Lines Drawn In Tesla Direct Sales Battle

by Carlton Fields

Law360, New York (July 22, 2014, 8:17 AM ET) --

Elon Musk's battle to sell Teslas directly to consumers continues. In the last five months, the governors and legislatures of Pennsylvania and New Jersey and, now, even the White House, have taken stands on whether or not Tesla Motors Inc. or any automobile manufacturer should be able to sell its products directly to consumers.

Tesla, with its over $70,000 all-electric Model S sedan, is company founder Elon Musk’s latest effort to disrupt the status quo of a long and well-established industry. But more than just trying to shift the paradigm by making all-electric vehicles an attractive alternative to gasoline, diesel and hybrid luxury cars, Musk is also bypassing the traditional franchised car dealership sales model and challenging state laws by trying to sell directly to consumers through company-owned stores.

Last March, Governor Chris Christie signed into law a bill specifically making direct sales illegal in New Jersey. Last month, the Pennsylvania legislature passed a bill that would permit Tesla to operate no more than five stores in the state. On July 14, 2014, the White House chimed in. As reported by Law360, in response to an online petition requesting intervention to allow Tesla to sell directly to consumers in all 50 states, President Obama’s Special Assistant for Energy and Climate Change, Dan Utech, said the regulation of automobile sales has “traditionally sat with lawmakers at the state level” and that “preempting current state laws on direct-to-consumer auto sales would require an act of Congress."

The issue has historically been governed by state law and neither the White House nor Congress now seem inclined to get involved in the debate. No doubt, the White House announcement dealt a setback to Musk’s efforts to pass federal legislation allowing startup companies to make direct sales of electric vehicles to consumers and, in the partisan atmosphere of today’s Congress, already faced a very difficult and lengthy fight. Likewise, Musk’s contemplated filing of a federal lawsuit to challenge state restrictions as violating interstate commerce could take many years to resolve.

In the meantime, at the state level, strong legal arguments on both sides have been made and these succeed or fail based upon the statutory language in existence. While all arguments are expressed in terms of what is best for consumers in the state, it is the application of the express language that has ruled. Of course, these arguments also have a highly charged political dimension and lobbyists on each side have framed the dispute in the way best suited to their respective client’s objectives.

On the traditional independent franchised dealer side, the contention is that allowing a manufacturer to also be the dealer creates an unfair playing field for existing dealers where, after requiring the dealer to make enormous investments in facilities, inventories and personnel, that manufacturer can then use its greater economic clout to sell vehicles for less than their independent franchisees. Once that independent franchisee is forced out of the market due to the unfair competition and imposition of a "vertical monopoly," the argument goes, the manufacturer is then free to raise prices and eliminate the discounting that a competitive independent franchise model encourages. This “pro-competition” position is buttressed by the assertion that it is the entrepreneurial drive and personal commitment to the local market of multiple independent dealers that lowers pricing, fosters innovation in customer service, and provides consumers with a more effective voice when problems arise. The rationale is that your car is not a laptop or cellphone, that the benefits of multiple vendors competing for business on the same product will be eliminated and having to handle a service issue or vehicle breakdown through a manufacturer’s corporate office or repair facility will neither provide the responsiveness nor aggressive consumer advocate on warranty matters as found at your local independent dealer.

On the side of manufacturers being allowed to sell directly is the argument that state laws mandating independent dealers create a "local monopoly" for the independent dealer, limit consumer choice and stifle innovation in improving the car buying experience. The contention is that the future belongs to the consumer’s ability to pick and choose how they want to make their purchases and the traditional independent dealer model is an unnecessary impediment to choice and the growth of e-commerce. After all, this argument goes, if you can purchase almost any other product on the Internet from the comfort of your home, why should you have to buy your car from a local dealer? Today, even if you visit a manufacturer’s website and decide you want to buy, the manufacturer still directs you to (and your purchase must be made from) a local independent dealer. The rationale in favor of direct sales is that interposing a dealer is antiquated and that consumers have changed, now feeling more comfortable buying and servicing products virtually and without the need for a sales pitch or personal contact with a local vendor. If, in fact, service issues arise, then the manufacturer will need to find a way to resolve them and do so in a competitive way that preserves customer confidence and loyalty.

