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Successful Attacks on ASFA Class-Wide Rescission

jberberich — Fri, 25 Jul 2014 20:34:17 +0000

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In recent years, California dealerships have been attacked with a rash of class action lawsuits under the Automobile Sales Finance Act (“ASFA”) seeking to force dealerships to rescind thousands of transactions over a four-year period for alleged disclosure violations on Retail Installment Sales Contracts (“RISCs”). Regardless of whether nor not these violations cause any actual damage or harm, the plaintiffs’ bar has sought to exploit such disclsoure violations - often very technical in nature - and the threat of large scale rescission to leverage substantial settlements. Fortunately, Manning Leaver has found success convincing courts that the remedy of rescission of RISCs is not appropriate in class litigation.

Common types of alleged contractual disclosure violations

The alleged contractual disclosure violations commonly seen in class actions filed under the ASFA include failing to separately itemize license and registration/transfer/titling fees (“lumping”), disclosing deferred downpayments as cash (“hold check”), backdating contracts, charging tire fees on used tires, and the use of ten day payoffs on trade-in vehicles. Because members of the purported class can be identified by reviewing dealership records, many courts have found that these ASFA claims are readily amendable to class treatment.[1]

What is Rescission Under the ASFA?

Under the ASFA, a contract may be deemed unenforceable based on these alleged disclosure violations, no matter how minor or trivial, and even if the customer suffers no cognizable harm.[2] If the customer demands rescission of the purchase contract, and a court finds in his or her favor, the customer is entitled to a refund of all payments made on the vehicle, and payment by the dealership of the remaining balance due on the RISC, in exchange for returning the vehicle to the dealership. The dealership may be entitled to an offset for the customer’s use of the vehicle, but offsets may be discretionary, and do not account for the passage of time.[3] This essentially results in a windfall for the customer.

While rescission of any individual deal will be painful for a dealership, the prospect of having to buy back thousands of class members’ vehicles represents a potentially catastrophic result. For example, a recent case handled by Manning Leaver involved ASFA class claims that sought to rescind the contracts of over 3,300 class members over a four year period.[4] In a hypothetical verdict granting all class members the right to rescind their contracts, and assuming a conservative response rate of 25%, the dealership was faced with the prospect of repurchasing over 800 vehicles. The capital required for such a repurchase would likely have exceed $15 million.[5] Many of these vehicles would be ineligible under the dealership’s flooring line due to age and/or mileage. Additionally, disposing of this excess inventory would place an extensive burden on the dealership. Through the whole process, we conservatively estimated that the dealership would incur losses in excess of $4 million.[6] Further compounding the danger, many insurance companies have taken the position that “rescission” does not constitute “damages” under the terms of dealerships’ insurance policies, thus leaving dealerships to fend for themselves in the event of a judgment of class-wide rescission.

Plaintiffs’ attorneys are well aware of the potential catastrophic impact of class-wide rescission on dealerships, and thus regularly make exorbitant settlement demands of $2,000 or more per class member.[7] When the dealership rejects these excessive demands, plaintiffs’ counsel continues litigating the matter, knowing that they are likely to recover all of their attorneys’ fees as the prevailing party, thus compounding the expense of the case.[8]

Attacking Class-Wide Rescission at the Outset

Dealerships should first consider attacking class-wide rescission at the pleading stage by filing a motion to strike class-wide rescission within 30 days after the dealership is served with the lawsuit. A pleading stage motion to strike is based solely on the allegations in the written Complaint, and the dealership is not permitted to submit additional evidence in support of the motion. This makes prevailing on this particular motion challenging. Additionally, motions to strike class remedies are generally disfavored at the pleadings stage. Nonetheless, Manning Leaver has successfully pursued this motion in some cases, thus eliminating the remedy which gives the case its potential value at the outset of the case. Even in instances where the trial court does not grant the pleading stage motion to strike, the pleading stage motion presents an opportunity to portray the class claims as patently unreasonable to the presiding judge. Additionally, in hearing the motion, the judge will often reveal his or her feelings about the manageability of class-wide rescission and the case in general, which can be very useful in pursuing later motions to eliminate class-wide rescission from the lawsuit.

A Second Attack on Class-Wide Rescission Prior to Class Certification

If the pleading stage attack on class-wide rescission is not granted, the dealership can again attack the remedy of class-wide rescission with a motion to strike class-wide rescission prior to plaintiffs filing their motion for class certification. This type of motion (referred to herein as a “BCBG Motion”) was discussed at length in the matter of In re BCBG Overtime Cases (2008) [78 Cal. Rptr. 3d 257]. In BCBG, the Court held that a party can move to strike class allegations based on evidence outside the pleadings after the pleading stage but prior to class certification, and that in doing so, the defendant is essentially initiating the class certification process. In doing so, the dealership can launch a targeted attack on class-wide rescission as a remedy, instead of having it lost amid the host of certification issues the plaintiffs would address if they initiate the motion for class certification. This allows the Court to focus on this singular issue, and also forces plaintiff’s counsel to grapple with the weakness in their class claims before they can present any strengths. Unlike a pleading stage motion, the dealership can and should submit evidence in support of a BCBG Motion regarding the unmanageability of class-wide rescission, including class size, cost of repurchasing inventory, man-hours required to repurchase/recondition/resell inventory, and additional staffing requirements.

Before the dealership files a BCBG Motion to strike class rescission, plaintiffs must first have had an opportunity to conduct discovery on class certification issues. This means that the dealership cannot immediately file a BCBG Motion if the pleading stage attack is unsuccessful. The dealership will have to respond to discovery propounded by plaintiff, produce witnesses for deposition, and provide class size estimates. This often means that the BCBG Motion cannot be filed until several months into the litigation. However, much of the same information provided in discovery will be used in support of the BCBG Motion to strike.

Legal Basis for Attack on Class-Wide Rescission

The ASFA neither authorizes nor prohibits rescission as a remedy available in class litigation. While the California Supreme Court has held that rescission is an available class-wide remedy under certain circumstances, the ASFA is based at least in part on the Federal Truth in Lending Act (“TILA”), and California courts have held that TILA “serves as a backdrop for liability under the ASFA.”[9] A recent spate of decisions under the TILA have held that rescission is not an available class-wide remedy in home mortgage cases for the following reasons:

The legislature did not intend for rescission to be a class-wide remedy;
Rescission is a personal remedy requiring an individualized inquiry inconsistent with the class action mechanism;
Class-wide rescission is impractical to administer; and
Class-wide rescission would have a potentially catastrophic impact on businesses.[10]

Manning Leaver has successfully applied these same four factors in the context of ASFA class actions through BCBG Motions to strike rescission as a class-wide remedy.

Factor #1: No Legislative Intent for Class-Wide Rescission

This purely legal argument focuses on the link between TILA and ASFA. There is no mention of class actions in the ASFA statutory scheme. While this factor on its own may not be persuasive, when evaluated in the context of the other factors, a compelling case can be made that the legislature had no intention to bog down courts and put dealerships out of business for mere technical disclosure errors.

Factor #2: Rescission is an Inherently Personal Remedy Incompatible with Class Litigation

In ruling on the TILA cases, the Federal courts repeatedly noted that rescission is a personal remedy requiring individualized inquiries that are inconsistent with class litigation. This theme is reinforced by the text of the ASFA itself, which requires that customers electing to rescind their contracts act “with reasonable diligence.”[11] This provision necessitates individualized inquiries for each class member concering (1) whether the buyer wants to rescind, (2) when the buyer learned of the right to rescind, (3) whether there was any delay in giving notice “substantially prejudicial” to the dealership,[12] (4) whether the buyer waived the right to rescind,[13] and (5) whether the buyer is estopped from seeking rescission based upon a default.[14]

Additionally, when a customer elects rescission under the ASFA, the dealership should be entitled to an offset for the customer’s use of the vehicle.[15] Determining the applicable offset for each class member’s vehicle requires a detailed and highly individualized inspection to identify and assess the following:

Mileage;
Exterior damage;
Frame damage;
Interior damage;
Functionality of equipment (power windows, locks, stereo, navigator, etc.);
Mechanical condition;
Whether proper maintenance has been performed;
Optional and aftermarket equipment installed;
Vehicle history report (Carfax, Autocheck, etc.).

