U.S. Motor Vehicle Industry Restructuring and Dealership Terminations
Released: 2010-01-08T00:00:00

Introduction

Automobile manufacturers rely on an extensive network of approximately 20,000 independently owned dealers for sales and service of their vehicles. Dealers provide the local connection between manufacturers and car buyers, and the dealership system is one of several linchpins in the complex web of relationships that make up the U.S. automobile industry. Automakers and dealers alike agree on the importance of this relationship. At a June 2009 congressional hearing, Fritz Henderson, then-President and CEO of General Motors Corporation (GM), said,

Simply put, a strong dealer body is vital to GM's success. Indeed, for many customers, our dealers are the "face of GM"—so this effort [dealer network restructuring] is critically important to the successful reinvention of General Motors.

At the same hearing, the chairman of the National Automobile Dealers Association (NADA) quoted from a commissioned report which states,

… the automobile dealers support the manufacturers' efforts by providing a vast distribution channel that allows for efficient flow of the manufacturer's product to the public at virtually no cost to the manufacturer.

While there is a consensus about the overall role and value of the dealer network, manufacturers and dealers have demonstrated that there is a wide gulf between them on the appropriate size of that network, the flexibility of the dealerships in running their business, and the GM and Chrysler visions of how the dealer network should perform going forward. In June 2009, Chrysler eliminated 789 dealers, 25% of its dealer network. GM has announced it will reduce its dealer network from 6,000 to approximately 3,600, to take effect in October 2010 when its contracts with dealers around the country are up for renewal. According to the NADA, the GM and Chrysler dealerships slated for elimination had more than 100,000 employees.

Dealers are not alone in facing a tough realignment. The highest level of new-vehicle sales this decade, including domestically-produced and imported autos, was recorded in 2000, with new vehicle sales of 17.3 million, while sales in 2009 were 10.4 million units. All parts of the auto supply chain have had to make what are seen as wrenching changes. In addition to closing multiple plants, cutting thousands of union and white-collar jobs, and curtailing many supplier relationships, both Chrysler and GM made reducing and reshaping dealerships a key component in their restructuring.

At issue for Congress are the decisions made by the Bush and Obama Administrations in aiding GM and Chrysler and the impact of their bankruptcies on dealers, retirees, bondholders, and other stakeholders. This report examines the size and scope of the U.S. automobile dealer network, its origins, and its economic contributions. It also examines the role of states in franchising, as well as federal legislation and actions in the development of the present auto dealership business model. It presents the arguments put forward by GM and Chrysler, on one hand, and dealers on the other, regarding the large scale termination of dealers as part of these two manufacturers' bankruptcy cases. The report concludes with a summary of recent Congressional interest and actions with regard to the U.S. auto dealer network. CRS Report R40736, Mandating Dealership Agreements for Automakers Receiving Federal Funds: Constitutional Analysis , by [author name scrubbed], [author name scrubbed], and [author name scrubbed], examines several of these legislative proposals.

The Role of Auto Dealers in the Distribution of Motor Vehicles

In the early 1900s, automakers often sold their vehicles directly to consumers. However, that system did not work well because the manufacturers were often far away from their ultimate customers and they found the expense of setting up a nationwide network of company-owned stores to be prohibitive. In their book on the auto supplier industry, Thomas Klier and James Rubenstein describe Ford's early experience with selling cars:

Ford did set up company-owned stores called branch houses during the first decade of the twentieth century. Located in major cities, branch houses were staffed by Ford employees who received a salary plus a bonus based on sales.

By the 1910s, though, Ford had abandoned direct selling. Ford could not open branch houses fast enough to meet demand, nor could it find enough qualified people to staff the branches. More crucially, Ford officials concluded that salaried employees were not sufficiently motivated to sell cars. According to an industry analyst writing in the 1920s, "If a dealer has a financial interest in his own company, he is found to be much more satisfactory than a branch manager, who has practically no financial interest in the branch."

As discussed in more detail later in this report, the dealer franchise system emerged as a way for the automakers to market, finance, and service motor vehicles. Dealers are independent businesses that enter into contracts with the manufacturers to represent those manufacturers, selling and servicing their cars locally. Most of the investments and capital risk of providing these services are borne by the dealer.

Over time, state legislatures in every state passed franchise laws to govern the relationship between dealers and manufacturers. The goal of these laws, which are not uniform, is—in the eyes of the dealers—to equalize the relationship between small businesses (i.e., the dealers) and large companies (i.e., the manufacturers). According to James Surowiecki, the laws have had their desired effect:

These laws do things like restrict G.M.'s freedom to open a new Cadillac dealership a few miles away from an old one. More important, they also make it nearly impossible for an auto manufacturer to simply shut down a dealership. If G.M. decided to get rid of Pontiac and Buick, it couldn't just go to those dealers and say, "Nice doing business with you." It would have to get them to agree to close up shop, which in practice would mean buying them out. When, a few years ago, G.M. actually did eliminate one of its brands, Oldsmobile, it had to shell out around a billion dollars to pay dealers off—and it still ended up defending itself in court against myriad lawsuits. As a result, dropping a brand may very well cost more than it saves, since it's the dealers who end up with a hefty chunk of the intended savings.

Under the franchise system, the manufacturers and dealers have found different ways to make money. All dealers are not the same; some have one or more large stores selling one or more brands in one or more metropolitan areas, while others operate smaller dealerships in towns or rural areas. Some dealers focus more on selling new cars and others put more attention on service and selling used cars.

… G.M. makes money (when it does) on new cars and on the financing of loans. Dealers, by contrast, make most of their money on servicing old cars and selling used ones. So dealers can thrive even when the automaker languishes. And at the state level they often have more political influence than automakers do. In the late nineties, for instance, local dealers were challenged by companies that wanted to sell cars over the Internet. In response, some states, including Texas, actually passed laws making it illegal to have a business selling cars online (unless you already owned a local dealership), and regulators told Internet companies to cease and desist. When Ford itself started experimenting with online sales, dealers' vigorous objections (along with legal challenges) caused the manufacturers to quickly retreat.

More than 57% of dealer sales stemmed from new vehicles, nearly 29% from used-car sales, and more than 14% from service and parts sales in 2008. New-vehicle sales, however, are becoming an increasingly less profitable segment of the dealer business. Dealer profits in new-car sales have evaporated and, since 2005, dealers have generally not made a profit on their new-car departments, "slipping below breakeven." Used-car sales and service work result in greater profits. According to the NADA, dealers make an average of more than $100,000 on used-car sales and as much as $350,000 through their service and parts departments.

