Subterfuge, Prevarication and Deception – Another Inefficient Franchise Territorial Dispute

Subterfuge, Prevarication and Deception – Another Inefficient Franchise Territorial Dispute

By: Jeffrey M. Goldstein, Esq.

In a recent automobile dealer territorial dispute case, the United States District Court for the District of Colorado dismissed several claims against the manufacturer and allowed one claim to proceed. European Motorcars of Littleton, Inc. v. Mercedes-Benz USA, LLC, 2017 U.S. Dist. LEXIS 93857. The practice of dual assignment, or the appointment of competing dealers near existing auto dealers, seems to be getting more prevalent.

Plaintiff Mercedes-Benz of Littleton (MBOL) has been a franchised Mercedes-Benz automobile dealership since 1996. Defendant Mercedes-Benz USA (MBUSA) is the North American distributor and manufacturer representative for the Mercedes-Benz brand of vehicles. In 2015, MBUSA invited Defendant Bobby Rahal Motorcar Company (BRMC) to establish a new Mercedes-Benz dealership less than nine miles from MBOL's facility. MBUSA did not inform MBOL of its intent to establish a new dealership until July 2016, when an MBUSA employee traveled to Colorado and informally notified MBOL's management of MBUSA's plan. In October 2016, MBUSA sent MBOL a formal notice pursuant to Colo. Rev. Stat. § 12-6-120.3 (the Statute), which stated the exact location of the new dealership. The address for the new dealership is nine miles and two freeway exits north of MBOL's dealership. The notice also identified the new dealer operator as BRMC. MBUSA and BRMC had taken material steps towards establishing the new dealership, such as executing a letter of intent.

When MBUSA establishes a dealership, it enters into an agreement with the dealer. The agreement governs the parties' relationship. The agreement also gives the dealer an Area of Influence ("AOI"), which consists of zip codes and census tracts. MBUSA uses the AOI to judge the dealer's performance. MBUSA's agreement with MBOL states that MBUSA may establish new dealerships within MBOL's AOI at any time. However, the addition of a new dealer "will result in an alteration of adjustment of MBOL's AOI."

MBOL filed five claims: two for violation of the Statute, and one each for fraudulent concealment, breach of the implied duty of good faith and fair dealing, and a permanent injunction. MBOL sought three remedies, “(1) to enjoin Defendants from establishing the dealership, (2) a declaratory judgment stating that MBUSA violated all three statutory sections, and (3) damages suffered as a result of MBUSA's statutory violations and tortious conduct.” Encroachment claims pervade modern-day franchise law.

MBOL’s Claims for an Injunction and for a Declaratory Judgment Were Moot

The Court began by stating that it must perform a mootness analysis in light of “the City of Centennial's zoning ordinance, which prohibits the establishment of the dealership at the proposed location.” A case is moot when its outcome would not have a practical effect on the litigants, or, in the Court’s words, when “a decision on the merits will not 'affect the behavior of the defendant toward the plaintiff.’”

The Court held that two of the three requests for relief were moot, because they were already fully addressed by the zoning ordinance: “The Court holds that the repeal of the zoning ordinance afforded MBOL the relief it seeks on its requests for a permanent injunction and declaratory judgment. Accordingly, these requests are moot.” The zoning ordinance already disallowed MBUSA from establishing the new dealership, so a permanent injunction or declaratory judgment would not “affect the behavior of the defendant toward the plaintiff.”

MBOL attempted to proceed with its request for a permanent injunction, “based on the theoretical possibility that the City Council will someday change its mind and reconsider its decision to revoke the ordinance.” The Court rejected this line of argument, stating that “the Court does not have jurisdiction to issue injunctions that will have effects in the real world only on the happening of a theoretical possibility.”

For the same reason, the Court also held MBOL’s request for a declaratory judgment as moot.

Defendant MBUSA, hoping to receive a judgment, also argued that MBOL’s claims were not moot. MBUSA argued that it would continue to pursue the dealership by lobbying the city to change its zoning ordinance. The Court was not convinced, explaining that even if “MBUSA will continue to seek financing, attempt to change the City of Centennial's ordinance, and accomplish other tasks incident to opening a dealership,” this would not change MBUSA's conduct toward MBOL, since MBUSA is forbidden from establishing the dealership under the ordinance.

