Measure of damages for lost income revisited: net profits and a new rebuttable presumption to deduct variable expenses

Although Law 75 characterizes the infringing act giving rise to a claim as a tort, the computation of damages for lost profits arising from an unjustified impairment or termination of a dealer’s contract has its origins in contract principles derived from the civil or common law. For as long as I can remember, reputable experts in Law 75 cases have offered contradictory opinions on whether the computation of lost profits should be made after deducting fixed or only variable expenses, or some formulation in between. These formulations are tagged as the “straight line” approach or a modified approach etc. This area of the law has provoked one of the last few “accounting” or ‘economic” damages controversies that remains under Law 75. It should be settled by now that recovery of lost profits and goodwill is not per se duplicative (but there is substantial authority that recovery of goodwill is not necessarily permissible even if not duplicative). It is also settled that recovery is pre-tax. The last remaining frontier that still divides franchise lawyers and experts had been the allocation of costs to compute lost profits. The reason should be obvious: less deductions equals more profits and vice versa. For their part, courts have largely declined to adopt bright line rules, and in federal cases tried to juries, the weight of conflicting expert opinions has been left for juries to resolve as a matter of credibility. This is a tall task for laymen or lay women sitting in juries producing in some cases “split the baby” awards. Not to digress too much, but if you read the First Circuit's Rubbermaid case carefully you will see what I mean when a jury faces two party appointed experts and one court appointed expert on damages. It split the award down the middle.


While the Supreme Court of Puerto Rico’s recent and thoughtful opinion that I am about to discuss still leaves work ahead for both accountants and lawyers alike, it does offer substantially more clarity as to the proper methodology to compute claims of damages for lost income in all civil cases. I anticipate that, after this decision, courts have greater leeway and more responsibility as the gatekeepers to ensure reliable expert opinions to determine whether experts have the adequate foundation (e.g.,evidentiary basis of the operational costs) before allowing opinions to reach the jury. This is not fundamentally different from what has existed since Daubert, but at least now, the proper computation of damages is not necessarily a jury issue.


In El Coqui Landfill Inc. v. Municipio de Gurabo, 2012 TS 141 (P.R. Sept. 20, 2012)(Fiol-Matta, J.), the Court’s holding has four components, first, the proper computation is net, not gross profits; second, the expenses that must be deducted from the gross are those costs that claimant saved because of the impairment or termination of the contract (stated differently, those are generally called variable expenses in that claimant would have incurred those costs had defendant performed the contract and those costs may vary with the volume of sales); third, the definition of what is a variable or fixed cost is not rigid and may change depending on the industry or the business; fourth, and perhaps most important, claimant has the burden to overcome with business records and analysis the newly-created rebuttable presumption that costs are variable and should proportionally (depending on sales volumes) be deducted to compute net profits. In other words, claimant has the burden to prove that the costs are fixed or that it saved no costs because of the termination or impairment (two Justices dissented on this point).


The facts of El Coqui illustrate that the Court’s holding has far-reaching implications in Law 75 and tortious interference cases. There, plaintiff, a waste disposal company, had an exclusive contract to provide waste disposal services at the municipality’s landfill. The defendant municipality breached the contract with a third party who was liable in solidum for tortious interference. Plaintiff’s accounting manager, who was a CPA, testified that he computed the damages for the income lost during the duration of the contract, but did not deduct any costs from the gross because he said the costs of providing services were fixed not variable. The trial court awarded damages of $1.2 million plus interest at 4.25%, a judgment affirmed by the appellate court. The flaw in the accountant’s analysis, which caused the Supreme Court to modify and remand the judgment, was that the accountant’s conclusory testimony was devoid of business records, data, and analysis of the operational costs of the claimant’s business.


It remains unclear the quality or quantum of the evidence that a claimant must offer to overcome the rebuttable presumption that the costs are variable with the volume of sales and should be deducted from gross profits. I predict that there will be collateral litigation, as there has always been, over the allocation and amount of costs to determine the proper measure of lost profits. Another point that may go unnoticed is that the opinion of damages need not necessarily rest on an independent expert, but may rely on a certified public accountant employed by the company who has personal knowledge of the business. This may not bode well for independent experts at least when the claimant can count on a reliable in-house accountant or finance manager to testify about the measure of damages.

Newborn Law 75 cases are moving upstream in the federal court

Both involve declaratory actions. In V. Suarez & Co. v. Welch’s Foods, Inc., No. 12-cv-1490 (FB), Puerto Rico’s largest distributor struck first in federal court asking for declaratory judgment and alleged potential (but not actual) termination damages alleging that VSC did not breach an obligation prohibiting activites with competing products in the distributorship agreement with Welch’s, a producer of grape juice products, when it acquired Campofresco, a local producer of Lotus-branded 100% juices, including grape juice. The case also involves allegations of an alleged impairment of contract from sales to club stores. The case is at the pleading stage and Welch’s will appear in due course to answer or move with respect to the Complaint. Note: The author represents Welch’s. The other action, Quaker Oats Corp. v. Ballester Hermanos, Inc., No. 12-cv-1712 (GAG), involves an action by Quaker Oats for the Court to declare what the amount of damages will be under Law 75 in the event of an unjustified termination of the dealer’s contract. Quaker Oats concedes that Law 75 applies and that it would not have just cause, but the parties (or their experts) disagree as to the amount of potential damages. Quaker intends to terminate the relationship effective from the filing of the complaint and seeks a declaration of how much money it will cost. Stay tuned.

