What a dealership franchise agreement usually covers

A new car dealership that sells a particular brand does so under a written agreement with the manufacturer or distributor of that brand. That agreement is called a franchise agreement. It sets out what the dealer may sell, where, and under what standards. Anyone who wants to understand how auto retail works needs to know what these agreements cover.

This article is a plain overview. Agreements differ by brand and by state, so treat it as a map of the topics and not as a description of any one contract. The details here come from the public annual report of AutoNation, a dealership group, which describes its franchise agreements in its filing with the U.S. Securities and Exchange Commission.

What a franchise agreement is

A franchise agreement is a contract between a dealer and a manufacturer or distributor. According to AutoNation's filing, franchises grant a non-exclusive right to sell the manufacturer's or distributor's brand of vehicles within a specified market area.

The manufacturer supplies the vehicles and sets the terms under which the brand is sold. The dealer sells them. The agreement is the document that connects the two.

Term and renewal

Agreements do not all run for the same length of time. AutoNation's filing says the terms provide for various durations, ranging from one year to no expiration date.

Renewal is a separate question. The filing says manufacturers have undertaken to renew such franchises upon expiration in certain cases, and that AutoNation anticipates routine renewals when agreements have set terms. Whether an agreement renews, and on what conditions, depends on the contract and on the law that applies to it.

Territory and market area

A dealer does not simply sell a brand anywhere. The agreement ties the right to sell to a market area. AutoNation's filing says manufacturers have designated marketing and sales areas within which only one franchised dealer of a given brand may operate.

For a person studying the business, this is one of the key points. A dealer's market area shapes who its customers are and how many vehicles it can reasonably sell. Moving a store or opening a new one for the same brand generally needs the manufacturer's approval, according to the filing.

Facilities and standards

Franchise agreements also address the buildings. The filing says franchise agreements impose requirements on showroom and service facilities and on signage, and that manufacturers impose minimum facility requirements that can require significant capital expenditures.

The dealer is expected to present the brand in the way the manufacturer requires, and the agreement is where those expectations are recorded. Meeting them can be a large expense for the dealer.

Ownership and management changes

A manufacturer has a stake in who runs a store that sells its brand. AutoNation's filing lists any unapproved change of ownership or management among the grounds for termination.

The filing also describes framework agreements that may give a manufacturer the right to buy a dealer's stores at fair market value, or to compel their sale, after a change in control. One example it gives is another manufacturer acquiring 20 percent or more of the company's voting stock. These provisions vary and apply to specific agreements, so they should not be assumed for every dealer.

Termination and non-renewal

The agreement says when a manufacturer may end the relationship. AutoNation's filing says its agreements provide for termination by the manufacturer, or non-renewal, for a variety of causes. It also says the agreements permit a manufacturer to terminate or compel a sale of the franchise for reasons that include uncured performance deficiencies.

Contract terms are only part of the picture. The filing says state dealership laws make it unlawful for a manufacturer to terminate or not renew a franchise unless good cause exists, and that these laws generally make it difficult for a manufacturer to terminate or decline to renew a franchise outside of bankruptcy.

Why this matters when you study a dealership

The franchise agreement explains a lot about how a dealership operates day to day. It ties a store to a brand and a market area, it sets facility expectations, and it brings the manufacturer into ownership changes. It also sets the rules for when the relationship can end.

When you read about a dealership group, whether in a company filing or a news report, look for how many franchises it holds, with which brands, and how it describes the risk that a manufacturer might end or not renew an agreement. Those points tell you how the business depends on the manufacturers it works with.

Questions worth asking

If you want to go deeper, a few questions help. How long is the term, and what are the renewal conditions? What market area does the agreement define? What facility standards does the manufacturer require, and who pays for them? What happens if ownership changes? What does the state's dealer law say about termination?

You can find some of these answers in public company filings, and others only in the agreement itself. Because each agreement is its own document, only the actual contract and a qualified attorney can tell you what a particular dealership has agreed to.

This article is general education about auto retail. It is not an offer to sell securities and it is not investment, legal or tax advice. Talk with your own advisors about your own decisions.