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Rights and Obligations In a Distributor Termination Case

If the supplier-distributor relationship is in jeopardy, each party should assess its rights and obligations.
If termination is inevitable, an agreed-to separation is the preferred alternative to protracted,
expensive and disruptive litigation.


Terminating a supplier-distributor relationship is a serious business decision with many commercial and legal ramifications.

For example, a supplier refused to renew a chemical products distributor’s contract when it expired. The distributor sued the supplier, alleging that the supplier and several other local competing distributors conspired to terminate the distributor because of its refusal to raise its resale prices. The distributor recovered $10.5 million in antitrust damages. Although the manufacturer’s products accounted for only 16% of the distributor’s sales, the distributor went out of business 4 years later as a result of the termination. The distributor recovered damages for the loss of its entire business. In general, the same rules apply to non-renewals and terminations.

A commercial solution to a problem between a supplier and one of its distributors—as opposed to litigation—is the best approach. Under a commercial solution, the two parties may either agree to acceptable termination conditions or salvage the relationship without legal action or arbitration. In any successful supplier-distributor relationship, the parties should be able to resolve these matters reasonably.

Each party should consult legal counsel and learn its rights and responsibilities when pursuing a commercial solution or termination. Each party should assert its right in any discussions so that alternatives to a lengthy dispute or a lawsuit can be explored.

Each party should consider whether or not:

Does Termination Violate Contract Rights?

The first question is whether or not there is a contractual arrangement between the parties that would be breached by termination. A contract is usually written but may be based on an oral understanding. The contract may require that termination be based on good cause (for example, past due on payments, failure to achieve reasonable sales quota, inadequate product promotion, or poorly trained salespeople), that the distributor be given notice of any deficiency and a chance to correct it, and that reasonable advance notice of termination (or non-renewal) be given. Contracts that may be terminated by either party for convenience (i.e., without cause) on 30 days notice are common.

The agreement must be carefully examined. If a breach has occurred, an action could be filed to recover damages. Or, termination may be postponed, giving the parties time to work out a commercial solution or give the distributor time to make arrangements with other suppliers to replace the lost line.

In some circumstances, the law implies a contract even when there is none. For example, with the supplier’s knowledge or at its request, a distributor may invest in new salespeople, more warehouse space and promotional expenditures to handle a manufacturer’s line. An implied contract could be enforced to allow the distributor to recoup its investment, which was based on anticipated sales of the new line. This is done to avoid imposing financial hardships on a distributor as a result of a short-notice termination.

What are the State Statutory Restrictions on Termination?

Various state laws may also restrict the ability to terminate a distributor. Generally these statutes require good cause for termination, and they may require that the distributor be given an opportunity to correct the problem. The burden of proving good cause is usually placed on the supplier. Written notice of intent to terminate given 30 to 90 days in advance is sometimes required. In some states a supplier is obligated to repurchase a distributor’s inventory if requested.

A number of states* have franchise termination laws that limit the ability of a supplier-franchisor to terminate (or not renew) a distributor-franchisee. Generally, the termination must be for good cause and the distributor-franchisee must be given a chance to remedy cited deficiencies.

Not every distributor can claim franchisee status. Generally, a franchise is defined as an agreement whereby one is granted the right to engage in the business of selling or distributing goods or services under the marketing plan or system prescribed or suggested in substantial part by the franchisor; the franchisee is required to pay, directly or indirectly, a franchise fee of a stated amount; and the operation of the franchisee’s business is substantially associated with the franchisor’s trademark, logotype, advertising or other commercial symbol designating the franchisor.

* States that have enacted franchise termination laws include Alaska, Arkansas, California, Connecticut, Delaware, Hawaii, Illinois, Indiana, Iowa, Maryland, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, N. Dakota, Puerto Rico, Virginia, Virgin Islands, Washington and Wisconsin.
Source: Legal Aspects of Selling and Buying, Third Ed., (2005). Legislation may be pending in other states. Always check state statutes for the current status.

 
Whether or not the parties denote the relationship as a franchise is immaterial. Additionally, a contract between the supplier and distributor that expressly attempts to void or waive rights under state franchise laws generally is ineffective.

There are differences in the various laws and regulations defining “franchise” so that a relationship may be a franchise under the laws of one state but not under that of another. In addition, several different state laws may apply to a distributor with multi-state operations. Therefore, it is necessary to determine which laws are applicable and review those statutes and court cases.

In addition to franchise laws, over forty states have enacted industry-specific laws that apply to a supplier’s business relationship with distributors and dealers of agricultural, construction, industrial, utility and/or outdoor power equipment.

Finally, if another person influenced the supplier’s decision to terminate the distributor, that person may have unlawfully interfered with the business relation. Under state court decisions, a person who induces another not to enter into or continue a business relationship may be liable for the harm caused. Involvement of a third person (such as a competitor of the terminated distributor) may also create antitrust problems.

Does Termination Violate the Antitrust Laws?

A supplier does have the right to select with whom it will or won’t do business. But even if the supplier has a contractual right to terminate and there are no statutory impediments to a termination, that does not end the inquiry. One must next assess whether or not the termination could violate antitrust laws.

Liability for wrongful termination under the antitrust laws can be substantial. A terminated distributor can recover three times the actual money damages, plus attorneys’ fees and costs of litigation.

A supplier may suggest to its distributors a resale price for its products. If the supplier goes beyond making a suggestion, it could constitute an unlawful resale price maintenance scheme. A supplier cannot use coercion, including threats to terminate a distributor who does not follow the suggested price. There is no clear rule on what constitutes coercion. According to one source, a suggestion made 10 times could be viewed as coercion.

Once again, the best solution to a distributor termination or non-renewal problem is a commercial one. Thorough preparation for discussions and negotiations by each party is essential. Make sure it includes an objective evaluation by legal counsel of the rights and obligations of the parties based on the facts in your case. An honest desire to resolve any difference and get back to business is less costly and keeps relationships intact.

 

Analyzing Termination Options

When considering a distributor termination, check all the facts. Review files, notes, conversations, letters and contracts. Interview salespeople and ascertain the reasons for the termination. Answer the following questions to help determine whether or not the termination is valid:

  • What is the real motive behind the termination?

  • Is the motive anticompetitive? Were there complaints to the supplier from the terminated distributor’s competitors? Were these related to price decisions or the terminated distributor’s pricing practices?

  • Is the supplier’s line vital for the distributor to keep? Can termination be postponed for a reasonable period to permit the distributor to find other sources of supply?

  • Has the supplier given the distributor reasonable advance notice of the termination? Will the supplier provide an opportunity to remedy the problem?

  • Will the supplier repurchase inventory? Will the supplier fill orders submitted by the distributor prior to the termination date?

  • Have all distributors been treated similarly? Although failure to obtain a sales quota may be a legitimate reason for termination, this reason is suspect if others who missed their quota weren’t terminated.

  • What is the financial exposure (and related business distractions caused by litigation) if a suit is filed in response to the termination decision?


Keeley, Kuenn & Reid, a Chicago based law firm with government relations affiliates in Washington, D.C., is engaged in the practice of business law, commercial litigation, employment law, taxation, antitrust, product liability, estate planning and legislative matters. Through its affiliates, the firm also meets its clients' needs in protecting intellectual property rights and international commercial law matters.

Keeley, Kuenn & Reid
200 S. Wacker Drive, Suite 3100
Chicago, IL 60606
Tel. No. (312) 782-1829
Fax. No. (312) 782-4868
Web: http://www.kkrlaw.com