This article aims to analyze the grounds for terminating automotive vehicle distribution agreements, the right to compensation for each type of termination,and the method for calculating the compensation when the vehicle manufacturer (Manufacturer) causes the termination of the agreement, thus triggering the obligation to compensate the dealer responsible for the sale of goods to final consumers (Dealer).

Law No. 6,729/1979 (Ferrari Law) is the specific legislation that governs the relationship between the Manufacturer and the Dealers of motor vehicles on public roads regarding their rights and obligations in the legal relationship aimed at commercializing cars manufactured by the Manufacturer. According to Article 2, I, the Manufacturer is the producer, the industrial company that manufactures or assembles motor vehicles. According to subsection II, the Dealer is the company that sells these vehicles.

Articles 2, III, IV, and V of the Ferrari Law specify that its scope covers the distribution network for any motor vehicle intended for public roads, such as cars, trucks, buses, tractors, motorcycles, and similar vehicles, as well as their parts and components. Despite the scope limitation of the Ferrari Law, it is not uncommon for companies in other industries to question the potential applicability of the Ferrari Law in their business relationships with their distribution networks for vehicles, which, like road vehicles, are propelled but intended for other sectors of the economy, such as mining trucks, construction machinery, and forestry tractors.

Dealers are entitled to sell vehicles within designated territories to facilitate the sale of vehicles covered by the Ferrari Law to the final consumer.

In Brazil, such legal relationships often last for decades and are generally governed by indefinite-term distribution agreements based on intense commercial exchanges between the Manufacturer and the Dealer. The parties ordinarily exchange information on various matters, including marketing, sales targets, inventory maintenance by the Dealer, location strategy, post-sales services, and technical maintenance, which are typically the Dealer’s responsibility, with the objective to sell as many vehicles as possible within the territory and to fully reach end consumers.

It is natural that, over time, the Manufacturer and the Dealer, either jointly or individually, may decide to terminate the agreement for various reasons. For example, changes in the automotive market may lead manufacturers to adopt new business policies, causing them to terminate their relationship with Dealers without cause, or, conversely, the Dealer may find it no longer makes sense to sell those vehicles.

It is also common for a Dealer to experience poor performance in vehicle distribution, failing to meet contractual targets, thus prompting the Manufacturer to terminate the agreement for cause. A contractual violation can also be committed by the Manufacturer, in which case the Dealer may request termination for cause.

The fact is that, depending on the reason and way the contract ends, the Manufacturer and the Dealer will face varied legal consequences as outlined by the Ferrari Law.

Article 22 presents the grounds for termination of distribution agreements, which may occur under the following circumstances: by mutual agreement of the parties or force majeure; upon the expiration of the agreed term; and at the initiative of the innocent party due to a violation of the Ferrari Law, the agreement, or the conventions (which are agreements that bind all the Dealers of a certain Manufacturer).

Note that the Ferrari Law does not provide for termination without cause, also known as unilateral termination (or “empty notice”). However, this option is widely accepted by doctrine and case law, as it is not expected that the contracting parties will be obliged to remain in the contract indefinitely without mutual interest.

Termination by Agreement or Force Majeure (Article 22, I)

Termination by agreement occurs when both parties mutually decide to end the contract, negotiating rights and obligations based on the established terms. Under this scenario, there is no obligation or right to compensation for either party. However, Article 22, §2, states that regardless of the type of contract termination, a minimum notice period of 120 days must be observed to end the obligations between the Manufacturer and the Dealer. Termination due to force majeure occurs when the parties face situations beyond their control, impacting the performance of the contract. The Ferrari Law does not elaborate on this type of termination. Still, Article 393 of the Civil Code states that “[t]he debtor is not liable for damages caused by force majeure or fortuitous events unless explicitly stated otherwise.”

Termination Due to Expiration of the Fixed Term (Article 21, Sole Paragraph, and Article 22, II)

A vehicle distribution agreement may initially be for a fixed term of five years. If neither party expresses its intention not to extend the agreement within 180 days of its expiration, the contract will automatically continue for an indefinite term. In case the contract end after the fixed term of 5 years expires, under Article 23, the Manufacturer must repurchase the Dealer’s inventory of vehicles and components at the sale price to the distribution network and purchase any equipment, machinery, tools, and installations used in the dealership at market value, as long as the Manufacturer was previously informed  by the Dealer that such goods would be purchased for the purpose of fulfilling the agreement.

On the other hand, if the Dealer decides not to renew the contract, the Manufacturer is not obligated to pay any compensation (Article 23, Sole Paragraph). It is important to note that under Article 25, if the Manufacturer violates the contract, causing its termination at the fixed term, the Dealer is entitled to the same compensation outlined in Article 24, which applies to termination without cause for indefinite-term contracts initiated by the Manufacturer.

