the manufacturer’s “captive” finance company also goes bankrupt, it will mean the automatic loss of my floorplan.
Not really. Again, any bankruptcy filing is likely to be a reorganization filing. The ability to reorganize will be minimized if the finance affiliate cannot continue to do business. It is unlikely that in the event of a bankruptcy that there will be a wholesale call of floorplan lines. More likely, the manufacturer finance affiliate floorplan lines will stay in place.
Everybody knows #6: I have a CMA account. In the event the manufacturer and its finance affiliate go bankrupt, I will be able to setoff the amount in my CMA account against the floorplan account. I have $8 million in floorplan and $2 million in a CMA, so I owe $6 million for floorplan.
Not true. Over the years, finance affiliate representatives have sold CMA accounts as offset accounts to floorplan lines. They are not. (The answer for banks may be different, however, since bank floorplan/CMA arrangements may be subject to federal regulations that may allow for a setoff).
Manufacturer finance affiliate CMA accounts are depository accounts. The interest rates paid on CMA balances are the same as the interest rates for the floorplan. Therefore, interest earned on the CMA account has had the practical effect of offsetting the interest paid on the floorplan. They are two separate accounts, however. The CMA is a depository account. The floorplan line is a demand loan.
In the event of bankruptcy, a dealer who owes $8 million in floorplan debt with $2 million in a CMA account will still owe the entire $8 million of floorplan. It will have to continue to service that debt. The CMA account, however, is likely to be treated simply as an unsecured debt owed by the manufacturer’s finance affiliate to the dealer. As such, it will be within the jurisdiction of the bankruptcy court to determine when and how much a dealer will be paid of the amount in the CMA account. The dealer may be able to characterize this as a fiduciary obligation of the finance affiliate that may give the dealer priority rights over other unsecured creditors. The CMA balance is unlikely to be treated as an offset account to the floorplan obligations, however.
A dealer that truly wants to use its CMA funds to offset its floorplan obligations should take those funds and pay down the floorplan line. There are practical problems with that since dealers will generally want to keep all cars floorplanned for administrative and insurance reasons. This will mean that the reduction of floorplan will have to be spread across inventory, and that will mean a daily job for the general office of balancing floorplan. There also may be issues if the CMA funds are personal funds or if they are necessary to maintain appropriate ratios under loan agreements. The dealer should consult its accountant on these issues.
Nonetheless, if a dealer is looking for a true offset against floorplan, that is probably not achieved through a manufacturer finance affiliate CMA account. That will only clearly be accomplished with a reduction of the floorplan amount.
Everybody knows #7: My manufacturer finance affiliate is putting pressure on me to provide additional security for the floorplan, and it has that right.
It might from a legal standpoint. Floorplan arrangements are basically demand notes. While there may be provisions in the documents that limit the ability of the lender to demand changes, under typical floorplan arrangements with manufacturer finance affiliates the lender can “call” the floorplan note at its discretion
While there may be a legal basis for the creditor’s demand, there may be practical problems for the floorplan lender. A lender that induced the dealer not to place its floorplan with another lender when it had the opportunity to do so could face a potential lawsuit by a dealer who finds itself prejudiced by the creditor’s precipitous demands and actions.
If you are facing demands for further security for your floorplan, there are some steps you should take.
- Seek legal advice. Have your floorplan documents reviewed. Understand your rights and understand the rights of the lender.
- Explore your alternatives. If you have other franchises that are successful there may be an opportunity to place your floorplan line with the finance affiliate of another franchisor or with a bank. Explore the availability of other floorplan sources.
- Do not go out of trust! It is critical when you are in the midst of discussions about a floorplan that you do not wind up out of trust. That is the easiest excuse for a floorplan lender to exercise its rights that will damage your business, probably irreparably. And there could be civil liability or even criminal exposure for a dealer who goes out of trust
Everybody knows #8: I have credit lines and loans with a local bank, and it will call them if the manufacturer declares bankruptcy.
Maybe not. Some loan documents contain language allowing the lender to demand payoff if it feels “insecure”. However, whether insecurity language is in your loan documents, whether the language justifies the creditor’s demands, and whether the law justifies calling a manufacturer bankruptcy a reason for insecurity are all legal issues. Consult your legal advisor in the event you receive demands from your lender.
So what should I do?
While it sounds trite to suggest that you run the dealership as lean and mean as possible, from the standpoint of dealing with your franchisor, it is nevertheless true.
- Set a target for a reasonable days supply of each model of new vehicle you sell. Keep new vehicle inventories in line with your target. Resist those daily calls to take more vehicles no matter how sweet the incentives.
- Keep new vehicles in “returnable condition”.
- Do not accumulate mileage.
- Do not “trick out” vehicles by adding non-OEM equipment.
- Avoid issuing new vehicle demos. If you must have demos, issue used cars.
- Keep parts inventories in line
- Carefully analyze days supply
- Keep parts in “returnable condition”. Keep sheet metal in wraps. Do not damage or break boxes unless necessary.
- Do not “bank” parts return allowances.
- Keep manufacturer receivables in line
- If you have been submitting claims for manufacturer payments monthly, submit them weekly or even daily if you have the staff to do so.
- Watch and demand overdue manufacturer receivables.
- If you don’t have an existing agreement with the manufacturer to upgrade facilities, now is not the time to enter one, regardless of what you are promised.