Changing Profile: Domestic and Foreign Auto Dealership Strength, Size, and Economic Impact

In 2007, U.S. new-car auto dealers sold more than $758 billion in motor vehicles, directly employed over 1 million men and women, and supported an annual payroll of over $54 billion. New-car dealerships have a substantial presence in their communities, with an average of 54 employees, receiving wages of $48,339 a year per employee, for an average dealer payroll of $2.6 million. There is a wide variance in dealer size and performance in different states. For example, the average sales per new-car dealership range from $71 million in Arizona to less than $16 million in Vermont. California has nearly 1,500 new-car dealers, and Alaska has 35.

Total U.S. auto industry sales have been on a downward trajectory for nearly a decade. As shown in Table 1 , in 2006 and 2007 there were over 16 million new cars and light trucks sold in the United States, but only 13.2 million units were sold in 2008 and 10.4 million units in 2009, the lowest annual sales since 10.35 million were sold in 1982, also a recession year. Although the seasonally adjusted annual sales rate in the first six months of 2009 was only 9.5 million new vehicles, the cash for clunkers program in July and August and a rise in sales in December helped boost the annual sales of new vehicles for the full year.

According to some analysts, U.S. auto sales may not return to more than 12 million units per year until 2012 or later. U.S. auto dealers, automotive manufacturers, suppliers, and workers have all been directly affected by the national recession, credit crisis, and the deteriorating economic situation in the United States. The result has been the worst consumer-spending slump since the 1940s and the worst market for automobile sales since 1982.

Donald Grimes, a University of Michigan economist notes that from 1970 to 2001, there were 0.76 vehicles sold per driver in the United States and that the figure has now dropped to 0.4 vehicles per driver—with little prospect for a rebound in coming years. The decline in auto sales is attributable to a range of factors that affect the number and size of cars sold, including volatile gasoline prices, tight credit markets for auto dealers and customers, declining consumer confidence, concerns over personal discretionary spending, and high unemployment rates. The finance arms of the manufacturers have faced higher than normal capital costs reflecting the credit risk posed by the Detroit 3.

As a result of these factors, the average dealership profile indicates total sales of over $33 million in 2004 dropped to just under $29 million in 2008. In the same years, the net profit before taxes for the average dealer was $559,000 and $280,000, respectively. Auto dealer industry analysts predict that if prevailing unfavorable economic conditions continue, and, in particular, if the availability of automotive loans remains limited to those customers with higher credit ratings, this could affect the ability of some consumers to purchase cars. Thus, vehicle sales and margins of the auto dealers could continue to be adversely affected. The recession has resulted in reduced sales and profits for all auto dealers and accelerating consolidations. Market share has also shifted away from GM and Chrysler to foreign-owned automakers as concerns about their bankruptcies cut into their sales.

Auto Dealers as an Economic Force

The nation's auto dealers are a significant economic force in the U.S. economy. Their $758 billion in revenue in 2007 makes the auto dealer retail industry one of the largest retail sectors in the United States, comprising 19% of the $4 trillion in retail sales that year. Retail sales by the nation's auto dealer industry exceeded the retail sales of other large retail industry sectors, including general merchandise stores, food and beverage stores, and gasoline stations (see Figure 1 ). Combined U.S. auto dealers (new- and used-car dealerships) accounted for 7.9% of total retail employment, directly providing jobs for an estimated 1.2 million American workers in 2008, based on preliminary employment statistics from the U.S. Department of Labor.

The auto dealer industry consists of two segments, new and used vehicles, with some overlap. New-car dealers, with revenues of $677.2 billion in 2007, are the larger segment, often called franchise dealers, who primarily sell new cars, sport utility vehicles (SUVs), pickup trucks, and passenger and cargo vans. They retail these new vehicles in combination with other activities, including warranty and non-warranty repair services, and selling used cars, replacement parts, and accessories. Virtually all new automobiles, light trucks, and vans bought in the United States are sold through franchise dealers. They sell and lease vehicles manufactured by one or more auto companies (e.g., Ford, Chrysler, GM, Toyota, Honda). New-car dealers also sell additional automobile-related services to potential buyers, including extended warranties, insurance, and financing. New-car dealers are selling proportionally more used cars than ever before. According to an estimate by the NADA, employment of salespersons alone apportioned to used cars at new-car dealerships is over 70,000 employees, with new-car dealers selling about 12 million used cars to retail customers in a strong year and 10.5 million in a slower one.

The other segment of the industry comprises car dealers who sell only used cars and trucks. With sales of $82 billion in 2007, they are often referred to as independent dealers because they do not have a franchise agreement with a manufacturer. Independent dealers sell a variety of vehicles that have been previously owned or formerly rented and leased. Used-car dealerships are a viable business today due to improvements in technology which have increased the durability and longevity of new cars and have raised the number of high-quality used cars that are available for sale.

Auto Dealerships and Related Employment

There was steady growth in employment among dealerships for over a decade. However, employment began to drop in 2005, caused in part by dealership consolidation. As shown in Figure 2 , there were 24,825 new-car dealers in 1990, dropping to just over 20,000 in early 2009. NADA estimated that by the end of 2009, the number of dealers would fall below 17,000.

The number of dealerships tends to fall during recessions, much like employment in the rest of the auto industry, and tracks national employment trends. (For a table showing the number of new-car dealerships by state, see Appendix A .)

U.S. government statistics indicate that new-car dealers employed more than 1 million workers in 2008, accounting for 89% of total auto dealer employment. Used-car dealers employed 126,300 workers, comprising the remaining 11%. Together, new- and used-car dealers employed nearly 1.2 million workers in 2008. Employment levels at the nation's dealerships dropped by 5% between 2007 and 2008, based on 2008 statistics from the Bureau of Labor Statistics. This was the biggest decline recorded since 1991, when auto dealership employment contracted more than 5% over the previous year.