Employees in the used car department and service department can provide declarations in support of the BCBG Motion affirming the need to inspect each of these items, and providing conservative time estimates.[16] Determining the applicable offset for each class member’s vehicle will inevitably lead to disputes that will have to be resolved by the Court on an individual basis and requiring further individualized inquires.

By presenting courts with evidence that fact-intensive individualized inquiries will be required for hundred or thousands of class members electing rescission, dealerships can successfully persuade courts that class-wide rescission of motor vehicle purchase contracts is inherently inconsistent with the class action mechanism.

Factor #3: Impractical to Administer

The individualized inquires discussed above that courts would have to oversee will likely evolve into mini-trials, making a strong case that class-wide rescission would be impractical to administer by the court. However, the dealership can further bolster this point by illustrating how impractical it would be to administer both the surrender of each class member’s vehicle, and the eventual disposal of the excess inventory that would result.

By using declarations from finance, sales, and service personnel, the dealership can eestimate the time it would take for the return of each vehicle. This estimate is based on the need to (1) contact the class member and arrange for the return, (2) inspect the vehicle, (3) prepare and explain the necessary paperwork, (4) determine and calculate the lien payoff and payment history, (5) confirm the applicable offset for use, (6) determine the amount to be refunded to the class member, and (7) preparing the necessary checks.

Once the vehicles are returned, dealership declarations can be used to show the time it would take to dispose of each returned vehicle, depending on whether it will be sold at wholesale or retained, and what reconditioning it may require. Some of the required tasks include a safety/mechanical inspection, reconditioning, preparing the window sticker and buyer’s guide, and determining whether to sell the vehicle “As-Is” or with a warranty.

Factor #4: Potentially Catastrophic Impact on Dealership

The Federal TILA cases clearly articulated that the potential catastrophic impact on businesses was a major factor in their determination that class-wide rescission was inappropriate. Class-wide rescission of motor vehicle purchase contracts dating back over a four year period would force the dealership to spend millions of dollars to repurchase the vehicles at severely inflated prices and hire additional staff to administer the repurchase and resale of the excess inventory, resulting in potentially millions of dollars in losses after the vehicles are disposed of.

By way of example, using the estimate of 800 class members electing rescission, a capital outlay in excess of $15 million may be required simply to pay off all remaining lien balances and to refund contract payments to class members. Many of these vehicles will not qualify for the dealership’s flooring line due to age or mileage. Additionally, the dealership is likely to take an estimated loss of at least $5,000 to $10,000 on each vehicle repurchased. Using a very conservative estimate of a $5,000 loss on each vehicle repurchased, a dealership stands to sustain losses in excess of $4 million from class wide-rescission for a class with approximately 3,300 members. A declaration from dealership management should be submitted in support of the BCBG Motion in regard to the likelihood of substantial and potentially catastrophic losses resulting from class-wide rescission.

Conclusion

By employing both pleading stage motions to strike and BCBG Motions, Manning Leaver has had success convincing courts that rescission in an inappropriate class remedy, especially for alleged technical disclosure issues on RISCs. Eliminating class-wide rescission as a remedy essentially eviscerates these class claims because class members generally have suffered nominal or no damage at all as a result of the alleged violation. By successfully pursuing this strategy of attacking class-wide rescission, dealerships can hopefully discourage further ASFA class actions based on trivial disclosure issues.

Footnotes

[1] Lewis v. Robinson Ford Sales, Inc. (2007) 156 Cal. App. 4th 359.

[2] Civil Code §2983; Rojas v. Platinum Auto Group, Inc. (2013) 212 Cal. App. 4th 997.

[3] For example, if the customer purchased a new vehicle in 2010, put 50,000 miles on the vehicle, and then filed suit to rescind the contract in 2014, the dealership would only be entitled to an offset for the 50,000 miles driven by the customer, but will have to repurchase the vehicle at its 2010 value with 50,000 miles. The dealership is forced to incur all depreciation in value over the four years, which, especially for a vehicle sold new, will be a substantial amount.

[4] 2008-2012.

[5] Based on a conservative estimate of $20,000 per vehicle.

[6] This is based on an conservative estimated loss of $5,000 per vehicle repurchased. Actual losses may be closer to or even exceed $10,000 per vehicle in some instances.

[7] Alternatively, they make policy limit demands, and then refuse to negotiate.

[8] Civil Code §2983.4.

[9] Nelson v. Pearson Ford Co. (2010) 186 Cal. App. 4th 983, 997.

[10] See LaLiberte v. Pacific Mercantile Bank (2007) 147 Cal. App. 4th 1, 12, McKenna v. First Horizon Home Loan Corp. (1st Cir. 2007)475 F.3d 418; In re Community Bank of Northern Virginia (3d Cir. 2010) 622 F.3d 275, 308; James v. Home Constr. Co. of Mobile, Inc. (5th Cir. 1980), 621 F.2d 727; and Andrews v. Chevy Chase Bank (7th Cir. 2008)545 F.3d 570. For further authority, see also Gibbons v. Interbank Funding Group (N.D.Cal.2002)208 F.R.D. 278, 285-286; Jefferson v. Sec. Pac. Fin. Servs., Inc. (N.D.Ill.1995)161 F.R.D. 63, 68-70; Handy v. Anchor Mortgage Corp., (7th Cir.2006) 464 F.3d 760, 765; Barrett v. JP Morgan Chase Bank, NA., (6th Cir.2006) 445 F.3d 874, 877; Belini v. Wash. Mut. Bank, FA, (1st Cir.2005) 412 F.3d 17.25.

[11] Civil Code §2983.1(d)

[12] Civil Code §1693

[13] E.g. Soon v. Beckman (1965) 234 Cal. App. 2d 33

[14] Integrated, Inc. v. Alec Fergusson Electrical Contractor (1967) 250 Cal. App. 2d 287.

[15] Nelson 186 Cal. App. 4th at 1012-13.

[16] We recommend that all time estimates be as conservative as possible so as to shield them from attack from plaintiff’s counsel.

Teaser

In recent years, dealerships across California have been hit with class action lawsuits under the Automobile Sales Finance Act (“ASFA”) for alleged contractual disclosure violations. These disclosure violations generally cause no damage at all to consumers. Nonetheless, under the ASFA, a contract may be deemed unenforceable as a result, and the customer could elect to rescind the contract. A customer electing to do so is entitled to a refund of all payments made on the vehicle, and a full release from the lien, in exchange for returning the vehicle.[i] When applied to class action claims involving thousands of transactions over a four year period, class-wide rescission could cause a dealership to incur millions of dollars in damages – a potentially catastrophic amount. Fortunately, we have had success convincing courts that the remedy of rescission was not intended for, and is not appropriate, for use in class actions.

[i] The dealership may be entitled to an offset for use, see infra.

Authors

Gary H Prudian

Gary H. Prudian is an associate attorney at the law firm of Manning, Leaver, Bruder & Berberich

Publication dateThu, 2014-07-24 21:03FALSE

Related resources

Vehicle dealers

class actions, rescission, tire fee, registration and license fees

Making a dealership sale viable: personal goodwill sales price allocations

jberberich — Thu, 24 Jul 2014 20:43:52 +0000

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The discussion surrounding a dealership business sale typically begins with a focus on net sales proceeds (proceeds after paying all debts and taxes). The tax cost of a sale is driven by several factors: the dealership’s entity structure, its tax attributes, and shareholder and employment agreements. These factors can either be favorable or unfavorable from a tax perspective.

For example, if a dealership is a C corporation, the tax cost of an asset sale generally includes two levels of taxation—once at the corporate level and again at the individual level upon distribution or liquidation. This double taxation can also apply to an S corporation that had previously been taxed as a C corporation, if such asset sale occurs within 10 years of the S election (although a shorter period may apply).

Sellers faced with the prospect of a tax applying at two levels typically want to sell stock rather than assets to avoid the double taxation. Buyers, however, nearly always want to purchase dealership assets to benefit from a basis step-up, if one is available. This conflict between buyer and seller often results in a compromise and, depending on the relative negotiating positions, a reduction in the sale price.

