A LEADING automotive legal specialist has outlined to dealers how the value they have created from a lifetime of building up their businesses and a client base is potentially being rendered valueless by recent court cases. 

Evan Stents, a partner at HWL Ebsworth, told dealers at the recent AADA Convention that recent court cases were pivotal for dealers in that they discount the concept of accounting goodwill which is the reward of a lifetime and only recognise the concept of legal goodwill which the courts are saying is worthless from the moment a dealer agreement ends.

He said there were very important implications in the outcomes of several recent landmark court cases, two of which have yet to be finally decided, especially in deciding the level of compensation a dealer might receive when an OEM elects to change their dealership model or leave this market.

Evan Stents

This is especially relevant in such a crowded market where the prospect of 10 more car brands coming to Australia will force many smaller players to consider pulling out with serious implications for compensation to the dealers who invested in their networks.

Mr Stents said it was alarming that goodwill, as the courts understand it, is merely a product of the right to conduct a business in substantially the same manner and means as attracted the customer to it.  In the case of a franchise agreement, that right to conduct the business is tethered to the tenure of the dealer agreement.  

Therefore, once the dealer agreement has come to an end, then so does the (legal) ‘goodwill’ as recognised by law.  Legal goodwill is therefore only tied to the tenure of the dealer agreement.

This did not accord with what the industry has always known, which is to value dealerships based on the ‘accounting’ concept of goodwill.  Accounting goodwill is the purchase price a person is prepared to pay for a business less the value of tangible assets.  

Thus a ‘goodwill’ premium is usually paid to reflect the value of assets not usually reflected in the balance sheet – such as a company’s intellectual property, customer base and employee relations.  

“An acquirer usually purchases a business based on a multiple of earnings which reflects the assessment of the value of the (accounting) goodwill.  The accounting goodwill premium dealers are prepared to pay is often based on valuing the business beyond the tenure or legal goodwill in the dealer agreement.

“This is really, really important, because, in particular, the Mercedes case has shone a light on a structural flaw in the investment regime of the whole basis of the dealers’ businesses.”  

Addressing dealers at the convention he said: “You will invest in your dealerships based on what you would recognize as accounting goodwill. So accounting goodwill is basically what you pay for the business, which is usually based on the multiple of profit or multiple of EBITDA that often looks beyond the tenure of the dealer agreement.

“However courts do not recognise accounting goodwill, they only recognises legal goodwill, and legal goodwill is merely the right to trade using certain rights and obligations that come with the dealer agreement and the trademarks”.

“So when an agreement comes to an end, the right to use the legal goodwill comes to an end and therefore it has no value. And that’s what happened in the Mercedes case. What the court found was, when the non-renewal notices were issued, the legal goodwill came to an end.

“It didn’t recognise any accounting goodwill. And therefore the very next day, there’s nothing to compensate because there’s no goodwill, despite the fact that the very next day the dealers are still operating the same business using the same customers in the same premises.

Evan Stents from HWL Ebsworth Lawyers and James Voortman

“Except that their accounting goodwill was diminished significantly because the legal goodwill is only recognised and that disappeared the day the non-renewal notices were issued. There’s nothing to be compensated for. That’s very problematic.”  The Mercedes case is still the subject of an appeal by the dealers.

Asked by AADA CEO James Voortman if the current situation was a “massive opportunity for franchisor exploitation,” Mr Stents said: “Absolutely. One of the things that the judge said in the Mercedes case was that his hands were tied because the Franchising Code offered no protection for goodwill.

“But he said reform was needed in this area. In other words, he said, the Franchising Code needed to be reviewed and amended to have protections for goodwill.

“That gave the AADA very powerful ammunition to go to the Schaper review of the franchisor code to seek reform in this area. That’s why you don’t have ‘agency’ distributions models in the US because there are those protections. Unfortunately, Dr Schaper, ignored those submissions.

“So dealers investing in their dealerships should remember, although they are encouraged to invest on the basis of accounting goodwill, when the proverbial hits the fan, and a dealer agreement comes to an end, OEMs do not recognize their accounting goodwill and they only recognize legal goodwill, which they value at nothing.

“But with all these new OEM entrants coming to the market, dealers have choices now into which brands they can invest,” he said.

He suggested that an OEM “should be courageous and actually recognize accounting goodwill. It might actually attract more dealers and make their brands much more attractive for dealers to invest in; especially now in a very crowded and competitive market”. 

Referring to a class action brought against GM Holden by some Holden dealers, Mr Stents said that Holden decided to retire the brand.

“In other words, they decided to stop selling cars in Australia and became exclusively service providers for their vehicles. They didn’t terminate the dealer agreements but offered all the dealers a compensation package. If a dealer accepted the compensation package, it also meant that their dealer agreement came to an end and a new service agreement was offered to the dealer as part of that package.

“Now remember Holden did not terminate the dealer agreements. For everyone who accepted the compensation package the agreements were lawfully terminated as part of the agreement. 

“But for the dealers who didn’t accept the package Holden argued in court that they were not entitled to any compensation because they still had a dealer agreement and Holden did not  have to sell any cars to them.

“So what they were saying is that when you sign as a dealer you are required under the dealer agreement to invest millions of dollars in your premises, to employ staff, be open seven days a week or whatever it may be, but we do not have to sell you one single car.

 “And that’s the question that’s been tested in this class action; whether there is an implied term in a dealer agreement that provides that when you enter into a dealer agreement, an OEM has an obligation to sell you cars. It sounds so fundamental, but Holden argued in court that they don’t have to.”

 Mr Stents went on to say that under the Franchise Code, compensation only has to be paid if an OEM terminates a dealer agreement before the term of the agreement has expired if, for instance, the OEM decides to exit the country or restructure its network.

 “If however an OEM decides to exit the country and do what Holden did and not terminate the dealer agreement, the OEM could say: ‘You still have an agreement, we don’t have to sell you any cars so you are not entitled to any compensation’.

“So watch this space. The class action is a really, really important case. The trial has concluded and we are waiting for the judgment to be handed down and I can tell you Holden is fighting really, really hard on this point.”