Termination for Breach of Contract (Article 22, III, and para. 1)

This occurs when one party terminates the agreement due to the other party’s breach. According to Article 22, para. 1, and case law, termination under Article 22, III, must always be preceded by the application of graduated penalties, making immediate and automatic contract termination impossible.

The application of graduated penalties is essential for contract termination for breach, even without prior regulation through brand conventions. In other words, to terminate for cause, the Manufacturer must inform the Dealer of any breach, applying an initial penalty, which should escalate with subsequent violations, ultimately leading to termination for cause.

It is important to note that even if either party has cause for terminating the contract, Article 22, para. 2, prevents automatic termination. The innocent party must observe a minimum period of 120 days to terminate the obligations, starting from the actual termination date. If the termination is due to a breach by the Dealer, Article 26 specifies that the Dealer must compensate the Manufacturer with 5% of the total value of the goods purchased during the last four months of the agreement.

Termination Without Cause (Article 24, I-IV)

The Ferrari Law does not expressly provide for termination without cause by either party. However, even though no specific provision exists, it is clear that either party may opt to terminate the agreement without cause. In such cases, if the Manufacturer requests the termination, the penalties outlined in Article 24 will apply, covering the obligations and compensation the Manufacturer owes for a breach of contract.

The interpretation of Article 22 by courts and legal scholars is broad, including “empty notice” by the Manufacturer within its scope. In concrete cases, “empty notice” by the Manufacturer is the most complex scenario for determining the compensation owed, not only due to the complexity and potential disagreement over the components of the compensation but also because of the lack of clarity regarding how compensation under Article 24(III) should be calculated.

According to Article 24 and its subsections, if the Manufacturer terminates the contract, the following must occur:

    • The Manufacturer must repurchase the Dealer’s stock at the value on the date the contract ended, based on the price the goods would be sold to the final consumer (Stock Repurchase);
    • The Manufacturer must purchase the Dealer’s equipment, machinery, tools, and installations used in the dealership at market value, excluding real estate (Compensation for Investments);
    • The Manufacturer must compensate the Dealer an amount equivalent to 4% of the projected sales over a period of 18 months fixed and 3 months per five-year period, based on the corrected sales figures from the previous two years (Legal Compensation);
    • The Manufacturer must compensate for any repairs agreed upon in the contract (Contractual Compensation).

There is small room for doubt regarding the calculation of the first, second, and fourth items. Still, disagreements are common when calculating the Legal Compensation, regarding the methodologies suggested by the involved parties, causing significant variations in the final compensation amount, leading to disputes in court over the recognition of the obligation to compensate.

Study of case law found that few court cases have established a method for calculating Legal Compensation. However, despite their scarcity, it is our understanding that the cases and respective expert opinions heard by the State Court of São Paulo[1] offer an appropriate solution for determining the Legal Compensation, which should be calculated as follows:

    • The gross revenue generated by the Dealer from goods and services over the last two years of the contract is determined, and this amount is adjusted for inflation up to the date of contract termination or Legal Compensation payment.
    • The corresponding monthly average is calculated from the Dealer’s total adjusted revenue for the last two years of the contract. Then, 4% of this monthly average is determined.
    • The 4% of the monthly average is projected over a period that combines a fixed portion of 18 months and a variable portion of three months for every five years of the contract’s duration.
    • In other words, by projecting 4% of the monthly average revenue over 18 months, the losses and damages related to the “fixed portion” are calculated.
    • Additionally, by projecting 4% of the monthly average revenue over a variable period of three months for every five years of the contract’s duration, the second component of this compensation—the so-called “variable portion”—is calculated.
    • Finally, the two components (fixed and variable) must be added together to determine the total value of the Legal Compensation.

Once the Legal Compensation is determined, the parties must add it to the Stock Repurchase, Investment Compensation, and Contractual Compensation, resulting in the total compensable amount. Adhering to the correct compensation criteria is essential and this can prevent unnecessary delays in negotiating the termination of contracts or judicializing the matter.

Lastly, it is essential to note that, in an appeal ruled by the Superior Court of Justice[2], it was decided that the compensations outlined in Article 24 of the Ferrari Law do not constitute an exhaustive list but rather represent a minimum baseline for compensation owed by the Manufacturer to the Dealer. Additional compensatory amounts may be added if agreed upon by the parties.

Authors: Priscila Sansone David Tutikian and Flávia Lanat Silveira

Footnotes

[1] Cases # 9120453-95.2005.8.26.0000 and 0142156-56.2010.8.26.0100.

[2] Superior Court of Justice, appeal # 1.811.792/SP, March 3, 2022.

More from Veirano Advogados