One possible solution to this conflict would be to identify value-for-value exchanges that may relate to the shareholder or employee’s personal consideration, such as covenants not to compete, employment agreements, and other uniquely personal assets. This requires careful consideration of all the elements of value being exchanged, however. Another such asset recognized by courts in certain circumstances is personal goodwill (as opposed to business goodwill or a non-compete agreement).

Let’s look at an example. XYZ Motors, a C corporation, sells its assets to National Auto Co. for $15 million and then liquidates, distributing the proceeds to the shareholders. Of the $15 million, $5 million was goodwill. XYZ Motors will pay 34 percent tax on the goodwill, or $1.7 million. When the money is distributed to the shareholders, they’ll pay capital gains tax on $3.3 million ($5 million minus $1.7 million), or $660,000. That leaves $2.64 million left for the shareholder of the $5 million in goodwill.

On the other hand, if XYZ Motors sells its assets for $10 million and the shareholder negotiates for, and sells, personal goodwill for $5 million, then the shareholder pays capital gains tax of $1 million on the sale and none of the goodwill is taxed at the corporate level. The tax savings amount to $1.36 million ($2.36 million minus $1 million).

Valuing personal goodwill takes into account the percentages or dollar amounts of the goodwill allocated between the dealer and the corporation. There are several factors to consider, including:

The number of years the dealer has been active in the dealership

The amount of personal identification of the dealer principal with the dealership (appearance in media advertising, community events or involvement, etc.)
The franchise agreement terms—does the agreement name the dealer principal, and is the agreement identified as a personal services contract? (See Akers v. Commissioner, 6 TC 693 [1946], and Zorniger v. Commissioner, 62 TC 435 [1974].)
Personal customer relationships and personal sales

Personal goodwill started appearing in transactions shortly after the landmark cases of Martin Ice Cream Co. v. Commissioner, 110 TC 189 (1998), and Norwalk v. Commissioner, TCM 1998-279. Personal goodwill allocations in sales agreements, if upheld, avoid the double taxation of either C corporations or the built-in-gains tax imposed on S corporations that have too recently been converted to C corporations.

This beneficial treatment has become highly sought after but won’t be successful without careful consideration and documentation of all the supporting facts. Case law has now developed several criteria that personal goodwill must meet to sustain court scrutiny. Here are some factors to consider:

Does any personal goodwill exist? Typically it does exist in an owner-managed business in which the identity or operations of the business is closely associated with that of the owner.

Has there been a valuation of personal goodwill? Valuations of personal goodwill have become increasingly important in recent court decisions. In some businesses there may be a higher personal goodwill amount versus corporate goodwill. In other businesses there may be very little personal goodwill. Without a valuation you may not have adequate support for your allocation.
Was there an existing non-compete agreement or employment agreement with the dealer and his or her dealership corporation? This has been held to eliminate the existence of personal goodwill.
Was there a negotiation between buyer and seller for the personal goodwill allocation? Last-minute additions of personal goodwill allocations (or no allocation) in sales agreements have been held to eliminate the ability to allocate a portion of goodwill to personal goodwill. The payment documentation at closing should align with the personal goodwill allocation and the proportion attributed to corporate intangibles. (See Solomon v. Commissioner, TCM 2008-102, in which taxpayers lost because there was no reference in the sales agreement to personal goodwill.)
Will there be a new non-compete agreement with the buyer? If there will be a non-compete agreement with the buyer, there should be a bargained-for fair market value allocation of the purchase price to the non-compete agreement as well. This allocation should be supported by the valuation allocations (see H&M Inc. v. Commissioner, TCM 2012-290).

Valuations prepared in this setting must also consider the relevant corporate goodwill components to ensure the resulting allocation is supportable—for example, the value of the dealership’s assembled workforce or a favorable lease, to the extent that such asset would be included in the transaction. Preparing a personal goodwill valuation proximate to the sale date is also essential, since the seller will have limited access to the necessary information to prepare such an analysis post-closing. (See Muskat v. United States, 554 F.3d 183, 1st Cir. 2009, in which taxpayers lost as a result of adding personal goodwill as an afterthought, on an amended return.)

To conclude, through careful planning, appropriate sales price and terms negotiation, and documentation, including valuations, the benefits of a personal goodwill allocation in a sale of a dealership can be very advantageous. However, sellers should take care not to shortcut the process and become yet another in a series of unfavorable court decisions.

Teaser

Authors

Sid Tobiason, CPA

Diane Anderson Murphy, ASA

Sid Tobiason, CPA, is a partner in the national Automotive & Dealer Services Practice at Moss Adams LLP. He can be reached at (858) 627-1448 or sid.tobiason@mossadams.com.

Diane Anderson Murphy, ASA, is a senior manager in the national Valuation Services Practice at Moss Adams. She can be reached at (206) 302-6523 or diane.anderson@mossadams.com.

Publication dateWed, 2014-07-23 18:46FALSE

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Vehicle dealers

Goodwill issues

California franchise law helps dealers resist export and resale claims chargebacks

jberberich — Thu, 24 Jul 2014 20:13:02 +0000

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In 2013 the California New Car Dealers Association (CNCDA) was successful in having a new California Vehicle Code statute enacted that will help dealers defend themselves from factory chargeback claims for vehicles that are exported or resold outside the United States. Effective January 1, 2014, Vehicle Code Section 11713.3(y) provides that it is unlawful for a manufacturer or distributer to:

…take or threaten to take any adverse action against a dealer pursuant to an export or sale-for-resale prohibition because the dealer sold or leased a vehicle to a customer who either exported the vehicle to a foreign country or resold the vehicle in violation of the prohibition, unless the export or sale-for-resale prohibition policy was provided to the dealer in writing prior to the sale or lease, and the dealer knew or reasonably should have known of the customer’s intent to export or resell the vehicle in violation of the prohibition at the time of sale or lease. If the dealer causes the vehicle to be registered in this or any other state, and collects or causes to be collected any applicable sales or use tax due to this state, a rebuttable presumption is established that the dealer did not have reason to know of the customer’s intent to export or resell the vehicle.

In the dealer agreement, most manufacturers prohibit the dealer from selling vehicles for resale in the U.S. or for resale or use outside the U.S. Manufacturers often have a separate written export policy which elaborates on the provisions of the dealer agreement. Manufacturers may also have requirements for the delivery of vehicles to retail customers with a process for explaining the vehicle’s safety and driving features.

The new California statute should significantly help dealers in resisting export chargeback and resale claims from manufacturers. A breakdown of the statute shows how it helps:

It is unlawful for the manufacturer to take or threaten to take any adverse action against a dealer because the dealer sold or leased a vehicle to a customer who exported the vehicle or sold it for resale unless:

the manufacturer’s policy regarding exports or sell-for-resale was provided to the dealer in writing prior to the sale or lease, and
the dealer reasonably should have known that the customer intended to export or resell the vehicle in violation of the prohibition.

If the dealer has the vehicle registered in California or any other state and collects sales or use tax due, there is a rebuttable presumption that the dealer did not have reason to know that the customer intended to export or resell the vehicle.

Consequences for a manufacturer violating the statute

If a manufacturer takes or threatens to take action against the dealer in violation of the statute, the manufacturer can be subject to prosecution for a criminal misdemeanor. The DMV can also take action against the manufacturer to suspend or revoke the manufacturer’s California license. It would be risky for a manufacturer to pursue a claim unless it was clear that the dealer knew, or reasonably should have known, that the customer intended to export or resell the vehicle.

Manufacturer written policies

Before any manufacturer makes export chargeback claims, the manufacturer must have provided to the dealer a written policy prohibition of the sale for export or sale-for-resale. The manufacturer prohibition must be clear and free from any ambiguities.

For a valid claim the manufacturer must show that the dealer knew or should have known of the customer’s intent to export or resell the vehicle. If the dealer registers the vehicle in the customer’s name and collects sales or use tax, there is a “rebuttable presumption” that the dealer had no reason to know of the customer’s intent to export or resell the vehicle. The words “rebuttable presumption” are found in the California Evidence Code and mean that in any export or sale-for-resale chargeback proceeding, if the vehicle was registered and tax paid, it is assumed that the dealer had no intent to sell the vehicle for export or resale. The manufacturer would have to prove that the dealer intended to sell the vehicle for those purposes, and the manufacturer would have to establish that fact by what in the law is known as a “preponderance of evidence.” A preponderance of evidence can be envisioned by a scale with all of the dealer’s evidence on one side and the manufacturer’s evidence on the other side. Whichever side weighs more (i.e. is more convincing) is the side who will win the dispute. Which evidence weighs more heavily does not depend so much on the amount of evidence (number of witnesses, number of documents, etc.), but is based upon who has the most convincing evidence and the probability of its accuracy i.e., one party’s evidence has more convincing force than the evidence opposed to it.