MBOL Could State a Claim for Unreasonable Approval of the New Dealer Facility

The Court then analyzed the claims for damages, which were not moot. The first claim for relief was for violation of the Statute (subsection (1.5)), which states that: “A manufacturer shall reasonably approve or disapprove of a motor vehicle dealer facility initial site location or relocation request within sixty days after the request or after sending the notice required by subsection (1) of this section to all of its franchised dealers and former dealers whose franchises were terminated, cancelled, or not renewed in the previous five years due to the insolvency of the manufacturer or distributor, whichever is later, but not to exceed one hundred days.”

MBOL argued that MBUSA did not perform the required reasonableness analysis (under subsection (4)) when approving the new dealership, which requires that MBUSA consider: the size of the investment of current dealers in the area, population growth or decline, the public welfare, and the current level of customer care provided by current dealers in the area.

MBUSA argued that the statute does not give existing dealers the standing to sue, but only the new dealer. The Court disagreed. Because there is a requirement that existing dealers be given notice before making a decision on the new dealership, it logically follows that they must also have standing to sue. As the Court explained, “by requiring that dealers receive the notice under Subsection (1) prior to initial site approval, the General Assembly demonstrated its intent to give dealers the ability to review the proposed location and lodge an objection if they determine it is unreasonable.”

But even if the existing dealers have standing to sue, MBUSA argued that MBOL could not assert a claim based on subsection (4) of the Statute because that section does not impose any affirmative obligations on MBUSA. The Court agreed that subsection (4) of the statute does not impose an affirmative obligation on MBUSA. By contrasting subsection (1) of the statute with subsection (4), the Court found that the former imposes an affirmative obligation while the latter does not: “Unlike Subsections (1) and (1.5), which specifically state what manufacturers shall or shall not do, Subsection (4) does not require or prohibit any conduct.”

But even though subsection (4) does not create a cause of action, the section is still significant. The Court stated that while the statute “does not form the basis of a cause of action, the Court holds that the factors delineated in Subsection (4) are nevertheless relevant to MBOL's claim under Subsection (1.5).” Subsection (4) does not provide its own cause of action, but it informs the analysis of Subsection (1.5). The Court interpreted Subsection (4) as “delineating four relevant factors for courts and juries to consider when determining whether a manufacturer unreasonably approved an initial site request in violation of Subsection (1.5).” The Court held that MBOL could not bring a separate claim under Subsection (4), but could use Subsection (4) in its claim brought under Subsection (1.5).

MBOL Could Not State a Claim for Fraudulent Concealment

MBOL’s second claim was for fraudulent concealment. MBOL contended that MBUSA concealed its actions to establish a new dealership in MBOL’s geographic area. In Colorado, to bring a successful claim for fraudulent concealment, the plaintiff must show “(1) the defendant's concealment of a material existing fact that in equity or good conscience should be disclosed, (2) the defendant's knowledge that the fact is being concealed, (3) the plaintiff's ignorance of the fact, (4) the defendant's intent that the plaintiff act on the concealed fact, and (5) the plaintiff's action on the concealment resulting in damage.” Further, there must be a showing that the defendant had a duty to reveal the concealed fact.

MBUSA argued that it had no duty to disclose its intent to open a new dealership. The Court found that Colorado had never addressed the issue of whether automobile manufacturers owe their dealers a duty to disclose. The Court, looking at the Restatement (Second) of Torts found that whether or not there was a duty to disclose turned on whether “MBUSA and MBOL had a special relationship of trust and confidence and whether MBOL would have reasonably expected disclosure because of objective circumstances within the parties' relationship.”

Looking at case law, the Court found that manufacturer-dealer relationships are not prima facie evidence of a relationship of trust and confidence, but that “an automobile manufacturer has a special relationship with one of its dealers, and thus, has a duty to disclose material facts, only if the dealer placed trust and confidence in the manufacturer beyond that inherent in a normal manufacturer/dealer relationship.”

