Article

Your Succession Plan: The Factory Influences Your Decision

January 2008, Auto Dealer Today - WebXclusive

by Ron Smith - Also by this author

An interesting study showed the vast majority of closely-held businesses have no cohesive long-term plan for an orderly transition or shift of control of the business. This appears to be true regardless of whether or not the "second-generation" operators are family members. One of the key factors in the operation of any closely held business (non-publicly traded company) is the continuity of management. In other words, you want to make sure you know who is going to eventually own the business and what you or your heirs are going to realize (monetary or otherwise) upon the transfer of control of the business.

For whatever reason, business owners (lawyers included) tend to handle their personal financial affairs as a "back burner" item. Many people wake up in their late 50s, 60s and even 70s, realizing there is no cohesive plan for succession or ownership transfer. What's worse, sometimes they don't wake up at all, and their heirs find themselves with unnecessary tax burdens, forced liquidations, and fellow shareholders comprised of widows, children (both active and not active in the business) or other relatives who have inherited a deceased founder's shares.

Historically, many people viewed a succession plan as "what happens when I die?" The modern succession plan treats many more topics than just death. As longevity continues to increase, more and more plans are being developed to deal with retirement. In the case of majority shareholders or children active in the business, many plans will have provisions relating to termination of employment or voluntary quits. For example, what happens if someone gets upset and leaves? Many times, individuals who demonstrate exceptional foresight during the creation of a successful business are totally unaware of what has to be done to assure an orderly shift to others who are going to continue in the business. If family members are involved, there are multiple issues. Control and a sufficient cash flow enable the deceased shareholder's estate to pay taxes and assure the owner's surviving spouse will have sufficient income.

Control, in the automobile dealer scenario, is critical. If the dealer has multiple children working in the business, some accommodation is going to have to be reached over ultimate control. There can be only one person in control and only one dealer principal (as far as the factories are concerned). Ultimately, whether family discussions are held or not, the existing dealer is going to have to make that difficult decision. It is, however, one that should not be shirked. There should be a clear understanding as to who is going to be groomed to assume control, both from a factory and family standpoint.

Oftentimes, the dealer will have children that are not involved in the dealership. In that situation, the dealer and spouse ultimately want to assure that the non-participating children will somehow be evenly provided for in the planning. This can be easily done, either through utilization of non-dealer assets set over to those non-participating children, life insurance, or even a situation of ownership of dealership real estate through family limited partnerships with long-term leases or some other planning devices.

With regard to the new car dealership, all new car dealers have a “partner” that carries a big stick: the factory. Many succession planning decisions will be governed by not only the factory sales and service agreement (“Franchise Agreement”), but also by appropriate provisions of state franchise statutes. It is absolutely essential that planning decisions be made in accordance with both the applicable franchise agreement provisions, as well as any applicable state statute.

A word about how factories draft their franchise agreements: For the most part, the Federal Dealer Day in Court statute is worthless. Most automotive lawyers who know what they’re doing ignore it. Many years ago, federal courts stripped that statute of any real dealer benefit; therefore, the manufacturers are left with a patchwork of state laws, some of which are weak, some of which are very strong, and most somewhere in the middle. They have universally taken the position that they will draft the franchise agreements for whatever is in their best interest; in short, whatever they can get away with.

NADA has done an admirable job in attempting to mute some of the more draconian aspects that have, from time to time, been proposed by the various manufacturers. The franchise agreements are known in the law as contracts of “adhesion,” where one party has a tremendous disparity of economic bargaining power. It would be impossible for the factory to draft a single franchise agreement which would meet the requirements of all 50 states. Therefore, it’s much easier to draft the agreement as they want it to be, subject to challenge in individual state courts or federal courts interpreting state law. The underlying notion behind the factory’s position is that most of the time dealers either lack the willpower or the economic power to challenge action taken by the factory. However, more and more dealers and dealer groups are successfully challenging adverse factory actions.

The Franchise Agreement
Virtually every manufacturer has some sort of succession requirement in their franchise agreement. There generally is some liturgy concerning entering into the agreement based upon the named dealer’s business acumen. That said, each manufacturer generally requires some sort of approval of a change in ownership or certainly controlling interest. Some require approval of any significant change in shareholder interest. This can represent a challenge of sorts where a dealer has multiple franchises. Most of the time, dealers don’t really know the conditions that the franchise agreement imposes or have sought to avoid setting up successor arrangements because of not wanting to deal with the factory on one issue or another.

A dealer needs to obtain a good legal analysis of the benefits conferred, if any, by state franchise agreements versus qualifying a successor via the franchise agreement route. Some states, such as Illinois noted below, will have stronger dealer-oriented successor provisions than other states. Therefore, it’s important to make sure you understand the intricacies of the franchise agreement together with any benefit under state law. Franchise agreements can, however, vary in the complexity with which they treat the subject.