Use of no-export addendum to contracts and leases

To buttress their claim that they have done everything possible to avoid factory claims for chargeback of incentives when vehicles have been exported, some dealers use a “Non-Export Addendum” which they attach to the customer’s purchase or lease contract. This addendum has the purchaser or lessee represent that the vehicle will be used in the United States and is not purchased or leased for resale outside the United States. If such an addendum is used, the dealer should check with the dealer’s attorney to avoid a single document rule violation. See Chapter 24 of the California New Car Dealers Association (CNCDA) F&I Compliance Manual authored by attorneys Manning, Leaver, Bruder & Berberich and distributed to members of CNCDA. Here is a link to the Table of Contents for the manual: http://manningleaver.com/sites/default/files/attachments/publications/ca...

What transactions does the new law apply to?

The new law is effective January 1, 2014. If a sale or lease of vehicles before that date is in question, it appears that the new law will apply to those transactions as well as to those occurring on or after that date.

What if a dealership believes that it has already received unfair chargebacks?

If a dealer has already been charged back for exporting or sales-for-resale, you should contact an attorney familiar with automobile dealer law to see if a claim can be made to recover the chargebacks. If a chargeback took away any dealer incentive compensation, then the new provisions of Vehicle Code Section 3065.1, effective January 1, 2014, regarding incentive program compensation can apply and you may have enforceable rights before the California New Motor Vehicle Board, However, there are time limits under the statute to enforce your rights. An attorney can also advise you whether there might be other avenues to pursue recovery of the chargebacks. Additionally, California Vehicle Code Section 11726 provides that if a manufacturer violates the provisions of the Vehicle Code, a dealer can recover in court its pecuniary damages and attorney fees.

Process for processing incentive claims and contesting chargebacks

Vehicle Code Section 3065.1 provides a process for processing and contesting incentive claims and chargebacks under factory incentive programs as follows:

Claims must be approved or disapproved within 30 days. Any claim not disapproved is deemed approved on the 30th day.

(a) All claims made by a franchisee for payment under the terms of a franchisor incentive program shall be either approved or disapproved within 30 days after receipt by the franchisor. When any claim is disapproved, the franchisee who submits it shall be notified in writing of its disapproval within the required period, and each notice shall state the specific grounds upon which the disapproval is based. Any claim not specifically disapproved in writing within 30 days from receipt shall be deemed approved on the 30th day.

Grounds for disapproval

(b) Franchisee claims for incentive program compensation shall not be disapproved unless the claim is false or fraudulent, the claim is ineligible under the terms of the incentive program as previously communicated to the franchisee, or for material noncompliance with reasonable and nondiscriminatory documentation and administrative claims submission requirements.

Factory appeal process after disapproval of claim to be provided to dealer within 30 days after disapproval.

(c) The franchisor shall provide for a reasonable appeal process allowing the franchisee at least 30 days after receipt of the written disapproval notice to respond to any disapproval with additional supporting documentation or information rebutting the disapproval. If disapproval is based upon noncompliance with documentation or administrative claims submission requirements, the franchisor shall allow the franchisee at least 30 days from the date of receipt of the written disapproval notice to cure any material noncompliance. If the disapproval is rebutted, and material noncompliance is cured before the applicable deadline, the franchisor shall approve the claim.

If claims denied after appeal, factory must provide written notification of “Final Denial” within 30 days after appeal process.

(d) If the franchisee provides additional supporting documentation or information purporting to rebut the disapproval, attempts to cure noncompliance relating to the claim, or otherwise appeals denial of the claim, and the franchisor continues to deny the claim, the franchisor shall provide the franchisee with a written notification of the final denial within 30 days of completion of the appeal process, which shall conspicuously state “Final Denial” on the first page.

Dealer has 6 months after Final Denial to file protest with the California New Motor Vehicle Board.

(e) Following the disapproval of a claim, a franchisee shall have six months from receipt of the written notice described in either subdivision (a) or (d), whichever is later, to file a protest with the board for determination of whether the franchisor complied with subdivisions (a), (b), (c), and (d). In any hearing pursuant to this subdivision or subdivision (a), (b), (c), or (d), the franchisor shall have the burden of proof.

Approved claims must be paid in 30 days.

(f) All claims made by franchisees under this section shall be paid within 30 days following approval. Failure to approve or pay within the above specified time limits, in individual instances for reasons beyond the reasonable control of the franchisor, do not constitute a violation of this article.

Audits of dealer incentive records can be conducted for 9 months after an incentive claim has been paid. No more than one audit in 9 month period. Audits may not be punitive or retaliatory.

(g) (1) Audits of franchisee incentive records may be conducted by the franchisor on a reasonable basis, and for a period of nine months after a claim is paid or credit issued. A franchisor shall not select a franchisee for an audit, or perform an audit, in a punitive, retaliatory, or unfairly discriminatory manner. A franchisor may conduct no more than one random audit of a franchisee in a nine-month period. The franchisor’s notification to the franchisee of any additional audit within a nine-month period shall be accompanied by written disclosure of the basis for that additional audit.

Grounds for chargeback of previously paid claims after audit. Extrapolation from samples must be reasonable and statistically valid.

(2) Previously approved claims shall not be disapproved and charged back unless the claim is false or fraudulent, the claim is ineligible under the terms of the incentive program as previously communicated to the franchisee, or for material noncompliance with reasonable and nondiscriminatory documentation and administrative claims submission requirements. A franchisor shall not disapprove a claim or chargeback a claim based upon an extrapolation from a sample of claims, unless the sample of claims is selected randomly and the extrapolation is performed in a reasonable and statistically valid manner.

Disapproval of claims after an audit must be within 30 days. A reasonable appeal process must be provided within 30 days after disapproval.

(3) If the franchisor disapproves of a previously approved claim following an audit, the franchisor shall provide to the franchisee, within 30 days after the audit, a written disapproval notice stating the specific grounds upon which the claim is disapproved. The franchisor shall provide a reasonable appeal process allowing the franchisee a reasonable period of not less than 30 days after receipt of the written disapproval notice to respond to any disapproval with additional supporting documentation or information rebutting the disapproval and to cure any material noncompliance, with the period to be commensurate with the volume of claims under consideration. If the franchisee rebuts any disapproval and cures any material noncompliance relating to a claim before the applicable deadline, the franchisor shall not chargeback the franchisee for that claim.

If factory denies claims after appeal process, factory must provide a “Final Denial” within 30 days after completion of appeal process.

(4) If the franchisee provides additional supporting documentation or information purporting to rebut the disapproval, attempts to cure noncompliance relating to the claim, or otherwise appeals denial of the claim, and the franchisor continues to deny the claim, the franchisor shall provide the franchisee with a written notification of the final denial within 30 days of completion of the appeal process, which shall conspicuously state “Final Denial” on the first page.

Factory may not chargeback dealer until after 45 days after the written notice in (3) or (4) above, whichever is later.

(5) The franchisor shall not chargeback the franchisee until 45 days after the franchisee receives the written notice described in paragraph (3) or (4), whichever is later. If the franchisee cures any material noncompliance relating to a claim, the franchisor shall not chargeback the dealer for that claim. Any chargeback to a franchisee for incentive program compensation shall be made within 90 days after the franchisee receives that written notice. If the board sustains the chargeback or the protest is dismissed, the franchisor shall have 90 days following issuance of the final order or the dismissal to make the chargeback, unless otherwise provided in a settlement agreement.

Dealer has 6 months to file protest with New Motor Vehicle Board. If the filing occurs prior to a chargeback, no chargeback may be made until final board decision.