The consolidation of dealerships parallels two other trends in the industry. First, the recession and the elimination of a large number of GM and Chrysler dealers are changing the balance of dealerships. In January 2008, the Detroit 3's U.S. dealerships totaled 14,199, but by January 2009 (even before the elimination of the Chrysler dealerships and the 2010 closing of GM dealerships), they had shrunk to 13,220. In contrast during the same time period, import-badged dealerships selling just one import brand (e.g., just Toyota or Honda, but not two or more brands) grew from 6,463 to 6,544 dealerships. This trend accelerated in 2009 and into 2010 with the closure of over 2,000 GM and Chrysler dealerships and the sale of GM's Hummer and Saab divisions and their corresponding dealerships. Hummer and Saab dealerships will now sell vehicles produced by their new owners. Saturn dealers will close, sell used cars only, or contract with another automaker to sell its vehicles. GM's Pontiac brand is also being terminated, but there was no effort to sell it to a third party.

The make up of the foreign-badged dealerships differs significantly from the Detroit 3's dealer networks. As shown in Figure 3 , nearly half of Honda's dealers are in metro areas, whereas a quarter of Chevrolet dealers are in those markets (in part reflecting the Detroit 3's strong position in light trucks). While GM, Ford, and Chrysler have far better representation in rural areas than the Asian automakers, urban areas are where population and incomes are generally growing faster.

Second, as the auto industry has matured, the nature of dealerships has also changed. Consolidations are creating larger dealerships as size and financial capabilities, especially in urban areas, become increasingly more important factors in the ability to compete successfully. As shown in Figure 4 , the loss of dealerships is concentrated in the smaller-volume categories. In 2008, more dealers sold at least 750 cars a year (6,142 dealerships) than those selling fewer than 150 cars a year (3,336 dealerships).

Some dealers see the advantage of the consolidation, which they maintain will enhance the competitiveness of the remaining dealers. Mike Jackson, CEO of AutoNation, the largest U.S. dealer group, which had seven of its Chrysler dealerships terminated, said recently, "dealer consolidation is a necessary measure in today's automotive industry, and will strengthen America's dealer network and improve dealer profitability over the long term."

The recession and the GM and Chrysler reductions in their dealership networks have also accelerated this trend. In June 2009, NADA estimated that the recession would have prompted the loss of about 1,200 dealers and that the GM and Chrysler reductions will double or triple the number of dealers who will have changed hands or gone out of business.

Auto dealer employment at nearly 1.2 million is larger than the number of workers employed in the entire automotive manufacturing industry, which employed 880,000 people last year. Within the auto assembly sector, GM, Toyota, BMW, Ford, and other assemblers employed an estimated workforce of 166,000 workers in 2008 (see Figure 5 ). The largest sector in automotive manufacturing is the motor vehicle parts manufacturing industry, with employment totaling an estimated 541,100 workers, according to U.S. government data.

That there are so many more workers in auto parts manufacturing is a result of extensive outsourcing by automakers over the past 20 years. At one time, the Detroit 3 made most parts themselves. This changed over time so that a majority of the 15,000 or so parts in a car or truck are today purchased from other companies (such as Dana, Delphi, American Axle, and Lear) and assembled into a finished car or truck by the automakers. Outsourcing of parts; the application of new technologies, such as robotics and computers; and the resulting rising productivity have greatly diminished the amount of labor needed to produce an automobile.

Within the auto supply chain, auto dealer employment has increased since 1990, rising from 989,000 to 1.2 million, posting an increase in employment of 19% by 2008 (see Figure 6 ) and in line with the general economy. By comparison, the overall increase in private sector employment between 1990 and 2008 was 25%, while retail trade employment grew by 14% during the same time period. These statistics are in sharp contrast to auto and auto parts manufacturing employment, which dropped by 21% between 1990 and 2008, declining from 1.1 million to an estimated 880,000. Within this category, employment at just the auto assemblers, such as GM and Ford, posted an even greater drop of 27% during the same time period, falling from 228,800 workers to 166,000.

Franchise dealers are significant contributors to the economic health of local and state economies. Bureau of Labor Statistics data shown in Table 2 below highlights five states—California, Texas, Florida, Pennsylvania, and New York—where the auto dealer industry in each state employed more than 50,000 workers in 2008; it exceeded 100,000 in California and Texas. In many states, dealer employment comprises a sizable share of total retail employment. For example, in Georgia, the 37,000 auto dealer employees account for 7.9% of all retail employment. Other states where auto dealers comprise a significant share of total retail trade jobs are Delaware (8.9%), Maryland (8.8%), Oklahoma (8.6%), and Virginia (8.6%).

Motor Vehicle Financing and State Franchise Laws Define Modern Dealerships

Floorplan Financing

Without financing, virtually no automobiles would be sold in the United States, either to dealers or to consumers. It is a vital component of the manufacturer-dealer-consumer value chain. Dealers buy cars from the automakers using financing, and 90% of consumers take out a loan to buy their car. With the credit crisis of fall 2008, this system broke down.

An integral part of the franchise system is floorplan financing. When automakers sell cars, the dealers serve as the intermediary between the manufacturer and customer. Dealers have traditionally used the manufacturers' finance arms (e.g., GMAC, Chrysler Financial, Toyota Motor Credit) to purchase the automobile inventory from the manufacturers. These loans are called floorplan financing.

When customers purchase cars or trucks from dealers, auto company financing also plays an important role. Through the finance arm of the manufacturers, auto dealers also provide their customers with retail financing from companies like Ford Motor Credit or GMAC. Those customers who do not want to purchase a vehicle with cash or do not use a credit union or an alternative source of credit frequently use auto dealer arranged financing. Much of the floorplan and retail financing for GM and Chrysler vehicles is provided by GMAC, which absorbed Chrysler Financial when Chrysler went into bankruptcy. Prior to that bankruptcy, Cerberus Capital owned 80% of Chrysler LLC, including its finance arm, Chrysler Financial. Both GMAC and Chrysler Financial were formerly captive companies, wholly owned by the automakers. Cerberus paid $14 billion to GM for a 51% stake in GMAC in November 2006. As described below, the majority share of GMAC is now owned by the federal government. Other auto financing companies, such as Ford Motor Credit Company and Toyota Financial Services, are still wholly owned by the automakers.

As the 2008 banking crisis intensified, floorplan and retail financing were seriously affected because the financing companies were unable to raise the capital to fund the manufacturer-dealer-consumer pipeline. A key component of the federal government's auto support program has been a recapitalization of GMAC and Chrysler Financial, the two financing companies. As part of this restructuring, GMAC entered into an agreement with Chrysler LLC in April 2009, to provide floorplan and customer financing for Chrysler dealers and customers. Over $16 billion in federal assistance has been provided to GMAC since December 2008, in an effort to jumpstart the flow of financing to dealers, including $3.8 billion provided in January 2010. In return for the U.S. Government recapitalizing GMAC, the U.S. Treasury now owns approximately 56% of the company, while Cerberus owns 15%, third party investors own 12%, General Motors owns just under 7%, and a blind trust owns nearly an additional 7% of GMAC. GM must sell its ownership of the trust by the end of 2011 in return for the GMAC bank holding company license it received in 2008.

