Warranty Reimbursement Rates Under the New California Law

Actually, even dealers who haven’t questioned the value of those memberships should pay close attention to this article. Major kudos are in order for CNCDA, OCADA and the other metro dealer associations for convincing the California legislature and Governor Newsom to pass and sign into law, Assembly Bill 179. This bill, which takes effect on January 1, 2020, accomplishes the following:

1. Prevents the law that permits dealer associations to file protests with the New Motor Vehicle Board against manufacturers related to anti-export policies from expiring next year. This bill keeps the law in effect until January 1, 2030.
2. Expands the types of protests a dealer can file with the New Motor Vehicle Board to include protests related to incentive program performance standards.
3. Deems a facilities upgrade request by a manufacturer to be unreasonable if the dealer has upgraded its facilities within the last 10 years (with a few exceptions).
4. Allows dealers to seek warranty reimbursement for labor and parts at retail rates.

Whereas all of these items are great for dealers, it is the last one that will have the most favorable financial impact, overall, to dealers. Therefore, that is the focus of this article.

IMPORTANT NOTE:  This is a really big deal and deserves some serious attention. If handled properly, this new law may result in some dealerships adding hundreds of thousands of dollars to their bottom line every year. But, handling it properly may require some outside assistance.

Current Law

Under current law, manufacturers must file a copy of a warranty reimbursement schedule or formula with the New Motor Vehicle Board.  Current law states:

The warranty reimbursement schedule or formula shall be reasonable with respect to the time and compensation allowed to the franchisee for the warranty diagnostics, repair, servicing, and all other conditions of the obligation…. The reasonableness of the warranty reimbursement schedule or formula shall be determined by the board if a franchisee files a protest with the board. (Cal. Veh. Code § 3065(a), effective January 1, 2017)

In determining the adequacy and fairness of the compensation, the franchisee's effective labor rate charged to its various retail customers may be considered together with other relevant criteria. (Cal. Veh. Code § 3065(b), effective January 1, 2017)

As you can see, current law states that retail labor rates “may be considered,” but clearly creates no obligation for the manufacturer to do so. In addition, current law is silent as to a dealer’s entitlement to retail reimbursement rates for replacement parts.

Battles with manufacturers over warranty reimbursement rates have been fought for decades.  In many instances, dealers have had to result to filing lawsuits in order to get proper reimbursement. These battles have resulted in most states adopting laws that permit dealers to seek factory reimbursement for warranty repairs at retail rates.  California, however, has been one of the few remaining states to have no such law.  That is, until now.

New Law

The new law modifies Vehicle Code section 3065 (quoted above) and now reads:

[A] franchisor shall compensate each of its franchisees for parts and labor at rates equal to the franchisee’s retail labor rate and retail parts rate. (Cal. Veh. Code § 3065(b), effective January 1, 2020)

Simple, right? Not so much.  As dealers well know, nothing is automatic and getting the manufacturer to pay you retail requires some effort. The remainder of this article is devoted to the process dealers must employ in order to get that elusive retail rate.

The Application Process

In order to secure retail rates for warranty repair work, an application must be submitted to the factory. The law allows a dealer to request a new/increased rate for labor, parts, or both, once per calendar year. In its most basic form, the application is fairly straightforward and requires two or three items: (1) the submission of repair orders (ROs); and (2) a calculation of the retail labor rate; and/or (3) a calculation of the retail parts rate.  Obviously, if only a new labor rate is desired, then only items (1) and (2) must be submitted. Similarly, if only a new parts rate is desired, then only items (1) and (3) must be submitted.

The calculations involve basic arithmetic and won’t cause much heartburn, even for those who are not very good at math. For labor rates, the law provides as follows:

The [dealer] shall calculate its retail labor rate by determining the total charges for labor from the qualified repair orders submitted and dividing that amount by the total number of hours that generated those charges. (Cal. Veh. Code § 3065.2(a)(2), effective January 1, 2020)

The formula, therefore, looks like this:

Labor Rate = Total Amount of Labor Charges/Total Number of Labor Hours

As for parts, the law provides:

The [dealer] shall calculate its retail parts rate by determining the total charges for parts from the qualified repair orders submitted, dividing that amount by the franchisee’s total cost of the purchase of those parts, subtracting one, and multiplying by 100 to produce a percentage.

The formula for parts, therefore, looks like this:

Parts Markup % = Total Charges for Parts/Dealer's Cost of Parts× 100-1

Although fairly simple, these calculations are based upon the ROs that are selected for the application. Therefore, the real tricky part in this whole process is selecting the proper (or, perhaps, the best) set of ROs to submit. How do you determine when a proper set is also the best? This is called optimization and it requires some serious know-how (and some solid technology to go along with it). More to come on this.