(6) Within six months after either receipt of the written notice described in paragraph (3) or (4), a franchisee may file a protest with the board for determination of whether the franchisor complied with this subdivision. If the franchisee files a protest pursuant to this subdivision prior to the franchisor’s chargeback for denied claims, the franchisor shall not offset or otherwise undertake to collect the chargeback until the board issues a final order on the protest. In any protest pursuant to this subdivision, the franchisor shall have the burden of proof.

Longer period for audit if dealer submits fraudulent claim.

(h) If a false claim was submitted by a franchisee with the intent to defraud the franchisor, a longer period for audit and any resulting chargeback may be permitted if the franchisor obtains an order from the board.

Government action against exporters

On September 11, 2013, the U.S. Attorney in South Carolina filed a court action for forfeiture of 12 high end vehicles and approximately $190,000 in bank accounts which the U.S. claims were involved in an exporting scheme. Click here to see a copy of the complaint. The U.S. alleges in part the following facts which are typical in an exporting scenario:

a. Automobile manufacturers generally prohibit the sale of new automobiles produced for sale inside the United States to individuals or companies intending to export the new automobiles outside the United States. The unauthorized export of vehicles destined for sale in the United States to foreign countries disrupts the manufacturers' distribution markets, causes market infringement problems, harms franchise dealerships abroad, and makes it difficult for manufacturers to issue recall and safety notices.

b. However, luxury automobiles often carry a higher purchase price, and high taxes and tariffs overseas. As a result, individuals will frequently attempt to export new vehicles from the United States to foreign countries in contravention of this prohibition.

c. To deter the purchase of luxury automobiles in the United States for immediate export to overseas nations, many luxury automobile manufacturers enter into contractual relationships with their licensed dealerships. These relationships prohibit dealerships from selling a vehicle to individuals or companies who intend to export that vehicle. These contractual relationships include provisions permitting manufacturers to implement a "charge back" as a financial penalty against a dealership if that dealership is discovered to have sold a vehicle that is subsequently exported. The charge back often requires the dealership to pay back any incentives or rebates tied to that vehicle, and also may reduce the number of authorized vehicles provided as the following year's inventory at that dealership.

d. As a result of these contractual relationships, dealerships take steps to protect themselves from purchasers who intend to export the vehicle. Dealerships often require purchasers of vehicles to sign agreements acknowledging an automobile manufacturer's export policy, which agreements are common throughout the United States. Many manufacturers also maintain an "Auto-Exporters" list, which is updated daily, and which is accessible by all of their dealerships. The list is comprised of individuals, their associates, and companies engaged in the exporting of vehicles produced for sale within the United States. Dealerships are obligated to check this list when selling vehicles, so as to confirm that the prospective purchaser is not on the list. Dealerships are prohibited from selling a vehicle to a person or company identified on the list.

e. However, individuals have devised a variety of schemes in order to mislead dealerships into selling them vehicles which they then very rapidly export overseas for a large profit. One such scheme involves the use of straw buyers by vehicle brokers. This scheme is designed to mislead the dealership into believing that the straw buyer is the true ultimate purchaser of the vehicle, and that the vehicle is not being purchased for export. A vehicle broker may receive an order for a specific vehicle, or vehicle type, from an overseas buyer. The vehicle broker may then contact various dealerships to find such vehicle, but will not inform the dealership the vehicle is actually intended for export from the United States. The broker then recruits the straw buyer to make the purchase, and pays the straw buyer a fee. During the purchase process, the dealership is not informed that the straw buyer is actually acting as a front for the broker, and is not informed that the vehicle is being purchased for export.

f.       If a broker purchases a vehicle from a dealership knowing the vehicle is destined for export, yet hides this fact from the dealership, either by using a straw buyer, or through other similar methods, the broker has obtained a thing of value, that is, a vehicle, which the dealership would not have sold had the true facts been disclosed. Had the dealership known the vehicle was destined for export, the dealership would not have sold the vehicle. The broker has acquired such vehicle by means of such scheme and artifice to defraud by false pretenses, representations, and promises. Thus, the misrepresentations involved in carrying out the scheme are material. Further, in order to carry out the scheme, the straw buyer typically faxes or emails a copy of the official bank check for verification of funds to the dealership, which constitutes a wire transmission in interstate commerce. Moreover, the straw buyers must apply for title to state agencies in order to acquire title to the vehicle. Such titles are ordinarily sent via the United States mails. The use of the wires and mails as part of the scheme constitute a violation of 18 U.S.C. §§ 1343 (wire fraud) and 1341 (mail fraud).

g.     After purchase, the vehicles purchased in this fashion are exported, or attempted to be exported, from the United States to another country. When any vehicle is shipped overseas, a Shipper Export Declaration (hereinafter "SED") must be filed with the United States Customs and Border Protection, United States Department of Homeland Security (hereinafter "CBP"). The SED includes information about the vehicle including the vehicle identification number (hereinafter "VIN") as well as information related to the title the vehicle was issued in the state the vehicle was sold.

h.     Frequently, individuals engaged in this scheme will submit false information on the SED in an attempt to conceal that the vehicle is, in reality, a new vehicle, and likely a vehicle involved in the type of scheme discussed above. 13 U.S.C. § 305 states that it is unlawful to knowingly submit false or misleading export information through the SED, or any successor document, or to knowingly report any information on or use the SED to further any illegal activity.

Teaser

...take or threaten to take any adverse action against a dealer pursuant to an export or sale-for-resale prohibition because the dealer sold or leased a vehicle to a customer who either exported the vehicle to a foreign country or resold the vehicle in violation of the prohibition, unless the export or sale-for-resale prohibition policy was provided to the dealer in writing prior to the sale or lease, and the dealer knew or reasonably should have known of the customer's intent to export or resell the vehicle in violation of the prohibition at the time of sale or lease. If the dealer causes the vehicle to be registered in this or any other state, and collects or causes to be collected any applicable sales or use tax due to this state, a rebuttable presumption is established that the dealer did not have reason to know of the customer's intent to export or resell the vehicle.

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Joseph E. Berberich

Publication dateWed, 2014-07-23 18:26FALSE

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California New Car Dealers Association publishes 16th edition of Dealer Management Guide authored by Manning Leaver

jberberich — Wed, 10 Jul 2013 20:56:10 +0000

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Our firm is the author of theCalifornia New Car Dealers Dealer AssociationManagement Guide, an extensive and detailed guide for dealers which is distributed by the California New Car Dealers Association to its members. The Guide, which is regularly updated, is approximately 500 pages in length, contains an in-depth discussion of the many laws and regulations applicable to California automobile dealers, and is widely used throughout California. See the link below to view the detailed Table of Contents for this publication. You can also view the Guide's index using the link below.

Download table of contents

Download Dealer Guide index

Teaser

Manning Leaver authors the 16th edition of the Dealer Managment Guide, a legal guide used extensively by California new car dealers for legal and regulatory compliance.

Authors

Publication dateMon, 2013-06-03 (All day)FALSE

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DG 13 Index-v1307.pdf

Early appraisal in dealership sales can save time, money and aggravation

Thu, 14 Apr 2011 17:22:41 +0000

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NOTE: The following article is from the collection of articles in our Automobile Dealership Buy/Sell Newsletters. The newsletter deals with the complex area of buying and selling automobile dealerships. Some of the material may not be up to date because of changes in the law from the date shown at the end of the article. This article is not to be taken as legal, accounting, tax, or other advice. You should consult your own professionals for such advice and for any updating of the information provided.

Buy-Sell Agreements that include options for future transfer of dealership interests should not be drawn up until the prospective buyers and sellers jointly engage an appraiser. Disregard this advice at risk of considerable amounts of time and money, not to mention heartache.

All too often, buy/sell agreements are prepared by attorneys at a time when the parties are amicably looking toward a future sale. Under these circumstances, attorneys insert language into the agreement which states that the company or partnership shares or corporate stock will be valued at “market value.”

But inasmuch as business valuations are profoundly affected both by the criteria selected for valuation and the ever-changing dynamics of the economy and the industry, vague references to “market value” can lead to substantial increased costs and possibly serious future problems.

Recognizing that circumstances could trigger the need for an appraisal at some point in the future, most buy/sell agreements permit each party in a transaction to engage their own appraiser to value the business or business interests. If the values set by appraisers hired by each party differ significantly, agreements often call for the two appraisers to select a third to value the business/business interests.

