Published July 6, 2010, Los Angeles Daily Journal – Last week marked an epic event in the automotive industry when Tesla Motors launched its ambitious effort to raise $185 million through a public offering of 11.1 million shares of stock.  The IPO was historic in that Tesla is now among the ranks of only a small handful of U.S. auto manufacturers to have ever had a public offering (General Motors, Chrysler and Ford, to name a few); the offering was notable in that this is the first time an all electric car company has ever graced the annals of Wall Street. But the event was remarkable for a much more subtle, and much more important, reason.  Tesla’s launch signifies the first time in U.S. history that an auto manufacturer of any significant scale has rejected the much-embraced franchised dealer sales system, in favor of company owned stores.

Although some may not recognize it, or perhaps have just never given it much consideration, the neighborhood Ford dealer down the block is not a “Ford” store at all; it is a separately owned business that enjoys a dealer agreement with the manufacturer.  This franchise system is as old as the manufacturers who use it, dating back to the early 1900s when Ford and General Motors forged partnerships with budding entrepreneurs who were able to penetrate the local communities in ways that the manufacturers couldn’t.  Throughout this time, the franchise system gained strength as the accepted way to sell and service automobiles, and to occasionally address other social issues such as the “minority dealer development” programs, where the manufactures assist minority groups in becoming dealers.  Now, some 100 years later, the franchise system is taken for granted as the way cars are sold in the U.S. –until now.

Tesla’s attempt to reinvent the way cars are sold is bold, pioneering and stimulating – and for Tesla, potentially problematic.  As the franchise system evolved in the U.S., state legislatures began to recognize significant disparities in the bargaining power between large auto manufacturers and independently owned dealerships.  These concerns grew as manufacturers were at times put in the position of having to take back independently owned dealerships (for instance, when a dealer was terminated or gave back the franchise), or when manufacturers just tried to open up competing “factory-owned” dealerships altogether.  Because of this uneven playing field, several states developed bodies of law intended to protect dealers from unfair competition from their manufacturers.  For instance, California prohibits manufacturers from owning dealerships if there is another franchised dealer within 10 miles; New York prohibits factory owned stores if there is another franchised dealer within the state; and Colorado bans manufacturers from owning more than one dealership altogether.

While the dealer laws originated to even the playing field between manufacturers and franchised dealers, it is not difficult to imagine that legislatures might have an interest in expanding the statutory schemes to protect the sanctity of the franchise system.  For instance, in March 2010 Colorado passed House Bill 10-1049, which expanded the state’s statutory dealer laws to prohibit manufacturers from owning multiple dealerships in the state.  Hence, an attempt by Tesla to open two dealerships in Colorado would be deemed unlawful.

With the inroads that the dealer bodies have had with the legislatures, it is not difficult to imagine that a widespread factory-owned dealer system, such as the one being implemented by Tesla, would be deemed unlawful.  Arguments could be made that such a system would enable unfair competition with dealers of other line-makes who were not as well-capitalized, or that the system would be against the public interest because dealerships would not be as plentiful, resulting in a diminished ability of the factory-owned dealers to handle maintenance, warranty and recall issues.  And, then of course, there is the erosion of the minority dealer development program, which would likely invoke a response from the National Association of Minority Auto Dealers.

Such arguments sound crazy?  Think again.  In the early 1970s petroleum producers, such as Exxon and Shell, began shedding their historic franchise system in favor of company-owned retail stations.  The movement was met with resistance, with dealers claiming that the company-owned stations were unfairly competing with the dealers and that the existence of the stores was against public policy.  The Maryland Legislature agreed, and in 1974 Maryland enacted a statute prohibiting any producer or refiner of petroleum products from owning and operating a retail station in the state.  Exxon, Shell, Gulf Oil and Ashland Oil challenged the law as an unlawful restraint on trade and a violation of the due process, resulting in U.S. Supreme Court review.  In [Exxon Corp. v. Governor of Maryland], 437 U.S. 117 (1978), the Supreme Court upheld the law, stating that the law bore a reasonable relation to the state’s legitimate purpose in controlling the gasoline retail market; that the statute did not impermissibly burden interstate commerce; and the fact that the statute might have anticompetitive effects was not in itself a sufficient reason to invalidate the law.

Would a state’s attempt to regulate the automotive industry lead to a similar result?  Probably.  Consider the 1978 U.S. Supreme Court case of [New Motor Vehicle Board v. Orrin Fox Co.], 439 U.S. 96 (1978), where California’s dealer protection laws were upheld as constitutional.  The Court held that the California Legislature was constitutionally empowered to enact a general scheme of business regulation that imposed reasonable restriction upon the exercise of the right, stating “the due process clause is not to be so broadly construed that the Congress and state legislature are put in a strait jacket when they attempt to suppress business and industrial conditions which they regard as offensive to the public welfare.”

So, what will become of the Tesla business plan?  Tesla describes one of its strengths as the fact that it “operates in a fundamentally different manner and structure than traditional automobile manufacturers.”  Judging by the response to the IPO, where the stock price nearly doubled in the first few days, Wall Street seems poised to embrace the plan.  One can only wonder if the legislature will be so kind.