ALI-ABA Course of Study Product Distribution and Marketing March 18-20, 2009 Charleston, South Carolina

Transcription

1 1023 ALI-ABA Course of Study Product Distribution and Marketing March 18-20, 2009 Charleston, South Carolina Manufacturer/Distributor Litigation and Negotiation Strategy By John F. Collins Dewey & LeBoeuf LLP New York, New York

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3 1025 MANUFACTURER/DISTRIBUTOR LITIGATION AND NEGOTIATION STRATEGY I. Preparation for litigation begins at the start of the Manufacturer/Distributor relationship: A. Terms of Contract Considerations The contract may, by its terms, determine the nature of the manufacturer/distributor relationship, i.e., whether the distributor is considered a dealer or a franchisee. Contractual provisions may be useful if disputes arise. Thoughtfully drafted distribution agreements not only limit parol testimony and serve to defeat state law fraud claims, but are beneficial in setting the proper stage upon which to view antitrust claims. If an agreement describes the dealers' obligations in some detail, a breach of these obligations will be good support for the contention that the decision to terminate was made for legitimate business, not anticompetitive, reasons. Thoughtlessly including boilerplate language that makes little sense in the context of the particular distribution system or industry may suggest to a judge or jury that the contract is an empty formality instead of a bona fide effort to spell out important rights and obligations. 1. Define the relationship within the distribution agreement: If the agreement does not fully specify the relationship between the parties the court may classify the relationship using different criteria than those contemplated by the parties. Often, because of franchise laws which offer protection to the franchisee, a dealer will want to fall within the definition. Courts have looked at some of the following to determine and classify the relationship of the parties: a. Marketing plan See Grand Light & Supply Co. v. Honeywell, Inc., 771 F.2d 672 (2d Cir. 1985) (The district court found that a marketing plan existed and therefore franchise relationship existed and warded substantial damages to the wrongfully terminated dealer. The court of appeals reversed expounding on the lack of dealer's general dependence on the supplier). b. Supplier's control over a dealer's:

4 Marketing territory See supra Distribution Dealer System discussion on exclusivity, I A(1)(c)(a). training materials See Travelhost Magazine, Inc., Bus. Franchise Guide (CCH) 6444 (Mar. 2, 1989) (magazine's extensive training manuals and support qualified magazine as within the franchise definition). 2. Appearance See Azcuy v. Amoco Oil Co., 1985 WL 5849 (N.D. Ga. Jan. 15, 1986) (failure to meet appearance standard is good cause for franchise non-renewal). 3. Facilities and equipment 4. Ability to renew c. Length and time of relationship See Misco v. United States Steel Corp., 784 F.2d 198 (6th Cir. 1986) (length of contractual relationship between parties determines what constitutes reasonable termination notice). d. Magnitude of dealer's investment Absence of real investment is a crucial element in cases where the distributor is alleging franchise status. See Representaciones EBI, Inc. v. Gator Indus., 629 F. Supp. 662 (D.P.R.), aff'd, 807 F.2d 1 (1st Cir. 1986) (sneaker manufacturer not deemed dealer due to lack of investment in advertising, inventories and lack of credit risks). e. Economic dependence The degree of economic dependence of the dealer on the supplier is a factor used in determining the nature of the relationship. 2

5 1027 f. Fees See New Jersey American, Inc. v. Allied Corp., 875 F.2d 58 (3d Cir. 1989) (court held that franchise did not exist unless there was a degree of economic dependence on franchisor). This construction is narrower than most courts would adopt. 1. Ways to insure economic independence a. Supplier could insist products not constitute more than a specified percentage of distributor's sales or profits. See Kusel Equip. Co. v. Eclipse Packaging Equip., 647 F. Supp. 80 (E.D. Wis. 1986) (2% of sales not enough for franchise "community of interest" test); and Foerster, Inc. v. Atlas Metal Parts Co., 105 Wis. 2d 17, 313 N.W.2d 60 (1981) (no dealership when representative of manufacturer handled four other accounts). Form of payment, even if not identified as franchise fee, may be considered by the courts as a form of a franchise fee. A court may consider the following fees or payments to be a form of franchise fee: 1. inventory costs above bona fide wholesale price 2. training fee 3. mandatory purchases 4. payments to third parties 5. upfront payments But see Schultz v. Onan Corp., 737 F.2d 339 (3d Cir. 1984) (expenditures for funds for travel, lodging, food and other ordinary business expenses 3

