Has the Traditional Automobile Franchise System Run Out of Gas?

Vol. 16 No. 3


Gordon & Rees LLP

From books to music to groceries, the internet has radically transformed the distribution of retail goods in the last decade. Companies leading the way have become paragons of retail success (such as Apple and Amazon), while those that were slow to adapt to evolving distribution platforms have withered (Borders, Blockbuster Video). Which fate awaits the local franchised car dealership? Is it time for a change in the way cars are sold?

The Auto Dealer Franchise System

In the early twentieth century, independently owned automobile dealerships were a rarity. Automakers sold vehicles through department stores, by mail order and through the efforts of traveling sales representatives. The prevailing delivery system was direct-to-consumer sales.

In 1898, automobile enthusiast William E. Metzger established what is generally believed to be the first car dealership, a General Motors franchise. See, The First Century of the Detroit Auto Show, p.265, Society of Automotive Engineers Inc., Pennsylvania, January, 2000. Today, tens of thousands franchised auto dealers conduct business across the United States.

Direct automaker-to-consumer sales are now prohibited in almost every state by franchise laws requiring that new cars be sold only by licensed, independently owned dealerships. The specific prohibitions in these laws vary from state to state, but most are based on two underlying principles. The first principle is that allowing automakers to sell cars directly to customers will endanger the businesses of automobile franchisees, which presumably do not have the economic resources to compete with manufacturers on vehicle pricing. The second principle is that consumers need a knowledgeable, independent sales intermediary who is capable of guiding individuals through the buying process and can later be called on for support in the event of difficulties with the vehicle.

The promotion of these principles is evident in various state franchise regulations. New York State, for example, has its Franchised Motor Vehicle Dealer Act (see, NY Vehicle and Traffic Law, Title 4, Article 17-A), which prohibits any automaker from possessing ownership in a dealership offering its vehicles. Massachusetts General Laws, Part I, Title XV, Chapter 93B, has a similar ban on manufacturer owned dealerships. In Texas, the sale of new cars is strictly controlled by Occupations Code Title 14, Subtitle A, Chapter 2301, which provides that a manufacturer or distributor may not directly or indirectly own an interest in a franchised or non-franchised dealership.

There have occasionally been challenges to the franchise distribution model for automobiles, but it has, for the most part, been accepted by automakers, dealers and consumers. Recently, however, a nascent automaker’s attempts to bypass franchised dealers in favor of direct to consumer sales has resulted in legal skirmishes with regional automobile dealer associations in New York, Massachusetts and Texas and other states.

Tesla Motors

Tesla Motors, Inc. (“Tesla”) is a San Francisco Bay area based company that designs, manufactures and sells electric automobiles and associated components. In 2008, Tesla captured the imagination of the auto buying public with its introduction the Tesla Roadster, the first fully electric sports car. The Tesla Roadster was followed by the Tesla Model S, a fully electric luxury sedan. The Model S has won several accolades and auto industry awards, including the 2013 Motor Trend Car of the Year, Automobile Magazine’s 2013 Car of the Year, and Time Magazine Best 25 Inventions of the Year 2012 award. Tesla posted profits for the first time during the first quarter of 2013.

In 2008, Tesla began opening automobile retail “Galleries.” This retail model has been opposed by numerous state auto dealer associations, including those in Colorado, Massachusetts, Illinois, New York, Oregon, Texas, and North Carolina, on the basis that Tesla’s retail Galleries operate in contravention of each state’s dealership franchise laws. Tesla argues that since no automobile orders are actually fulfilled at the Galleries, franchised dealership laws do not apply.

Typically, when customers enter Tesla’s Galleries, they have an opportunity to ask questions and read materials about a particular model. Usually, only a single car is on site. If and when a customer asks about purchasing a vehicle, a Gallery employee points out a computer connected to the Tesla factory in Fremont, California. Gallery employees do not take orders, customer payments or make delivery arrangements with customers. Those functions are all managed from Tesla’s Fremont factory.

Legal Challenges

The National Automobile Dealers Association (“NADA”) represents nearly 16,000 new automobile dealers with 32,500 franchises throughout the United States and internationally. See, www.nada.org/aboutnada/. NADA and its members assert that Tesla’s Gallery sales model violates the franchise laws of several states. While NADA itself has not brought an action against Tesla, is has actively supported lawsuits by its members. These lawsuits are intended to drive Tesla towards selling cars through traditional franchised dealerships. Tesla has vigorously defended these actions, arguing that it cannot survive without the ability to sell cars directly to consumers.