Is the floodgate open? McDonald Corporation’s disgruntled retail franchisees in Puerto Rico find coverage under Law 75

In a case with potentially far-reaching implications in the food services retail industry, the Court of Appeals, San Juan Division in AA& S Food Service Corp. v. McDonald’s Corporation, 2012 WL 2577784 (TCA, May 12, 2012), denied a petition for certiorari to vacate the lower court’s adoption of a report by a Special Commissioner (Angel Rossy, Esq.) that certain McDonald’s franchisees are protected by Law 75. According to the court’s opinion, the complaint alleges that defendants intend to impair and terminate the established dealer relationships and appropriate the goodwill by requiring the franchisees to invest significant amounts of money to remodel stores and then force the franchisees to sell their franchise rights. In response to the franchisees’ motion for preliminary injunctive relief, McDonald’s moved to dismiss arguing that the franchise agreements were not distribution contracts within the meaning of Law 75. McDonald’s main argument was that the franchising contracts are atypical and resemble the franchise agreement in the Supreme Court’s Martin BBQ case which, according to McDonald’s counsel, was outside the scope of Law 75. Applying the traditional factors in Lorenzana to determine who qualifies for Law 75 protection, the appellate court determined that the lower court was not arbitrary and capricious in adopting the report which found that the franchisees complied with most of the factors for Law 75 coverage, such as taking risks in signing the franchising agreements, investing in advertising and promotion, assuming the costs and responsibility of maintaining an inventory, and complying with standards of quality required by the franchisor. Author’s Note: Why did the Court of Appeals need to explain its reasons to deny certiorari, aside from maximizing the possibility of a denial of certiorari by the Supreme Court? It can hardly be said that the decision denying certiorari would be precedent in similar cases. The court’s reasoning could be criticized as dictum or as an advisory opinion. Be that as it may, the case may open the door to a potential class of Law 75 plaintiffs- including hundreds of retailers, franchisees, and mom and pop stores that resell products to the ultimate consumer. To me, the focus is not whether franchisees are excluded from Law 75 coverage as a matter of law- a proposition doubtful at best given Law 75’s broad definitions of “distributor” and “dealer’s contract” in §278(a)(b) to include a “franchise” … “on the market of Puerto Rico.” Rather, the opinion begs the threshold question whether retail franchisees have standing under Law 75 to claim the misappropriation of goodwill when the franchisor is the owner of its trademarks and associated goodwill developed from its investments worldwide in advertising and publicity. At least one federal case, Carana v. Jovani, 2009 WL 1299569 (D.P.R. 2009), held that Law 75 does not contemplate such recovery when the retailer free rides on the goodwill and clientele created by the franchisor of a famous or recognized brand.

Should an exclusive distributorship be implied from the supplier’s silence? Not according to a panel of the local appellate court.

In Next Step Medical Co. Inc. v. Bromedicon, Inc., 2012 WL 2399503 (TCA San Juan, May 23, 2012)(Dominguez-Irizarry, J.), the plaintiff-distributor filed suit for preliminary injunctive relief and damages under Law 75 in the Court of First Instance, San Juan Part, alleging an impairment with an alleged exclusive relationship for the distribution and servicing of medical products in Puerto Rico. The facts are somewhat unusual, but crucial for the court’s conclusion that there was no meeting of the minds over exclusivity. The parties exchanged and amended two drafts of an exclusive distribution agreement. The distributor signed and delivered the last draft to the supplier’s principal who never signed it. Subsequently, the parties met to discuss contractual expectations and differences of opinion arose as to whether the supplier would be bound by a purported obligation not to offer competing products for the services required by the distributor. At no time during those meetings did the distributor allege the existence of an exclusive relationship. Nor was an exclusive agreement ever signed. The distributor filed suit when the supplier began to offer the same medical services through other entities. The standards for preliminary injunctions in Law 75 cases are straightforward and addressed at length in the appellate court’s opinion. The appellate court affirmed the trial court’s denial of preliminary injunctive relief reasoning that the distributor had failed to establish irreparable harm as there was no evidence of actual damages and the sales of the line at issue were small when compared to total company sales; the distributor had failed to show convincingly the existence of an exclusive dealership necessary to prove likelihood of success on the merits; the allegation of harm to reputation was not substantiated and it incurred in laches. The court in effect affirmed the judgment by denying the petition for certiorari.

