Wednesday, August 19, 2009

Closing of GM, Chrysler Dealerships Raises Termination Issues for Bankruptcy Courts

This posting was written by Bruce S. Schaeffer of Franchise Valuations, Ltd., co-author of CCH Franchise Regulation and Damages.

With the noticed closings of so many GM and Chrysler dealerships, wrongful termination statutes have become a question before the bankruptcy courts.

Simply put: Does the right of a bankrupt undergoing reorganization to reject contracts supersede the wrongful termination statutes that afford protection to dealers under many state relationship laws?

Rather than face the issue head on, however, an accommodation was reached. On July 5, 2009, the attorneys general (AGs) of 30 states reached an agreement in principle with GM regarding protections afforded under state laws to dealers and consumers.

The agreement requires New GM, a newly formed entity created by the U.S. Treasury, to comply with state relationship laws. It was formally ratified by the U.S. Bankruptcy Court, and additional states are expected to participate.

The AGs had filed objections to GM’s plan to reduce the number of its dealerships by 2,641—from 6,246 to 3,605—by the end of 2010, contending that the plan would have permitted GM to ignore state statutes that protect dealerships from unfair terminations and other oppressive conduct by motor vehicle manufacturers.

Greater Statutory Protections

And in light of the current economic slump particularly affecting the automotive industry, state legislatures appear to be moving to provide greater protections for their in-state dealerships and distributorships.

For example, the new Alabama Heavy Equipment Dealer Act prohibits suppliers from unilaterally amending, terminating, or refusing to renew a dealer agreement without "good cause," which is limited to withdrawal by the supplier from the market and certain performance deficiencies. The law also requires suppliers to provide advance written notice and an opportunity to cure in most instances of an amendment, termination, or failure to renew a dealer agreement. (Senate Bill No. 308 was approved and became effective May 22, 2009. See CCH Business Franchise Guide ¶4105).

In another attempt to protect its auto dealers, Illinois went further, recently amending its statute to eliminate language in the motor vehicle dealer law that a manufacturer has good cause to cancel, terminate, or fail to extend or renew the franchise or selling agreement to all franchisees of a line make when the manufacturer permanently discontinues the manufacture or assembly of such line.

It also (1) makes it a violation for a manufacturer to require or coerce a motor vehicle dealer to underutilize their facilities by requiring them to cease operations for the selling or servicing of any vehicles with another manufacturer and (2) provides an itemized list of reasonable compensation for the value of a motor vehicle dealer's business and business premises. (Senate Bill No. 1417 was approved and became effective May 22, 2009. See CCH Business Franchise Guide ¶4135).

Maine too amended its motor vehicle dealer law by deleting language stating that good cause for termination exists when a manufacturer discontinues production or distribution of the franchise product. (Senate Bill No. 483 was approved and became effective June 11, 2009. See CCH Business Franchise Guide ¶4195).

Impairment Write-Downs and Loan Guarentee Ratios—A Problem?

Many venture capital firms and other buyers of franchise companies over the past decade used substantial leveraging in their acquisitions. Many of these loans have certain financial ratios that must be maintained often involving net worth. In some instances, there are also personal guarantees.

As we have written often, Financial Accounting Standards Board (FASB) 141 and 142 require purchasers of intangible property (IP)—as opposed to owners of self-created IP—to test their IP assets (including “goodwill”) at least annually for impairment. If, as in many cases, the value of purchased franchise agreements, distributorship, or dealership agreements has been reduced (“impaired”), such as Chrysler dealerships purchased within the past 10 years, prudent auditors will be asking whether franchise company management is honestly valuing their IP in light of potential loan problems that could affect them personally. Beware!

Lost Future Royalties: Must Expenses Be Proven? Is There a Mitigation Defense?

In a recent decision, a franchisor’s claim for lost future royalties was denied because it failed to submit any evidence as to its own operating expenses. (Rocky Mountain Chocolate Factory v. SDMS, DC Colo., CCH Business Franchise Guide ¶24,093)

Under Colorado law, future royalties, like all future damages, are subject to the “rule of certainty.” On that basis, a federal district court ruled that a franchisor’s claim for lost future royalties was basically a claim for lost profits and that without evidence of both revenues and expenses, the court was left to speculate about the amount.

Additionally, the court left open the possibility of a mitigation defense against a claim for lost profits based on imminent franchisee failure. The court noted that it was not clear that the franchisor would have been entitled to future damages even if it had provided evidence of expenses because the franchisee cast doubt at trial on its continued financial viability because of its persistent operating losses.

Additional information on the issues discussed above is available in CCH Franchise Regulation and Damages by Byron E. Fox and Bruce S. Schaeffer.

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