The law allows dealers to select sets of ROs based on specific criteria. The good news is, there is considerable flexibility in the set of ROs that you choose. The bad news is, you really have to know what you’re doing in order to select the set that will yield the best rates.

Selecting Repair Orders

The criteria you must use when choosing the set of ROs to submit are as follows:

1. The universe of ROs you may choose from for your submission are those dated no earlier than 180 days prior to the date of application.
2. You may select one set of ROs to establish a labor rate and a different set of ROs to establish the parts rate. Or, you can use the same set of ROs to establish both the labor and the parts rate. But, as I will discuss below, most dealers will want to submit two different sets of ROs, one for labor and one for parts.
3. You must submit 100 consecutive, qualified ROs unless 90 days’ worth of all repair orders results in fewer ROs. What constitutes a qualified RO is discussed below.
4. In order to prove that your qualified ROs are, in fact, consecutive, you must also submit all ROs during the same time frame from which your 100 qualified ROs were selected. This is clearly not required if your service volume allows you to submit 90 days of ROs.

Let’s break this down a little more. You have a 180-day universe of ROs to choose from, but that doesn’t mean you can cherry-pick individual ROs. The law requires consecutive ROs. Actually, the law requires consecutive, qualified ROs. What’s a qualified RO?  Glad you asked.

Here’s how the new law defines a qualified RO.

[A] “qualified repair order” is a repair order, closed at the time of submission, for work that was performed outside of the period of the manufacturer’s warranty and paid for by the customer, but that would have been covered by a manufacturer’s warranty if the work had been required and performed during the period of warranty. (Cal. Veh. Code § 3065.2(j), effective January 1, 2020)

Put more simply, a qualified RO is a closed, customer-pay RO that contains repairs which would have been covered by the factory warranty if the vehicle were still under warranty.

Now that you know what ROs to look for, can you just start pulling them and totaling up the numbers?  Not quite. The law also allows/requires dealers to exclude many types of charges/repairs. Here is the list of repairs that have to be excluded when calculating retail rates:

1. Manufacturer, manufacturer branch, distributor, or distributor branch special events, specials, or promotional discounts for retail customer repairs.
2. Parts sold, or repairs performed, at wholesale.
3. Routine maintenance, including, but not limited to, the replacement of bulbs, fluids, filters, batteries, and belts that are not provided in the course of, and related to, a repair.
4. Items that do not have individual part numbers including, but not limited to, nuts, bolts, and fasteners.
5. Vehicle reconditioning.
6. Accessories.
7. Repairs of conditions caused by a collision, a road hazard, the force of the elements, vandalism, theft, or owner, operational, or third-party negligence or deliberate act.
8. Parts sold or repairs performed for insurance carriers.
9. Vehicle emission inspections required by law.
10. Manufacturer-approved goodwill or policy repairs or replacements.
11. Repairs for government agencies or service contract providers.
12. Repairs with aftermarket parts, when calculating the retail parts rate, but not the retail labor rate.
13. Repairs on aftermarket parts.
14. Replacement of or work on tires, including front-end alignments and wheel or tire rotations.
15. Repairs of motor vehicles owned by the franchisee or an employee thereof at the time of the repair.

(Cal. Veh. Code § 3065.2(c), effective January 1, 2020)

It is true that the law requires these items to be excluded from calculations, but that’s a good thing because including these types of repairs will almost certainly result in lower labor and parts rates.

Optimization

As you may recall, I mentioned optimization above in the context of selecting the “best” set of ROs for submission to the manufacturer. Because of the flexibility this law allows, a dealer with the proper resources and/or technology will be able to perform an iterative analysis in order to select optimized sets of ROs. Did I just lose you?  Let me try to explain using some actual numbers.

Let’s say your dealership closes 1000 ROs each month. Of these, 400 are customer-pay. Of these customer-pays, 100 are qualified. For the sake of illustration, let’s also say that the dealership generates exactly 100 qualified ROs every 30 days. Let’s also assume your service department is open seven days a week, 365 days per year (no holidays). Using these improbable assumptions, a dealer could conceivably have 150 different sets of ROs to choose from. How did I arrive at 150?

Let’s assume that you are going to submit your application on January 15, 2020 and you want to use the most recent/newest set of ROs that you could possibly use. Using our assumption that your dealership generates 100 qualified ROs every 30 days, the most recent set we could conceivably use would be the set of ROs dated between December 16, 2019 and January 14, 2020 (30 days). We will call that set number 1. From there, we can start going backwards, one day at a time, to arrive at the additional sets. Set number 2 would be taken from December 15, 2019 through January 13, 2020. Set number 3 would be taken from December 14, 2019 through January 12, 2020. And so on, all the way back to set number 150, from July 19, 2019 through August 17, 2019. Set number 150 is the earliest/oldest set we could use because July 19, 2019 is 180 days before our submission date (January 15, 2020).