6 1028 do not constitute a franchise fee within meaning of Minnesota Franchise Act). 2. Use of trade name, trademark and trade secrets: The agreement should make reference to the use and limitation of trade names and trademarks. The agreement should also contain a clause prohibiting the dealer or any of its employees from disclosing to others, privately or publicly, any information conveyed to the dealer by the franchisor and this duty should transcend the agreement. a. Tradenames and trademarks are signs recognizable to the general public as assurance that the supplier stands behind the product. See RJM Sales & Mktg., Inc. v. Banfi Prod. Corp., 546 F. Supp (D. Minn. 1982) (trademark license requirement satisfied where alleged franchisee was authorized to distribute advertising material bearing the franchisor's trade name). b. Trade secrets are defined as secret business information which assists franchisor in conduct of business. Trade secrets must be carefully guarded or any protection afforded by laws may be lost. See Aetna Bldg. & Maintenance Co. v. West, 39 Cal. 2d 198, 246 P.2d 11 (1952) (a defense to trade secret misappropriation is that the information is generally known or commonly known to the trade); William J. Keating, Franchising Advisor, (1989); and Roger M. Milgrim, Trade Secrets 1.01 (1997); 3. Bases for dealer termination: If the contract does not have a "no cause" provision or does not explicitly spell out provisions for dealer termination, courts will supply own interpretation based on case law. Courts have considered some of the following factors as being "good cause" or "bad cause" for termination. 4

7 1029 a. "Good cause" for termination: 1. Supplier's desire to restructure distribution so as to avoid losses See Lee Beverage Co. v. ISC Wine, Inc., 623 F. Supp 867 (E.D. Wis. 1985) (good cause for dealership termination can be based on suppliers business motives irrespective of dealer's performance). 2. Distributor's failure to meet reasonable quota See L-O Distrib., Inc. v. Speed Queen, 611 F. Supp (D. Minn. 1985) (a grantor may terminate a dealership that fails to achieve reasonable sales goals). b. Not considered "good cause" for termination: 1. Shift in product distribution Mere shift in product distribution from one dealer to another may not constitute good cause for termination. See Bimel-Walroth Co. v. Raytheon Co., 796 F.2d 840 (6th Cir. 1986) (corporate policy of combining two divisions did not constitute good cause for 10 day notice and cancellation of one division's distributorships). 2. Supplier's economic reasons Franchise statute limits just cause for termination to a dealer's acts or omissions; a supplier's economic reasons do not constitute just cause. See Medina & Medina v. Country Pride Foods, Ltd., 631 F. Supp. 293 (D.P.R. 1986) (only distributor's acts and omissions may constitute just cause permitting termination of distribution relationship). Also see Kealey Pharmacy & Home Care Svcs. v. Walgreen Co., 761 F.2d 345 (7th Cir. 1985) (good 5

8 1030 cause did not exist when dealership grantor decides to withdraw from entire geographic marketing area because of inadequate rate of return). 4. "Evergreen" or deliberate renewal provisions Courts generally protect franchisees against arbitrary termination or non-renewal. There is an implied prohibition against termination without reasonable cause if the contract is silent. See Shell Oil v. Marinello, 120 N.J. Super. 357, 294 A.2d 253 (1972), aff'd, 63 N.J. 104, 307 A.2d 598 (1973) (oil company could not unilaterally terminate except for good cause); But see Nike Int'l. Ltd. v. Athletic Sales, Inc., 760 F. Supp. 22 (D.P.R. 1988) (distributor's failure to give written notice of renewal as required by contract was held good cause for non renewal). 5. Restrictions against transferring/assigning dealership Restrictions against or allowing transfer or assignment of the dealership must be specified in the agreement. In addition the conditions under which franchisor or franchisee may sell or assign all or any interest in the franchise or any assets must be disclosed to franchisee prior to entering franchise agreement. 16 C.F.R (a)(15)(ix) (2002). Personal service contracts, including distribution agreements, are not usually assignable by either party in the absence of a provision permitting assignment. See Berliner Foods Corp. v. Pillsbury Co., 633 F. Supp. 557 (D. Md. 1986) (Unauthorized assignment is good cause for termination). 6. Non-litigation methods of resolving disputes: a. Arbitration clause/dispute resolution clause A provision in the agreement as to arbitration and/or alternative dispute resolution may increase the likelihood of avoiding local bias, and discovery may be more curtailed. If an arbitration clause is included, the supplier should consider providing that it can obtain whatever equitable 6