For example, Honda has a succession arrangement by which the dealer nominates a successor. That nomination is “conditionally” approved dependent upon the successor’s situation at the time of the death of the dealer principal. There are capital requirements as well as other requirements that are supposed to be based upon a “reasonable criteria”. After the death of the dealer, the successor, if still qualified, will get a one-year term agreement. Presumably that would lead to a regular Honda agreement if performance was acceptable during the term.

Chrysler has provisions requiring the successor nominee meet certain standards, including capital requirements and “operating qualifications satisfactory”. They are then issued a two-year term agreement with an opportunity to qualify for the standard Chrysler agreement. The Chrysler agreements are also interesting in the fact that they do provide for a surviving spouse to maintain a financial interest in the dealership, even if that financial interest is a majority ownership. Qualified operators, however, must act as the dealer principal.

Perhaps most dealer-friendly is General Motors, which does have a successor addendum, whereby approval can be garnered in advance. Again, certain qualifications must be met, and the term agreement awarded the successor is a three-year agreement. Dealers will be well advised to become familiar with the succession provisions of their franchise agreements and to seek assistance from competent attorneys and other professionals to take full advantage of whatever contractual rights they have with regard to succession versus state law. An informed decision can then be made with regard to the succession plan. The worst thing a dealer can do is nothing.

State Franchise Acts
Most states will have some provision relating to succession. The patchwork of state laws has grown because of past factory abuses. Most of the factory succession provisions have, in fact, been in response to state laws.

In any event, you should become familiar with the provisions of your particular state statute. Some statutes will provide for succession only to spouses and members of the immediate family. Others will allow succession and appointment of individuals on at least an interim basis for in-laws and/or managers or minority shareholders that have been with the dealership operation for a certain period of time. Generally, all will require some minimal compliance with working capital requirements or other sorts of “reasonable” requirements of the manufacturer.

Sometimes there are other statutory hoops that must take place in the event of the death of a dealer. ALL state statutes that exist really deal with the death or incapacity of the dealer principal. They don’t really deal with an issue of retirement or degrees of illness that would not render somebody totally incapacitated. Therefore, dealers are better off doing that with contracts between family members or employees and succession under the franchise agreement.

In Georgia, for example, the statute applies to death or incapacitation of an “owner”. The designated heir has 60 days to file notice of intent to become dealer, and the factory has 60 days to respond. The transfer is subject to various factory requirements. In Illinois however, the manufacturer has the burden of proof to show that the dealer successor is not a person of good moral character or does not meet existing, reasonable capital and business standards.

Texas takes a slightly different approach, again placing the burden on the factory to show that the designated succession plan will be “detrimental to the public interest” or the representation of the manufacturer. These sorts of provisions, found in Illinois and Texas, greatly enhance the dealer’s position because it places the burden of proof on the manufacturer and not on the successor dealer.

Factory Actions
Many times, manufacturers will try to strong-arm dealers illegally when a dealer seeks to get a successor dealer approved under the franchise agreement. You should not let this happen. Strong arm actions regarding facilities, relocations, or any other issue would generally run afoul of state law and should be met with resistance. Often times a well-placed letter drafted by a lawyer with experience in automotive retail law would put an end to any untoward factory action. A dealer should not acquiesce to factory demands of this sort.

Likewise, if a dealer has made no provision for succession and the dealer’s family is faced with decisions after the dealer’s death, they should note that most state laws will not allow facility tag-alongs with the approvals that are mandated by statute. As stated earlier, most states will at least require if not a permanent agreement, an interim agreement to be followed by a regular “term” or permanent agreement if the dealer’s heirs are performing reasonably. As many of the manufacturers are now going to term agreements rather than permanent agreements, the manufacturer would be required to only give what they would normally give in the way of a franchise agreement. Again, that agreement should not be subject to conditions for improvement of facilities, exclusive use, etc.

Again, neither you nor your successors should let the factory strong-arm you with regard to the transfer of franchise rights or the naming of a successor dealer under the franchise agreement. Returning to the Texas statute for a moment, the only way a manufacturer could try to enforce a facilities upgrade with successor approval would be to weave it into an argument that the appointment would somehow be detrimental to the representation of the manufacturer. Since business presumably would be continued at the same location that the manufacturer had approved before, a manufacturer would be hard-pressed to make any such argument stick.

Don’t wait until tomorrow; it may not arrive.

If you have a question regarding a franchise issue e-mail it to [email protected].

Vol 4, Issue 12

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