By Leonard A. Bellavia, senior partner at Bellavia Blatt & Crossett P.C.
With their collective fortunes turning as the industry continues to recover from the recent recession, many manufacturers are pressuring their dealers to commit to costly facility programs. In the past, manufacturers would threaten a dealer with termination of the franchise for refusing to update the facility. Recent changes to states’ franchise laws have curbed manufacturers’ use of this threat as a tool to persuade dealers to upgrade their facilities.
Instead, many manufacturers now resort to creative incentive programs that make it economically unfeasible to compete with competitors unless the dealer upgrades the dealership. These incentive programs can cause significant problems for unsuspecting buyers of dealerships, and can result in a corresponding destruction in value for sellers.
One such incentive tied to a dealer’s facility is Jaguar Land Rover’s (“JLR”) “Business Builder Program.” It creates a tiered incentive that allots payment based on dealers’ compliance with certain standards, such as customer satisfaction and volume. If a dealer meets all but one standard, for example, the dealer does not receive the amount of the incentive allocated to that particular standard. For the dealer to receive any payment under the incentive program, however, the dealership must comply with JLR’s current, and costly, facility image standards. A dealer who meets all of the standards JLR sets, but does not have a compliant facility, receives no incentive payment under the program. The amount of the incentive payment is enough to place a noncompliant dealer at a significant price disadvantage versus compliant dealers.
In the context of a buy/sell, these incentives play an important role. For example, suppose a buyer wished to purchase a JLR dealership. On paper, the dealership appears to be profitable, and there is nothing to indicate to the buyer that the facility does not comply with JLR’s then-current standards. The seller chooses not to comply with the Business Builder Program and forgoes the additional incentive, perhaps because of longevity and the seller’s unwillingness to invest additional capital into the business. Without additional inquiries, an unsuspecting buyer purchases the dealership and is at an immediate disadvantage versus competitors who qualify for the Business Builder Program incentives. The buyer now must decide whether to expend additional capital to upgrade the facility, or suffer lower sales and gross than what was forecasted.
Sellers are also adversely affected by these incentive programs. A savvy buyer is likely to know, or perform sufficient due diligence to find out, about the manufacturer’s incentive programs and whether they are tied to facility standards. These buyers are likely to demand price concessions to compensate the buyer for its expenditures to upgrade the facility post-closing. If the seller is unwilling to upgrade the facility, the dealership may take a hit in value when offered for sale. It is possible that the extent of the upgrades may reduce the value significantly below the seller’s target price.
Because incentive programs like the Business Builder Program are relatively new, there have not been many legal challenges to them. Some states prohibit “two-tier” pricing, which is a pricing scheme that results in one dealer purchasing a vehicle from the manufacturer (or selling a vehicle to a consumer) at a lower price than what is available for other dealers. States that have these prohibitions offer manufacturers a “safe harbor” to avoid liability if the incentive is available to all dealers in the state on a proportionally equal basis.
Using the JLR program as an example, one may argue that the program is not available to all dealers on a proportionately equal basis because not all JLR dealers sell all of JLR products from one location. The Business Builder Program does not take into account whether a JLR dealer sells only Jaguars, only Land Rovers, or Jaguars and Land Rovers. A dealer who sells both generates higher sales and gross than a standalone Jaguar dealer, and is in a better position to absorb the costs associated with compliance.
The standalone Jaguar dealer is now at a competitive disadvantage vis-à-vis price. While compelling, these arguments have not been tested in court, and the applicable facts in each case would make it difficult to offer buyers and sellers a discernable, general rule on whether the incentive is unlawful in all cases. Therefore, buyers or sellers should consider seeking legal advice on whether the manufacturer may offer these incentives in the dealership’s state and the likelihood of successfully challenging these incentives should either party choose to do so.
Whether you are buying or selling a dealership, or representing buyers or sellers in any capacity, it is important to include a thorough review of the manufacturer’s incentives as part of your due diligence, and whether they are tied to complying with facility standards. Not understanding the implications of these incentives, and the impact on the dealership’s profitability and value, may have a significant impact on buyers and sellers alike.