Twists and turns of the V. Suarez and Bacardi arbitration to validate a measure of potential damages in a sub-distribution agreement governed by Law 75

After a business relationship of five years turned sour, Bacardi and V. Suarez parted ways, but not before the sub-distributor alleged a $30mm termination claim under Law 75. A three-lawyer Panel of the AAA decided, by a 2-1 vote in a reasoned opinion, that contractual provisions to compute potential damages were valid, binding, and enforceable under Law 75. Any damages from a termination of the sub-distribution agreement, if determined to be without just cause, would be set off from the “distribution value” owned by Bacardi. Because Bacardi created the goodwill and clientele for its brands and products and the sub-distributor paid no consideration to obtain the exclusive sub-distribution rights, the parties agreed that the sub-distributor would recover compensatory damages from an unjustified termination only to the extent that its net profits on the sale and distribution of Bacardi’s products exceeded the “distribution value” at relevant times. The sub-distributor V. Suarez argued that the damages provision was null and void as a “waiver of rights” under Law 75 because of the prospect that it could recover nothing from a termination. In an opinion of first impression, the Panel sided with Bacardi. Litigation in both local and federal courts quickly followed. V. Suarez first filed a proceeding- D AC2011-2354 (402)- in Bayamon local court to invalidate the award under Puerto Rico’s arbitration statute. VSC claimed that the Panel’s majority outcome was biased and the award should also be set aside for legal error as it allegedly violates Law 75’s policy against waiver of rights. Bacardi responded with two shots: it removed the vacatur proceeding to federal court and filed a separate motion to confirm the award under Section 9 of the Federal Arbitration Act. After consolidation of the proceedings, the federal court remanded the removed case concluding that there was no complete diversity jurisdiction and applied Rule 19 to dismiss the independent proceeding to confirm the award for lack of an indispensable party. The court’s opinion is reported at V. Suarez v. Bacardi Intern., 826 F. Supp. 2d 433 (D.P.R. 2011), appeal pend’g. The court’s opinion overlooked Bacardi’s threshold argument that FRCP 81preempts the Federal Rules when the FAA establishes the procedures to confirm awards and there was complete diversity jurisdiction on the face of the motion to confirm. This novel procedural issue in the First Circuit remains pending on appeal in No. 12-1032. Meanwhile, after hearing extensive oral argument from the parties, the Court of First Instance issued on July 18, 2012 an opinion denying V. Suarez’ motion to vacate. Accordingly, it confirmed the award. The court rejected the argument that the Panel was biased simply because it ruled in Bacardi’s favor. The court further held that the FAA governed the sub-distribution agreement; that the choice of Puerto Rico substantive law provision and the incorporation of the AAA rules in the agreement were not intended to incorporate Puerto Rico’s arbitration laws and rules to review awards; that the FAA’s standard to review awards under Section 10 preempted Puerto Rico’s arbitration law or rules; the award was enforceable under Section 10 of the FAA and alternatively, it did not violate the manifest disregard standard assuming it survived the Supreme Court’s Hall Street precedent; finally and in any event, the Award was legally sound and correct. About the wisdom of the damages methodology in the agreement, Judge Sylvette A. Quinones-Mari wrote: “In this case there has been no waiver, express or implied, by the distributor protected by Law 75. Law 75 does not prohibit sophisticated parties from agreeing in advance, after exchanging financial information and negotiating extensively, to determine the distribution rights and goodwill of the principal over a brand that is recognized worldwide, with an established clientele and over which the principal has invested millions of dollars to promote and develop it.” (translation ours).

Verbal statements of exclusivity are insufficient by themselves to prove the existence of an exclusive distributorship under Law 75.

In Medina & Medina, Inc. v. Hormel Foods Corporation, No. 09-1098 (JAG)(March 30, 2012), the federal court adopted, in part, Magistrate Lopez' “well-thought out” R&R to deny the distributor’s motion for summary judgment and allow the principal’s partial motion for summary judgment.

There were two main issues. First, was there exclusivity? On summary judgment, the distributor Medina claimed an exclusive distributorship for certain products based on a verbal authorization by an officer of Hormel for Medina to distribute Hormel’s products. Medina also introduced a letter of Hormel referring to Medina as the “primary if not the exclusive partner.” Nonetheless, Hormel disputed the assertion of exclusivity as the parties did not agree on the scope and terms for the distribution of the products. There was no written contract and Hormel contested the assertion of exclusivity. Reinforcing the argument that exclusivity is a right conferred by the principal, the court noted “Medina seems to think that the fact that Hormel may not have had another distributor in Puerto Rico means that Medina was by definition Hormel’s exclusive distributor. The Court fails to find this line of reasoning persuasive.” The reader should observe that there is precedent that exclusivity is determined by the contract between the parties and the course of dealings. But, none of the cases has supported allowing summary judgment for a distributor based solely on a course of dealings and at least in the absence of a written exclusive agreement. Finding it was a stretch to allow the distributor’s motion for summary judgment, the court adopted the Magistrate’s R&R finding material issues of fact precluding the distributor’s motion for summary judgment.

