Legal Update
Oct 26, 2016
Tesla Takes on Michigan
Tesla’s fight to sell its popular electronic cars directly to consumers, rather than through independent dealers, recently took a decidedly more aggressive turn. On September 22, 2016, Tesla sued the State of Michigan, including its Governor, Attorney General and Secretary of State. (Tesla Motors, Inc. v. Johnson, et al., Civ. Action No. 16-cv-1158, United States District Court, Western District of Michigan). While Tesla has had to fight several challenges to its ability to sell directly to consumers, here Tesla argues that the State of Michigan has violated Tesla’s constitutional rights by enforcing a law passed in 2014 that bars Tesla from directly selling or servicing cars in the state of Michigan. This is the first lawsuit we are aware of filed by Tesla arguing constitutional violations as a result of a direct sale ban.
Tesla has long argued that it should not be required to sell its cars through a traditional dealer network model because of the added costs of establishing and maintaining a network of authorized dealers.1 According to Tesla, its leading-edge electric cars need to be sold directly if Tesla is to survive as an auto manufacturer. Given the smaller, more niche market for its expensive cars and the limited number of Tesla vehicles currently on the road that would be serviced at a franchised dealership, Tesla also argues that a traditional franchised dealer network for Tesla vehicles would not survive.
Over the past several years, Tesla’s efforts to sell directly to consumers has given rise to much litigation and, as a result of anti-Tesla legislation sponsored by state dealer associations, a patchwork of state laws and regulations. According to the Complaint, Tesla currently is allowed to sell directly to consumers in 23 states,2and there are 24 states like Michigan, which prohibit any direct sales.3 Some states are reevaluating whether to allow Tesla to sell direct as a result of Tesla’s recently announced intention to go down market and sell lower-priced cars.4 That is because some states allowed Tesla sales on the grounds that Tesla’s expensive, luxury cars were a niche or novelty electric product that would not be sold to a broader market.
In October 2014, on the last day of the legislative session, Michigan passed an amendment to an existing law that had the effect of barring automakers from selling or servicing cars other than through a franchised dealer. Section 445.1574 of the Michigan Compiled Laws was modified to provide that a motor vehicle manufacturer “shall not . . . sell any new motor vehicle directly to a retail customer other than through franchised dealers.”5 This provision was passed without public comment or debate. Prior to this amendment, automakers could not compete against their own dealer networks. But a manufacturer like Tesla--without an existing dealer network--could sell directly to retail consumers. Now, even though Tesla does not have a dealer network so it would not be competing with its own dealers, the new law provides that Tesla cannot sell or service except through a franchised dealer network. There is little doubt that the law was passed to stop Tesla, and other start-ups like Elio, from selling or servicing cars in Michigan without first establishing a traditional franchised dealer network.
Tesla alleges three constitutional violations in its complaint. First, Tesla claims that the Michigan law violates the due process clause of the Fourteenth Amendment to the U.S. Constitution. Tesla argues that the statute prohibiting a “non-franchising manufacturer . . . from selling or servicing cars in Michigan is not a rational means of achieving any legitimate government interest.”6 Second, Tesla alleges that the Michigan law violates the Equal Protection Clause of the Fourteenth Amendment because Michigan distinguishes between manufacturer-owned dealerships and franchised dealerships that are not similarly situated.7 Third, Tesla argues that Michigan violates the dormant commerce clause of Article I of the Constitution by favoring in-state interests (franchised dealers of other brands and Michigan-based manufacturers).
In its Complaint, Tesla alleges that competition and consumers are hurt by Michigan’s prohibition on direct sales and service by Tesla. Tesla cites recent communications and initiatives from the Federal Trade Commission about the anti-competitive nature of state laws that protect dealers and the FTC’s advice to legislatures to consider the effects of dealer laws and the harm to consumers from them.8 The FTC held a workshop on January 19, 2016, in which it discussed how many aspects of current dealer regulations adversely affect consumers. We understand that the FTC is preparing a report on the competitive effect of the current franchised dealer network model, and that it will be released late this year or early next year. This report bears watching as it may have a persuasive effect on legislatures and courts.