Some agreements call for a third value to be accepted as the final value for buy/sell purposes; others require concurrence by at least two of the three arbitrators; others call for an average of three to be used as the final buy/sell determinant.

Given the obvious propensity for the buyer to want to pay as little as possible and the seller to want to receive as much as possible, it is not surprising that the appraisals done for each often reflect their own self-serving opinion of the value of the company and their ownership interest.

The appraiser for the buyer might value only the tangible assets on a forced or orderly liquidation value basis with the view that the business has no true worth as a going concern. The appraiser for the seller, on the other hand, might value the business on a going concern basis utilizing a market and income approach with consideration of overly optimistic projections into the future of the company’s prospective earnings.

In the first scenario, the appraisal will render a low value; in the second, the appraisal will render an extremely high value. And a third valuation may or may not be able to reconcile the disparities between the two.

On the other hand, if an appraiser is called in before a buy/sell agreement is drawn up, he or she can work with both parties to decide what criteria will be used in establishing the value of the business and the business interests, so that any future appraisal is based on pre-agreed-upon parameters.

A buy/sell agreement should address the specific scope of the appraisal, prospective purposes for subsequent appraisal requirements and the appropriate premise of value to be utilized for each purpose. It should also establish what ownership interest is to be valued, how majority/ minority interests are to be valued and how to select the appropriate appraiser to serve the interests of both buyer and seller.

If the subsequent appraisal is performed by the same appraiser who advised both parties before the buy/sell agreement was drawn up, it is of course incumbent on him or her to balance the conflicting self-interests of both parties in the fairest possible manner. When the decision is left up to two or three different appraisers and the buy/sell agreement does not clearly address the valuation criteria, process and related procedures, the valuations can differ significantly.

Choosing an appraiser to assist in developing the language of a buy/sell agreement before it is prepared is critical to avoiding the unnecessary cost of three appraisals and the grief associated with appraisals being conducted with totally dissimilar approaches that provide no resolution to any disputes.

A qualified appraiser can also be extremely helpful in both appraising the company at the time the buy/sell is executed and in assisting partners/ stockholders in developing stock options, key man life insurance limits and target incentives for growth with bonuses to be paid if certain revenue/profit goals are realized.

Once the initial appraisal which establishes the basis of value of the subject company is complete, a formula for determining subsequent values can be set forth with provisions for valuation updates at least annually.

This article was written in 1993.

Teaser

This is an article by John Glenn regarding the importance of dealership appraisals.

Authors

John Glenn

When John Glenn authored this article he was a Regional Vice President of the Pacific Division for Marshall and Stevens, Inc. He can now be reached through The Mentor Group at 714-220-1200.

Publication dateWed, 2011-04-13 18:31Hide the date on this post

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Representations and warranties in purchase agreements

Thu, 14 Apr 2011 17:20:49 +0000

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What if the factory had notified the prior dealer that it intended to establish a new dealer within ten miles of the dealership you just purchased? You cry foul, but no one listens. If your purchase agreement had contained a proper representation and warranty that the seller is not aware of any intention on the factory’s part to establish a new dealership, you would have recourse against the seller for breach of warranty if the seller knew of the factory’s plans.

Obviously, representations and warranties in a dealership purchase agreement are extremely important! Representations and warranties consist of statements in the agreement by either the buyer or seller, or both, that certain facts are true.

The buyer usually wants as many representations and warranties as possible from the seller. The representations and warranties help the buyer smoke out anything that might not be proper in the running of the dealership. For example, buyers usually require sellers to make extensive representations and warranties about the environmental and hazardous waste condition of the premises and regarding compliance with laws regulating such substances.

People sometimes want to qualify representations and warranties by limiting them with a phrase such as “to the best of my knowledge….” This is generally unacceptable, especially where the warranty is important. Without this qualifying language, the representations and warranties must be true, regardless of any knowledge or lack of knowledge.

It is a good idea to require the owners of any corporation to also be parties to the agreement so that you will have a personal claim against those owners or shareholders, and not merely a claim against what may become a worthless corporation.

Most attorneys are familiar with the many standard representations and warranties that belong in small business purchase agreements. These so-called “boilerplate provisions” are too numerous to discuss here in detail. However, discussed below are some of the major areas covered by representations and warranties in the context of dealership stock and asset purchases.

Representations and warranties in a stock purchase agreement are often more detailed than in an asset purchase. This is so because when one buys stock, the buyer is taking the corporation with all of its assets and all of its liabilities. The buyer therefore needs to have as many representations and warranties as possible about the liabilities of the dealership, including tax liabilities.

In both asset and stock purchase agreements, the representations and warranties will usually cover areas such as making sure the buyer gets clear title to the assets or stock, the environmental and hazardous waste condition of the dealership premises, litigation the dealer might be involved in, and other matters that might subject the buyer to successor liability for the obligations and debts of the seller.

As most dealers know, COBRA refers to the federal law which gives employees who lose coverage under an employer’s group health plan the right to continue health coverage by paying for their own health coverage. Serious consideration must now be given to including COBRA representations and warranties in the agreement. Does the selling dealer have employees who are on COBRA? Does the selling dealer have employees who are eligible for COBRA, but have not yet elected COBRA coverage? Will the employees the selling dealer terminates be able to elect COBRA? In a stock purchase the buyer assumes all these COBRA liabilities. In an asset purchase agreement there are some strong arguments that the buyer has successor liability for COBRA coverages. COBRA issues will be discussed in more detail at a future time in another edition of this newsletter. (See COBRA Issues in the Buy/Sell Newletter list of artcles written.)

Corporate good standing, approval of execution of the agreement, and other assurances of good faith are customary and important warranties for the seller to obtain from the buyer. If the seller is accepting a promissory note from the buyer as partial payment of the purchase price, the seller will want representations and warranties concerning the buyer’s financial condition.

Can representations made orally, or in letters, take the place of formal representations and warranties in the agreement? No, because purchase agreements almost always contain “integration clauses ” that can make such informal side agreements invalid. It is therefore crucial to have a representation and warranty in the agreement as to each fact that is important to you.

What rights and remedies are available for breach of a warranty? This depends on the terms of the agreement, especially the indemnification clause. Remedies can include a complete rescission and unwind of the buy/sell, payment of damages equal to the loss in value caused by the warranty being untrue, or holding of the non-breaching party harmless from any liability or expense that results from untruthfulness of the warranty.

Representations and warranties are an integral part of any dealership purchase agreement. They must be carefully considered and drafted, and should also be tailored to the specific transaction so that they meet the objectives of the parties. When properly drafted, they can provide much protection for the buyer who usually is the party who is most in need of the protection representations and warranties offer. On the other hand, sellers will negotiate hard to limit their liability by attempting to narrow the scope of their representations and warranties and to have them terminated as soon as possible after the closing.

This article was written in 1993.

Teaser

This is an article by Joseph E. Berberich which discusses representations and warranties typically made in an automobile dealership buy-sell agreement.

Authors

Joseph E. Berberich

This article was written by Joseph E. Berberich, a partner of Manning, Leaver, Bruder & Berberich.

Publication dateWed, 2011-04-13 18:31Hide the date on this post

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A look at buy-ins

Thu, 14 Apr 2011 17:07:15 +0000

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When a dealer considers selling a portion of the dealership business, it is essential that he/she addresses several critical issues raised by a buy-in transaction.

A dealer may contemplate such a sale when planning for his or her eventual departure from the dealership business by retirement or as a result of death or disability; if heirs are unqualified or uninterested in operating the dealership; or as a means to attract and retain key management personnel, such as a general manager.

Since a dealer usually operates a dealership business through a corporation, the sale or transfer of a portion of such a business will involve stock. The number of shares actually involved in this type of transaction would be less than fifty percent (50%) of the total number of outstanding shares. The stock to be transferred is either owned by the dealer, or, in certain instances presents new shares issued by the corporation. While this transaction may not be as complicated as a buy/sell agreement involving the sale of the total dealership business, a buy-in has many aspects which a dealer should carefully review including the following:

FRANCHISOR RELATIONS: Normally, any change in the ownership of the dealership business is subject to franchisor approval. A franchisor may have other requirements applicable to a buy-in transaction, some of which may be spelled out in the franchisor’s sales and service agreement. For example, if the person buying in is to be named in the successor addendum to the sales and service agreement, there usually are requirements as to the percentage of stock that person must own or have the option to acquire within a specified period of time. Dealer compliance with the applicable franchisor requirements is critical to avoid serious problems. Although it is not really an issue of approval, a dealer should also be aware that any change in the ownership of the corporation holding the dealer license must be reported to the California Department of Motor Vehicles.

