Dealer Protection Statutes Level the Playing Field for Heavy Equipment Dealers

One such law ' the Virginia Heavy Equipment Dealer Act ('the Act') ' was recently the subject of a major court battle. On one side was a Virginia dealer engaged in the business of selling and leasing heavy equipment at retail. On the other side was a Canadian company that manufactures heavy forestry and logging equipment. A written agreement between the two firms had been in effect for nearly 6 years.

The Canadian manufacturer tried to terminate the agreement in 2005. The Virginia dealer went to court to stop the termination. The manufacturer responded aggressively with a three-point counterattack. As a threshold matter, the manufacturer claimed that the dealer did not carry enough inventory to fall within the statutory definition of 'dealer,' and therefore did not qualify for the Act's protection. It also claimed that the Act violated the state constitution's prohibition against 'special laws.' Finally, in an argument with potential industrywide ramifications, the manufacturer claimed the Act violated the Commerce Clause of the U.S. Constitution.

In an April 2006 decision of the U.S. District Court for the Eastern District of Virginia, the Canadian company lost and the applicability and constitutionality of the Act were upheld. Atlantic Machinery & Equipment, Inc. v. Tigercat Industries, Inc., 419 F.Supp.2d 856 (E.D. Va. 2006) ('Atlantic Machinery I'); Atlantic Machinery & Equipment, Inc. v. Tigercat Industries, Inc., 427 F.Supp.2d 657 (E.D. Va. 2006) ('Atlantic Machinery II'). This precedent should help equipment dealers defend ' or enact ' similar statutes in other states.

The Virginia Act

Adopted by Virginia in 1988, the Act lists a variety of goals. Among them are (i) promoting 'a stable business climate for the supply and distribution of heavy equipment ' [thereby encouraging] economic development' as well as (ii) 'foster[ing] fair business relations between suppliers and dealers of heavy equipment,' and (iii) 'prohibit[ing] unfair treatment of dealers of heavy equipment.' 1988 Acts of Assembly, ch. 73 (emphasis added). (The Act is found at Virginia Code '59.1-353 et seq.)

The Act defines 'heavy equipment' as 'self-propelled, self-powered or pull-type equipment and machinery, including engines, weighing 5000 pounds or more, primarily employed for construction, industrial, maritime, mining and forestry uses.' Motor vehicles requiring registration and certificates of title, farm machinery, equipment and implements sold or leased pursuant to dealer agreements with suppliers subject to other provisions of Virginia law, and consumer goods are carved out of the definition of 'heavy equipment.'

In a nutshell, the Act prohibits a 'supplier' of heavy equipment from canceling ' or failing to renew ' a dealership agreement without 'good cause.' The term 'good cause' is limited. It means a decision by the supplier to withdraw from selling its products in Virginia or some 'performance deficiency' on the part of the dealer. As a general rule, the supplier must give the dealer at least 120 days prior written notice and an opportunity to cure any alleged deficiency. There are exceptions to the notice requirement for certain severe situations, such as dealer bankruptcy, fraud, delinquency in paying the supplier, a felony conviction, etc. Significantly, the Act states that these protections apply 'notwithstanding the terms ' of any agreement.' Va. Code '59.1-354. Thus, these are not rights that equipment dealers can be forced to give up when they contract with manufacturers.

There is, however, a limitation on who qualifies for these protections. Occasionally selling or leasing a piece of heavy equipment is not enough. Under the Act, a 'dealer' is a person who is '(i) engaged in the business of selling or leasing heavy equipment at retail, (ii) who customarily maintains a total inventory, valued at over $250,000, of new heavy equipment ' and (iii) who provides repair services for the heavy equipment sold.' Va. Code '59.1-353.

The Dealership Agreement

Signed in 1999, the agreement between the Virginia equipment dealer and the Canadian manufacturer in this case was not unusual. The manufacturer designated the dealer as an authorized representative of its equipment for a geographic area of 'primary responsibility' that included much of Virginia. The manufacturer had no other direct sales outlets in the state. Its equipment was manufactured in Ontario, Canada, and was shipped to the dealer 'free on board' Ontario.

