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Strategies for Dealing with Ownership Transfer Issues

This expert in franchise law offers farm equipment dealers some straight-talk advice for working through contract approval concerns.

Dave Kanicki, Executive Editor
For more than 30 years, J. Michael Dady has been an unabashed crusader for the rights of the dealer, distributor and franchisee. In those three decades, the Dady & Garner P.A. trial lawyers in Minneapolis cite helping farm equipment dealerships to successfully challenge their major suppliers as among its most memorable and satisfying victories.

Dady says he learned his lesson about supplier-dealer relationships early when his father, a successful beer distributor in South Dakota, attempted to sell his business. "My father always thought, 'be a good distributor and you'll be home free.' "But it doesn't always work that way," says the attorney.

Michael Dady

"When my dad got ready to sell his beer business, he believed Anheuser-Busch and Miller Brewing, his two big suppliers, would help get a big price for his business, but they didn't. I cared that he'd been in the business since 1948, but they didn't.

"The supplier cares about the buyer and wants him to get the business as cheaply as possible so they have more money to invest in selling more of their product."

Telling long-time dealers that their major equipment supplier is not their friend can be a rude awakening. This should have become clear to all dealers when Deere & Co. CEO Robert Lane said in the August 14, 2007 issue of the Wall Street Journal, "For years we talked about Deere as a family. The fact is, we are not a family. What we are is a high-performance team. If someone is not pulling their weight, you're not on the high-performance team anymore."

Shrinking Dealer Networks
Lane's comment was not the initial salvo in Deere's announced plan to streamline its North American distribution channels. At a 2002 meeting in Louisville, Ky., dealers were told they needed to decide whether they would be the shark (buyers) or bait (sellers) as the grow-or-get out strategy gained momentum.

"Deere announced to the world they want to shrink their number of dealers," says Dady. "They have a view that there are too many dealers out there and their cost at the supplier level will go down if they're dealing with one dealer rather than four. They're clearly shrinking their number of dealers because they think less is more. I think they're wrong."

Whether the strategy is a good one or not isn't the real heart of the issue for long-time equipment dealers who find themselves on the wrong side of their suppliers' plans.

"Not only do the manufacturers want to shrink the numbers," says Dady, "but more importantly, they want to decide who's going to stay and who's going to go."

And therein lies the real rub for the dealers who find they're not among the "chosen ones."

Who Stays? Who Goes?
The seeming unfairness of the supplier's ability to determine which retailers stay and which don't and who's going to get their business is keeping many farm equipment dealers up at night. It would be one thing if it were simply a matter of being up front and on paper. But Dady points out that manufacturers employ a number of ways to force dealer consolidation by way of contract approval.

"They may have an announced way of terminating a contract," he says. "For example, a lot of dealer agreements stipulate that the supplier will terminate a dealer if it isn't capably performing and then only if the supplier provides notice and an opportunity to cure the problem. If the dealer does not perform afterward, the contract can be terminated."

Dady points to a case that his law firm handled that involved a Minnesota dealership that demonstrated that lack of performance isn't always the reason behind canceling a dealer's contract.

"Wadena Implement, a John Deere dealership, was confronted with a shrinking marketplace and took on another line, in this case, Ford New Holland equipment. Deere terminated Wadena for allegedly not getting their market share. The statute in Minnesota prohibited them from terminating a dealer for taking on another line, which we believed was the real reason.

"We went into court and got a restraining order and ultimately we received a summary judgment that the termination was unlawful and we were able to keep them in business," Dady says.

It's considered a landmark case because it resulted in Deere changing its dealer agreements.

"This case spells out how suppliers need to deal with their dealers if they think they have a problem with them," says Dady. "It laid out how John Deere had a protocol in place, at least on the surface, to be fair to their dealers, but wasn't always following it."

The 'Transfer' Issue
To determine if there's a legitimate case when it comes to transfer of ownership, Dady says his firm follows a 6-step process, or asks 6 pointed questions, in every instance where his firm is asked to help. This determines whether or not the dealership has a case against its supplier.

STEP 1. What is the array of real vs. announced reasons for the supplier's conduct?
Dady says he's increasingly seeing suppliers come up with a variety of reasons, many of which are facades, as to why a dealership must sell and puts pressure on them that's "very unfair."

