The term “encroachment” describes the situation where a new auto dealership is established in close proximity to an existing one. This can happen when there is market growth and a factory decides to add a new dealer to meet customer demand. It may also happen when a factory reorganizes its network and grants additional brands to existing dealers in the same market area.

Encroachment can easily lead to conflict between a dealer and its factory. After all, dealers don’t exactly welcome the addition of nearby competitors selling the same products. Yet, in most cases, there is language in contractual agreements giving factories the right to add new dealer points and to manage their networks as they see fit.

Courts have acted in a number of cases to stop encroachment. The cases are very fact specific, and depend on a dealer marshalling a case to persuasively explain the negative consequences that can result from decisions that fail to properly take into account the impact the new dealer will have on the existing dealer’s market.

Courtesy Chrysler

A recent court decision from Alberta illustrates the type of scenario in which a court will prohibit the adding of a new dealer. The case involved Courtesy Chrysler Ltd., located in an affluent Calgary neighbourhood. When Courtesy learned Chrysler was awarding a franchise for a new dealership it felt was too close to its long-established operation, it went to court to block the move.

Courtesy had invested heavily in expanding its showroom and repair areas over the years to serve the growing area of southern Calgary. Although others had wanted to open dealerships in the area in the past, Chrysler would not allow this because it thought a new dealer would have a serious impact on Courtesy’s profitability.

But in 2012, Chrysler changed its mind, deciding to award a new dealership “virtually in the middle of Courtesy’s existing trade zone.” The proposed new dealership was to be located directly in between Courtesy and the neighbourhood where most of its customers lived.

When Courtesy’s owners objected, Chrysler replied that it could locate the new dealership where it wanted because the franchise agreement gave it the sole right to make these decisions. Courtesy’s contract gave Chrysler the right to determine where, when and how many authorized dealers are necessary, and to appoint additional dealers within an existing dealer’s sales area when in it thought doing so is necessary.

But the court disagreed with Chrysler, concluding that even though the franchise agreement gave the factory broad discretion to award new dealerships, it still had an obligation to act in good faith. The court concluded that Chrysler could not add the proposed new dealership while the lawsuit was pending because there was enough evidence that Chrysler did not sufficiently consider the dealer’s interests.

Paul Sadlon Motors

Another recent lawsuit had similar facts to the Courtesy case, but ended differently. The case involved a Chevrolet dealer called Paul Sadlon Motors Incorporated, which operated in Barrie, Ontario. Sadlon had been the only authorized Chevrolet dealer in Barrie for 45 years.

Shortly after the reorganization of General Motors in 2008, the automaker approached Sadlon with a plan. It told Sadlon it was going to split the Barrie market area in two: a North Barrie for Sadlon, and a South Barrie which the factory was going to grant to a former Pontiac dealer. In return, the factory was planning to grant Sadlon two new brands, Buick and GMC, in addition to Chevrolet and Cadillac.

Sadlon sued the factory to ask the court to prohibit the factory from proceeding with its plan while the lawsuit was ongoing.

Sadlon’s dealer agreement required the factory to give Sadlon 30 days’ notice before it granted a new dealer point within its territory. The dealer was also entitled to put its position to the factory and to have its case heard. The court concluded that the factory did not follow this process, instead presenting the plan as a “done deal” that the dealer had no choice but to accept.

The court also took issue with the fact that Sadlon was going to be excluded from an area which it had been servicing for decades. At the same time, its own market area would be cut in half. Ultimately, the court agreed with the dealer, granting the injunction, prohibiting the factory from proceeding with its plan to divide the Barrie market area in two while the lawsuit was pending.

Shortly after Sadlon won that first court battle, General Motors came up with a new plan. This time, instead of dividing the Barrie market area in half, it would appoint two Chevrolet dealers in the same market area. Both would have the right to service the entire market area.

Sadlon brought the factory to court again for an injunction to stop the new plan. This time, the dealer was not successful. The motion was heard by a new judge who concluded that the factory’s second plan fixed many of the problems with the first plan. Under the new plan, the court concluded the dealer was not being excluded from an area it previously serviced and its market area was not shrinking.

The judge also found that the interests of the former Pontiac dealer had to be taken into account. That dealer had lost a key brand in the 2008 restructuring and could not effectively compete with the remaining brands it had. On the whole, the court found that granting an injunction would have been more unfair to General Motors and the former Pontiac dealer than it was to Sadlon. Accordingly, the motion was denied and the factory went through with its plan.

The bottom line

The cases above illustrate a general principle: although factories typically have the right to add new dealers, they must also take the interests of existing dealers into account. Courts will consider whether the decision to add a new dealer was a reasonable and balanced business choice or whether there is an inherent unfairness to the existing dealer. If there is, courts may be willing to step in to block a factory from adding a new dealer.

The decisions reaffirm the crucial role of good faith and fair dealing even if there is language in an agreement that gives franchisors broad discretion to encroach. Ultimately, as the decisions reveal, the factual history, business reasons and expert evidence about the impact is critical for a court to decide whether to grant relief for alleged encroachment.

Jean-Marc Leclerc is a Toronto-based lawyer practicing exclusively in the field of commercial litigation. Stuart Freen is an associate lawyer practicing in corporate and commercial law. This article originally appeared in the January 2014 issue of Canadian Auto World.