The agreement said that the manufacturer could terminate the equipment dealer relationship upon 60 days written notice, rather than the 120 days required by the Act. And, unlike the Act, the agreement contained no requirement that there be 'good cause,' nor did it require the reason for termination to be explained, nor did it provide for the dealer to be given an opportunity to cure. In July 2005, the manufacturer sent the dealer a termination notice. While the bare bones notice complied with the agreement, it did not comply with the Act. Facing a major blow to its business, the equipment dealer filed suit in state court.

Based on 'diversity of citizenship' ' Virginian and Canadian ' the manufacturer removed the lawsuit to federal court.

The Inventory Claim

The manufacturer claimed that the equipment dealer did not meet the Act's inventory requirement because the dealer did not 'customarily maintain a total inventory, valued at over $250,000, of new heavy equipment' from this manufacturer. The court held that 'total inventory' means inventory from all suppliers, not just the individual supplier in the case. It also held that 'customarily' is flexible and dependent on the facts in a specific case. Applying 'customarily' to the case before it, the court decided that the equipment dealer's total inventory should be assessed on a monthly or quarterly basis for the 5 years immediately preceding the supplier's termination of the agreement. Atlantic Machinery I, 419 F.Supp.2d at 860-61. With that clarification by the court, the equipment dealer easily established that it customarily maintained total inventory exceeding $250,000. Atlantic Machinery II, 427 F.Supp.2d at 660-61.

The State Constitutional Claim

The manufacturer claimed that the Act did not further any legitimate state interest, and that it was 'designed to protect a specific group ' existing heavy equipment dealers in Virginia to the detriment of other[s].' Id. at 662. Thus, it said the Act was 'economic favoritism' and invalid under the state constitutional prohibition against 'special laws.' See Va. Const. Art. IV, '14. Not persuaded, the court noted that an 'economic classification' is valid if there is 'a reasonable and substantial relation' between the law and a legitimate legislative goal. Id. There was nothing on the face of the Act ' and nothing in the evidence ' to support the manufacturer's claim that the Act was 'unreasonable or arbitrary.' Id. Thus, the court rejected the state constitutional challenge, saying it would not 'second guess' the legislature's judgment on whether the Act promoted its objectives ' economic development and fair business relations. Id.

The Federal Constitutional Claim

The manufacturer also claimed the Act violated the federal Commerce Clause. The Constitution gives Congress the power to regulate interstate and international commerce. See U.S. Const. Art. I, '8, cl. 3. Even where a state enacts economic regulation in the absence of congressional action, however, the regulation still must be judged in light of judicially developed constitutional standards known as the 'dormant Commerce Clause.'

The dormant Commerce Clause involves two tiers of analysis. On the first tier, a state statute will almost always be struck down if it discriminates against interstate commerce. One way for a statute to discriminate is to regulate commerce occurring wholly outside the state's borders. This was the theory pressed by the manufacturer. Even though the dealership agreement was executed in Virginia ' and governed the retail sale of equipment there ' the manufacturer cited the 'free on board' provision in the agreement. Noting that formal ownership passed to the dealer while the equipment was still in Canada, the manufacturer claimed the Act was being used to regulate conduct occurring beyond Virginia's borders, and thus was unconstitutional. It was a creative argument, but the court readily rejected it. Where elements of a transaction occur in two states, or here in Virginia and Canada, both have an interest in the terms and performance of the contract. As the court explained, 'Virginia has a legitimate interest in regulating contracts entered into within her borders, particularly those affecting the stability of its economy ' [and] involv[ing] conduct between the parties of an on-going nature ' within the state's borders.' Id. at 666. Thus, the manufacturer's attempt to take advantage of a technicality ' where title passed ' proved unsuccessful.

The manufacturer also argued that the Act discriminated against interstate commerce on the theory that dealers are local while suppliers of heavy equipment are out of state. It claimed that the Act was a 'one-sided attempt' to favor local equipment dealers over foreign suppliers. See Id. at 666-67. The court rejected this argument too. Taking issue with its factual assumption, the court then went further and suggested that the actual location of existing suppliers does not affect the outcome. 'The Act cannot be considered economic protectionism when it affects both in-state and out-of-state suppliers equally.' Id. at 666-67 (emphasis added). The focus must be on how the Act affects in-state suppliers versus out-of-state suppliers, not on how it affects in-state dealers versus out-of-state suppliers. A state law protecting dealers against unfair treatment by suppliers should not be struck down merely because all suppliers are out of state.