So, where and how can you buy a Tesla today and what are the implications of the direct sales model in the U.S. going forward?

Based upon their current statutory language, the states have divided into three categories: (i) unrestricted direct sales permitted, (ii) direct sales prohibited and (iii) direct sales permitted, but restricted.

Unrestricted Direct Sales Permitted: While not presently operating in all of these states, the statutory language in California, Connecticut, Delaware, Florida, Hawaii, Idaho, Illinois, Massachusetts, Minnesota, Missouri, Montana, Nevada, New Hampshire, North Carolina, Oregon, Rhode Island, Tennessee, Utah, Vermont and Wyoming appear to permit the unrestricted use of the Tesla direct sales model. In these states, the statutory provisions distinguish between a manufacturer, like Tesla, that has no franchised dealers in place and those that already have a network of franchised dealers. Since Tesla has no franchised dealers, it cannot be deemed to be unfairly competing with them. The language contained in the California Vehicle Code Section 11713.3(o)(1), (“It is unlawful and a violation of this code for any manufacturer ... [to] compete with a dealer in the same line-make operating under an agreement or franchise from a manufacturer ... in the relevant market area.”), is representative of statutory provisions where Tesla has been successful in challenging the traditional independent dealer model.

Direct Sales Prohibited: At the other end of the spectrum, the current statutory language in Alabama, Arizona, Arkansas, Kansas, Kentucky, Louisiana, Maryland, Michigan, Nebraska, New Jersey, New Mexico, North Dakota, Oklahoma, South Carolina, South Dakota, Texas, Virginia, West Virginia and Wisconsin appears to explicitly prohibit Tesla’s direct sale to consumers. In these states, there is no distinguishing between manufacturers with or without franchised dealers in the state and no mention is made of the potential for unfair competition between manufacturer and dealer. The representative statutory language in these states is generally reflected in Michigan Section 445.1574(l)(i), (“ ... a manufacturer shall not ... sell any new motor vehicle directly to a retail customer other than through its franchised dealers ...”). Nevertheless, these states will permit manufacturers to operate what Tesla calls a “gallery,” where its cars can be viewed, but typically prohibit discussing price, taking orders for vehicles, or allowing test drives (except for Maryland, where only test drives are permitted).

Direct Sales Permitted, But Restricted: Some state legislatures, responding to political pressures, are trying to have it both ways. The current statutory language or agreed legislative deals in Colorado, Georgia, New York, Ohio, Pennsylvania and Washington allow direct sales, but significantly restrict them. These restrictions are typically based on exemptions from an existing statute that include limitations on the number of manufacturer owned stores operated, the number of vehicles that can be sold annually, or that apply only to zero-emission and/or other electric vehicles as of a specified date.

Given Tesla’s current tiny share of the U.S. auto market, the debate over Tesla’s direct sales to consumers may seem like much ado about nothing (or, at least, a lot about very little). However, the issue is not likely to just go away or simply remain settled “as is” with each state adopting and enforcing its own rules. Not only has Elon Musk shown persistence in battling to disrupt the status quo, the direct sales model is also being studied by both new Chinese automakers and mainstream U.S. and global manufacturers as they plan their future U.S. marketing strategies. Companies like General Motors, Ford and Toyota could attempt to launch new brands that would employ a direct sales business model at the perceived expense of their existing dealers. For example, what if Toyota had decided to launch its Lexus brand in the U.S. without establishing an independent franchised dealer network? Surely, the Toyota dealers and their lobbyists would have argued that the creation of the new brand by the same parent company and its direct sale to consumers was only a clever ruse to bypass state law, undermine their investment and, ultimately, eliminate the price competition among independent dealers that consumers have come to rely upon.

Consequently, although the battle lines have become clearer, the one thing that is certain is that this war is far from over.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Carlton Fields | Attorney Advertising

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