Keep your distance!

by John Yiokaris and Bailee Kleinhandler 

For automotive dealers, the investment required to establish a new dealership can be significant, covering everything from tools and machinery to vehicle inventory and due diligence, along with other associated start-up costs. Meanwhile, manufacturers face ongoing challenges of staying competitive in a rapidly evolving automotive market. A key strategy for manufacturers to remain relevant is ensuring a sufficient number of dealerships exist to meet customer demands and expectations. However, this strategy can sometimes lead to conflicts known as “encroachment”.

Understanding Encroachment

Encroachment occurs when a new dealership is opened or an existing one is relocated closer to another dealership in the same network. Such moves often lead to disputes between existing dealers and manufacturers. To mitigate these conflicts, manufacturers typically include provisions in their dealership agreements that reserve the right to establish new locations or relocate existing ones. However, beyond the agreement’s terms, both dealers and manufacturers need to be mindful of other important factors, such as standards set by the National Automobile Dealer Arbitration Program (NADAP), if applicable, and the obligation to engage in good faith dealings.

The Role of NADAP

NADAP was established to provide a structured process for resolving disputes between manufacturers and dealers for those manufacturers and dealers that have opted into NADAP. Initially, parties are encouraged to use the manufacturer’s internal dispute resolution process. However, if that process is unavailable or fails to resolve the issue, mediation through NADAP is the next step.

For encroachment disputes, Rule 6 of NADAP is particularly important. This rule grants manufacturers the right to determine the size and structure of their dealer network, including the creation of new dealer points, relocation of existing dealerships, and appointment of new dealers. However, manufacturers are required to provide notice to existing dealerships before establishing a new dealership location or relocating an existing dealer point.

Generally, in metropolitan areas, an existing dealer selling identical vehicle brands as those of the proposed new dealer point or relocated dealership may challenge a new or relocated dealership within 8 km (20 km in non-metropolitan areas). If these distance requirements are not offended, an existing dealer cannot bring its NADAP challenge. While these distance requirements are a common basis for challenges, they are not definitive. According to Rule 6(e), even if the distance requirements are met, the dealer must also prove potential losses in sales and profits as a precondition for obtaining relief.

Good Faith Obligations

Separate and apart from any NADAP rules regarding new dealer points and relocation, pursuant to Canadian law, automotive manufacturers are required to exercise the powers granted to them by a dealership agreement honestly, fairly, and in good faith. Given the potential power imbalance between local dealerships and automobile manufacturers, courts work to ensure that neither party engages in conduct that undermines the core purpose of their business relationship.

How are courts dealing with claims of encroachment?

1. Consideration of dealer interests: Courts have clarified that even when a manufacturer retains broad powers under a dealership agreement, it must still consider the interests of existing dealers. Manufacturers are required to evaluate the potential adverse impact on individual dealers before making decisions that could affect them.
2. Case-by-case approach: Courts emphasize that every encroachment case is unique. As a result, an existing dealer must provide substantial expert evidence demonstrating that a new or relocated dealership would harm its financial interests.

Conclusion

When a dealer is granted an exclusive selling territory or a designated market area, it has a reasonable expectation that the manufacturer will not encroach on its territory. Manufacturers are under an obligation to treat their dealers fairly, and exercise the powers they have reserved for themselves under the dealership agreement in such a manner so as to not unfairly disadvantage their dealers. At the end of the day, a well planned dealership network not only meets the needs of the marketplace, but it provides its dealers with a favourable environment in which to obtain a reasonable return on their investment.

 

John Yiokaris, Partner

John Yiokaris is a partner with Sotos LLP in Toronto, Canada’s leading franchise law firm. He has been recognized by Chambers Canada, LEXPERT, Who’s Who Legal, Lexology, and Best Lawyers in Canada as a leading Canadian franchise law practitioner. John can be reached directly at 416.977.3998 or jyiokaris@sotos.ca.

Bailee Kleinhandler, Associate

Bailee is an associate in the corporate and commercial group of Sotos LLP. She is building a diverse practice in corporate and franchise law. Bailee can be reached by email at bkleinhandler@sotos.ca or by phone at 416.572.7311.