Effectively Managing Distributor, Dealer And Sales Representative Relationships Steven D. Kelley and Mark Jacobson* Introduction If your business involves relationships with distributors, dealers and sales representatives (referred to collectively as “distribution relationships”), you should be aware of numerous issues that can lead to legal trouble when a manufacturer, supplier, broker, or master distributor decides to terminate or change those relationships. This bulletin presents a general overview of the types of legal issues that can and frequently do arise, and is intended to help your business spot the legal issues and preemptively deal with them to, hopefully, avoid litigation. 1. Manage your distribution/sales relationships with fully signed, written agreements. The days when businesspeople operated distribution relationships with a handshake and a good reputation are or should be over. Having a business relationship with a distributor, dealer or sales representative without memorializing the terms and conditions of that relationship in an agreement can be an invitation to be sued if the relationship sours or changes. Without a written agreement setting forth each party’s rights and obligations, the enforceable terms of an unwritten relationship agreement will be whatever a party persuades a court, jury or arbitrator that the terms in fact are. A standard Minnesota jury instruction on “proof of a contract” states: “A contract may be made orally, in writing, or by the actions of the parties, or by a combination of all three.” That standard is extremely broad. Without a definitive written agreement, a complaining distributor, dealer or sales representative may argue that the actual agreement is a combination of oral promises, of statements made in informal letters or email, or is established by the manner business has been conducted in the past. For example, if a distributor or sales representative has, in the past, been the only such party operating in its territory or market, the distributor or representative may claim it has exclusive rights in that territory and threaten to sue for breach of contract if additional distribution is later added. If a manufacturer terminates a distribution relationship, the aggrieved distributor may look to casual statements in correspondence (“we look forward to a long and profitable partnership with your business”) to claim that the termination is a breach of a contractual right to a long-term relationship. If the commission payable to a sales representative is lowered, the representative could argue years later that there was no agreement to the change and the manufacturer owes past due commissions and penalties. Virtually anything may be used to support a claim that a supplier or manufacturer’s change to the relationship is a breach of contract or a violation of the duty of good faith and fair dealing imposed by law on distribution contracts. A distribution relationship written agreement should set forth, at a minimum: the performance agreed upon (i.e. to supply, or to purchase for resale; or to solicit sales for commissions); the market or territory involved and whether the agreement is exclusive or not; exceptions to the territory; whether the relationship has a definite duration or not; the grounds for termination of the agreement; a list of the obligations of each party (with reference to some measurable performance obligations for the distribution party); an explanation of any limitations or special conditions that may affect performance; reference to price, commission, payment and terms; designation of which state’s law will govern in the event of a dispute, and where the dispute will be resolved; any limitation on either party’s remedies; a description of what must happen for the agreement to be amended or modified; and a statement that the agreement is the entire agreement between the parties and supersedes any prior agreements or understandings. While this list is not exhaustive and your own particular circumstances will dictate the terms that should be present in your company’s relationship agreements, what must be emphasized is that, without a written agreement covering these terms, you cannot with any certainty know what the legally enforceable actual terms are until a judge, jury or arbitrator decides that question. 2. Be aware of “invisible” regulation. Even if you have memorialized the terms of your distribution relationship by a written agreement, there may be additional restrictions or conditions imposed on the distribution relationship that are outside of the contract and imposed by law. A myriad network of statutes, regulations and laws exist, primarily on a state-by-state level, which may regulate the distribution relationship. Many of these laws may even supersede any inconsistent terms of your written distribution agreement through “antiwaiver” provisions in the statute (“… any provision of an agreement purporting to waive any of the rights provided by this Act is void.”). To further complicate the situation, many of the statutes and regulations are so poorly written such that, even if you are aware of the laws, you may not be able to determine whether your distribution relationship is covered by them (invisible regulation). Franchise Laws. 19 states and Puerto Rico and the Virgin Islands have enacted some form of regulation