Wednesday, September 23, 2009

Minimize the exposure to potential liability from Puerto Rico's relationship Laws 75 and 21


General Observations

At least eighteen states and Puerto Rico have laws which protect dealers, distributors, and franchisees. In Puerto Rico, a supplier, franchisor or manufacturer (the “principal”), may not terminate, impair, or refuse to renew an agreement with a dealer, franchisee, or sales representative for the distribution of goods and services in Puerto Rico without “just cause”. The remedies include preliminary injunctive relief and damages (lost profits, goodwill, the value of capital investments and inventory etc.). These special laws, known as Law 75 (covering dealers), and Law 21 (protecting sales representatives) are remedial and have public policy implications. Regardless of how the parties characterize their business relationship, there is no enforceable way for a principal to escape coverage from those special laws by contractually opting-out in advance. Even a state choice of law clause in a written agreement will not be effective to make Law 75 (or 21) inoperative. See Caribbean Wholesalers v. JVC, Business Franchise Guide CCH at 10,470 (S.D.N.Y. 1994) (holding that a New York choice of law clause is null and void in a distribution contract governed by Law 75).

Practice Pointers

An option to avoid Law 75 or 21 altogether would be to establish an employment relationship. Generally, an employee lacks Law 75 (or Law 21) protection. Lugo v. Matthew Bender, 579 F. Supp. 638 (D.P.R. 1984). Another special law in Puerto Rico, No. 80, limits damages for a wrongful termination of employment to approximately one-month’s salary. To be sure, there are important corporate, labor, and tax law considerations which govern employment relationships (and increase the risks and costs of doing business in Puerto Rico), which do not apply to independent contractors. Laws 21 and 75 presume the existence of an independent contractor or partnership relationship.

Essential legal protections for suppliers or manufacturers when doing business with sales representatives or distributors in Puerto Rico, include, 1) a comprehensive written agreement with a definite term, 2) a non-exclusive relationship, 3) arbitration and reasonable choice of forum clauses, 4) appointment of a distributor or sales representative with “limited functions”, and 5) completeness and integration clauses.

The only time it would make sense for a principal not to have a new written sales representative agreement would be if commercial dealings arose before the effective date of Law 21 (the sales representative protection statute), that is, before December 5, 1990, and no Law 75 dealer relationship existed. Law 21 does not apply retroactively before its effective date. Nieves v. Dymax, 952 F.Supp. 57 (D.P.R. 1996)(holding that Law 21 did not apply retroactively to relationship that began in 1986 despite written agreement of 1995 that did not extinguish prior obligations). The same considerations apply to Law 75 which was enacted in 1964.

A strategy when drafting a written agreement may be to limit certain functions of the sales representative or dealer (as much as business considerations permit) and minimize potential liability if these laws do apply [And, define a methodology or formula to compute actual compensatory damages in the event of a termination or establish a set off procedure to deduct the principal’s value associated with its ownership rights in the line from the net profit, if any, earned by the distributor]. For example, a service mark licensor (Thrifty Rent-A-Car) was able to escape coverage from the distribution laws in Puerto Rico where the licensee did not have an obligation to distribute or resell products to customers and relied on the national advertising, goodwill, and reputation of the franchisor. See Velasco Rental v. Thrifty, 1990 CCH par. 21,073 at 9589 at (D.P.R. 1990). A principal may structure the promotion obligation of the licensee or dealer to require the payment of a fee to tap into the licensor’s mark, reputation, and goodwill. Another possibility is the elimination of quotas or sales goals (which normally are a quid pro quo of exclusivity). The licensee or dealer, however, should still use its best efforts to maximize sales of the products. The relationship should be on a purchase and sale basis (no commissions or compensation based on achievement of sales goals or quotas). A licensee or dealer should be prohibited from warehousing or distributing goods beyond the need to keep an adequate inventory for resale to customers in the stores (i.e., no resale to wholesalers or retailers).

A non-exclusive agreement is arguably outside the coverage of Law 21 (but protected by Law 75). The scope of the non-exclusivity should be clearly defined to mean that the supplier retains the right to sell directly in the territory, appoint other distributors, or sell through e-commerce.

Although a principal cannot refuse to renew a dealer’s contract (or sales representative agreement) after it expires without just cause, a reasonable contractual provision for pre-expiration notice of a renewal term is enforceable in the Law 75 context and binds the dealer. Nike v. Athletic Sales, Inc., 689 F. Supp. 1235 (D.P.R. 1988).

Quotas or sales goals must be reasonable. Language such as the one below may work as an admission that serves to avoid potential disputes over the reasonableness of quotas: “Given actual data and forecasts of market conditions in Puerto Rico, Sales Representative or Dealer recognizes that the minimum sales requirements in this Agreement are reasonable and adjust to the reality of the Puerto Rico market at this time.”

If litigation is imminent, the supplier should carefully consider the adage that “the best defense is a good offense.” Since the Constitution of Puerto Rico affords no right to trial by jury in civil cases, the supplier normally wants to avoid litigation with a disgruntled dealer or representative in the U.S. District Court of Puerto Rico which does guarantee it. The supplier may consider filing a claim in local court for collection of monies (if any are past due and owing) or declaratory judgment action against the resident dealer or representative. Because federal law prohibits a removal of the action to federal court if any of the defendants is a resident of the forum state, the dealer or representative will be unable to litigate a Law 75 or 21 claim with a jury in federal court even though the action could have been filed originally there.

[Note: Since 2001, there have been judicial decisions that may affect the observations described above. The author disclaims expressing any legal opinion on any issues without prior consultation and the establishment of an attorney-client relationship].