Private sector and government efforts to revive floorplan and retail financing met with limited success in 2009, and dealers have been constrained by the amount of funding available to them and their customers. Many banks have exited the auto financing market, further tightening credit availability. While zero percent retail financing has been widely advertised, it has been available mainly for those customers with excellent credit.

Other Financial Steps to Aid Dealers

In addition to support for the financing companies, the federal government has taken other steps that have provided help for dealers and dealer financing—although not always as successful as envisioned—including:

Warranty commitment . In March 2009, the Obama Administration announced a new "warrantee commitment program" to assure potential vehicle purchasers that new-car warranties would be backed by the federal government during the period in which GM and Chrysler were being restructured. Whatever the status of the companies, even in bankruptcy, any vehicle warranty offered by the companies would be "back-stopped" with federal support. Treasury ended this program after the new GM and new Chrysler were formed. Small Business Administration (SBA). Through the SBA's 7(a) loan program, the Dealer Floorplan Financing (DFP) pilot program permits government-guaranteed loans to be issued to finance dealer inventories for autos (as well as recreational vehicles, boats, manufactured homes and other dealerships). Starting July 1, 2009, this new program has allowed dealers to borrow from banks against retail inventory and "acts as a revolving line of credit for a dealer to obtain financing for retail goods. The dealer repays the debt as its inventory is sold and can borrow against the line of credit to add new inventory." The DFP makes individual loans of up to $2 million available. Many dealers believe the cap undercuts the usefulness of the program, and President Obama has asked Congress to raise it to $5 million. Term Asset-Backed Securities Loan Facility (TALF) . The Federal Reserve announced in December 2008 that auto dealers could participate in a new $200 billion loan facility to finance inventory purchases. TALF is not a source to which dealers can apply to obtain floorplan loans directly, but it helps by reopening the floorplan securitization market and in turn providing capital to banks and other floorplan lenders so they can extend better credit to auto dealers. This facility has had limited success. According to NADA, "Unfortunately, because the funding is limited to AAA-rated securitizations and many dealer floorplan securitizations were recently downgraded below AAA, the initial funding of the TALF is not expected to significantly enhance the availability of credit for floorplan loans. Nevertheless, the initial funding is assisting in the availability of retail auto credit." Consumer Assistance to Recycle and Save Act of 2009 (CARS Act; P.L. 111-32 ) . In June 2009, Congress passed a $1 billion "cash for clunkers" bill to stimulate the purchase of new cars for the period July 1 to November 1, 2009. Unlike some other initiatives, this program exceeded expectations and the program reached its maximum support level within a week of regulations being issued, prompting Congress to pass an additional $2 billion appropriation that carried CARS through until the end of August. Nearly 700,000 vehicles were sold during the summer, and it is estimated that most of them would not have been sold without the federal rebate. A website— http://www.cars.gov/ —was established by the National Highway Traffic Safety Administration (NHTSA) to explain the cash for clunkers program to the public.

State Franchise Laws

Over the years, all 50 states and the District of Columbia have adopted franchise laws governing contracts between independent auto dealers and the manufacturers they represent. Initially these laws were passed to level the playing field between auto manufacturers and dealers. However, auto manufacturers and dealers often do not see eye to eye on the reach of these statutes. Dealers say they need protection from termination without cause, while auto manufactures claim they need more flexibility to improve the distribution of their automobiles and their ability to react to changing market conditions.

Evolution of the Automobile Franchise System

As the motor vehicle industry developed, automotive manufacturers quickly realized that a distribution system was needed to outsource the costs associated with vehicle retailing and maintenance. The early automakers viewed dealers as a source of cash and sales experience, and as a way to increase their businesses with minimal expenses. Thus, the automobile manufacturers moved to set up franchise arrangements to sell their products. This gradually evolved into the franchise dealer system.

Franchise agreements cut the cost of the middleman and gave manufacturers greater control over how their cars were sold. The first franchise agreements were vague with many of these agreements benefitting the automotive manufacturers at the expense of the dealers. Generally, the auto manufacturers had the superior bargaining position and were able to gain control over much of the dealer's operations. Auto dealers were exclusive agents of automakers. In exchange, according to auto industry economist Lawrence Seltzer, the car manufacturers imposed tough conditions on dealers, including requirements such as payment of huge cash deposits when dealers ordered vehicles, payment upon delivery of the automobiles by the dealers, and acceptance of cars regardless of market conditions.

Prior to 1940, automobile dealer agreements typically were on a year-to-year basis and were also subject to unconditional cancellation by the manufacturer. In return, the dealers agreed to provide suitable facilities and their best energies to sell the cars. Dealers could carry as many brands as they wanted, but they were restricted to an assigned selling territory and had to sell the cars at the price specified by the manufacturer. Responding to pressure from NADA to investigate the auto industry, the Federal Trade Commission (FTC) conducted a study in the late 1930s that criticized the power that manufacturers could exert over dealers. A 1939 FTC report concluded that the automobile franchise agreements were unfair and noted that the franchise agreements were "between parties of very unequal economic bargaining power. The terms of the agreements were set by the manufacturer." In the same report, the FTC criticized dealer practices that were not in the interests of consumers, pointing to practices such as price fixing, padding new-car prices, and packing finance charges.

Automobile Franchising Laws at the National and State Level

Because of the perceived inequality in the relationship between the auto manufacturer and auto dealer, states began to enact statutes pertaining to the regulation of automobile distribution, with Wisconsin being the first in 1937. Almost 20 states had dealer franchise laws in place regulating some aspect of the auto manufacturer and auto dealer relationship before a federal measure was enacted on auto franchising. Despite these state laws, there were continued concerns about the business issues arising from the inequality of power between the manufacturers and dealers.