of franchise relationships that may or may not apply to distribution relationships. Although we are all generally familiar with fast food, automobile repair, convenience store and hotel franchises (considered business format franchises), many distribution relationships that do not resemble the common notion of a franchise may nonetheless fall within the purview of franchise regulation (product distribution franchises). While there are many permutations of franchise laws, in general, a franchise agreement exists where (i) the franchisor enters an agreement with a franchisee or distributor granting the right to offer, sell or distribute the goods or services 2 of the franchisor using the franchisor’s trademarks or commercial symbols, (ii) there is either a “community of interest” between the franchisor and franchisee in the marketing of goods or services (put very simply, an expectation of mutual economic benefit from the relationship or a perception in the eyes of consumers that the two are linked) or a marketing plan or system prescribed in substantial part by the franchisor, and (iii) the franchisee is required to pay the franchisor an initial or ongoing “franchise fee” (a direct or indirect fee paid for the right to enter into the business). Whether a relationship is or is not a franchise depends on a fact-specific inquiry into how the distribution relationship is structured and the nuances of any particular state franchise law that may apply to your distribution relationships. Frequently, manufacturers and master distributors do not know they are a franchisor until they are facing a lawsuit for violation of franchise laws. The requirement of the payment of a “franchise fee” prevents distribution relationships from being deemed franchises in most (but not all) state statutory schemes. Most distributorships are not charged royalties or joining fees, and thus are not subject to franchise regulation. It is common, however, for disgruntled distributors and dealers to claim that there are “hidden” franchise fees in the form of license fees, advertising or marketing contributions, charges for services or training, manuals or literature, or in any payment by the distributor/dealer to the supplier/manufacturer for anything other than a bona fide wholesale purchase of goods. For example, a federal appeals court has ruled that a forklift dealer’s payment of $1,600 to the forklift manufacturer over an eight year period to purchase required sales and service manuals constituted indirect franchise fees, rendering the dealer relationship subject to the Illinois Franchise Disclosure Act. The court found that there was no wholesale market price for the manual. In another case, an arbitrator ruled that a prefabricated home dealer’s $800 deposit for the manufacturers sales and service manual constituted an indirect franchise fee even though the deposit could be returned. The arbitrator found that the interest that accrued on the $800 over the lengthy term of the dealership relationship created a franchise fee. The lesson is that if any manufacturer requires a payment from a distributor or dealer for a good or service, and it would be difficult for the manufacturer to document a bona fide wholesale market price for the good or service, there is a risk that such a payment may be deemed to be a franchise fee. The Minnesota Franchise Act, for example, exempts from the definition of franchise fee the purchase of “goods” at a bona fide wholesale price, but does not include mention purchases of “services” at wholesale nor define what is meant by “wholesale price”. Other franchise laws specifically include “services”. Any manufacturer who charges its distributors or dealers for “training” and assistance is at risk. Finally, the minority of states (for example Arkansas, Connecticut, Missouri, New Jersey, and Wisconsin) do not require payment of a franchise fee at all in order to deem a distribution relationship a franchise, and manufacturers have an increased risk of unknowingly being subject to the franchise laws in those states. Should a franchise law apply to your distribution relationships, it may restrict your company’s right to terminate, non-renew, substantially change the competitive circumstances of the relationship, or to take numerous other actions with your 3 distributor, dealer or sales representative. Such laws typically have rules requiring a mandatory notice period prior to taking significant action, a mandatory period in which the distributor can “cure” performance deficiencies and void the notice of action, and require statutorily defined “good cause” in order to terminate or non-renew the relationship. “Good cause” is frequently defined as a failure by the franchisee to substantially comply with the material requirements imposed on the franchisee by the franchise agreement, or the franchisee’s engaging in specifically defined bad acts (filing for bankruptcy, abandoning the business, conviction of felony, etc.). “Good cause” does not typically include the manufacturer’s business decision to change direction, try some new distribution strategy, add additional distribution points to a market, withdraw from the market or even to take distribution in-house. Numerous supplier/manufacturers find themselves facing claims of franchise law violations even though they never remotely considered themselves in