9 1031 relief is needed to protect its interests in trademarks, tradenames, copyrights and other forms of goodwill. The enforceability of mandatory arbitration clauses in agreements is specifically included in the Federal Arbitration Act as well as in various state statutes governing the law of contract enforceability and other commercial relationships. See Federal Arbitration Act, 9 U.S.C. 4; Southland v. Keating, 465 U.S. 1 (1984) (Arbitration clause enforceable notwithstanding state franchise laws); and Burger King v. Rudzewicz, 471 U.S. 62 (1985) (locale for arbitration specified in contract will be enforceable if not totally unreasonable). 7. Choice of law clauses Counsel should bear in mind that choice of law considerations may vary depending on the nature of the legal action. Most courts will uphold a choice of law clause in the absence of a prohibiting state statute. See McGowan v. Pillsbury Co., 723 F. Supp. 530 (W.D. Wash. 1989) (New York choice of law provision contained in franchise agreement upheld because chosen law did not violate public policy); Guild Wineries & Distilleries v. Whitehall Co., 853 F.2d 755 (9th Cir. 1988) (giving preclusive effect to administrative ruling to enforce choice of law provision); and Winer Motors, Inc. v. Jaguar Rover Triumph, Inc., 208 N.J. Super. 666, 506 A.2d 817 (App. Div. 1986) (parties' contractual choice of New Jersey law applied generally, but the court held that the New Jersey Franchise Practices Act did not govern the transaction since plaintiff's business was in Connecticut). B. Other Considerations in Negotiating the Manufacturer/Distributor Relationship 1. The F.T.C. Rule: See 16 C.F.R

10 1032 The Rule provides for extensive disclosure to franchisees or those entering into a "business opportunity". The Rule applies nationally and merits study because its definitions of the covered relationships are similar to those in many of the state franchise and business opportunity laws. a. For a general definition of the term "franchise" see supra Initial Distribution Considerations, I(A)(1)(d). b. The definition of "business opportunity" is extremely broad and encompasses: 1. Buyer who sells goods and services supplied by seller; 2. Seller who secures or helps buyer secure outlets for goods and services or sites for displays; 3. Fees charged by seller to buyer for the right to conduct business. c. See 16 C.F.R for complete definitions. 2. It is also important to check all individual state laws governing franchises and business opportunity laws. See 1 Bus. Franchise Guide (CCH) , for individual state franchise statutes and business opportunity laws. 3. Misrepresentation of information in the negotiation process may form a basis for termination or litigation. Areas of special concern during negotiation are: a. Potential profits or projected sales; b. Amount of capital required; But see Budget Rent a Car Corp. v. C. Shaffer, Inc., No. 91C2721, 1992 WL (N.D. Ill. June 2, 1992) (prior business experience of defendant made defendant privy to working capital requirements of car rental business regardless of franchisor's statements). c. Extent of public figure involvement, if any 8

11 1033 If a public figure is involved and used in product or franchise promotion, the extent and terms of the public figure's involvement must be clearly set forth. 16 C.F.R (a). See also 1 Bus. Franchise Guide (CCH) 6336 (definition of public figure). d. Prior history of franchisor such as litigation, bankruptcy, or operating history. See 16 C.F.R (a)(4) (2002) (for other required areas of disclosure). e. Consider adding disclaimer within the agreement. 4. Adhesion Contracts See Rosenberg v. Pillsbury Co., 718 F. Supp (S.D.N.Y. 1989) (court dismissed misrepresentation claims due on existence of disclaimer and integration clause in franchise agreement). Adhesion contracts are standard form printed contracts prepared by one party and submitted to another party on a "take it or leave it" basis. See Fred Briggs Distrib. Co., Inc. v. California Cooler, Inc., No , 1993 WL (9th Cir. Aug. 11, 1993) (adhesion contracts are fully enforceable provided they are not unconscionable and do not fall outside the reasonable expectations of the weaker party). 5. Unlawful horizontal or vertical agreements or courses of conduct. If supplier wants to use non-price vertical restraints, the contract should articulate them clearly and unambiguously because of possible antitrust implications. II. Monitoring the Manufacturer/Distributor Relationship Preparation for possible litigation continues throughout the course of business. A periodic checkup of the relationship is advisable. Ways to internally monitor the relationship include: 9

