In the current economic climate, many dealers are shutting down all or part of a dealership without warning. While this situation seems to present a clear case for termination, some traps exist for the unwary. This Alert provides a quick checklist of items to be considered if you should find yourself confronting this issue. 

CAN I TERMINATE THE DEALER AGREEMENT?

Most state statutes and dealer agreements provide that a dealership's failure to conduct business for some period of time constitutes good cause to terminate the dealership agreement. Attention must be paid to the statutes of the state in which the closed dealership is located, because state statutes will vary on the specific length of time and degree of closure of the subject dealership that are necessary, and may contain other requirements, such as mandating that the manufacturer have a good faith belief that a dealership is going out of business.

CAN I TERMINATE UNDER A NOTICE WITH A SHORTENED EFFECTIVE DATE?

A manufacturer can generally utilize a shorter notice period for dealership closures if both the dealer agreement and applicable state statute allow for an abbreviated notice period.

Most dealer agreements and some statutes require that the dealer be performing its "normal sales and service operations" in order to avoid the expedited notice. Some states, however, recognize the so-called "light bulb rule," i.e., keeping a light bulb on in the service department is sufficient for the dealership to avoid a shortened notice of termination.

Also, field personnel should take steps to make sure that the dealership has not merely changed locations, rather than ceased to do business at all. Even if a relocation is unauthorized, such a move, while grounds for termination in its own right, is most likely not grounds for issuing an expedited notice.

HOW DO I PROVE THAT THE DEALERSHIP IS CLOSED?

Proof of actual closure for the required period is critical in these situations. Field personnel should document the closure with daily photographs and logs of daily phone calls to the dealership in order to establish conclusively the closure for the longer of the statutory or contractual period. Monitor the dealership's website for address changes and/or efforts to sell vehicles at unauthorized locations or on-line. If your field staff is unable to monitor the dealership on a daily basis, you may need to retain the services of a private investigator to conduct surveillance.

WHAT SHOULD I INCLUDE IN THE NOTICE OF TERMINATION?

If you have determined that the dealership may be sent a notice of termination with a shortened effective date, consideration must be given to the content of the notice.

A determination should be made as to whether a notice of termination may later be amended, or if the grounds for termination may be "expanded" after discovery during a protest. If so, consideration should be given to including only those grounds for termination which would entitle the manufacturer to send an expedited notice. This approach removes any argument that the expedited notice is invalid, or that a dealer has additional time to file a protest if "non-expedited" grounds are included.

WHERE SHOULD I SEND THE NOTICE OF TERMINATION?

A manufacturer/distributor must prove receipt of actual notice by the dealer in order to start the time period for filing a protest to run. Therefore, we recommend that you serve the notice of termination in all appropriate places to which service can be proven: the closed dealership, the dealer principal's/owner's home(s), any person listed in the dealer agreement to whom notices must contractually be sent and the agent for service of process. Be cautious of sending the announcement to related businesses and/or persons who are not officers of the dealership entity or who do not have an ownership interest, because defamation claims or others may result.

Likewise, check the applicable state statute to see if a particular form of service is required, e.g., certified mail. If not, any delivery service by which actual notice can be proven, with date, time and signature of person receiving service, will be acceptable. Finally, consider hiring a process server if the dealer is evading service.

WHAT IF I GET A BUY/SELL WHILE THE NOTICE OF TERMINATION IS PENDING?

The law regarding a manufacturer's duty to consider a change in ownership during a pending termination, again, varies by state. State laws vary widely on what exactly is capable of being transferred. Some case law upholds the principle that a dealership corporation cannot increase its contractual rights merely by selling itself. Specifically, the dealer agreement may be transferred, where it can be transferred at all, only as an agreement subject to the notice of termination.

If, on the other hand, the law compels or you decide to consider the proposed transfer, make sure that company representatives are not stating or implying that the dealer may ignore the notice of termination, that it will not be enforced, that the buy/sell will be approved, or anything else that could rise to a collateral tort claim. The best course, to avoid a later dispute about promises that may or may not have been made, is to advise the dealer, in writing, that the company is not backing off from the termination, and that the dealer should consult its counsel. If no protest of the termination is timely filed, proceed with the termination.

If you decide to follow the buy/sell statute or are compelled to do so, follow your normal evaluation procedures for considering the new dealer candidate, including whether the prospective buyer fits your criteria or whether your agreement and the state statute allow you to exercise a right of first refusal. Whether the mere closure of the dealership constitutes sufficient grounds to reject the buy/sell will also vary by state.

WHAT DEFENSES CAN A DEALERSHIP RAISE TO THE TERMINATION?

Defenses to terminations based on cessation of dealership operation generally fall into three categories. The first grouping -- that the dealership is not really closed, because of the "light bulb rule," temporary conditions, or operation at another location -- can either be foreclosed or avoided altogether by adequate investigation and documentation of the situation, as described more fully above.

The second group -- that the dealership is closed for reasons outside the control of the dealer -- may or may not be sufficient to avoid termination. For example, landlord/tenant issues are usually not a sufficient excuse. Some state statutes, however, do contain exemptions, and declare that certain external forces will prevent the termination of the dealership agreement despite the closure. For instance, in some jurisdictions, closure due to DMV directive may not constitute grounds for termination.