a franchise business at all. If your business permits or requires your distributor/dealer/sales representative to sell or offer your company’s products using your trademarks (in marketing materials, in catalogs, signs, door logo decals, on vehicles, etc.), you need to be aware of the specific franchise statutes that may be deemed to apply, evaluate the risk that your distribution relationship falls within them, consider whether your proposed action may be a violation, and assess potential liability consequences. If your distributor/dealer/sales representative has a multi-state territory, the franchise laws of each state must be evaluated. Generally, if there is a good chance that a statute may apply, it is usually most prudent to simply follow the mandates of the statute and reduce your business’s risk. Industry Specific Distributor and Dealer Regulation. Many states have a hodge-podge of statutes and regulations that regulate distribution relationships in specific industries. Many of these statutes are well known within their industry, such as motor vehicle dealers, gasoline and petroleum products distributors and dealers, etc. Many statutes, however, are so poorly written and so broadly define the distribution relationships covered by them that it might be extremely difficult to determine whether they apply to your particular distribution relationship (again, invisible regulation). If applicable, these statutes may require 90 days to six months prior notice of termination, non-renewal, or a substantial change to the competitive circumstances of the distributor or dealer, a 60 day or longer period to “cure” a performance deficiency stated in the notice, and most require statutory “good cause” for termination, non-renewal or change to competitive circumstances. As with franchise laws, good cause is generally defined as a performance failure on the part of the distributor or dealer (with the manufacturer or supplier’s business strategy falling outside statutory good cause). Many such statutes have special rules that apply if the reason for termination is a failure of the dealer or distributor to achieve market penetration requirements. Many statutes require the supplier/manufacture to repurchase the inventory of the distributor/dealer within a certain number of days following termination or expiration of the distribution agreement. Some statutes make it unlawful for a distributorship agreement to bar the distributor from selling competing 4 goods or prohibit discrimination in supply or price. All provide the distributor or dealer with the right to a civil lawsuit to enforce the statute and recover damages for violations, and most provide for the recovery of attorneys’ fees and litigation costs. Examples of industry specific distributor and dealer relationships that variously receive special protection from state law include: farm implements; agricultural equipment; livestock equipment; machinery; power equipment; utility equipment; industrial equipment; light industrial equipment; forestry equipment; construction equipment; heavy equipment; lawn and garden equipment; outdoor power equipment; soft drink distributors; alcoholic beverage distributors; mobile home dealers; marine products; outboard motors; office machines; motorcycles; ATVs; watercraft; personal watercraft; snowmobiles; recreational vehicles; personal sports mobiles; etc. Some of the laws apply only to dealers selling at retail, some to wholesale distributors, and some to both. These laws developed over the years in a haphazard manner depending on whether there were lobbyists or advocates for distributors in the various industries. Problems arise when the laws do not adequately define which relationships they are intended to protect. For example, most laws protecting dealers and distributors of “industrial equipment” provide no definition of what is meant by the term, or say that “industrial equipment” has the meaning generally in use in the state according to “custom and usage” in the industry (providing virtually no guidance as to what the term actually means). While the general notion of industrial equipment may be machines utilized in the mechanized production of goods, consider the following: Is a vacuum sweeper that cleans the factory floor but is not directly part of any industrial process (and is used only incidentally at the factory) a piece of industrial equipment? Is office equipment that is used in the business office of a factory industrial equipment? If equipment is defined as “machines”, is a distributor of “components” used in a conveyor belt production line protected by the statute? Another problem arises when industry laws contain broad “catch all” language. For example, Minnesota’s Agricultural Equipment Dealer Act defines “farm equipment” by listing six types of machines associated with farming (i.e., tractors, combines) but also defines the term as “… other equipment … used in the planting, cultivating, irrigation, harvesting, and marketing of agricultural products.” If a farmer uses a desktop computer to market his produce and a cell phone to conduct business, is the dealer or distributor of the computer or cell phone a farm equipment dealer protected by the statute? In a recent arbitration ruling, a dealer of all terrain vehicles was deemed to be a farm equipment dealer protected by the statute, despite the fact that the predominant use of ATVs is sports and recreation. Would a snowmobile dealer also be protected by the statute? Minnesota’s Heavy and Utility Equipment Dealers Act also suffers from a lack of precision. The statute provides that the term equipment includes “but [is] not limited to” 11 types of designated machinery and “… other equipment … used in all types of construction of buildings, highways, airports, dams, or other earthen structures or in moving, stock piling, or distribution of materials used in such construction”. 