U.S. Automobile Dealer's Day in Court Act

In 1956, after nearly two decades of demands for federal automobile dealer legislation by NADA, national legislation was passed by Congress. The Automobile Dealer's Day in Court Act (the Dealer's Act) provides for legal remedies for dealers harmed by the actions of manufacturers that are not in good faith, the so-called good faith law, in complying with or performing the terms of the franchise agreement, or in terminating, canceling, or not renewing the franchise agreement.

Auto dealers contend that the 1956 federal law has not been effective in protecting them. According to a study of the Dealer's Act by NADA, dealers attained relief in about 20 of 115 cases they filed in the law's first 30 years. Since the passage of the Dealer's Act, which the dealers maintain did not give them protection from the abusive and coercive practices of the auto manufacturers, all the remaining states and the District of Columbia have enacted automobile dealer legislation. In 2002, Alaska was the last state to pass legislation on dealer franchises. The state-level auto franchise laws have been scrutinized by the courts and the statutes have been upheld by them.

State Automobile Franchise Laws

The main instrument at the state level for regulating auto dealers' operations is each state's motor vehicle franchise law, which often goes into considerable detail about the relationship between auto manufacturers and dealers. The dealerships are seen as a heavily regulated sector, particularly when compared to franchisees in other industries. The business relationship between auto dealers and manufacturers has been subject to a level of regulatory scrutiny not found in many other industries. For instance, states such as Texas and North Carolina have asserted that the smooth operation of the retail auto industry has such broad economic implications that it is a matter of public interest, and thus requires a unique set of laws.

Auto dealer franchise laws vary from state to state, and states regularly amend them. Generally speaking, state laws typically cover a much broader range of conduct than the Dealer's Act and provide for certain obligations on how car manufacturers must interact with their dealers. They typically address a range of issues in the franchise relationship, including:

relevant marketing area (RMA) laws which define the geographic area within which a new-car dealer is presumed to be directly competing with existing dealers; the administration of warranty claims; level of investments made by dealers; new cars, parts, and specialty tools to be purchased by dealers; the allocation and delivery of automobiles; and the mechanism for terminating a franchise.

A central concern in many of the state automobile franchise laws is the manner of and terms for termination, cancellation, or nonrenewal of the dealer relationship. Typical state franchise laws can require "a manufacturer to show good cause in order to terminate a dealer agreement, provide a framework for determining fair value of the franchise terminated, and establish basic rights of succession from generation to generation." Some state franchise laws (e.g., Massachusetts, California, New Jersey, North Carolina, and Virginia ) also place limitations on the manufacturer's ability to place new dealers in an existing dealer market area without first giving the dealer notice and an opportunity to protest the action. Automakers assert that some of these state franchise laws make it difficult and costly for them to adjust to changing market conditions.

According to the NADA, the state franchise laws were enacted to create a more level playing field to "address the vast disparity in the bargaining position between a dealer and its manufacturer." Others view these laws as having shifted too much power in the relationship to the dealer. For example, in many states, state franchise legislation restricts the auto manufacturer's ability to terminate its relationship with a dealer. While effectively preventing a manufacturer from arbitrarily and unfairly terminating a dealer, some experts contend that the termination provisions that exist in many state automobile franchise laws are a key reason for the existence of too many dealers. In other instances, some state franchise laws "protect the dealers by making it unlawful for the auto manufacturers to engage in coercive behavior, such as forcing the dealers to take unwanted and unordered vehicles, parts, and accessories."

Auto manufacturers argue that it is becoming increasingly more difficult for them to comply with more recently enacted state franchise laws. They claim that these state laws severely constrain their ability to operate their businesses efficiently and strategically. Increasingly automakers contend that, in addition to state level automobile franchise laws making it hard for them to adjust to changing market conditions, these laws also benefit the narrow interests of traditional franchise dealers at the expense of consumers, manufacturers, and other retailers. For instance, in 2002, 45 states did not allow manufacturers to sell cars directly to consumers in competition with their dealers (e.g., over the Internet). As a result of such restrictive legislation, some argue that automakers are unable to develop more efficient ways to sell cars to consumers. According to Gerald Bodisch, an economist at the Antitrust Division of the U.S. Justice Department:

Perhaps the most obvious benefit from direct manufacturer sales would be greater customer satisfaction, as auto producers better match production with consumer preferences ranging from basic attributes on standard models to meeting individual specifications for customized cars. With better information about consumer demand, optimal inventory levels should fall, even short of full build-to-order capability by auto manufacturers.

Bodisch goes on to note:

The total value of new car inventory held by the 20,700 franchise new car dealerships in the United States near the end of 2008 was about $100 billion and the annual carrying cost of that inventory was estimated as $890 million. These figures may provide an order-of-magnitude perspective of the savings potential from a reduction in inventories that might derive from direct manufacturer sales of autos.

The issue of automobile franchise laws remains hotly contested. Beyond existing state-level dealer franchise legislation, about two-thirds of the state legislatures are considering new dealer franchise laws, including California, Colorado, New York, South Carolina, Texas, and Washington, as auto dealers continue to press to strengthen statutes that benefit them on such matters as warranty rate reimbursement and post-termination assistance.

The General Motors and Chrysler Bankruptcies: Impact on Dealers

Detroit 3 in Crisis

The global recession and credit crisis have caused serious problems for automakers all over the world, but none have been affected as much as the Detroit 3. GM and Chrysler have gone through bankruptcy; Chrysler is now managed and partially owned by Fiat, while 72.5% of GM is owned by the U.S. and Canadian governments. Ford Motor Company narrowly avoided bankruptcy because it took steps several years ago to shore up its finances. From two-thirds of the U.S. market for passenger cars in 2000, the Detroit 3 share fell to less than half in 2008, with foreign-owned companies making steady inroads.

In the fall of 2008, the combination of rising gasoline prices and a full-blown credit crisis and the recession it spawned created a major downturn in automobile sales in the United States and abroad, with 2008 sales 30%-40% lower than a year before. U.S. auto sales fell to a 26-year low, from a high point of 17.3 million cars and light trucks in 2000 to 13.2 million in 2008. Sales fell much further in the first half of 2009 and were 10.4 million units for all of 2009. Many analysts say that recovery to 12 million units is several years away.

In light of the market turmoil and credit contraction, the weak financial base of both GM and Chrysler led them to seek federal assistance. The path to federal assistance and the congressional and Administration steps to encourage restructuring outside of bankruptcy are detailed in CRS Report R40003, U.S. Motor Vehicle Industry: Federal Financial Assistance and Restructuring , coordinated by [author name scrubbed]. While both companies succeeded in obtaining new contracts with their unions and most of their creditors, they were unable to reach agreement with all creditors.