When a statute survives the first tier of analysis, there is still a second tier that must be considered ' the Pike balancing test. See Pike v. Bruce Church, Inc., 397 U.S. 137 (1970). A statute will survive the Pike test unless the burdens the statute imposes on interstate commerce are 'clearly excessive' compared with the benefits it provides for the state. Id. at 142. The court must identify both the benefits and burdens of the challenged statute and weigh one against the other.

The court easily recognized that the Act provides Virginia with legitimate benefits ' 'namely, the overarching objective of stimulating economic development by encouraging stability and consistency between suppliers and dealers of heavy equipment ' ' Atlantic Machinery II, 427 F.Supp.2d at 667. In trying to overcome these benefits, the manufacturer tried to amass a number of alleged burdens. The court was not impressed. Some of the alleged burdens, such as the scope of the dealer's geographic area, flowed not from the Act but from the agreement. Other alleged burdens were not viewed as burdens at all. For example, the court regarded the length of the notice period ' 120 days ' as both 'relatively short' and necessary to achieve the goals of the Act. Id. at 669.

The manufacturer sought to draw an analogy between the Act and Virginia's motorcycle dealer protection statute, recently invalidated in another case. See Yamaha Motor Corp. v. Jim's Motorcycle, Inc., 401 F.3d 560 (4th Cir. 2005). The court did not buy the analogy. Under the statute in Yamaha, an existing motorcycle dealer could prevent his manufacturer from creating a new dealership anywhere in the state, even outside the existing dealer's market area. By contrast, the Virginia Heavy Equipment Dealer Act did not prevent the creation of any new dealerships; it only imposed certain requirements on the termination of an existing one. To the extent the existing equipment dealer enjoyed any territorial control, it was the result of the agreement, not the Act. The Commerce Clause challenge failed.

The Result

Having ruled that the agreement was governed by the Act and that the Act was constitutional, the court then found that the notice given by the manufacturer was invalid.

Lessons

If you finance lessors or sellers of heavy equipment, you should not necessarily take their contracts with suppliers at face value. The chances are good there is state legislation that provides dealers with valuable protection from termination, cancellation, or non-renewal by their suppliers. Whether the dealer or supplier knows it or not, such legislation may well trump inconsistent provisions in the supplier's contract, which itself may well be, or appear on its face to be, non-negotiable and a contract of adhesion. The courts will apply and enforce this protective legislation to favor the dealer because doing so is consistent with the broad, remedial purposes of the legislation and is exactly what the state legislature intended when it enacted the law.

Bradfute 'Brad' W. Davenport, Jr. is a partner in the Richmond, VA office of Troutman Sanders LLP. A member of the firm's Complex Litigation group, Davenport has 33 years experience in complex commercial litigation including environmental, construction, contract, banking, franchise, leasing, bankruptcy, and other business cases. He may be reached at 804-697-1311 or mailto:[email protected]. William H. Hurd is of counsel in the firm's Richmond, VA office. Prior to joining Troutman Sanders LLP, Hurd served as Virginia's State Solicitor General from 1999-2004. He may be reached at 804-697-1335 or [email protected].

Dealers who sell and lease expensive heavy equipment, and therefore those who finance them, are often at the mercy of the manufacturers whose products the dealers sell or lease. Disparities in bargaining power between a local equipment dealership and a national or international manufacturer can force the dealership to accept unfair or oppressive terms. And if the manufacturer arbitrarily terminates the dealership agreement, the thriving business that the equipment dealer built can be totally ruined, often with little or no legal recourse, thereby also putting those who finance the dealer at peril.