Two, did the existing dealer relationship prohibit sales by Hormel to mainland distributors? The court analyzed the trilogy of impairment cases involving sales to mainland distributors: The First Circuit’s Irvine decision, and district courts’ decisions in Sterling and Di Giorgio and concluded that the factual situation in this case was not analogous to the other cases because Hormel had sold its products directly to mainland distributors. Despite the Magistrate’s conclusion that Law 75 would reach to proscribe those sales, it determined that the existing agreement did not prohibit Hormel’s sales to stateside distributors and recommended granting Hormel’s motion for summary judgment to dismiss that claim. The Magistrate gave weight to Medina’s failure over many years to contest Hormel’s sales to mainland distributors. The court concurred and adopted the Magistrate’s recommendation on the alternate ground that the impairment of contract claim was time-barred under the Commerce Code’s three-year caducity period. Finding that, at least since 2005, Medina had been aware that Hormel would continue to sell to mainland distributors despite its objections (Medina wanted better prices), the claim for impairment under Law 75 was time barred. As to the issue whether the existing agreement (i.e., the business relationship created from the course of dealings) prohibited direct sales to mainland distributors, the issue turned moot because the court concluded that Medina’s claims arising from sales to mainland distributors, though covered by Law 75, are time barred. Presumably, the impairment claim for damages that remains alive after the court’s ruling arises from sales within Puerto Rico if a jury concludes that Medina and Hormel had an exclusive agreement for certain products.

Puerto Rico Supreme Court issues order to show cause as to why it should not reverse appellate court’s refusal to compel arbitration of Law 75 dispute

It is worrisome that some lower courts in Puerto Rico still find ways not to enforce arbitration agreements. The latest is a theory that, if the contracting parties lack the necessary information to provide an informed consent to the implications of arbitration, the arbitration provision is invalid.

A sub-distributor of Nissan motor vehicles filed suit in the Court of First Instance, San Juan Part, against Motorambar, the general distributor, invoking Laws 21, 75 and asserting claims for breach of contract and preliminary and permanent injunctive relief. The dispute originated when Motorambar purportedly attempted to change the exclusive nature of the relationship in a designated territory and terminated the relationship when the sub-distributor refused to acquiesce to change the existing dealer agreement.

Motorambar moved to dismiss and to compel arbitration alleging that the dealer agreement has an arbitration clause. The sub-distributor responded that there was no obligation to arbitrate as the dealer agreement had expired; that the agreement was null and void, and that it was governed by Puerto Rico’s arbitration statute, 32 LPRA §3201 and not by the Federal Arbitration Act. The trial court refused to dismiss the action in favor of arbitration reasoning that an evidentiary hearing was required before deciding the validity of the arbitration provision. After an evidentiary hearing, the trial court invalidated the arbitration provision on a theory of lack of informed consent. The trial court also rejected a constitutional attack under the FAA to Article 3C of Law 75 that requires a court to validate the voluntariness of arbitration provisions in Law 75 cases.

A Panel of the Court of Appeals denied both Motorambar’s motion to stay and a petition for certiorari. In L.M. Quality Motors Inc. v. Motorambar, Inc., 2011 TSPR 158 (P.R. Oct. 28, 2011), by a vote of 5-4, the Supreme Court of Puerto Rico stayed injunction proceedings in the trial court and entered an order to show cause as to why the appellate court’s decision should not be reversed. The majority did not issue a reasoned opinion but likely will reverse. Four Justices of the Court explained in the dissent that there was sufficient evidence to invalidate the arbitration agreement for lack of informed consent and did not believe that the FAA preempted the application of Puerto Rico’s commercial arbitration law in the circumstances of this case. Stay tuned.

Update: Since then, the local court denied the sub-distributor's request for preliminary injunctive relief to maintain the status quo pending further proceedings. Not surprisingly, Motorambar filed a motion for voluntary dismissal of its certiorari petition in the Supreme Court noting that it would be more efficient to try the case in the local court than to arbitrate. The motion to dismiss, if allowed, would moot the appeal.

Federal Court enforces arbitration award of $3.7 million under Law 75 in favor of Puerto Rico distributor

In Thomas Diaz Inc. v. Colombina, S.A., 2011 WL 6056717 (D.P.R. Dec. 6, 2011)(PG), Thomas Diaz Inc. (TDI), a Puerto Rico distributor of candies, successfully arbitrated a dispute with Colombina Inc., a Colombian corporation. The sole arbitrator was Angel (Paco) Rossy, a prominent retired Judge of the Court of Appeals of Puerto Rico. Arbitrator Rossy had been the Chairman of the Panel in the Mendez & Co. Inc. arbitration under Law 75 previously reported in this Blog. Mendez prevailed in the arbitration and recovered substantial damages.