MBOL argued that it placed trust in MBUSA when it upgraded its dealership. The Court found that this did not rise to the level of trust and confidence required to create a duty. “Indeed, required standards and upgrades does not differentiate the parties' relationship from that between every manufacturer and dealer.”

Further, the Court found that the dealer contract weighed against finding a special relationship. The contract has statements such as “Dealer is an independent business” and “No fiduciary obligations are created by this Agreement.” Further, the agreement “permits MBUSA to establish a new dealership ‘at any time.’”

For the foregoing reasons, the Court dismissed the fraudulent concealment claim, stating that “because MBUSA did not owe MBOL a common-law duty to disclose its intent to establish a new dealership, the Court dismisses MBOL's fraudulent concealment claim.” Although the Court's position is not universal, it is the prevailing view.

MBOL Fails to State a Claim for Breach of the Implied Covenant of Good Faith

MBOL’s third claim was for breach of the implied covenant of good faith and fair dealing, which requires that the plaintiff “plead that the defendant used ‘discretion conferred by the contract to act dishonestly or to act outside of accepted commercial practices to deprive the other party of the benefit of the contract.’”

The Court found that MBOL alleged two separate theories for the breach of the duty of good faith. MBOL alleged that MBUSA improperly exercised its discretion in deciding whether to establish a new dealership in the vicinity of MBOL, and that MBUSA did not act in good faith when it “covertly solicited and invited new dealers into the Denver metropolitan market and approved the establishment of the new BRMC dealership approximately nine miles from MBOL.”

The Court rejected MBOL’s first claim, because MBOL could not show that it was “deprived of any reasonably expected benefits under the contract,” which is a requirement for a breach of good faith claim. “The implied covenant of good faith and fair dealing is breached when a party uses discretion conferred by the contract to deprive the other party of the benefit of the contract."

MBOL could not have reasonably expected that MBUSA would not establish a new dealership within MBOL’s geographic area, because the contract between MBOL and MBUSA explicitly allowed for the MBUSA to establish new dealerships.

The implied duty of good faith cannot contradict the express terms of the contract: “the implied duty of good faith and fair dealing cannot contradict terms or conditions for which a party has bargained, not can it inject substantive terms into the parties' contract.” Because the contract explicitly contemplates the establishment of new dealerships, this cannot be the basis for a breach of the implied covenant claim.

The Court also rejected MBOL’s second theory, that “MBUSA breached the duty of good faith by soliciting new dealers into the Denver metropolitan market without providing notice to MBOL.” Again, the Court found “MBOL fails to plead that the lack of notice deprived it of a reasonably expected benefit of the contract.” MBOL would have had to explicitly state what benefit the notice would have provided it.

The Court underscored its point here by way of contrast with another case, where a breach of the implied covenant was found. In that case, “the plaintiff had a reasonably expected benefit in receiving loan funds, and the defendant's failure to provide notice of its changes to the cost breakdown allegedly deprived him of that benefit.” In that case, the plaintiff was able to show how the defendant’s bad faith had deprived the plaintiff of a reasonably expected benefit. MBOL was unable to make any such similar showing, and so the claim was dismissed.

MBOL Fails to State a Claim That MBUSA Failed to Give MBOL Notice of New Dealer

MBOL asserted a fifth claim, that MBUSA, in violation of the Statute, did not notify MBOL of its attempt to modify MBOL’s AOI. The relevant text of the Statute states that it is unlawful to: “fail to notify a motor vehicle dealer at least ninety days before modifying, replacing, or attempting to modify or replace the franchise or selling agreement of a motor vehicle dealer, including a change in the dealer's geographic area upon which sales or service performance is measured, if the modification would substantially and adversely alter the rights or obligations of the dealer under the current franchise or selling agreement or would substantially impair the sales or service obligations or the dealer's investment.”