It's essential that the dealership ferret out the real reasons why its supplier wants it out.

STEP 2. What does the written agreement say?
Dealers need to be acutely aware of the details of their rights to sell and their supplier's obligation to approve reasonably qualified potential buyers.

Dady says selling dealers need to ask 3 basic questions to determine if a potential buyer is a good candidate to purchase and operate a dealership.

1. Do the buyers have the financial wherewithal to purchase the business?
2. Do they have the operational skills to run the dealership?
3. Do they have a conflict or a criminal record that would give the supplier a reason for rejecting them?

"If a potential buyer is handling a competing line and there is a statute in place that allows it, the supplier cannot use this as a reason for not approving the sale," says Dady.

"These are the big three and if our buyer meets these criteria, we'll typically tell our clients that we can encourage the equipment supplier to approve the transfer."

STEP 3. Is there any statutory protection?
"I've helped write a lot of the dealer protection statutes around the country. We really like to see statutes in place because there are still agreements out there that allow termination without cause.

"I've seen second- and third-generation dealerships that have invested their life's work in their business before a supplier suddenly decides to terminate. The supplier will say, 'Read your contract. It says 'we can terminate with 30 days notice with or without cause' and we're doing it.'

"These cases are extremely unfair and we have ways of attacking them using common law," Dady says. But we'd rather see statutory protection so no matter what your agreement says, you can't terminate unless you have good cause. This is extremely important."

STEP 4. Are there any anti-trust issues?
"Typically, there aren't, but we always look because of the potential for triple-damages, criminal sanctions and significant attorney fees," Dady says.

STEP 5. Are there any judge-made common-law theories that may apply to this case?
"We have 14 different judge-made laws that we look at. One worth noting, especially in this environment, is the covenant of good faith and fair dealing," says Dady.

This asserts that no matter what the agreement says, a covenant is attached that obligates both parties to deal with each other in a fair, reasonable, honest and non-discriminatory fashion. "Who could be against this?" asks Dady.

"We push this big time for ag dealers around the country. In my opinion, in the common law, it's the single most important development for equipment dealers in the past 30 years."

STEP 6. What are the damages if our client isn't treated properly?

On this issue, Dady says that if there was no damage, even if there's a violation, he advises clients to forget about it.

"But if the family business is wiped out, there are catastrophic damages and you have to consider injunctive relief," he says.

Ambiguous Market Share
Dady says the number one reason cited by suppliers for terminating a dealer contract or "encouraging" a dealer to sell is failure to achieve share of market.

He points to the 1992 landmark Wadena Implement case as an example of how market share targets can be unreasonable or manipulated in an attempt to make a supplier's case for termination.

"In this case, I weighed in on the manufacturers' calculation and found it was patently unfair. Our client's territory was in the eastern part of a county, which was heavily involved in dairy production.

"In the western part of the territory is some of the most fertile, big farming land in the world. Our client was selling small farm tractors to dairy farmers and few, if any, combines because another dealer was covering the western area that utilized the big equipment. The supplier told our client, 'You have 50% of the county assigned to you, and so you should be getting 50% of the market.'

"It was preposterously unfair," explains Dady. "We pointed this out and the judge agreed with us."

The ambiguity of how suppliers calculate market share is a huge issue, according to Dady. "Ask the supplier's reps that call on dealers, 'What's the numerator? What's the denominator? What's the geographic area? Where do you get your data?' It's clear that they don't have answers to any of these questions when it comes to market share.

"This is something for the national and state dealer associations to tackle. They should invite the major equipment makers to their meetings and have them demonstrate how they calculate market share. We'll give them a list of questions to ask," says Dady. "These groups need to take this up with the manufacturers."

Good Dealer Agreements
Contracts that fairly represent the interests of both dealer and supplier should be the ultimate goal in all dealer agreements, says Dady. And while he steers his clients toward 12 major areas they need to scrutinize, the right to transfer for fair value, he says, is among the most important.

"These agreements should never include rights of first refusal, but some manufacturers have it in there. The biggest problem with this is that it chills the interest of others to buy. If I'm a potential buyer and I'm looking at two dealerships, but one of the supplier agreements says that once I make my deal, the supplier can match it and take it away from me, which one do you think I'm going to go with?"