12 1034 A. Antitrust Educational Program An educational program is important to avoid the danger of executives and marketing personnel not knowing general requirements of antitrust laws and state dealer protection laws. Not implementing such a program creates a serious risk of personnel engaging in improper or illegal conduct or refraining from legitimate, aggressive marketing practices. 1. A program should illustrate the differences between state and federal antitrust enforcement authorities. 2. Compliance manuals should be geared toward the client and the industry in question and updated regularly to reflect new law and developments. 3. Clearly illustrate permissible and impermissible conduct. B. Robinson-Patman Act Compliance Program The Robinson-Patman Act was enacted in 1936 to solidify and enhance the Clayton Act's attack on discriminatory pricing. The Robinson-Patman Act was designed to address specific types of harmful pricing behavior, in particular the favoring of newly developing chain stores over long established, independent, but smaller retailers. C. Document Retention Policy Documentation can be crucial to the litigation process. There should be national monitoring of documents created and documents retained. See Wesley v. Mobil Oil Corp., 513 F. Supp. 227 (E.D. Pa. 1981) (importance of maintaining a record). D. Payment Performance Evaluations Records of past poor payment performance may be used to show good cause for termination or refusal to deal. Frequent monitoring of areas such as accounts receivable and extensions of credit can identify possible future litigation and/or termination problems. See Joe Regueira, Inc. v. American Distilling Co., 642 F.2d 826 (5th Cir. 1981) (distributors failure to pay debts to manufacturer when they became due was cause for termination of the agreement on 30 days notice). 10

13 1035 But see Biomedical Instrument & Equip. Corp. v. Cordis Corp., 797 F.2d 16 (1st Cir. 1986) (Dealer's untimely payments to his supplier were not deemed essential obligations of dealer's contract and did not create good cause for termination when there was an established pattern of untimely payments accepted by supplier). E. Complaint Evaluation Complaint and contacts from actual or potential competitors, distributors or customers should be evaluated and updated. See Monsanto Co. v. Spray-Rite Serv. Corp., 465 U.S. 752 (1984) (more than evidence of complaints about a terminated distributor's prices is needed for a court to infer a vertical price-fixing conspiracy). F. Performance Standard Evaluations Documentation of failure to comply with supplier's standards or policies may be helpful in litigation especially in termination and/or renewal actions. See Jack Kahn Music Co. v. Baldwin Piano & Organ Co., 604 F.2d 755 (2d Cir. 1979) (Failure to achieve quotas constituted good cause for termination when the quotas were reasonable and the shortfall was more than de minimis). III. Litigation Strategy Should be Oriented Towards Reasonable Business Goals. A. Pre-Litigation Considerations 1. Do you have accurate information about events that are the subject of possible litigation? A strong documentation policy lays the ground work for recreating the situation. a. Examine file and interview knowledgeable people. 1. What story do documents tell? 2. What story do witnesses tell? 3. How do you account for any discrepancies? 11

14 1036 b. Have there been contacts with third parties such as competitors, customers, other distributors? 1. Do they form a basis for antitrust claim? See, e.g,. Monsanto Co. v. Spray-Rite Serv. Corp., 465 U.S. 752 (1984) (More than evidence of complaints about a terminated distributor's prices is needed for a court to infer a vertical price-fixing conspiracy). 2. Has there been or should there be a reasonable opportunity to cure? The dealer should be allowed to avail itself of any opportunity to cure to which it is entitled. Not allowing a dealer to do so may make the supplier appear unduly harsh and such a perception could affect the ultimate decision of a judge or jury irrespective of the law. a. length of time of such opportunity b. specific steps that would correct the problem E.g., a loan workout agreement 3. Is there a valid business reason for litigating? B. Litigation Considerations 1. Litigation risk analysis: an assessment of the risks, the costs and the benefits contemplated in litigation. a. helps management; b. serves as a control on outside counsel; 2. Substantive and Procedural Considerations a. Preliminary injunctive relief A preliminary injunction preserves the status quo until a full hearing on the issues occurs. Preliminary injunction motions tend to move rapidly. If a dealer makes such a motion supplier's counsel should be prepared to resist the preliminary injunction effectively. 12