Recognizing the need to level the playing field, some states have enacted laws to protect equipment dealers from arbitrary cancellation of dealership agreements. These laws often cover dealers in equipment and machinery used in the construction, forestry, maritime, mining, and other industries. Several states ' Virginia, Delaware, Georgia, Maryland, Mississippi, Tennessee, and West Virginia ' have laws that prohibit a manufacturer from terminating an equipment dealer without good cause and an opportunity to cure. Garner, 2 Franchise and Distribution Law and Practice, '16:5 (Thompson/West 2005). These dealer protection statutes take various forms. Some states require manufacturers to repurchase the dealer's inventory after termination; others require the manufacturer to compensate the dealer for the value of its premises. Id. In one form or another, '[t]hirty-five states have statutes protecting dealers in farm equipment and similar heavy equipment.' Id.

The Recent Virginia Decision

One such law ' the Virginia Heavy Equipment Dealer Act ('the Act') ' was recently the subject of a major court battle. On one side was a Virginia dealer engaged in the business of selling and leasing heavy equipment at retail. On the other side was a Canadian company that manufactures heavy forestry and logging equipment. A written agreement between the two firms had been in effect for nearly 6 years.

The Canadian manufacturer tried to terminate the agreement in 2005. The Virginia dealer went to court to stop the termination. The manufacturer responded aggressively with a three-point counterattack. As a threshold matter, the manufacturer claimed that the dealer did not carry enough inventory to fall within the statutory definition of 'dealer,' and therefore did not qualify for the Act's protection. It also claimed that the Act violated the state constitution's prohibition against 'special laws.' Finally, in an argument with potential industrywide ramifications, the manufacturer claimed the Act violated the Commerce Clause of the U.S. Constitution.

In an April 2006 decision of the U.S. District Court for the Eastern District of Virginia, the Canadian company lost and the applicability and constitutionality of the Act were upheld. Atlantic Machinery & Equipment, Inc. v. Tigercat Industries, Inc. , 419 F.Supp.2d 856 (E.D. Va. 2006) (' Atlantic Machinery I '); Atlantic Machinery & Equipment, Inc. v. Tigercat Industries, Inc., 427 F.Supp.2d 657 (E.D. Va. 2006) (' Atlantic Machinery II' ). This precedent should help equipment dealers defend ' or enact ' similar statutes in other states.

The Virginia Act

Adopted by Virginia in 1988, the Act lists a variety of goals. Among them are (i) promoting 'a stable business climate for the supply and distribution of heavy equipment ' [thereby encouraging] economic development' as well as (ii) 'foster[ing] fair business relations between suppliers and dealers of heavy equipment,' and (iii) 'prohibit[ing] unfair treatment of dealers of heavy equipment.' 1988 Acts of Assembly, ch. 73 (emphasis added). (The Act is found at Virginia Code '59.1-353 et seq.)

The Act defines 'heavy equipment' as 'self-propelled, self-powered or pull-type equipment and machinery, including engines, weighing 5000 pounds or more, primarily employed for construction, industrial, maritime, mining and forestry uses.' Motor vehicles requiring registration and certificates of title, farm machinery, equipment and implements sold or leased pursuant to dealer agreements with suppliers subject to other provisions of Virginia law, and consumer goods are carved out of the definition of 'heavy equipment.'

In a nutshell, the Act prohibits a 'supplier' of heavy equipment from canceling ' or failing to renew ' a dealership agreement without 'good cause.' The term 'good cause' is limited. It means a decision by the supplier to withdraw from selling its products in Virginia or some 'performance deficiency' on the part of the dealer. As a general rule, the supplier must give the dealer at least 120 days prior written notice and an opportunity to cure any alleged deficiency. There are exceptions to the notice requirement for certain severe situations, such as dealer bankruptcy, fraud, delinquency in paying the supplier, a felony conviction, etc. Significantly, the Act states that these protections apply 'notwithstanding the terms ' of any agreement.' Va. Code '59.1-354. Thus, these are not rights that equipment dealers can be forced to give up when they contract with manufacturers.

There is, however, a limitation on who qualifies for these protections. Occasionally selling or leasing a piece of heavy equipment is not enough. Under the Act, a 'dealer' is a person who is '(i) engaged in the business of selling or leasing heavy equipment at retail, (ii) who customarily maintains a total inventory, valued at over $250,000, of new heavy equipment ' and (iii) who provides repair services for the heavy equipment sold.' Va. Code '59.1-353.