Paths to Bankruptcy

General Motors and Chrysler submitted viability plans to the Obama Administration in mid-February 2009, to demonstrate how they would work their way out of their financial situations. At that time, the federal government had already provided GM with a $13.4 billion loan and Chrysler with $4 billion. These funds were inadequate to stem the losses caused by these two companies' precarious finances and the deteriorating economy. The incoming Obama Administration asked for viability plans on which it would base further federal assistance. The viability plans submitted by GM and Chrysler in February 2009 were rejected by the Administration at the end of March 2009 as inadequate. Chrysler was given 30 days, until April 30, 2009, and GM was given 60 days, until June 1, 2009, to develop comprehensive restructuring plans, including the dealer network. During this time, the Administration's Auto Task Force worked closely with the two automakers to line up stakeholders so that bankruptcy could be avoided.

The companies were unable to complete their restructuring in the time allotted. Chrysler filed for bankruptcy on April 30, 2009, and GM followed a month later on June 1, 2009. The Chrysler and GM proceedings went swiftly. A new entity, formed in part by Fiat, purchased most of Chrysler's assets in mid-June and then changed its name to Chrysler Group LLC. In early July, the sale of most of GM's assets to a new entity named "General Motors Company" was approved. The new automakers are smaller companies that have fewer plants, workers, and, in some cases, brands than did the former GM and Chrysler.

Other parts of the auto supply chain have been affected by the downturn in auto sales as well. During the first half of 2009, at least 15 auto parts suppliers have sought Chapter 11 protection, including two of the largest auto suppliers, Lear Corporation and Visteon, as well as Cooper-Standard and Metaldyne. An increasing number of smaller auto suppliers are also going out of business or filing for bankruptcy as the restructuring process and the months-long closure of GM and Chrysler plants left them with few backup financial resources and limited prospects for quick or large increases in car and light truck production.

Terms of Restructuring Affects Dealer Networks

As part of its restructuring plan, Chrysler terminated 789 of its 3,200 dealers in June 2009, and General Motors announced that it would reduce its dealerships from over 6,000 dealers to 3,600 when contracts expire in October 2010. The Auto Task Force, in rejecting the companies' viability plans in March, cited a number of steps the manufacturers should accelerate, including reducing the number of dealers, while leaving the details of such reductions up to GM and Chrysler management.

Chrysler and GM have argued that reducing the size of their dealer networks will be a key ingredient in the success of the new automakers. Many dealers across the country are opposed to the size and scope of the reductions. In addition, many Chrysler dealers have objected to the short wind-down period (26 days) and lack of appeals process; some GM dealers voiced objections to the allegedly onerous terms of wind-down agreements (for dealers to be terminated) and performance agreements (for dealers continuing with GM). Many Members of Congress have been made aware of these concerns from dealers in their districts and states.

Dealers presented their cases before the U.S. Bankruptcy Court judges who are adjudicating the Chrysler and GM bankruptcies, asking the court to alter the dealer terminations planned by both companies. The bankruptcy judges rejected such changes. As part of its bankruptcy proceedings, Chrysler rejected contracts with 789 dealers. The new entity purchased Chrysler's assets without assuming those rejected contracts. See Appendix B for a table showing the number and state breakout of dealerships closed by Chrysler and announced for closure by GM. Ford Motor Company, by contrast, which is neither receiving federal funds nor in bankruptcy, has said that it does not intend to significantly trim its dealer network.

Congressional Hearings: Chrysler and General Motors Arguments for Terminating Dealers

In June 2009, hearings on dealer closings were held by the Senate Commerce, Science, and Transportation Committee and the House Energy and Commerce Committee's Subcommittee on Oversight and Investigations. GM and Chrysler leadership faced off against auto dealers and the NADA.

At these hearings, GM's then-president and CEO Fritz Henderson and James Press, then-vice chairman and president of Chrysler LLC, addressed the importance of dealer closings to their restructuring efforts. The main points made by the automakers included:

Market realities have changed . The companies say that cutting their dealer network is an essential element of their restructuring and downsizing in response to a U.S. auto market that has shrunk from 16 million light vehicle sales in 2007 to around 10 million in 2009. The automakers cite projections used in their February 2009 viability plan that the market will recover to no more than 10.8 million units annually by 2012. GM's president stated that its market share has shrunk dramatically since the 1950s when many dealer franchises were opened and that GM now has too many dealers compared to the competition. Mr. Henderson said, "GM today has roughly 6,000 dealerships in the U.S. compared to 1,240 for Toyota and 3,358 for Ford." All segments of the GM and Chrysler auto making and auto marketing industry are downsizing . The automakers, their employees, suppliers, and dealers are all going through the most difficult economic climate since the Great Depression. Sacrifices are required of all parties. Chrysler cites the remarks of Bankruptcy Judge Gonzalez, who presided over its bankruptcy filing:

The underlying argument of many opposing the transaction is not against the Government Entities' involvement. Rather, it is a desire to have the Governmental Entities protect every constituency within the auto industry from economic loss, and not to limit the protection to those interests that the government perceives as being essential to the survival of a successful "New Chrysler." For example, any dealership rejection that is approved will cause hardship to the particular dealership involved, but may well be necessary if New Chrysler is to survive. These are the kinds of economic decisions that have to be made in every bankruptcy case.

Parts of the current GM and Chrysler dealer networks are underperforming and hurting sales . Mr. Press said that the Chrysler dealer network "is not profitable and therefore not viable." Poor performing dealers cost them customers. He noted that in 2008, the average U.S. automotive dealer made a profit of $279,000, according to NADA, but Chrysler dealers lost $3,431. The per-franchise annual breakdown of sales for major automakers is shown in Table 3 , showing the big disparity between Chrysler, GM, and Ford compared to the foreign-owned car makers. For example, Chrysler's unit sales of 181 cars per franchise were below Toyota's comparable 1,523 units. Chrysler asserts that even with the terminations, it is retaining 86% of its dealer network and that customers will only have to drive an average of 11 miles to reach a Chrysler dealer, compared with 19 and 25 miles, respectively, for Toyota and Honda customers. GM states that the main goal of the dealer changes is not to reduce costs, although that is a factor. The main reason is to create "a healthy, strong and profitable dealer network …"