STATEMENT OF TERMS: The buy-in agreement must state the precise terms of the stock sale. One of the important terms is how the stock is to be valued for purposes of the sale. Typically, stock is valued according to a formula, either based on book value, capitalized earnings or appraisal. A dealer needs to carefully evaluate what valuation approach makes the best sense as to that dealer’s situation because the formula used can have an impact on valuation issues relating to other transfers of the corporation stock that may occur in the future.

SPECIFICATION OF PAYMENT: The buy-in agreement should also address how the person buying in is to pay for the stock being acquired. Often the financial resources of that person may be limited, so payment may need to be structured under a promissory note with terms which realistically take into account his or her expected after tax income. If the buy-in involves payment by promissory note, the stock to be acquired can be pledged pursuant to a pledge agreement to give greater security for the payment. This approach can also minimize the chance of an unauthorized transfer of the stock.

REACQUISITION TERMS: The buy-in agreement should include terms allowing the dealer to reacquire, upon the occurrence of certain events, the stock being transferred. Routinely, these provisions give the dealer and the corporation at least the option to purchase the stock in the event of the death, disability or termination from employment of the person buying in. To be effective, these provisions should provide precise terms as to what events trigger an option, what time frame is allowed to accomplish the purchase of the stock, what formula is used to determine the purchase price of the stock, and how the purchase price is to be paid.

EMPLOYMENT RELATIONSHIP: A buy-in agreement should include provisions that prevent it from being construed as an employment agreement which changes the nature of any employment relationship between the dealer and the person buying in. This is especially important where that person is an “at will” employee and the dealer wishes that status to continue. This issue is also important in those situations where a dealer may transfer stock to a dealership employee as part of a stock bonus program. Just as with a full-blown buy/sell transaction, certain formalities should be followed regarding a buy-in including the following:

Both parties to the transactions should be, or at the very least have the opportunity to be, represented by legal counsel to help ensure that the agreement is legally enforceable if a dispute should arise at a later date.
Compliance with formal requirements of the Commissioner of Corporations of the State of California which apply to the transfer of stock should also occur.
Formal corporate minutes and other records should be maintained to confirm any necessary corporate approvals of the transaction.
Routinely, the buy-in agreement will provide that the actual corporate stock certificates being transferred are to contain a legend referring to the restrictions that exist as to the future transfer of the stock. This legend should be actually typed or otherwise placed on the stock certificates prior to transfer.

Certainly, there are many issues that can arise concerning a buy-in which may represent the critical point in the life of a dealership business. With so much at stake, a dealer needs to carefully review such a transaction to ensure that it accomplishes what the dealer intends.

This article was written in 1994.

Teaser

This is an article by Brent W. Smith concerning issues that come up in buy-in transactions.

Authors

Brent W Smith

Publication dateWed, 2011-04-13 18:31Hide the date on this post

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Hydraulic hoists prompt environmental concerns

Thu, 14 Apr 2011 17:01:11 +0000

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In recent months, the environmental risk associated with hydraulic vehicle hoists has flared up as an issue for auto dealers planning on selling their dealerships. It’s not so much that environmental risks from hoists have become greater; it’s that environmental consultants seem intent on taking them more seriously.

First, some basic background: most hydraulic hoists include an underground reservoir that contains the hydraulic oil needed to make the thing work. Reservoir capacities are usually quite limited, typically ranging from 35-50 gallons. Because they are so small these reservoirs are exempt from state and federal underground storage tank regulations. That is, they do not have to be permitted. Nor does an owner or operator of a hoist have to install any leak detection system to asses its integrity.

As a result of this exclusion most dealers have paid little attention to their hoists. But, as noted above, that may be changing. One important reason is that a 1993 California law removes the regulatory exemption on hoists as of January 1, 1996. This change has a number of vendors touting the benefits of alternative systems. There is, however, a strong possibility that this law will be changed and the exemption restored. In fact, the state WRCB (the folks who make rules on underground tanks) may be close to recommending just that to the legislature.

Another reason for this change is that dealers are now coming to understand that, despite any regulatory exemption, a leaking hydraulic reservoir can create an environmental problem. More specifically, if oil leaks from one of these reservoirs into surrounding soil or groundwater, such a release may have to be reported and cleaned up. And, as dealers are well aware, cleanups of this sort can be expensive. Then there is the risk of liability; particularly if the dealership is operating on leased property or if the contamination has somehow placed a cloud on nearby properties.

The long and short of it is that from a risk standpoint, nothing has really changed. What has changed are perceptions. For reasons unknown, leaking hydraulic oil reservoirs have become a hot issue among consultants performing Environmental Assessments. An Environmental Assessment, incidentally, is an investigation that tries to identify any environmental issues or problems at a site that may restrict its future use or require a costly cleanup. These assessments are commonly performed as one component of franchise or property sales.

In years past, these assessments often overlooked underground hoists. Others discussed the risk only in general terms. Now, however, it is not uncommon for an assessment to recommend that the soil adjacent to each reservoir be checked for evidence of contamination. Some assessments even go so far as to recommend that all underground hoists be removed and replaced with aboveground units.

It is difficult for another consultant to argue with such recommendations. After all, we don’t have to pay for any modifications. But dealers do. And the cost can be significant; probably $1,000 or so for each soil sample and about $6,000-$7,000 for each hoist removal/ replacement.

With that in mind, we should go back to the beginning and recall that the oil reservoirs in these lifts are small. Consequently, the loss of a small amount of oil, say 5 to 10 gallons, will normally result in a hoist not working properly. Even a catastrophic failure would result in a comparatively small release.

While any release of a hazardous material is bad news, the failure of one of these reservoirs will not create the same type of problems as a hole in, say, an underground fuel tank. The liquid in such a tank is continually replenished and a leak can go on, undetected, for years. In contrast, hydraulic hoists have an excellent built-in leak detection system–they stop working. Thus, so long as maintenance on a leaking hoist does not consist of simply adding hydraulic oil, the consequences of such a leak can normally be minimized.

Considering the comparative risk of these hoists, dealers may wish to consider alternative methods for managing them. These alternatives could include:

- Programmed maintenance: A program which includes schedule preventative maintenance (possibly including periodic integrity testing) and prompt repair of faulty hoists can minimize the risk of operating underground hoists. Your hoist maintenance service company may have useful suggestions on how to structure a program.

One note of caution: these types of programs often start off with a bang only to soon fade away. If a scheduled maintenance program is to endure, management will have to periodically check its status.

- Replace hoist hydraulic oil with non-hazardous substitute: Vegetable-based hydraulic oils are now on the market. Under the right conditions, such an oil can provide many years of reliable service. And if a leak should occur, vegetable oils are commonly non-hazardous and therefore may not have to be cleaned up at all. Wouldn’t that be nice?

There are, of course, some downsides. First is the cost. Flushing out the oil in a unit and replacing it with a vegetable-based oil could easily run $ $1,000-$1,500. Also, this oil will reportedly degrade rather quickly if the hoist does not have a supply of dried and filtered compressed air. Some dealerships may have to upgrade their compression air systems in order to provide this quality of air.

Also, a lawyer may be able to make some sort of argument that leaking vegetable oil, even if nonhazardous, somehow contributed to an environmental problem.

- Replace underground hydraulic hoists with aboveground units: Aboveground units seem to be popping up everywhere and dealers no doubt know what they look like. From an environmental standpoint, these hoists are pretty much risk-free. On the other hand, they cost a lot. If a dealership does install aboveground units, it should get the oil out of the underground hoists that are going out of service. As for the unused units them selves, once emptied, they may be removed, capped off or simply abandoned. Remember, these units are not presently regulated and they may be abandoned in place.