The Dealership Agreement

Signed in 1999, the agreement between the Virginia equipment dealer and the Canadian manufacturer in this case was not unusual. The manufacturer designated the dealer as an authorized representative of its equipment for a geographic area of 'primary responsibility' that included much of Virginia. The manufacturer had no other direct sales outlets in the state. Its equipment was manufactured in Ontario, Canada, and was shipped to the dealer 'free on board' Ontario.

The agreement said that the manufacturer could terminate the equipment dealer relationship upon 60 days written notice, rather than the 120 days required by the Act. And, unlike the Act, the agreement contained no requirement that there be 'good cause,' nor did it require the reason for termination to be explained, nor did it provide for the dealer to be given an opportunity to cure. In July 2005, the manufacturer sent the dealer a termination notice. While the bare bones notice complied with the agreement, it did not comply with the Act. Facing a major blow to its business, the equipment dealer filed suit in state court.

Based on 'diversity of citizenship' ' Virginian and Canadian ' the manufacturer removed the lawsuit to federal court.

The Inventory Claim

The manufacturer claimed that the equipment dealer did not meet the Act's inventory requirement because the dealer did not 'customarily maintain a total inventory, valued at over $250,000, of new heavy equipment' from this manufacturer. The court held that 'total inventory' means inventory from all suppliers, not just the individual supplier in the case. It also held that 'customarily' is flexible and dependent on the facts in a specific case. Applying 'customarily' to the case before it, the court decided that the equipment dealer's total inventory should be assessed on a monthly or quarterly basis for the 5 years immediately preceding the supplier's termination of the agreement. Atlantic Machinery I, 419 F.Supp.2d at 860-61. With that clarification by the court, the equipment dealer easily established that it customarily maintained total inventory exceeding $250,000. Atlantic Machinery II, 427 F.Supp.2d at 660-61.

The State Constitutional Claim

The manufacturer claimed that the Act did not further any legitimate state interest, and that it was 'designed to protect a specific group ' existing heavy equipment dealers in Virginia to the detriment of other[s].' Id. at 662. Thus, it said the Act was 'economic favoritism' and invalid under the state constitutional prohibition against 'special laws.' See Va. Const. Art. IV, '14. Not persuaded, the court noted that an 'economic classification' is valid if there is 'a reasonable and substantial relation' between the law and a legitimate legislative goal. Id. There was nothing on the face of the Act ' and nothing in the evidence ' to support the manufacturer's claim that the Act was 'unreasonable or arbitrary.' Id. Thus, the court rejected the state constitutional challenge, saying it would not 'second guess' the legislature's judgment on whether the Act promoted its objectives ' economic development and fair business relations. Id.

The Federal Constitutional Claim

The manufacturer also claimed the Act violated the federal Commerce Clause. The Constitution gives Congress the power to regulate interstate and international commerce. See U.S. Const. Art. I, '8, cl. 3. Even where a state enacts economic regulation in the absence of congressional action, however, the regulation still must be judged in light of judicially developed constitutional standards known as the 'dormant Commerce Clause.'

The dormant Commerce Clause involves two tiers of analysis. On the first tier, a state statute will almost always be struck down if it discriminates against interstate commerce. One way for a statute to discriminate is to regulate commerce occurring wholly outside the state's borders. This was the theory pressed by the manufacturer. Even though the dealership agreement was executed in Virginia ' and governed the retail sale of equipment there ' the manufacturer cited the 'free on board' provision in the agreement. Noting that formal ownership passed to the dealer while the equipment was still in Canada, the manufacturer claimed the Act was being used to regulate conduct occurring beyond Virginia's borders, and thus was unconstitutional. It was a creative argument, but the court readily rejected it. Where elements of a transaction occur in two states, or here in Virginia and Canada, both have an interest in the terms and performance of the contract. As the court explained, 'Virginia has a legitimate interest in regulating contracts entered into within her borders, particularly those affecting the stability of its economy ' [and] involv[ing] conduct between the parties of an on-going nature ' within the state's borders.' Id. at 666. Thus, the manufacturer's attempt to take advantage of a technicality ' where title passed ' proved unsuccessful.