5 Theoretically, virtually any type of equipment used in construction may qualify, subjecting manufacturers of the equipment to potentially significant liability for violations of the statute. If applicable, both of these Minnesota laws require statutory “good cause” to terminate, non-renew, or to substantially change the competitive circumstances of the dealership (and 90 days prior notice of termination with a 60 day opportunity to cure). The problem, of course, is that every possible piece of equipment related to a particular industry cannot be expressly designated in the statute, so some degree of generalization and openness is required to maintain flexibility. All sorts of creative arguments can and are raised by disgruntled distributors and dealers when they are terminated or have substantial changes to their competitive circumstances imposed on them by their supplier. Such claims, even exotic, far flung ones, can result in expensive litigation and settlements. If your distributor/dealer has a territory including multiple states, the industry specific laws of each of the states must be evaluated. The lesson to the manufacturer or supplier at risk is to be aware of the problem and seek competent legal counsel prior to taking actions with distribution relationships that even arguably could be covered by invisible regulation. Sales Representative Regulation: Many suppliers and manufacturers (and even many sales representatives) are simply unaware of statutes protecting independent commissioned sales representatives from improperly withheld or delayed commission or even from termination or nonrenewal of the sales representative agreement. Beyond this lack of awareness, however, is the further difficulty of knowing with any certainty whether the laws actually apply to any given representative relationship (translucent, if not invisible, regulation). Thirty-five states and Puerto Rico have enacted some form of legislation providing special protection to independent representatives. These laws typically apply to principals who use independent contractor sales representatives (not employees) to solicit wholesale orders within that state and are paid, in whole or in part, by commission. Some statutes require agreements to be in writing. Some address how commissions during the course of the relationship are paid. Two (Minnesota and Puerto Rico) are expansive and require statutory “good cause” to terminate a sales representative. All of them address the payment of commission after termination of the agreement and most provide penalties (of up to two or three times the actual commission due) for withheld commissions or those paid later than the statutorily defined payment deadline (between five and 45 days after termination depending on the state). Most of the representative laws have “antiwaiver” provisions, making them applicable even if the representative agreement has inconsistent terms. All provide for the recovery of attorneys’ fees and costs if the representative prevails. The various state laws have their own peculiarities and each must be evaluated. A common theme in lawsuits filed by terminated sales representatives is that their commissions on certain products were unilaterally reduced by their principal 6 sometime in the past in a manner not authorized by the representative agreement. Even though the representative may have continued to do business under the reduced commission structure for years, if the agreement sets forth a specific commission rate and does not, in fact, authorize the principal to unilaterally change the rate during the term of the agreement, the representative may have a claim to put before a jury. Depending on your state’s law, a sales representative making such a claim may be able to claim unpaid commissions going back as many as six years. The claim for underpaid commissions grows over time, and, if a representative statute provides for treble damages penalties, a successful suit could yield the representative the recovery of the actual underpaid commission and three times that amount as a penalty, in addition to paying the representative’s attorneys’ fees and court costs. Given this risk, it is imperative that qualified counsel review your sales representative agreements to identify and deal with such issues. It is also extremely important to obtain some documentary evidence of the representative’s agreement to continue the relationship following a commission reduction or other substantial change in the relationship (i.e., even a letter agreement signed by the representative can support a “waiver” defense by the principal). The Minnesota Sales Representative Act is not typical in that it requires statutory “good cause” for a principal to terminate the relationship, 90 days prior notice of termination, and a 60-day opportunity to