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Manufacturing Industry Updates

Dealing with Dealers after Covid-19: Product Allocation

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Manufactures and suppliers must be careful when adjusting the supply of products to dealers, ensuring that new and revamped product allocation formulas are sufficiently “equitable” amid the coronavirus pandemic. (iStock/Andrei Stanescu)

The Covid-19 pandemic presents a number of challenges for manufacturers and suppliers managing dealership sales and service networks. Business and supply chain disruptions are depressing product output, requiring changes to product allocations and allocation formulas. It is important to execute these changes in a way that does not run afoul of state dealer regulations.  Part of a series, this article focuses on the issue of product allocation

If your company manufactures products and sells them to a network of authorized third-party retail dealers, most states regulate your relationship with those dealers. One common area of regulation involves the allocation of products. State dealer regulations typically prevent suppliers from playing favorites for product allocation, mandating nondiscriminatory allocation formulas. 

The motor vehicle industry hosts the most extensive set of dealer regulations, with similar regulations applicable to the construction equipment, agricultural equipment, powersports equipment and outdoor power equipment industries. State dealer regulations typically contain anti-waiver provisions, ensuring application to dealer relationships notwithstanding the contractual terms of any dealership agreement.

Allocation is typically regulated in state dealer laws using terms like “fair,” “reasonable,” or “equitable.” The meaning of those words is complicated by the context of an ongoing pandemic.  Most states provide some protection for manufacturers when allocation is affected by “conditions beyond the manufacturer’s control.” Product shortages driven by statewide “Stay Home” or “Shelter-in-Place” orders should fall within such safe harbor provisions, but manufacturers and suppliers must tread carefully when realigning a diminished supply with dealer allocation.

Product Allocation Practices

In some cases, product shortages present a mutual issue for both suppliers and dealers.  Decreased demand may lead dealers to favor diminished product allocation.  Manufacturers have a shared interest in preventing a flood of excess products into the market, depressing prices.  Finding the right balance may feel like a high wire act because these same product allocation regulations intended to shield dealers can also be used as a sword against manufacturers.

When dealer relationships sour — especially when dealer performance is a contributing factor — dealerships often blame the manufacturer’s product allocation practices. Dealers argue that any performance problems are because they were not allocated enough products, too many products, or the right mix of products. These allegations are easy for dealers to make because state dealership regulations create an affirmative obligation for an “equitable” allocation of products, and place the burden on manufacturers and suppliers to justify the allocation practices amidst the uncertain times of our ongoing coronavirus pandemic.

One problem facing manufacturers is the manner in which product allocation is intertwined with dealer performance. A dealer that entered 2020 expected to sell 100 units of a product will be unable to meet that sales goal if it is not even supplied 100 units due to supply chain disruptions or plant shutdowns. Thus, it is critical to consider changes to product allocation and allocation formulas in conjunction with adjustments to performance goals.

Illustrating this pitfall is the case of Hyundai Motor Am. v. New World Car Nissan, Inc., 581 S.W.3d 831 (Tex. App. 2019). The case started with a dealer complaint to the Texas DMV in November 2013, with the dealer alleging Hyundai’s allocation methods and performance requirements were unlawful under the Texas motor vehicle dealer law. That led to an administrative hearing, after which the Administrative Law Judge issued a proposed order to the Texas DMV Board (charged with adjudicating state dealer law disputes), in favor of the manufacturer Hyundai. 

The Texas DMV Board rejected the proposed order and instead wrote a new final order favoring the dealer. After appeal, a Texas Court of Appeals in July 2019 reversed and remanded that DMV Board order, holding that the Board overstepped its authority when it rewrote the Administrative Law Judge’s original order. On Feb. 6, 2020, the DMV Board relented, voting to adopt the original Administrative Law Judge proposed order it previously rejected. Hyundai eventually prevailed, but only after seven years of ongoing litigation.

Key to the dispute was the allegation that Hyundai required the dealer to sell more vehicles than it was actually provided, in order to achieve a high score under Hyundai’s performance metrics.  In other words, the dealer was complaining that it was expected to sell “x” number of vehicles to get a perfect score, yet it was not even supplied “x” number of vehicles in the first place, making a perfect score impossible. 

As many manufacturers realize, the argument is a bit circular because typical allocation formulas factor-in actual performance, creating a chicken-or-the-egg scenario. A poor performing dealer is likely to see less product allocation because it is not selling enough product, and yet when it comes time for the manufacturer to critique the dealer’s poor performance, the dealer retorts by claiming an inadequate supply caused the poor performance (when the reverse is likely the true cause). This can present a lose-lose situation for manufacturers and suppliers, and if it is not carefully managed it can result in a years-long dispute like the Hyundai case.

‘Equitable’ Distribution of Assets

Thus, manufactures and suppliers must be careful when adjusting the supply of products to dealers, ensuring that new and revamped product allocation formulas are sufficiently “equitable” amid the coronavirus pandemic. Changes to allocation may similarly require changes to performance goals. A dealer challenging allocation formulas has the support of protectionist dealer laws written to purposefully favor dealers. Not only are the laws and regulations more beneficial to dealerships, disputes may be heard by adjudicative boards made up of industry insiders.  The Hyundaicase in Texas demonstrates this imbalance, where a favorable decision by an administrative law judge was initially rejected by the Texas DMV Board made up of industry insiders.

The ongoing pandemic is scrambling a number of norms for dealerships, and product allocation is a major one. Manufacturers and suppliers need to be prepared for pushback from dealers as everyone pursues a “new normal.” Manufacturers should expect dealers to leverage product allocation regulations to protect the ongoing viability of their dealerships and allege problems with product allocations in an effort to shift the blame for poor performance onto manufacturers and suppliers.

Connor A. Sabatino, Senior Counsel at Foley & Lardner LLP, is a litigator and member of the firm’s Distribution and Franchise practice group.  He advises clients on compliance issues under state dealer relationship laws and franchise laws, and serves as litigation counsel for manufacturers and suppliers facing dealership disputes or state regulatory actions.

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