As you can imagine, each set of ROs will have different totals and result in different rates when plugged into the formulas shown above. You should now start to understand what I mean by optimization. If you run calculations based on 150 different sets of ROs, you will most likely find the one set that is better than the rest, and VOILA! That is the set you’ll want to submit to the manufacturer.

It is important to note that in our scenario, you would actually want to perform a total of 300 calculations based on 150 different sets of ROs, two for each set (one for labor and one for parts). The set that produces the best parts rate will typically not be the same set that produces the best labor rate. This is because big ticket customer-pay ROs (e.g., engine or transmission replacement) have lower parts margins but very high labor costs.

Although the above scenario makes unrealistic assumptions, it is quite likely that a dealer with a high-volume service department will have hundreds (potentially thousands) of qualified RO sets to choose from. This emphasizes the need for optimization.

Rebuttal Rights

Once you submit your application, the manufacturer has 30 days to take action. Such action must be one of the following: (1) accept your calculations, (2) contest and rebut your calculations, or (3) request a supplemental set of ROs. Of course, a manufacturer is also free to take no action. However, if no action is taken within 30 days, your application will be deemed accepted and you should start receiving your requested labor and/or parts rates on the 30th day following the day the manufacturer received your application. (Cal. Veh. Code § 3065.2(e), effective January 1, 2020). Of course, manufacturers may not comply that easily and dealers may need to apply some pressure.

Accepted Calculations

Similar to taking no action, if a manufacturer accepts your calculations, you should start receiving your requested labor and/or parts rates on the 30th day following the day the manufacturer received your application.

Contested and Rebutted Calculations

A manufacturer may contest your application but only for very specific reasons. An application may be contested for being “materially inaccurate or fraudulent.” Fraud is a pretty well-defined term and I suspect that will not be the grounds chosen by manufacturers to contest applications. Rather, they will most likely select the “materially inaccurate” grounds as that provides much more wiggle room.

Fortunately, if a manufacturer chooses to contest an application, it can’t just respond with a big red “REJECTED” stamp. The law requires a notice to the dealer with the following information:

1. A full explanation of any and all reasons for the allegation of material inaccuracy or fraud;
2. Evidence substantiating the manufacturer’s position;
3. A copy of all calculations used by the manufacturer in determining their position; and
4. A proposed adjusted retail labor rate or retail parts rate.

 (Cal. Veh. Code § 3065.2(d)(1), effective January 1, 2020)

If you receive a notice of contested application, you can do one of three things: (1) accept the rebuttal and proposed rates (i.e., give in), (2) try to resolve the discrepancy with the manufacturer (i.e., negotiate), or (3) file a protest with the New Motor Vehicle Board (i.e., call your lawyer). While the negotiations are taking place (and/or until the Board renders a decision), the manufacturer is required to pay you the rate they proposed in their notice beginning on the 30th day following receipt of your application.

Request for Supplemental Repair Orders

A manufacturer may request an additional set of ROs in the event your requested rates are “substantially higher” than your current rates. What constitutes “substantially higher” remains to be seen and will provide the manufacturer with a considerable amount of discretion. Therefore, I suspect this option will be employed quite often, if for no other reason than to buy some more time. The manufacturer may request all ROs closed either 30 days prior to the starting date of the original set of ROs or 30 days following the last date of the original set.

The manufacturer has 30 days to provide a notice requesting supplemental ROs. Once a dealer receives the notice, all deadlines are suspended until the dealer complies with the request. Then, once the manufacturer receives the additional ROs, the clock starts ticking again and it has 30 days to respond. The manufacturer can then contest the submission and include calculations based upon either the original set of submitted ROs or the supplemental set. In doing its own calculations, the manufacturer must adhere to the exact same criteria and formulas as dealers must use when submitting the application.

Other Considerations

There are many moving parts to this new law, all of which are designed to afford dealers the most protection against manufacturers’ attempts to short-change you on warranty reimbursements.

When to Submit an Application

The law does not take effect until January 1, 2020. Therefore, I recommend not submitting an application before then. Submitting an application early could conceivably give the manufacturer a reason to ignore it.  For those dealers who have decided it makes sense to submit an application, I recommend having the application arrive on the first business day after New Years Day. That is, January 2, 2020. Of course, if you can’t get your application to the manufacturer that quickly, just get it in as soon as possible. Every day that you wait is a day that you will not receive the higher rates.

