With Dealer Defaults Looming, Smart Lenders Will be Patient
As attorneys for marine dealers, the calls we are receiving lately are becoming far too frequent and have a common refrain: "My floor planner doesn't know it yet, but I am seriously out of trust."
The good news is that dealers are acting pre-emptively by not waiting to call us until spring when the boats that have been paid for are delivered and the bank discovers the problem. Too many times, dealers contact us after the horse is out of the barn and the floor planner has taken the matter to court.
First of all, it is unfortunate that the economy is presenting challenges, serious ones, to boat dealers. It is more enjoyable to represent dealer clients in times of growth, when they need a lawyer to represent them for expansion, such as buying additional property and acquiring additional product lines.
Boat dealers have not created this economic downturn. They are victims of the housing debacle from subprime loans, escalating gas prices, the economic effects of the war and the various other non-marine industry causes for the slump in boat sales. If there is any correlation at all, it is in the irony that the very lenders who hold their floor plans are the same lenders who issued credit to borrowers who probably should not have been approved in the first place. In a sense, marine lenders were just as liberal as mortgage lenders in granting loans to subprime borrowers.
Why is this relevant?
Simply because these retail lenders, who fund boat loans by allowing the negative equity in a trade-in to be rolled into a brand new loan on a more expensive boat, are sustaining losses because of increased default trends by consumers. Typically, these retail customers were referred to the lender by boat dealers. Consider the substantial savings to banks that issue marine loans by not having to pay millions of dollars on marketing to consumers because a loyal network of boat dealers refers hundreds of millions of dollars of loan business to these lenders. In contrast to home and car buyers, purchasers of boats are generally unfamiliar with specific banks that issue marine loans. They cannot be assured that their own lenders issue boat loans. Consequently, marine lenders have a more genuine basis to refer to boat dealers as "business partners."
When a downturn in the retail marine industry occurs, as it has, it is inappropriate for lenders to respond precipitously in acting with full legal force against a dealership that has fallen out of trust with its floor planner. To be sure, banks have rights that need to be enforced. There should not be a "cookie cutter" response, however, to each dealer who has fallen behind in floor plan payoffs. This is especially true in a weakened economy, where blame cannot be placed on mismanagement at the dealership level.
The best illustration of an overreacting banking community is to take the scenario of widespread dealer floor plan defaults to an absurd extreme. Imagine the standard procedure of a bank when it discovers an "out-of-trust" situation at one of its dealers. It demands full payment of the unpaid amount within three days. It suspends all drawing privileges on all boats, sold or unsold. If there is no prospect of immediate payment, it goes to court for an order of seizure to repossess the dealer's inventory.
Now multiply the above procedure by the many dealers who will likely be discovered this spring as being "out of trust." Consider the value of the new boat inventory. How will the lender dispose of the inventory? Will other dealers be willing to accept these units when they are struggling to retail their own inventories? What impact will forcing a high number of dealers out of business have on future business generations?
After all, haven't these very dealers been a huge source of profits to floor plan lending institutions over many years, even decades. If a bank has earned $5 million throughout the years from floor plan interest charges, and another $5 million from "interest income" on retail installment contracts, is it appropriate to terminate a relationship because a dealer is $500,000 in arrears on floor plan payoffs? Should losses and defaults in 2008 invalidate the $10 million worth of profits enjoyed by the lender from 1997-2007 in my example?
The answers are simple if the default is isolated to one or two dealers, and for reasons unrelated to the economy. Surely, a lender has the right to cut its losses if a dealer demonstrates an inability to become profitable again. Family issues, gambling problems and illness of a key operator are examples of how defaults can occur.
A sophisticated lender in an industry downturn will not act viscerally by pulling the plug on scores of dealerships. The lender will understand the need to take a huge step back in hard times and analyze the long-term picture, even if it means absorbing multi-million dollar losses in the short-term. This approach is not out of benevolence, but stems from the recognition that dealers are best suited, substantial floor plan defaults notwithstanding, to fetch the highest prices for the bank's collateral (unsold boats). Of course, the bank must assess whether it is dealing with a "good customer." Does the dealer have integrity? Has he or she been committed to the business over a long period of time? If so, the lender will likely see the benefit of allowing the dealer to remain in possession of the inventory. Consider the lender's choice. It could repossess $2 million worth of boats and dispose of them for $1 million, thereby, adding to its losses. If the dealer has personally guaranteed the floor plan and has deep pockets, perhaps the above approach is most sound.
If a lender were to follow its standard protocol of ridding itself of defaulted dealers during bad economic times, it would simply find other, economically stronger dealers to replace them. Good luck. These dealers are economically stronger, in part, because of their unwillingness to expand in a weak market. This brings the banks full circle back to their "business partners," through whom they have made millions of dollars over the years and know best how to retail boats. Did they suddenly become incompetent in 2008? The moral of the story is that an astute lender will know when to look past a default, however serious, if the essential elements of integrity and a long-term prospect for recovery exist. If GMAC foreclosed on all its "out-of-trust" dealers over the past five years, General Motors would have an even harder time maintaining its market presence.
To the extent a dealer may avoid the most serious consequences of being out of trust, it must act pre-emptively, generally before the lender finds out. Meeting with your franchise attorney and accountant is an essential step. More gets accomplished in a two hour brainstorming session than in months of sleepless nights, wondering what will happen when the weather turns and customers want to "splash" their paid-for boats. The business plan will need to be rewritten and difficult personnel and related overhead decisions made. The process is painstaking, but necessary.
Your advisers will then draw upon demographic data and independent industry projections to help you assess whether the business can enjoy a reasonable return on investment over the long term. If so, a presentation to your floor planner, fully disclosing the loan defalcation, may be appropriate. After the predicable havoc it will create, level heads will eventually prevail. The negotiations will then begin with the lender, your manufacturer, your landlord and others to rebuild this business with certain necessary concessions, commitments and waivers by all concerned.
In those instances where we conclude, along with the client, that there is no likelihood of economic recovery, that realization can be empowering to the dealer. It allows the dealer to come to terms with the end of the business operation, and focus all his or her energies on an exit strategy and a future. The process is cleansing and puts an end to the day-to-day stress, even if it means continuing problems with creditors.
The foregoing is achieved only by advance planning with qualified industry professionals. When dealers turn their problems over to attorneys and accountants, the reduction in their stress levels is palpable, perhaps the most important step in the process.
Founding partner of the law firm Bellavia Gentile & Associates, LLP, Leonard A. Bellavia is a nationally recognized authority in the field of marine and automotive franchise law. Bellavia is endorsed by the Marine Retailers Association of America. He chairs the Litigation Section of the National Association of Dealer Counsel and serves on its board. LBellavia@DealerLaw.com
Originally Posted on 21 April 2008 in Soundings Trade Only Today