cure. The Act also requires 90 days prior notice of non-renewal (or if there is no expiration date in the agreement, the Act requires 180 days notice of intent to end the relationship). At the representative’s option, a dispute under the Act will be submitted to mandatory arbitration (even over the principal’s objection, even where there is no arbitration provision in the agreement). The Act provides that, upon termination, the representative is entitled to all commissions, at the contract rate and terms, for sales made prior to the date of termination or the end of the statutory notice period, whichever is later, regardless of whether the goods have actually been shipped. Many representative agreements provide that no commission will be paid for sales for which the goods have not been shipped or invoiced within a number of days following the termination date, setting up a manufacturer for a violation of the Act unless they are aware of it. Even more dangerous, however, is the situation where the principal is unaware of the Act, and, therefore, fails to give proper statutory notice of termination – the language of the Act implies that the representative is entitled to continue to receive commissions until the end of the notice period (which in this case never commenced because the principal was unaware of the law). Whether the Minnesota Act applies to a given relationship can be complicated. To qualify for protection, the representative must: (i) not be an employee of the principal; (ii) must not place orders for the representative’s own account for resale; (iii) not sell or offer goods to end users of the goods, not for resale (i.e., they must be wholesale orders); and (iv) the representative must be a resident of Minnesota or maintain the principal business place in Minnesota, or have a territory that includes all or part of Minnesota. 7 Numerous court cases address whether the prohibition on sales to end-users is an all or none requirement (i.e., is the protection of the statute denied if only a small percentage of sales are to end users not for retail?). There is no bright line answer. Moreover, uncertainties arise when a manufacturer sells components or parts that are purchased by an OEM manufacturer who integrates the parts or components into a new product. For example, a fan blade is sold to an integrator purchaser who places the blade, along with other components and parts, into an air conditioner, and the air conditioner is resold as a new product to the ultimate end user. Is the solicitation of the order for the fan blade a wholesale sale (because the fan blade will be resold as a part of a new integrated product) or a sale to an end user (because the integrator purchaser is actually “using” the blade in its production process)? Again, there is no bright line answer. Either of these issues could be determinative of whether the Minnesota Act applies to a given relationship. 3. Be aware of antitrust and price discrimination laws. If your business supplies distributors or dealers with product for resale, and one or more of your distributors or dealers competes with another one or more of your distributors or dealers for the same resale to a purchaser, you must be aware of the federal statutes prohibiting price discrimination. The federal Robinson-Patman Act generally prohibits sales of goods (as opposed to services) to two or more competing dealers or distributors who intend to resell the product, at different prices. While there are exceptions to this general rule, the Act is complex and can be a trap for business people. In addition to prohibiting sales of goods to competing dealers at different prices, the Act also generally prohibits discrimination between competing dealers through the use of different rebates, volume discounts, promotional allowances, and the like. Claims in lawsuits under the Act often arise as counterclaims when companies terminate distributors or take similar action. Among the actions that raise issues under the Act and should be reviewed by a lawyer are the following: • Different commission rates or prices for “preferred” distributors and dealers • Volume discounts that can’t be achieved by all dealers • Special commissions or rates to allow new dealers or distributors to establish themselves in the market • Promotional allowances available to some, but not all, dealers Another issue that is sometimes problematic for companies that distribute through dealers or distributors is what to do when you receive complaints about one dealer or distributor from competing dealers or distributors. While you have a right to determine whether you will do business with a particular dealer or distributor, it is critical that the decision be made entirely by your company. Involving competing distributors or dealers in that decision, or even “keeping them informed,” can create problems. Again, 8 guidance from a lawyer with antitrust experience can prevent costly claims down the line. *Disclaimer. This paper is intended for general information purposes only and should not be construed as legal advice or legal opinions on any specific facts or circumstances. An attorney-client relationship is not created or continued by sending and receiving this paper. Members of Lindquist & Vennum PLLP will be pleased to provide further information regarding the matters discussed in this paper. 9