Brand focus is part of the recovery strategy. Chrysler's Project Genesis seeks to increase the strategic effectiveness of the dealer network by bringing all three brands—Chrysler, Dodge, and Jeep—under one roof. Some dealers are being terminated because they do not fit this profile. Both companies are also seeking to end dual dealerships, where a Chevy dealer may be paired with a Nissan dealer, for example. GM and Chrysler want their dealerships to focus solely on their brands and some dealerships do not now fit that business model. There are cost savings from the dealer reductions . Chrysler's president outlined several costs resulting from the dealer network. He said "excess dealerships are costly in several ways." Maintaining multiple distribution systems is inefficient and costly. Marketing and advertising message are split among too many products. GM also cited costs for information technology systems and sales incentives. Mr. Press cited these costs and lost revenues: product engineering and development of $1.4 billion over four years to develop "sister" vehicles such as the Dodge and Chrysler minivans; lost sales due to dealer underperformance of $1.5 billion annually; administrative costs of $33 million annually to maintain the 789 dealers; and marketing and advertising costs of $150 million annually. Process and Local Impact . The automakers say that a rigorous and thoughtful process was used to select dealers for termination, including total sales, customer satisfaction reports, a dealer scorecard, quality of the dealer facility and location. GM has provided an appeals process for dealers; more than 50 have been reinstated. GM and Chrysler maintain that the potential job loss associated with dealer closings has been exaggerated. Chrysler estimates that nearly 30,000 people are employed in the 789 terminated dealerships but 44% of those dealers sell other types of vehicles and are expected to remain in business. In addition, 84% of dealerships sell more used vehicles than new and they are likely to retain their profitable used-car businesses after termination.

Dealer Counterpoints to the Automakers

At the June 2009 House and Senate committee hearings, NADA also testified about the dealer closings. At those hearings, NADA Chairman John McEleney addressed the industry's perspective on the dealer closings and why they would be counterproductive to the recovery of GM and Chrysler. In his testimony, he argued that:

Transparency of decision-making about dealers has been poor . There has been too little transparency in the decision-making of the Treasury Department's Auto Task Force. While NADA criticized the Auto Task Force in May 2009 for demanding "the rapid and disorderly elimination of thousands" of Chrysler and General Motors dealers, relying on "a dangerous misperception that new car dealers somehow create a cost burden to auto manufacturers." NADA says that dealers are the primary source of revenue for automakers and bear most of the costs associated with selling and servicing motor vehicles. NADA also contends that the May 14, 2009, announcements by GM and Chrysler that more than 1,900 dealers would be closed were drastic, and lacked an objective standard and public accountability. The companies had not previously indicated that such large reductions were in the works. Dealers were under the impression that Chrysler, for example, would follow the patterns set by its ongoing Genesis program which, NADA observed, "relies principally upon negotiated transactions based on conditions in the local market." With only 26 days to dispose of inventory and close as Chrysler dealers, the 789 companies subject to termination were faced with a chaotic situation. Dealers contend that this short wind-down period was unfair and inconsistent with state franchise requirements. Mr. McEleney said, "the franchise agreement requires the manufacturer to buy back vehicles, parts, and tools. No manufacturer has ever imposed such onerous conditions on terminated dealers." He said that GM's request that dealers who will be terminated sign wind-down agreements has onerous conditions, and the performance agreements GM has asked continuing dealers to sign are too vague, leaving dealers open to undefined financial commitments. A larger number of dealerships will lead to more sales of GM and Chrysler products. Dealers say that cutting dealerships will not make GM or Chrysler more successful. Mr. McEleney notes that dealers "generate more than 90% of manufacturer revenue. Auto manufacturers created the franchise dealer network to outsource virtually 100% of the cost associated with selling and servicing cars. A rapid reduction in dealer numbers would further CUT [emphasis in original] manufacturer revenue and market share." In addition, the dealers contend that terminating dealerships means GM and Chrysler will lose the long-standing customer relationships those dealers have built up for their brands in their community. The dealers have been loyal partners with the automakers and many dealerships have been family-owned for generations. Purported administrative savings will not be achieved. Because the franchise system effectively shifts most costs to the dealers, Mr. McEleney says that manufacturers "incur very little costs related to the dealer network. Therefore, few savings are likely to be generated from dealer reductions." Dealers currently absorb costs such as state and local marketing and advertising and employee training. In addition, manufacturers' incentives and shipping costs are determined by the number of vehicles sold, not the number of dealers, so this and other similar costs will not be affected by the elimination of these dealers. State franchise laws are being "eviscerated." These structured bankruptcies are described as having the unprecedented effect of wiping out laws enacted in the 50 states to govern manufacturer and dealer contracts and relationships. Circumventing these laws is seen as threatening even the surviving dealerships by raising the capital risk of future dealer investments. Local impact of terminations will be severe. Mr. McEleney said that the dealer terminations will result in the elimination of nearly 100,000 jobs at dealerships across the country at a time when U.S. unemployment remains high. He asserted "the rapid dealer reductions will adversely affect many lives and many communities." According to Mr. McEleney, fewer dealers mean that state and local governments will lose millions of dollars in auto sales tax revenue. In addition, he said, fewer dealers will mean reduced competition and, in some communities, consumers will have to drive much further to remaining dealers to have their cars serviced. Lack of credit availability remains a challenge . The retail auto industry, says McEleney, is highly dependent on credit availability and has been "disproportionately hard hit by last year's financial crisis." Floorplan financing for dealers "contracted dramatically and even creditworthy dealers are having trouble finding access to floorplan financing."

Legislation in the 111th Congress

Congressional Hearings Held

After the mid-May 2009 announcement by GM and Chrysler that they planned to close approximately 2,000 dealers between them, many Members of Congress began to hear from dealers in their districts and states who were slated for termination. As mentioned in the previous section of this report, committees in both the House of Representatives and Senate held lengthy hearings where GM and Chrysler executives testified, as well as the NADA chairman and several owners of automotive dealerships. At the hearings, some Members of Congress were sympathetic to the concerns of the dealers, citing instances in their districts and states where long-standing dealers had been notified of termination. These hearings served to raise the visibility of the dealers' concerns in Congress and with the media.