After bifurcating liability from damages, the Arbitrator found that Colombina had terminated a forty-year relationship without just cause and awarded TDI substantial damages under Law 75 for lost profits, loss of goodwill, costs, legal interest and expenses. The Arbitrator adopted the contribution of revenues approach deducting only certain variable expenses- a methodology endorsed by the Ballester and Goya line of federal cases to compute five years worth of lost profits from a termination. For goodwill, the Arbitrator was persuaded by the capitalization of future earnings approach over the IRS excess earnings method, which came with a seal of approval by the Puerto Rico Supreme Court’s Dayco decision. The record does not reflect the reasons for the termination. It does not appear that the Arbitrator considered or awarded attorney’s fees to the prevailing party under Law 75. Colombina did not challenge the partial award finding no just cause for the termination.

In May 2010, TDI filed a motion (improperly denominated a “complaint”) to confirm the award in federal court under Section 9 of the FAA invoking the court’s diversity jurisdiction. Colombina filed a cross motion to vacate or modify the award. Following the Supreme Court’s Hall Street decision and noting the extremely deferential grounds for review of arbitration awards, the District Court (Perez-Gimenez,J) held that the FAA preempted Puerto Rico’s arbitration statute to the extent that it provides “lesser protection” for the enforcement of arbitration awards. The court then confirmed the award and denied the motion to vacate concluding that the Arbitrator’s Award is plausible, supported by the record, and based on valid legal principles. The court denied TDI’s request for attorney’s fees for the enforcement action finding that Colombina was not frivolous to challenge the award at least taking into account its size.

Colombina’s advocacy could not have helped its cause as the District Court found many of its arguments incomprehensible and deemed waived. Courts often wave goodbye and leave unpunished uncivil or overzealous litigation providing no deterrent for future misdeeds, but this Judge would have none of it as can be appreciated from the Court’s footnote:

“…When making reference to the Arbitrator’s Award, the Defendant’s motion to vacate (Docket No. 29) is riddled with empty phrases such as “blindly capricious ... adoption,” “blatant disregard of law,” “basic flawed assumption,” “such flawed logic,” “palpably faulty,” “patently absurd and faulty assumption,” “draconian windfall of punitive nature,” “magical tergiversational twist of ... financial realities” among others. The Court had to ferret through the motion in order ascertain the grounds of Defendant’s objections to the Arbitrator’s award. Therefore, to the extent the Defendant’s arguments were unclear or incomprehensible to this Court, the same are hereby disregarded.”

In the end, reasonable persons can disagree and take sides with the damages methodology of the Award, but the rule of law prevailed when the District Court, albeit not so promptly, confirmed the award into a Judgment.

Declaratory judgment is appropriate vehicle to obtain declaration of just cause for termination of agreement in Law 75 case

In General Motors v. Royal Motors Corp., 769 F. Supp. 2d 73 (D.P.R. Feb. 1, 2011)(Gelpí, J.), GM filed a preemptive suit against one of its dealers seeking a declaration under 28 U.S.C. §2201 that it had just cause for termination of the motor vehicle dealer agreement with one of its dealers. GM alleged that the dealer submitted false or fraudulent claims related to warranty repairs of vehicles which constituted a material breach of the agreement. GM pleaded complete diversity of citizenship and the amount in controversy exceeded the requisite jurisdictional amount.

The dealer moved to dismiss the action for lack of subject matter jurisdiction. It alleged that the complaint did not satisfy the jurisdictional minimum and did not present a justiciable controversy. The court held that the amount in controversy “is measured by the value of the object in the litigation.” Because the “value of the dealer agreement” exceeds the jurisdictional minimum, the court denied the motion to dismiss on that basis.

As to the justiciability of the claim, the court found that the federal Declaratory Judgment Act “is designed to enable litigants to clarify legal rights and obligations before acting on them.” “GM’s right to terminate its contractual relationship is the exact type of dispute considered ripe for declaratory judgment”, held the court. The court also found that GM showed the hardship it would suffer absent a judicial determination of its rights and denied the motion to dismiss.

Note: CAB represents General Motors in the litigation.

Plaintiff wins a remand to local court but loses a tortious interference claim in federal court: was it a pyrrhic victory?

In Alpha Biomedical v. Phillips Medical, 2011 WL 5837374 (D.P.R., Nov. 21, 2011)(Besosa, J.), Plaintiff, a distributor of medical equipment, filed an action in local court asserting claims under Law 75, tortious interference, and defamation against various Phillips corporations for breach and interference with an alleged verbal distribution contract. Defendants removed the case alleging that certain non-diverse defendants had been fraudulently joined to defeat diversity. Plaintiff moved to remand. A U.S. Magistrate recommended that the action should be remanded, which the Court adopted. The Magistrate (Silvia Carreno, J.) found that the standard of fraudulent joinder was unsettled in the First Circuit and adopted a prong of a Fifth Circuit test whether Plaintiff fails to state a claim upon which relief can be granted against the non-diverse defendants. She determined that the complaint properly pleaded a claim for defamation and there could not be a finding of fraudulent joinder.