Another thing dealers should examine closely are provisions in the contract-approval step that says the dealer must let the supplier know when it is considering selling the business prior to entering into a purchase agreement.

"This is a terrible provision," Dady says. "If you're not contractually obligated to tell your supplier, my typical advice to my ag equipment dealer clients is don't."

Negotiating a Deal
He suggests that any prospective buyer should be required to sign a confidentiality agreement with legal guarantees that states any and all information disclosed during negotiations remains classified and private.

Second, the dealers should get an auction going with synergistic buyers to get the best price they can, and then sign a purchase agreement that's subject to approval by the supplier or supplier. At this point, work with the supplier to get the purchase approved, citing the dealer's contractual rights that the supplier must be reasonable.

On the other hand, Dady says, "If we're representing a buyer, and the supplier has the right of first refusal, we request that the selling dealer get the supplier to waive that right so we don't spend a lot of money and waste our time.

"Our firm is very heavy in the car dealership business right now and we've been able to get some suppliers to waive this right. This helps the buyer know that when they get an attorney involved, they'll see a return on their investment and the deal won't be taken away from them," says Dady.

In Today, Out Tomorrow
As the major farm equipment manufacturers continue to push to reduce their dealer numbers and streamline distribution, contract approval will remain their big stick. Even if a dealer or dealer group considers itself the "shark" in the "shark or bait" competition for survival, Dady suggests that the important thing for farm equipment dealers to understand is that "suppliers change their minds. The designated buyer one year becomes the guy who has to sell the next year. You may think you're safe in year one, then find you're very unsafe in year two."

Deere's Waffling Created a Costly Mess for RDO
Dave Kanicki, Executive Editor

By 1997, Fargo, N.D.-based RDO Equipment Co. had grown to a network of more than 30 John Deere ag and construction equipment stores. CEO Ron Offutt was in his mid-50s and, in his own words, "I started thinking about my own mortality."

With none of his family involved in the business at the time, he recalls thinking: "With John Deere having the right to name its dealers, this is a poor business to die in without a successor. I also thought being a public entity would solve that problem."

He also remembers thinking that being a public company would bring some liquidity to the dollars he had tied up in the company.

Because the dealer base at that time was predominantly made up of "a lot of gray hairs, no hairs and white hairs," Deere demanded that its dealers have an exit strategy that outlined when they were ready to get out of the business. Offutt believed taking the company public would satisfy John Deere's requirements as well as meet his own needs.

First Blessing, then Shutting off the Gate

In 1997, with John Deere's blessing, the initial public offering of company shares was made and surpassed Offutt's expectations, generating $68 million by selling 35% of the stock.

The dealership's phones were ringing off the hooks with dealers wanting to sell at a multiple of earnings instead of book value. "We were on the phone, too, calling John Deere and telling them we would like to buy one place or another, both on the ag and CE side.

"John Deere corporate became fearful, thinking that maybe it had created a monster," says Offutt. "So what it did was shut the gate and not let us buy anything. We had the analysts calling every quarter asking 'What are you going to buy the next quarter?' 'What's on the line?' 'Where's the growth coming from?'"

The firm was under enormous pressure to grow, but with no place to go. "John Deere had the fear and we were paralyzed. So as a company, we decided we had to develop other platforms of growth."

One was getting into the trucking business, which Offut reflected upon as a strategic mistake. "We lost a lot of money," Offut says in retrospect, "and we didn't know how to get ourselves out of trouble. We had to amputate our arm to save the company. Our earnings tanked. The value of our stock tanked. With all of this, we lost the investors following the company to where there were only 3,000-4,000 shares of the stock sold every week and it just kept getting cheaper and cheaper and cheaper.

"We were digging ourselves out of a hole and nobody was following us. I think our book value was $7 a share and dropped to $2 or $3."

This was down from a high of $29.50. "Anyway, it just made sense to take it back private. It gave John Deere a comfort level because the monster went back into its cave," says Offutt.

"I feel bad. People bought our stock and a lot of them lost money. The stock price rose to $29 a share and stakeholders would have done alright selling at that point. The same goes for me, but that didn't happen."

Contract Approval: The 'Big Hammer' in Dealer Consolidation
Strategies for Dealing with Ownership Transfer Issues
Dealer Associations Get Into the Ring with the Majors

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