There was no disagreement that MBUSA had not provided notice; rather, the argument turned on the definition of “modify or attempt to modify.” MBUSA argued that the claim should be dismissed because MBOL never alleged that MBUSA modified or attempted to modify MBOL’s AOI, as required for a violation of the statute. MBUSA argued that “attempt” implies taking a “substantial step.” The Court agreed, stating that: “the General Assembly intended ‘attempt’ to carry the same or a similar meaning to that in the criminal context. Criminal attempt requires that the defendant take a substantial step toward the commissioning of the offense beyond mere preparation.”

In order to attempt to modify a dealer’s franchise agreement, the Court held, the manufacturer must take a substantial step. The only alleged action, “such as negotiating a letter of intent with BRMC,” was preliminary, and not substantial.

Conclusion

MBUSA’s non-disclosure in this case is difficult to justify on both legal and economic grounds. Indeed, MBUSA was able to side-step liability for non-disclosure based on an archaic (although commonly used) formulation of the caveat emptor doctrine. However, ironically, the Court’s application of the doctrine of caveat emptor – the entire purpose of which is to maximize economic efficiency – directly depresses economic efficiency in several ways.

First, the rule of non-disclosure liability used by the Court will significantly diminish the expected return to those considering making remodeling and tooling investments. To the extent that these larger investments in modernization and equipment will now be more costly to the investing party (since the ruling ensures that the investments will be worth merely a fraction of their fair market value due to the direct competition of new competing dealers), fewer of such beneficial or efficiency-augmenting investments will occur. This entails a loss in allocative efficiency.

Second, the ruling allowing for non-disclosure will cause dealers to incur substantial transaction costs in the form of legal and other professional fees to determine the future motives and plans of their franchisors or manufacturers on issues like new location openings. This is because under the prevailing legal model of non-disclosure, a manufacturer or franchisor, who otherwise would not have a duty to disclose, would likely incur such a duty if certain answers by the franchisor to a franchisee’s specific inquiries become incomplete or ambiguous over time; in essence, the franchisee’s inquiries, with significant diligence and cost, could put the franchisor on constant notice that the franchisor’s answers, although true when initially made, must always be updated whenever new information or plans, which frequently change over time, make the initial answers untrue or misleading. Transaction costs incurred in this way, merely to trigger the disclosure of already existing directly relevant information, cannot be efficient.

Third, and related to the last matter, is the endless loss of resources (primarily transaction costs) associated with litigating the proper application of archaic legal doctrines to modern-day business relationships, to wit, whether or not one has a ‘legal duty’ to provide obviously germane, relevant and important information to another party directly participating in the same business venture or deal. For instance, in this case, the legal skirmish, other than achieving a temporary resolution of the dispute, did nothing to guide the parties in the instant or future disputes regarding how to act in a more efficiency-enhancing manner. The esoteric discussion of whether such a ‘disclosure duty’ exists in a franchise context is intellectually, economically and socially stultifying. The historical case law, which has erroneously refused to impose any common law quasi-duties on franchisees and franchisors in a franchise relationship, has blinded the judiciary to the tangible realities of the market place. The invalid view that a franchise relationship is closer to an arms-length relationship between two strangers rather than to a close legal partnership relationship is one of the most destructive myths in franchise and dealership law. As the instant case shows, the efforts expended by litigants and the judiciary trying to ‘characterize’ the existence or non-existence of a special duty in the franchise context is disingenuous, extravagant and unnecessary.

Fourth, it is clear that the information in dispute (whether MBUSA intended to place another dealer in direct competition with its existing dealer) was itself not in anyway ‘expensive’ to derive and acquire. In other words, the information was casually and normally acquired in the normal course of MBUSA’s business operations. Accordingly, a legal rule that required the disclosure of that information to the franchisee would not in any way free-ride on the development of that information by the manufacturer. In other words, this isn’t a case where a more forthcoming legal rule requiring disclosure would make the costs of acquiring and developing the information costlier; indeed, under the rule of disclosure, the development and provision of the information would still remain with the franchisor, which of course in this case would be the least costly developer of the information.

Jeffrey M. Goldstein, Esq. Goldstein Law Group, PLLC  www.goldlawgroup.com (202) 293-3947  jgoldstein@goldlawgroup.com Washington, DC