Things then get tricky. While the Magistrate’s determination on the existence of a valid defamation claim sufficed to require granting the motion to remand for lack of jurisdiction, the Magistrate went further and concluded that Plaintiff failed to state a claim for tortious interference, which the Court agreed. Was there subject matter jurisdiction to make such a recommendation? The issue was not addressed in the opinion. Over Plaintiff’s objection, the Court held that Puerto Rico law would not recognize a valid claim for tortious interference with a verbal contract having an indefinite term and is terminable at will. Law 75 contracts without a fixed term could become indefinite in the sense there can be no lawful termination without just cause. However, Plaintiff’s allegations were defective in that it failed to allege the duration of the alleged verbal agreement or that it was in effect at the time of the alleged interference. The Court adopted both the recommendation to remand the case for lack of jurisdiction and the decision not to award attorney’s fees as the removal was objectively reasonable, citing Martin v. Franklin, 546 U.S. 132, 141 (2005).

Would the Court’s adoption of the Magistrate’s recommendation that no valid tortious interference claim exists be res judicata upon remand of the case to local court? It is questionable whether the court’s de facto dismissal of the tortious interference claim is reviewable on appeal when a remand order is not. The court’s determination that a valid defamation claim exists was enough to remand the case for lack of jurisdiction. It remains to be seen if the local court will pass judgment independently on the Court’s reasoning or conclude that the determination to dismiss the tort claim is res judicata. Did Plaintiff really win at all with remanding the case?

A powerful weapon in the arsenal: the new trade secrets Puerto Rico Law No. 80 of June 3, 2011 would provide substantial remedies for violations of confidentiality obligations in distribution contracts

Distribution contracts generally contain provisions protecting confidential business information, such as client lists, price lists, marketing and other business plans and strategies.

It used to be that a party affected by a breach of a confidentiality obligation had to sue in tort or breach of contract under the Civil Code with the burden to establish the existence of a trade secret under the rules of evidence and prove damages. Law 75 did not provide a claim for relief. In the distribution context, breach of confidentiality issues may arise when a key employee with access to confidential information leaves the firm to a competitor or to the other contracting party, or when the principal terminates the contract and the distributor uses confidential information obtained during the relationship for its financial benefit (or the other way around).

On June 3, 2011, the Legislature of Puerto Rico enacted a far-reaching law protecting trade secrets and providing substantial remedies for unauthorized violations. The law is patterned after the Uniform Trade Secrets Act.

The elements of a claim under Law 80 are: 1) proof of a “commercial secret” (a defined term meaning information which provides an actual or potential economic benefit, is not public, and whose confidentiality has been maintained by reasonable means); 2) the commercial secret has been misappropriated; and 3) it has caused damages to the owner.

The statute provides preliminary, permanent injunctive relief, and the payment of royalties in extraordinary circumstances. The measure of damages can be substantial; including actual damages and “additional damages” to the extent that the offending party has derived a benefit from the use of the confidential information, or in the alternative, the payment of royalties. The measure of damages includes lost profits, the value it would have cost to develop the information, depreciation, development costs, and market value of the information.

If the violation was intentional or in bad faith, the court has discretion to award three times the amount of actual damages and grant attorney’s fees. The Law supplements any remedies that the parties may have under the contract and other laws. Thus, regardless of any contractual provision, Law 80 provides relief to the owner for damages caused from the misappropriation of commercial secrets.

Law 80 claims will most certainly arise in the labor-employment context and in actions involving a breach of fiduciary duties. But, Law 80 will become relevant in commercial litigation as well. I would expect that a Law 80 trade secret claim will go hand in hand with trademark infringement claims and those under Law 75. Because of its recent enactment, there is no case law so far interpreting its provisions.

The battle in arbitration under Law 75 between Puerto Rico’s largest distributor and the world’s leading producer of rum reaches federal district court

The Puerto Rico sub-distributor V. Suarez filed an action in local Bayamon court, where it has its principal place of business, seeking to vacate a commercial arbitration award under Puerto Rico law. The principal Bacardi countered with a removal of the action to federal court and the filing of a separate federal action to confirm the award under the Federal Arbitration Act.

As reported in my previous blog, a commercial arbitration panel of the AAA ruled in favor of Bacardi, as a matter of first impression, that sophisticated parties may, by contract, predetermine the methodology to value the principal’s direct contribution and goodwill associated with the line and set off that value from the distributor’s actual damages in the event of an unlawful termination under Law 75.

The award is part of the public record in the proceedings to vacate and confirm the award. The cases pending in the U.S. District Court of Puerto Rico are styled V. Suarez & Co. v. Bacardi International Limited, No. 11-01858 (GAG) and Bacardi International Limited v. V. Suarez & Co. Inc., No. 11-01871. Stay tuned.