Legislative Activity

The rising visibility of the dealers' concerns has led to the introduction of a wide range of legislative proposals. These follow on more limited steps to help dealers that Congress has taken this year, including:

1. SBA Loans . Expanding the SBA 7(a) loan program in the American Recovery and Reinvestment Act of 2009 ( P.L. 111-5 ), to establish a Dealer Floorplan Financing program. 2. " Cash for Clunkers ." Passage of a $1 billion, four-month fleet modernization program (also known as cash for clunkers) in the Supplemental Appropriations Act of 2009 ( P.L. 111-32 ). (A similar $4 billion, year-long program was approved by the House prior to the vote on the Supplemental Appropriations, but this provision was not enacted into law.) Congress passed an emergency $2 billion extension of the program when it became clear that the $1 billion limit had been reached in only one week; H.R. 3435 was signed by the President on August 7, 2009 ( P.L. 111-47 ), and ran until late August 2009, when the funds were exhausted. 3. Reversing Dealer Terminations . On July 7, 2009, the House Appropriations Committee adopted by voice vote an amendment offered by Representative LaTourette that would require automobile companies that receive federal funds and are partially owned by the federal government to reinstate agreements with franchise dealerships to the extent that a valid dealer agreement existed prior to a Chapter 11 proceeding. This amendment to the Financial Services and General Government Appropriations Act, 2010 ( H.R. 3170 ), was reported out of the Appropriations Committee on July 10 and approved by the House on July 16, 2009. Newspaper articles have indicated that the provisions of the amendment would apply to General Motors and Chrysler and their dealers; however, CRS legal analyses question whether it could effect that result.

Representative LaTourette said that the amendment was needed because the bankruptcy judge had undercut state franchise laws and the dealerships have been closed in a "punitive and secretive" manner.

GM and Chrysler opposed the amendment. A Chrysler statement said that it "would jeopardize the new company" and that Chrysler used "sound business judgment" to eliminate 789 dealers. GM issued a similar statement saying that failure to complete dealer restructuring would jeopardize its long-term viability. The Obama Administration also opposed the amendment. The House passed the Financial Services and General Government Appropriations Act, 2010 ( H.R. 3170 ), on July 16, 2009, by a vote of 219-208.

Final legislation affecting the terminated dealers was passed in December 2009 in the FY2010 Consolidated Appropriations Act ( H.R. 3288 ); the earlier LaTourette amendment was replaced in conference committee with an entirely new provision. President Obama signed this appropriations bill on December 16, 2009 ( P.L. 111-117 ). Under the new law, terminated GM and Chrysler dealers are provided the opportunity to participate in a binding arbitration process that must be completed by June 2010.

Under this provision (Section 747 of the Consolidated Appropriations Act), GM and Chrysler must provide each terminated dealer by mid-January 2010 a letter explaining why it was terminated and a summary of this new arbitration process. Affected dealers have 40 days to decide whether to seek arbitration, the costs of which will be split equally between the dealer and the manufacturer. Arbitrators are to be selected jointly by the dealer and manufacturer; negotiations will be held in the state where the dealership is located and, in general, must be concluded by June 2010. The law specifies seven factors that arbitrators must evaluate, some of which were not part of the original criteria used by GM and Chrysler when they developed their original list of dealer terminations. If the arbitrator finds on behalf of a terminated dealer, GM or Chrysler has seven days to send those dealers a letter of intent to enter into business.

4. Administration's Auto Task Force Activities . On July 17, 2009, the House Committee on Financial Services agreed to H.Res. 591 (Boehner), requesting that the President report to the House of Representatives on the work of the Auto Task Force within 14 days of passage of the resolution. It requests that the President transmit to the House all information in his possession relating to specific communication with and financial assistance provided to General Motors Corporation and Chrysler LLC. The legislation specifically asks for all records pertaining to Auto Task Force actions with regard to dealer closures, retiree pensions, and allocation to labor unions of ownership of GM and Chrysler and other restructuring decisions. A similar resolution, H.Res. 462 (LaTourette), requests information relating to Chrysler's restructuring. The committee reported it without recommendation on June 10, 2009.

Other legislation addressing dealer concerns includes:

H.R. 2743 (Maffei), the Auto Dealer Economic Rights Restoration Act and the companion Senate bill, S. 1304 (Grassley). This legislation would restore the "economic rights" of GM and Chrysler dealers, seeking to ensure that state franchise laws would still protect them as the automakers go through bankruptcy proceedings. H.R. 2793 (Kline), the Auto Dealers Pension Fairness Act, would require a report to Congress from the auto task force on GM and Chrysler dealer closings and suspension of certain pension actions until that report is delivered. S. 1253 (Corker), the Auto Dealers Assistance Act, would require reimbursement by GM and Chrysler to closed dealerships, through their federal loans. S. 247 (Feinstein), the Accelerated Retirement of Inefficient Vehicles Act of 2009, a one-year cash for clunkers program that would require the purchase of new vehicles with higher fuel economy standards than some other proposals. Its companion bill is H.R. 520 (Israel). Subsequently, Senator Feinstein introduced S. 1200 , the Short Term Accelerated Retirement of Inefficient Vehicles Act of 2009, which would establish a temporary cash for clunkers program similar to the plan in S. 247 . S. 1135 (Stabenow), the Drive America Forward Act, a cash for clunkers proposal similar to the plan passed in the House in H.R. 2751 . This legislation would authorize $4 billion for a one-year program. H.R. 1606 (Manzullo), the New Automobile Voucher Act, to encourage purchase of new cars. H.R. 2224 (Terry), which would direct SBA to provide dealer inventory financing through the 7(a) program. H.R. 2285 (Peters), the Vehicle Efficiency Heightening Investment Credit to Lift our Economy Act of 2009, which would provide a tax break for a new-car purchase. H.R. 2750 and H.R. 2796 (LaTourette), the Automobile Dealer Economic Rights Restoration Act of 2009, which would require restoration of franchise law protections to GM and Chrysler dealers, prior to bankruptcy. H.R. 3088 (Carson), the Jeremy Warriner Consumer Protection Act, which would require the newly restructured GM and Chrysler to carry liability insurance to cover claims made against them for any defective products produced by their predecessor companies. S.Amdt. 1189 , offered by Senator Hutchison in May 2009 during Senate consideration of H.R. 2346 , the Supplemental Appropriations Act, would have called on Chrysler to allow for a 60-day wind-down of its 789 terminated dealers. The amendment was withdrawn after reassurances about the company's dealer closing process, from then-Chrysler President James Press.

Appendix A. New-car Dealerships by State

Appendix B. Dealerships Announced for Closure by GM and Chrysler