The third group -- that the manufacturer's actions forced the dealership to close -- is becoming more prevalent and may require more traditional litigation, especially if the dealership is seeking damages instead of or in addition to simply trying to retain the franchise. These "defenses" include claims that the manufacturer had a plan to put the dealer out of business, forced the dealership to take unwanted additional inventory, conspired with the manufacturer's affiliated credit company to pull its credit or engage in other "coercive" acts, etc. These types of cases require swift and aggressive action to demonstrate and prove the true sources of the dealership's financial problems.

WHAT IF THE DEALERSHIP FILES BANKRUPTCY?

Unfortunately, many manufacturers are receiving a message or a notice in the mail that its dealer has "filed bankruptcy," most likely due to the slumping economy. Whatever the case may be, your market representation and legal department must address this situation immediately.

Automatic Stay

Once a dealer files for bankruptcy protection, an automatic stay takes effect immediately, preventing actions by creditors to collect debts from a debtor. Under Section 362 of the Bankruptcy Code, the automatic stay acts as an automatic injunction, which suspends various forms of creditor action(s) against the debtor.

Automatic stay provisions immediately prevent creditors from initiating actions against a debtor, including: (1) commencement, or continuance of judicial proceedings against the debtor, (2) actions to obtain the debtor's property, (3) actions to create, perfect or enforce a lien against a debtor's property, and (4) set-off indebtedness owed to the debtor before commencement of the bankruptcy filing. A court may grant relief from the automatic stay to a creditor, if the creditor can show that the stay does not give the creditor "adequate protection," or if it jeopardizes the creditor's interest in certain property.

Application of the automatic stay to a state's motor vehicle board or commission operates very much the same. A petition filed under the Bankruptcy Code operates as a stay, applicable to all entities, of the commencement or continuation of a judicial, administrative, or other proceeding against the debtor that was or could have been commenced before the commencement of the case under the Code. Thus, if a manufacturer is in the process of terminating a dealership who then files for bankruptcy protection, the termination of such dealership is essentially put on hold.

Executory Contracts

Bankruptcy courts have held that franchise agreements between a manufacturer and dealer are subject to the Bankruptcy Code provision on assumption and rejection of executory contracts. Section 365 of the Bankruptcy Code provides that, subject to court approval and certain limitations, debtors can assume or reject any executory contract. In re Tom Stimus Chrysler-Plymouth, Inc., Debtor. Whether a dealer accepts or rejects the executory contract (i.e., the Dealer Agreement) will determine whether or not a manufacturer has the right to immediately terminate the ailing dealer.

Assumption or Rejection

If there has been a default in an executory contract, the trustee may not assume such contract, unless (a) at the time of assumption the trustee cures the default; (b) compensates, or provides adequate assurance that the trustee will promptly compensate, a party other than the debtor to such contract or lease, for any actual pecuniary loss to such party resulting from such default; and (c) provides adequate assurance of future performance under such contract.

In a Chapter 7 filing, if the trustee does not assume or reject an executory contract within 60 days after the Bankruptcy Court's order for relief, the contract is deemed rejected. In this case, a manufacturer may consider the Dealer Agreement terminated and may fill the open point with a new dealer.

In a Chapter 11, 12, or 13 filing, the trustee may assume or reject an executory contract at any time before the confirmation of a plan. The Court, however, on the request of any party to such a contract, may order the trustee to determine within a specified period of time whether to assume or to reject such a contract.

The Bankruptcy Code gives the Bankruptcy Court power to issue any order, process or judgment necessary or appropriate to enforce the debtor's right to assume an executory contract. Further, the jurisdiction of the Bankruptcy Court to hear assumption of executory contract issues pre-empts the jurisdiction of a Commission or Motor Vehicle Board to decide whether good cause exists for termination of a dealer franchise where the dealer seeks relief under the Bankruptcy Code. In re Dan Hixon Chevrolet Co.

In sum, the Stimus court found that the franchise agreement is not "a personal service contract based on a special trust and confidence and on a special relationship" between the Debtor and Chrysler. Thus, the breach of the executory contract may not only be curable, but also, in fact, the agreement may be assignable, so long as the assignee is able to meet the requirements set out under Section 365 of the Bankruptcy Code. Further, while a manufacturer has a right to file an objection to the Debtor's Motion to Assign an executory contract, even a reasonable objection may not be sustained by the Court. Although, counsel familiar with both bankruptcy and motor vehicle franchise law may increase the likelihood of success of such an objection.

Should the dealer choose to reject its executory contract (i.e., the Dealer Agreement) as an asset of the estate, the Manufacturer will have the right to immediately terminate the Agreement and create an open point for a new dealer.

Abandonment Issues

In the case where a dealer has been issued a Notice of Termination and has not protested, but has requested additional time to find a buyer, the manufacturer should be alert to any such request for delay. Should the "terminated" dealer file for bankruptcy protection, the automatic stay will prevent the manufacturer from effecting the termination and may significantly impact your ability to evaluate prospective transferees. Moreover, contrary to intuition, should a dealer abandon his/her dealership operations post-bankruptcy petition, even statutorily allowed termination is stayed (Stimus). As you can see, the automatic stay in bankruptcy is the ultimate protection for a dealer, albeit a temporary one, against a manufacturer's termination attempts.