In a case of first impression, a commercial arbitration panel of the AAA validates provisions for the computation of damages in a distribution agreement governed by Law 75

In a watershed ruling, a commercial arbitration panel of the American Arbitration Association has decided that sophisticated corporations may pre-determine the methodology for computing actual damages in the event of a future termination of the business relationship without violating Law 75.

There, a renowned worldwide producer of liquor entered into a distribution agreement with a Puerto Rico distributor. The brands and products that were subject to the agreement were famous, had an established goodwill in the Puerto Rico market, and produced significant annual revenues to the previous distributor, an entity affiliated to the producer. The agreement did not require the new distributor to pay a franchise fee, make any capital investments, or provide any consideration in exchange for the exclusive distribution rights.

The parties negotiated at arms-length with the advice of counsel and agreed on the formula to compute damages in the event of a termination without just cause. Essentially, the agreement established the annual distribution value of the exclusive distribution rights owned by the producer that would be conditionally granted to the distributor. The distribution value was based on actual historical data of revenues generated by sales of the products in the Puerto Rico market and an estimate of the new distributor’s direct costs. If the measure of actual damages under Law 75 was less than the distribution value, the distributor would recover zero damages in the event of an unjustified termination. Under the agreement, the distributor could only recover the excess profits generated by its efforts to the extent that those exceeded the distribution value.

The distributor argued that the damages provisions infringed Law 75 as a waiver of rights, but a majority of the panel disagreed. The Panel recognized that the Puerto Rico distributor cannot recover for the franchisor’s goodwill and value of its trademarks. Further, the measure for computing damages did not violate Law 75 because there is no prohibition from valuing the manufacturer’s goodwill (which the distributor did not create or contribute) and setting off that value from the measure of actual damages under Law 75. Damages under Law 75 are not automatic or mandatory, ruled the panel in favor of the producer.

This decision may have a significant impact in the way that distribution agreements are negotiated and executed, especially for famous brands that have an established clientele and goodwill in the Puerto Rico market.

Author’s note: The undersigned is lead counsel for the producer in the arbitration proceedings, with Rosalie Irizarry participating as trial counsel and Natalia Morales for research and motion practice.

First Circuit vacates final judgment for a supplier in a Law 75 case after consolidation of a preliminary injunction hearing with a bench trial on the merits did not provide adequate prior notice.

In Lamex Foods v. Audeliz Lebron, No. 10-1677 (1st Cir. June 27, 2011), the First Circuit vacated the District Court’s (Fusté, J.) Judgment holding that consolidation of a preliminary injunction hearing with a bench trial on the merits without providing adequate and clear prior notice violated the constitutional right to a jury trial.

Plaintiff Lamex is a Minnesota corporation that facilitates the sale of food from manufacturers to suppliers and vendors worldwide. Plaintiff entered into a “business relationship” where it purchased frozen chicken for resale to Defendant ALC, a Puerto Rico corporation, that supplies product to supermarkets and retailers in Puerto Rico. In 2009, after failed collection attempts, ALC fell behind in its payments for poultry sold and delivered totaling $1.2 million. Lamex, among other actions, canceled ALC’s account and cashed in on a letter of credit tendered as security.

ALC sued Lamex first in local court alleging violations of Law 75. Before Lamex was served, it sued ALC in federal court naming ALC and its President as defendants. Lamex sought to recover payment of unpaid monies due and to pierce the corporate veil to hold the President personally liable. Lamex also sought a declaration that it was not a principal under Law 75, and even if it was, it had just cause to terminate the relationship.

There were mixed or contradictory signals on the record whether the court had in fact consolidated the case. After an evidentiary hearing, the District Court found for Plaintiff in all respects on its complaint except that it disallowed the request to pierce the corporate veil.

Defendant appealed and argued that the court erred in consolidating the preliminary injunction hearing with a bench trial on the merits. The First Circuit accepted, without deciding, an argument for the present case that Law 75 actions are essentially legal to which the Seventh Amendment attaches. Despite Defendant’s counsel’s failure to object to consolidation, the First Circuit held that the court’s failure to give unequivocal and adequate prior notice did not comply with the heavy burden to show a waiver of the constitutional right to a jury trial.

Thus, the court vacated the judgment with respect to the claims for declaratory relief and to pierce the corporate veil and remanded the action for further proceedings. Significantly, because Defendant conceded the amount and existence of the debt owed to Plaintiff, it affirmed the court’s monetary judgment in Plaintiff’s favor. As to the appeal from a discovery sanction, the court affirmed the court’s imposition of sanctions against Defendant for its President’s evasive and non-responsive answers during his deposition.

Dealers beware: is acceptance of commissions for direct sales by supplier in contravention of exclusive distributorship agreement by itself a waiver of a breach of contract claim under Law 75?