The manufacturer also argued that the Act discriminated against interstate commerce on the theory that dealers are local while suppliers of heavy equipment are out of state. It claimed that the Act was a 'one-sided attempt' to favor local equipment dealers over foreign suppliers. See Id. at 666-67. The court rejected this argument too. Taking issue with its factual assumption, the court then went further and suggested that the actual location of existing suppliers does not affect the outcome. 'The Act cannot be considered economic protectionism when it affects both in-state and out-of-state suppliers equally.' Id. at 666-67 (emphasis added). The focus must be on how the Act affects in-state suppliers versus out-of-state suppliers, not on how it affects in-state dealers versus out-of-state suppliers. A state law protecting dealers against unfair treatment by suppliers should not be struck down merely because all suppliers are out of state.

When a statute survives the first tier of analysis, there is still a second tier that must be considered ' the Pike balancing test. See Pike v. Bruce Church, Inc. , 397 U.S. 137 (1970). A statute will survive the Pike test unless the burdens the statute imposes on interstate commerce are 'clearly excessive' compared with the benefits it provides for the state. Id. at 142. The court must identify both the benefits and burdens of the challenged statute and weigh one against the other.

The court easily recognized that the Act provides Virginia with legitimate benefits ' 'namely, the overarching objective of stimulating economic development by encouraging stability and consistency between suppliers and dealers of heavy equipment ' ' Atlantic Machinery II, 427 F.Supp.2d at 667. In trying to overcome these benefits, the manufacturer tried to amass a number of alleged burdens. The court was not impressed. Some of the alleged burdens, such as the scope of the dealer's geographic area, flowed not from the Act but from the agreement. Other alleged burdens were not viewed as burdens at all. For example, the court regarded the length of the notice period ' 120 days ' as both 'relatively short' and necessary to achieve the goals of the Act. Id. at 669.

The manufacturer sought to draw an analogy between the Act and Virginia's motorcycle dealer protection statute, recently invalidated in another case. See Yamaha Motor Corp. v. Jim's Motorcycle, Inc ., 401 F.3d 560 (4th Cir. 2005). The court did not buy the analogy. Under the statute in Yamaha, an existing motorcycle dealer could prevent his manufacturer from creating a new dealership anywhere in the state, even outside the existing dealer's market area. By contrast, the Virginia Heavy Equipment Dealer Act did not prevent the creation of any new dealerships; it only imposed certain requirements on the termination of an existing one. To the extent the existing equipment dealer enjoyed any territorial control, it was the result of the agreement, not the Act. The Commerce Clause challenge failed.

The Result

Having ruled that the agreement was governed by the Act and that the Act was constitutional, the court then found that the notice given by the manufacturer was invalid.

Lessons

If you finance lessors or sellers of heavy equipment, you should not necessarily take their contracts with suppliers at face value. The chances are good there is state legislation that provides dealers with valuable protection from termination, cancellation, or non-renewal by their suppliers. Whether the dealer or supplier knows it or not, such legislation may well trump inconsistent provisions in the supplier's contract, which itself may well be, or appear on its face to be, non-negotiable and a contract of adhesion. The courts will apply and enforce this protective legislation to favor the dealer because doing so is consistent with the broad, remedial purposes of the legislation and is exactly what the state legislature intended when it enacted the law.

Bradfute 'Brad' W. Davenport, Jr. is a partner in the Richmond, VA office of Troutman Sanders LLP. A member of the firm's Complex Litigation group, Davenport has 33 years experience in complex commercial litigation including environmental, construction, contract, banking, franchise, leasing, bankruptcy, and other business cases. He may be reached at 804-697-1311 or mailto:[email protected]. William H. Hurd is of counsel in the firm's Richmond, VA office. Prior to joining Troutman Sanders LLP, Hurd served as Virginia's State Solicitor General from 1999-2004. He may be reached at 804-697-1335 or [email protected].