In spring, 2012, Tesla opened its first Massachusetts Gallery in the fashionable Natick Mall. Within weeks of its opening, a lawsuit was brought against Tesla by the Massachusetts State Automobile Dealers Association (Mass. State Auto. Dealers Assoc., Inc. et al v. Tesla Motors MA Inc., No. CV2012-1691, Mass. Super. Ct., Norfolk Cty. Dec. 31, 2012). In MSADA v Tesla, the plaintiff claimed Tesla was violating Massachusetts law by conducting sales within the commonwealth at dealerships in which the company has an ownership interest. Tesla countered that because all orders from its Natick Gallery are taken and fulfilled at its California factory, there is no actual sale taking place in Massachusetts. The MSADA argued that Tesla’s delivery method is merely a dodge of the intent of the Massachusetts law.

In January 2013, a Massachusetts Superior Court judge ruled against MSADA, finding that state law doesn’t necessarily give dealers standing to pursue legal claims over manufacturer-owned stores. “This court is unconvinced that the 2002 amendment to Chapter 93B expanded the purpose of the statute to protect the motor vehicle franchise system,” stated Judge Kenneth J. Fishman, referring to provisions of Massachusetts law regarding trades. Id. MSADA is currently considering an appeal of Judge Fishman’s decision.

A New York Supreme Court judge gave Tesla another victory in its efforts to avoid the traditional franchised auto dealership structure. In Greater N.Y. Auto. Dealers Assoc. v. Dept. of Motor Vehicles, No. 5865-12, 2013 WL 3242761 (N.Y. Sup. Ct. Albany Cty. Apr. 10, 2013), Justice Raymond J. Elliott III concluded that the Greater New York Automobile Dealers Association could not assert a claim against Tesla under the New York Franchised Dealer Act. The court also ruled that the dealers could not prove injury arising from the three Tesla Galleries and two service depots currently operating in the state. Id. at *5.

The Greater New York Automobile Dealers Association is predictably unhappy with the ruling, arguing that Tesla’s factory-owned dealer model is “clearly prohibited” by the state’s franchise dealer law. The Dealer Association has not, however, indicated that it will appeal the decision or seek other recourse.

Tesla’s efforts have, however, suffered major setbacks. In April 2013, Tesla’s CEO, Elon Musk, appeared before the Texas Legislature’s House Business and Industry Committee to voice his support for two bills that would allow Tesla to sidestep the state’s franchise dealership laws and sell cars directly to Texas residents. If adopted into law, the two bills—Senate Bill 1659 and House Bill 3351—would provide Tesla with narrowly tailored exemptions from Texas franchise laws. The bills provide that American manufacturers of electric cars that have never previously had franchised dealerships could sell cars directly to Texans.

House Bill 3351 was replaced by a committee substitute that offered auto dealers another layer of protection: if Tesla sells more than 5,000 cars a year in the Texas, it will become subject to existing franchise regulations.

Both Tesla-backed bills failed to reach the floor of the Texas House or Senate for a vote before the Legislature’s regular session ended on May 27. The Legislature will not meet again in a general session until 2015.

More bad news for Tesla recently came from the governments of Virginia and North Carolina. In April 2013, Tesla’s application to the Virginia Department of Motor Vehicles to grant it a special exemption to operate a dealership in that state was declined. Tesla can, and likely will, appeal this decision. On May 9, the North Carolina Senate unanimously passed a bill that appears to be intended to preemptively hinder the automaker. If the bill is passed by the House and signed into law by Governor Pat McCrory, Tesla will be required to sell its cars exclusively through independent dealers in North Carolina.

Tesla has offered an olive branch to automobile dealers by indicating that the company may use franchised dealers after it is on more solid economic footing. Elon Musk has also stated that he would be open to a discussion of a dual retail network—a combination of Tesla-owned and independently owned dealerships—when Tesla’s sales reach one percent of new-car sales market in the United States.


The likelihood that Tesla will successfully convince federal courts to invalidate the various state auto dealer franchise laws in their entirety is remote. In the author’s opinion, Tesla’s greatest chance for success lies with convincing the courts that narrow exemptions from state regulations should be tailored for the company, based upon its unique status in the automotive marketplace.

Ultimately, plotting a course through the state patchwork of laws governing new auto sales will be extremely difficult for Tesla. Perhaps in recognition of this fact, Musk recently told Automotive News magazine: “If we’re seeing nonstop battles at the state level, rather than fight twenty different state battles, I’d rather fight one federal battle.” Amy Wilson, Tesla’s Musk: I’ll Take Store Fight Federal, Automotive News, Apr. 15, 2013. Although left unsaid, perhaps Mr. Musk is planning a lobbying effort of his own with the goal of federal legislation exempting Tesla from the patchwork of state auto dealer franchise statutes.

In a conflict between political influence and free market forces, established auto dealership interest groups have thus far been able to sharply restrict Tesla’s ability to market its products directly to consumers. The auto dealership associations have, to date, been able to convince state legislators to protect their franchisee constituents from direct-to-consumer sales by automakers. Only time will tell whether Tesla can overcome this hurdle to market, and whether it will become the next direct distribution success story (like Amazon) or another casualty of market inefficiencies and entrenched special interests.

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