Tesla’s Settlement with the State of Michigan

Tesla and the State of Michigan have settled Tesla’s constitutional challenge to Michigan’s refusal to grant Tesla’s request for a Class A license, which would have allowed Tesla to open a company-owned dealership in the state. The lawsuit, which was filed in federal court in the Western District of Michigan in 2016 and was scheduled to go to trial this year, grew out of a 2014 legislative amendment to Michigan’s automobile dealer law that made it unlawful for an automobile manufacturer to open its own retail store in the state, essentially forcing automobile manufacturers to distribute cars through franchised dealers. I detailed the nefarious circumstances and effects of the 2014 legislation in Tesla, Dealer Franchise Laws, and the Politics of Crony Capitalism, 101 Iowa L. Rev. 573 (2016).

There are two important terms to the settlement: (1) the state will not contest Tesla’s right to operate service centers in Michigan through a subsidiary; and (2) the state will not contest Tesla’s right to market cars to consumers in Michigan through a “gallery” model. This settlement  allows Tesla to sell and service cars in Michigan as it wants, and thus represents a total victory for Tesla in Michigan. It could also be a tipping point in Tesla’s ongoing battle for the right to engage in direct distribution in other states.

In my view, the service component is the more important aspect of the settlement. Tesla was already able to sell cars to customers in Michigan by marketing them over the Internet and delivering them out of state, so the agreement on the gallery marketing model is helpful but not essential. On the other hand, until today Tesla was prohibited from opening a service center in Michigan, which required Michigan Tesla owners to drive to Ohio for service. It will now be able to open service centers in Michigan through a subsidiary. (The subsidiary requirement will not impose any greater burden than a few hours of corporate lawyer time). Having access to service centers in Michigan will significantly increase the appeal of owning a Tesla in the Wolverine State.

The settlement also allows Tesla to open galleries in the state, although it still may not transact “sales” of its cars in the state. In effect, this means that Tesla can have sales people show its cars to potential customers in retail spaces (i.e., malls), arrange for test drives, help customers figure out what options they want on their car, and facilitate the paperwork. The customer will then have to complete the actual sales transaction over the Internet or telephone with Tesla in California (or wherever Tesla houses its sales function). The car will then be delivered to the customer in Michigan, which will increase the convenience of the buyer experience. The only remaining limit is that the sales contract needs to say that title will transfer out of state; otherwise, the customer can configure and order the car from within the state. 

There is no good reason to deny Tesla the right to open whatever sort of sales operation it wants in Michigan, but this remaining limitation will have relatively little effect on Tesla’s business model. Even in states where Tesla has complete freedom to sell cars as it wants, it doesn’t generally open traditional dealerships with lots of inventory sitting on a lot. The company operates on a custom order basis and usually uses the sort of galleries it will now be able to open in Michigan. So, while still arbitrary and annoying, the Michigan settlement gives Tesla everything it needs to compete in Michigan.

Tesla is clearly a big winner in this settlement. Who are the other winners? And who are the losers? 

Other new electric vehicle manufacturers, like Ford and Amazon-backed Rivian Motors (which will begin selling cars in 2020) and Faraday Future (which hopefully will be able to get to market eventually) will benefit from the trail Tesla has blazed. Having settled on these terms with Tesla, it would seem legally very difficult for the state to deny a similar arrangement to any other company situated like Tesla. 

The car dealer’s lobby, which has fought tooth-and-nail to stop Tesla from distributing directing on a state-by-state basis, is clearly a big loser. Michigan, the state with the most pro-dealer law on direct distribution, has now opened the doors for new EV companies to bypass the traditional dealer model entirely.

In the short run, traditional car companies like General Motors and Ford are also losers. GM, in particular, has backed the dealers politically in opposing the right to engage in direct distribution, apparently because forcing Tesla to distribute through the dated and increasingly inefficient dealer model will slow Tesla’s market penetration. Not only does the Michigan settlement allow Tesla to avoid the cumbersome dealer model and to start gaining significant market share in America’s car capital, but it’s far from clear that traditional car companies that do franchise independent dealerships would be eligible to operate their own direct distribution system on a similar model. In other words, the Michigan settlement may permit Tesla and other EV manufacturers to leapfrog traditional car companies on distribution.

Just as there is no good basis in public policy to limit Tesla’s right to engage in direct distribution, there is also no reasonable basis to prohibit it to traditional car manufacturers either. As I have previously detailed at length, there is simply no consumer protection reason that any car company shouldn’t be able to choose how it sells cars to consumers. As companies like Tesla and Rivian accustom car buyers to the benefits of dealing directly with the manufacturer, there will be increasing competitive pressure on GM, Ford, Chrysler, and foreign auto makers to seek legislative changes in hold-out states like Michigan that still prohibit direct distribution.

Finally, although the immediate consequences of the settlement will be felt only in Michigan, the settlement will put increasing pressure on other hold-out states that still block Tesla from selling to consumers. The more states that allow direct distribution and the more customers that experience it, the less credible the dealers’ lobby will be in arguing that direct distribution harms consumers. With new entry by other companies like Rivian on a direct distribution model, the political and legal battles over car distribution are at a tipping point. Although there will still be a place for franchised dealers to play a role in car distribution for some time, the inflexible and mandatory system created by the dealer laws of the mid-twentieth century is on its last legs.