Tesla’s approach to selling and servicing cars represents a paradigm shift for the automobile industry. While the concept of dual distribution, with franchisors operating company owned outlets alongside franchisees, occurs in many industries, the thought that auto manufacturers could sell directly to consumers strikes at the heart of the dealer networks that dealers have worked so feverishly to protect through state dealer statutes. Of course, state dealer statutes should only seek to address unfair and coercive business practices and conduct that actually needs to be regulated to address demonstrated harm or to protect legitimate pro-competition, pro-consumer interests. The default should always be that the free market and beneficial competitive forces should be left to operate whenever possible. State dealer statues should also be based on current conditions in the automobile industry and should not inhibit competition, or otherwise impose upon automakers regulations or business restrictions that manufacturers and distributors in other areas of the economy do not face. Not only should the state franchise statutes protect the interests of dealers, but they should also protect the interests of OEMs and, significantly, the beneficial competition that aids consumers. They should promote a balanced relationship between dealers and OEMs, and they certainly should not interfere with the ability of an OEM to meet changing consumer demands or trends. State dealer laws should recognize and protect the OEM’s ability to compete effectively in a competitive business environment and respond to changing market conditions. Of course, consumers should reasonably expect that the laws governing the relationship between dealers and OEMs will promote beneficial inter-brand competition and the effective selling and servicing of all new vehicles.
In its Complaint, Tesla requests a declaratory judgment on an expedited basis. Tesla’s equal protection and dormant commerce clause arguments are considered strong by some law professors because Michigan has passed legislation that specifically targets Tesla.9
Tesla faces court battles in other states. On August 31, 2016, Tesla lost a court battle in Missouri to sell its cars directly to consumers after the state had already issued licenses to Tesla for dealerships in University City and Kansas City.10 The Missouri Automobile Dealers Association filed the lawsuit to cancel the licenses on the ground that a manufacturer cannot be a dealer and manufacturer at the same time. Tesla submitted a franchise agreement to the state appointing Tesla as a franchised dealer. The Court found that a manufacturer and dealer could not be the same party. The Court enjoined the Department of Revenue from renewing dealer license to Tesla and ordered the Department not to issue a dealer license to Tesla in the future.
On September 15, 2016, the Arizona Automobile Dealers Association (“AADA”) sued the Arizona Department of Transportation, Arizona’s governor and the Director of the Arizona Department of Transportation.11 In July, an administrative law judge for the Department of Transportation ruled that Tesla could be a licensed dealer after previously being denied a license. The AADA seeks a declaration preventing the state for issuing a dealer license to a manufacturer regardless of whether the manufacturer has other dealers in the state. On October 5, 2016, Tesla filed a motion to intervene in this case. Nothing further has been filed in this case.
We will continue to monitor Tesla’s litigation. Please reach out to any member of our Franchise Team if you have any questions.
1 It is hard to argue against this because Tesla has yet to earn any profits despite widespread acclaim for its products and services.
2 Tesla Motors, Inc. v. Johnson, U.S.D.C., W.D. Mich., Civ. Action No. 16-cv-1158, Compl. ¶22.
3 Shepherd, Ken, “Tesla Is Taking Michigan’s Governor to Court,” Washington Times, Sept. 22, 2016.
4 Underoffler, David, “Imitating Tesla Will Be Tough,” Automotive News, Oct. 3, 2016.
5 Compl. ¶31.
6 Compl. ¶52.
7 Compl. ¶56.
8 Compl. ¶45 (citing FTC blog Competition Matters by FTC Office of Policy Planning, Bureau of Competition and Bureau of Economics on harmful effects to consumers of laws passed to help dealers).
9 Hull, Dana, “Telsa Cranks Up Pressure to End Ban on Direct Auto Sales,” Bloomberg News, Sept. 22, 2016 (http://www.bloomberg.com/news/articles/2016-09-22/tesla-lawsuit-claimsmichigan-direct-sales-ban-unconstitutional)
10 State of Missouri v. Ray, et al., Case No. 15AC-CC00032, Circuit Court of Cole County (MO), Final Judgment & Order.
11 Arizona Automobile Dealers Assoc. v. Department of Transp., et al., Case No. CV2016-015190, Superior Court, Maricopa County (AZ), Verified Complaint for Declaratory Judgment.