Before submitting an application, it is important to fully understand your current warranty reimbursement program. What are your current rates? What will be the impact of submitting an application? Some dealers may be contractually bound to a reimbursement schedule, possibly for multiple years. If you’ve previously entered into a reimbursement agreement, it is unlikely that your manufacturer will just let you out of it. In addition, requesting an adjustment to your rates could trigger adverse provisions in such an agreement.  However, you may be able to terminate such an agreement by giving a certain amount of notice. Therefore, be sure to check with your attorney to better understand your rights and obligations.

NOTE: Some manufacturers have already started approaching dealers with a “retail reimbursement deal.”  Be very skeptical of these offers. I strongly recommend performing your own calculations to determine what your rates will be under the new law before agreeing to any factory program. Signing an agreement will likely prevent you from taking advantage of this new law while the agreement is in effect.  Don’t leave money on the table!

The new law allows you to submit an application for increased rates no more than once per calendar year. You are allowed to submit an application to adjust your labor rate, your parts markup rate, or both. The law is clear that you can use two different sets of ROs, one for labor and one for parts. What is not entirely clear is whether you can submit those different sets at different times. Given the way the law is written and the “once per calendar year” limitation, I would not recommend attempting to submit two different applications at different times during the year.

Most dealers will want to submit an application for adjustments to both labor and parts rates as soon as they can. Then, in subsequent years, seek only labor rate adjustments. This is because the labor rate is a set rate per hour. Since your labor costs may increase year-to-year, your labor rates may also need to increase. As for parts, that is based upon a retail markup rate. As the wholesale cost of parts increase, so does your retail reimbursement. Nevertheless, there may be times when you will want to raise your markup due to market conditions (or other circumstances) and this might trigger the need to seek a parts rate adjustment in future years.

Outside Help

Most dealers will see a considerable uplift in parts and labor rates if the submission is done properly. However, going through the ROs and selecting the best sets to submit for parts and labor requires considerable expertise and most dealers would be well-suited to seek outside help. As you can imagine, law changes like these create opportunities and opportunists. Be sure to carefully vet anyone who is claiming to have a program designed to get you the best reimbursement rates. Here are some criteria to consider when selecting an outside company.

1. How long have they been doing this type of work? I have heard about accounting and law firms offering to help dealers file their applications. This may be fine, but merely understanding the law is not the same as knowing how the warranty reimbursement world really works.  Manufacturers all do things a bit differently and some don’t play very nice.  Be sure to choose a company that has had extensive experience working (or fighting!) with manufacturers specifically on warranty reimbursement schedules.
2. How many submissions have they done? What is their track record? What is the average uplift they have achieved for similar line-make clients? Any reputable company will have statistics to back up their claims. Ask for referrals. Call the dealers that have used them and confirm their uplift numbers are accurate. A company that has done thousands of submissions and has a very high uplift rate will likely generate less of a fight from the manufacturer than a newcomer.
3. What kind of technology do they use? True optimization really requires a technological solution, particularly when you are dealing with thousands of ROs. Some service providers can connect directly to your DMS, perform the optimization, and submit your application; requiring very little work on your behalf.

Service Writer and Parts Personnel Pay Plans

As mentioned above, a proper submission will generate considerably more revenue for most dealers. This may have an impact on service writer and parts personnel compensation. Increased compensation for warranty repairs will also impact overtime calculations. Be sure to work with knowledgeable labor and employment counsel to update your pay plans.

Conclusion

With new vehicle sales margins being reduced to the size of leftover crumbs and operating costs constantly rising, this new law provides a much-needed boost for dealer revenues. If you haven’t already started working on preparing your applications, don’t wait another day. Time is money. Lastly, be sure to include your state and metro dealer associations on your holiday card list. They certainly deserve that, and a whole lot more.

Rob Cohen started with Auto Advisory Services (AAS) in 1994 as a law clerk. He worked as an auditor, staff attorney, and managing partner. Rob then served as president of AAS from 2006 to 2014, and chairman from 2014 to 2018. Rob sold AAS to KPA Services, LLC. in May of 2018. Rob is a co-founder of Motor Vehicle Software Corporation (MVSC) which, in 2007, launched DMVdesk, the industry’s first comprehensive vehicle registration management system. In 2015, Rob sold his interest in MVSC to Accel-KKR. Rob joined Arent Fox, LLP in 2011 and is currently Senior Automotive Counsel for the firm’s Automotive Industry Practice.

 Rob worked as a car salesman and did F&I during law school. He received his B.A. and M.B.A. from the University of California, Irvine and then went on to earn his J.D. from Whittier College, School of Law.

 Rob is a founding director and past-president of the National Association of Dealer Counsel (NADC) and co-authored the top-selling Automotive Dealership Information Safeguards Manual, the Automotive Dealership Identity Theft Guide, the Automotive Dealership Red Flags Rule Guidebook, as well as Auto Dealer Law, First Ed. 

 Rob can be reached at rob.cohen@arentfox.com.