15 1037 See Fed. R. Civ. P. 65. b. Preliminary injunction: bond If the court grants a preliminary injunction it will normally require an indemnification bond from the party seeking the injunction. The amount of the bond is discretionary with the court and depends on the circumstances of the parties and the facts of the case. See Fed. R. Civ. P. 65(c). But see People ex rel. Van De Kamp v. Tahoe Regional Plan, 766 F.2d 1319 (9th Cir. 1985) (court dispensed with the security requirement); and Friends of the Earth v. Brinegar, 518 F.2d 322 (9th Cir. 1975) (court required nominal fee instead of security bond). c. Franchisor/supplier causes of action 1. Termination 2. Non-renewal d. Parties to be sued 1. Class action e. Potential counterclaims by franchisee or dealer if action is commenced by franchisor: 1. No violation of agreement by franchisee/dealer In this type of action, the franchisee/dealer may try to show that terms of the agreement are ambiguous. Franchisee dealer may also try to show intent of parties by their own documentation. 13

16 1038 f. Class actions Members of a class action benefit from a number of economies of scale which may be crucial to maintaining an action where individual damages are relatively slight. However, the party opposed to a class may prefer to be in a position to deal with all its adversaries at once. g. Equitable Estoppel, Promissory Estoppel A party seeking to enforce the contract is precluded when its conduct is inconsistent with the rights or position of opposing party. Justice forbids a person from denying his own conduct when others relied upon him and acted based upon that reliance. See Miskimen v. Kansas City Star Co., 684 S.W.2d 394 (Mo. Ct. App. 1984) (Publisher was estopped from terminating 250 contract carriers because, over a ninety year period, publisher had led carriers to believe they had proprietary rights and not just contractual rights). h. Declaratory judgment Uniform Declaratory Judgment Act, 28 U.S.C. 2201, states that in case of actual controversy within its jurisdiction, except in specified situations, any United States court may render a declaratory judgment, regardless of whether further relief will be sought. See also Fed. R. Civ. P. 57; and Aida Eng'g, Inc. v. Red Stag, Inc., 629 F. Supp (E.D. Wisc. 1986) supplier requested declaratory ruling to determine whether defendant dealer was dealer within the meaning of Wisconsin Fair Dealership Law and whether supplier could terminate relationship without first complying with the law. Court ruled in favor of supplier on both requests without discussing any issues of prematurity). i. Choice of forum: jurisdiction, venue, state or federal court, non-judicial forum. The question of forum encompasses not only where the litigation can occur but also where you'd like it to occur. Issues that should be considered include: 14

17 convenience of parties 2. location of witnesses and documents 3. rules of discovery 4. rules of evidence 5. judges' expertise, experience and independence 6. local partiality 7. speed of adjudication 8. availability of desired remedy 9. jury v. arbitration 10. cost 11. trial procedure a. voir dire b. closing arguments j. Availability of summary judgment The grant of a motion for summary judgment is predicated on the basis that there are no disputed questions of fact involved in the case, but merely questions of law or application of the law. A successful motion for summary judgment constitutes a victory for the party bringing the motion, without the attendant expense and uncertainty of a trial on the merits. See Fed. R. Civ. P. 56. k. Limitations on discovery Discovery can be used as a form of harassment by the opposing party. Franchisors/suppliers are especially vulnerable due to the amount of paperwork involved in operating franchise or supplying products to a large number 15

18 1040 C. Settlement Considerations of dealers. It is advisable to seek a protective order from the court limiting discovery. See Fed. R. Civ. P. 34(a) (requests for production of documents from another party); Fed. R. Civ. P. 34(c) (requests for production of documents from non-parties); Fed. R. Civ. P. 34(b) (timing for such requests). Counsel for the respective parties should be continually aware of the possibility of settlement. The terms of settlement will depend on the bargaining leverage of each of the parties, including ability to finance the litigation, interest in maintaining the relationship, and overall business objectives. Settlement negotiations require a good faith attitude by each of the parties, such that they are willing to relinquish some of their perceived rights in order to achieve settlement. If either party insists on full compensation, then settlement is probably not possible. 16