In summary, underground hydraulic hoists do present some environmental risk to the dealership. This risk, however, is comparatively modest and can be further reduced by relatively common-sense practices. Alternately, it can be essentially eliminated if the dealership is willing to invest the necessary sums.

This article was written in 1995.

Teaser

This is an article by Kip Prahl concerning the impact of underground hydraulic hoists in the buying and selling of automobile dealerships.

Authors

Kip Prahl

Kip Prahl is an environmental engineer who is president of Kip Prahl Associates; 510-745-9007.

Publication dateWed, 2011-04-13 18:31Hide the date on this post

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Selling your dealership: assets vs. corporate stock

Thu, 14 Apr 2011 17:00:04 +0000

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How much can I sell for? How much do I get to keep after taxes? These are probably the key questions most owners have once a sell decision has been made.

The final answer has too many variables for the scope of this article. This article deals with a comparison of selling assets versus selling the existing corporation.

Historically, the sale of an existing corporation (corporate stock) has not been usual in the automobile industry. However, there are significant advantages to the seller. Serious consideration should be given this method where possible.

Some of the advantages are:

A single, simpler transaction, resulting in a capital gain on sale of stock.
Avoidance of LIFO inventory recapture.
Avoid corporate-level tax on gains from asset sale. This will usually not be an issue if the corporation is an S-Corporation and made its election prior to 1987.
Avoid the after-sale liability issues of finance reserve charge-backs and warranty policy charge-backs.
Avoid the after-sale continuing accounting costs of maintaining records, collecting receivables, paying payables, and liquidating the remaining assets.
If the corporation has tax net operating loss carry-overs, the buyer may be able to use them to offset future profits under certain circumstances.

All of these issues are important. Each can save significant amounts of money in either taxes or aftersale costs of liquidation. The after-sale cost of liquidation alone can be extremely expensive and can take several years to complete.

Some of the disadvantages are:

Non-traditional. May be more difficult to negotiate.
Does not allow an “asset basis” adjustment to the buyer for depreciation purposes.
Will usually require the seller to give warranties and representations of indemnity for prior corporate acts to the buyer.

The items of advantage and disadvantage are by no means all inclusive. Each dealership has different facts and each issue will not have the same degree of importance in a sell decision. To be properly informed you should give each issue consideration as to the impact it may have on your net realized sale.

If you are thinking about selling your dealership, I suggest you explore the possibility of a corporate stock sale.

Regardless of the method of sale, I urge you to review your options and consult your attorney and C.P.A. before beginning any negotiation with a prospective buyer.

This article was written in 1995.

Teaser

This is an article by Floyd Clem, C.P.A., regarding the differences between an asset and a stock purchase of an automobile dealership.)

Authors

Floyd C. Clem

Floyd C. Clem is a C.P.A. with the Covina, CA firm of Rogers Clem & Company; 818-858-5100.

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Assets versus stock sale

Need a partner or investor? Consider an LLC

Thu, 14 Apr 2011 16:58:42 +0000

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Automobile dealers are increasingly transferring minority interest in their dealerships to third parties. They are doing so for a variety of reasons–to bring in new management, to turn the dealership around, or in preparation for retirement, or simply to raise cash.

Often, however, the dealership is owned by a corporation and there may be numerous reasons why the third party should not own stock in the corporation. For example, if the corporation has significant assets in addition to the dealership itself, the current shareholders would be justifiably concerned about the new minority shareholder having an interest in the non-dealership assets. The value of the non-dealership assets might also make the price per share prohibitively expensive for the minority owner. Creditors also complicate the situation: the non-dealership assets of the corporation will continue to be available to dealership creditors, even if the majority owner is no longer actively involved in the business. Subsidiary corporations or preferred and common stock offer some assistance here, but current tax law limits their usefulness.

California’s recently enacted Limited Liability Company Act offers new business and tax planning strategies that may help resolve many of these issues.

Rather than selling stock of the corporation to the proposed minority owner, the existing corporation and the proposed minority owner would form a Limited Liability Company through which dealership activities would be conducted.

A Limited Liability Company (“LLC”) is a business entity that is generally treated as a corporation for purposes of determining liability under state law but may be structured as either a corporation or a partnership for federal and state income tax purposes. Usually, classification as a partnership provides the more desirable tax benefits.

An LLC may be funded with money, property, services or an obligation to contribute money, property or services. For example, the corporation could contribute its dealership business to the LLC in return for a majority interest in the LLC (and retain its other assets in the corporation) and the minority owner could contribute money and/or a note for its minority interest in the LLC. The LLC would then own the dealership and all activities would be conducted through it. If the LLC is organized as a partnership for tax purposes, the contribution of the going business (the dealership activities) will generally be tax-free. However, certain LIFO adjustments may be required.

With only the dealership assets belonging to the LLC, the corporation could retain all other assets, generally beyond the reach of creditors of the LLC. And, under partnership tax treatment, other than a graduated minimum tax which caps out at $4,500 for gross revenues over $5,000,000, no income taxes are payable by the LLC as the income of the business is taxed only at the owner’s level.

An LLC has distinct advantages over other business forms. In contrast to a corporation, an LLC organized as a partnership has only a single level of taxation while corporate earnings are subject to double taxation. LLC members are not exposed to unreasonable compensation issues and, unlike a corporation, the accumulated earnings tax and the personal holding company tax are not imposed on an LLC. Furthermore, items of income and loss can be specially allocated to members.

While there are no significant tax differences between an LLC organized as a partnership and a general or limited partnership, there are significant differences in the liability of the members. In a general partnership, all partners have unlimited liability. In a limited partnership, at least one partner is required to have unlimited liability and if a limited partner participates significantly in the management of the limited partnership, that partner may be liable for the debts of the partnership. In contrast, all members of an LLC have limited liability. Furthermore, members of the LLC may participate in management and not become liable for debts of the LLC.

S corporations, like partnerships and LLCs, have only a single level of taxation at the owner’s level. However, restrictions are imposed on S corporations as to both the number and kind of shareholders the S corporation may have. In contrast, there are no restrictions on the number or kind of entities that may be members of an LLC.

LLCs are not the perfect business entity for all situations and there are certain disadvantages associated with LLCs. For instance, partnership tax treatment means members are taxed on the LLC’s income even if the income is not actually distributed to the members, and individual members may be subject to higher marginal income tax rates than corresponding corporate tax rates. Complicated tests also pertain to whether partnership tax treatment is available to an LLC, some of which place limits on the free transferability of interests in the LLC and on the ability of the LLC to continue after the death, bankruptcy or withdrawal of a member. Having all members involved in management may also result in certain inefficiencies. Careful planning and drafting of the legal documents, however, can usually avoid these problems.

A Limited Liability Company could also be useful in situations where a dealer might want to separate out some dealership operations with a separate business entity. A dealer might want to have a separate entity for the dealership’s leasing operation, body shop department, or any other department or business in which the dealership is engaged. Either the dealer or the dealership corporation could be a partner in the LLC with an individual who might run that aspect of the business and who would have an equity interest in the LLC without having an interest in the entire corporation. The owners of the LLC would not have personal liability for the LLC’s acts and would have all of the benefits described above. An LLC thus can be a very flexible business entity which can be used to provide employees an interest in a particular aspect of the dealership’s business. It is likely that many imaginative concepts will arise out of this new business entity now authorized under California law.

In a buy-in or a buy-out, as in all business transactions, there is no substitute for careful business and tax planning. The lure of a single level of income tax combined with limited liability offered by an LLC is appealing, but the ultimate choice of a business entity should be made only after thorough consultation with your legal and business advisors.

Action in Washington over the last few weeks may offer more help soon. A bill by Senators Hatch and Pryor would allow S corporations to own, and be owned by, other closely held corporations, and to issue different classes of stock. And the IRS itself has proposed even more sweeping reforms under which all forms of closely held business entities would simply elect between partnership or corporate tax treatment, with no complicated tests. From our experience, dealers would benefit greatly if either of these proposals became law.

This article was written in 1995.

Teaser

This is an article by Halbert B. Rasmussen concerning the flexibility of the use of a limited liability company for automobile dealerships, or for separate operations of a dealership such as a body shop.

Publication dateWed, 2011-04-13 18:31Hide the date on this post

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