The issue often arises when a dealer claims that payment of commissions by its principal for direct sales made by another distributor (or retailer) to its customers in the exclusive territory is proof of an exclusive distributorship. Case law in Puerto Rico is mixed on the issue. One First Circuit case holds that payment of commissions does not legally modify the terms of a clearly non-exclusive distributor agreement. Problems arise (for the supplier) when a clearly non-exclusive distributorship agreement has expired or there is no written agreement at all. In those circumstances, as in a reported federal district court case, the payment of commissions may create a genuine triable issue of fact on the existence of exclusivity. In their commercial dealings parties may contractually agree that payment of commissions is the quid pro quo or consideration for exclusive distribution rights. But, absent a contract, it is by no means settled that payment of commissions is per se proof of exclusivity.

Picking up where I left off in my prior blog that common law authorities may be persuasive when interpreting Law 75, at least in the State of Ohio, an appellate court (but reversed on other grounds) held that payment of commissions is a waiver of a breach of contract claim. In Miller v. Wikel Manufacturing Company, 545 N.E. 2d 76 (Ohio 1989), a jury found that a principal had impaired and terminated an exclusive distributorship agreement and awarded damages of $1.5 million for breach of contract.

On the relevant issue, the appellate court reversed the verdict and reasoned:

“It was proven at trial that the Millers [the distributor] had been aware of direct sales by Wikel Mfg. [the principal] in Michigan since 1971 and that the Millers had accepted commissions on these sales. Such sales were in contravention of the exclusive distributorship contract. The court of appeals reasoned that the Millers’ election to continue as Wikel Mfg’s distributor, notwithstanding Wikel Mfg’s actions, constituted a waiver of their rights under the agreement, and thus, that they were estopped from asserting a breach of contract claim on this basis.” See 1998 WL 62980 Ohio App. 1988, citing, Section 683 of Williston on Contracts (“….where a contract is breached in the course of its performance, the injured party has a choice presented to him of continuing the contract or refusing to go on.”), reversed on other grounds, 545 N.E. 2d 76.

These facts depict a scenario of “willful blindness”, “deliberate acquiescence”, or “laches” by a distributor who has knowledge of the breach for years but elects to continue the relationship receiving benefits under the contract in exchange for additional consideration consisting of commissions. Unless the dealer protects itself with contractual language to ensure that the commissions do not novate (or affirmatively ratify) existing exclusive rights, there is a risk of waiver or estoppel from accepting commissions in the face of a clearly exclusive contract.

Right or wrong, this is all dicta as the appellate court’s holding never became law of the case. The Supreme Court of Ohio did not reach the waiver issue on the merits for it reversed the appellate court, reinstated the verdict, and held that waiver and estoppel are affirmative defenses which were waived in the case. Thus, the appellate court erred in raising the issue sua sponte.

The interplay of comparative law and Law 75: is it appropriate for guidance?

“[A] U.S. Court interpreting a federal statute or constitutional provision can look at the reasoning of a foreign or international tribunal on similar issue.” Al-Bihani v. Obama, 619 F.3d 1, 33 n. 18 (D.C. Cir. 2010)(Kavanaugh, J., concurring), citing Ruth Ginsburg, “A decent respect to the Opinions of [Human] kind”; The Value of a Comparative Perspective in Constitutional Adjudication, Address to the International Academy of Comparative Law (July 30, 2010). While foreign decisions do not rank as precedent, they can be informative and just as persuasive as reasoned law review articles or commentators on the subject matter. See, i.d.

When interpreting Law 75 it is advisable to resort to common law and civil law jurisdictions for their persuasive value. Foreign jurisdictions which can be persuasive include Spain, Cuba and the Dominican Republic, the last two have statutes similar and preceding ours. But common law jurisdictions have also shaped many of the amendments to the presumptions of lack of just cause in Law 75, including California, Colorado, Florida, Georgia, Illinois, Indiana, Kentucky, Maine, Massachusetts, Mississippi, North Carolina, Nevada, New Hampshire, New Jersey, New Mexico, Ohio, Rhode Island, South Carolina, Tennessee, Texas, Vermont, and possibly, Wisconsin. See Report of the Chamber of Commerce of Puerto Rico, P. of C. 774, at 3, April 23, 1986; Report of the Chamber of Commerce of Puerto Rico, P. of. C. 774, at 4 May 10, 1998.

Delaware enacted a “Franchise Security Law” on July 8, 1970 protecting certain franchisees with a place of business within the state from unjustified terminations. Damages include lost profits and loss of goodwill. “[Delaware law], within the ambit of legislation in the United States, is closest in its focus to Law 75.” See 97-page Study about Law 75 of 1964, Chamber of Commerce of Puerto Rico (undated)(translation ours).

In future blogs, I will comment about noteworthy state and foreign decisions which may be helpful to resolve open issues under Law 75.

Law 75 protects dealers who develop the “market” in Puerto Rico. But, does the “market” include federal military installations, cruise ships, or duty free shops?

There are two elements for Law 75 to apply, prima facie, first, the statute protects a Puerto Rico dealer, and who qualifies as a dealer is a highly factual question; second, the business activities of the dealer must be directed to promote the sale or service of the principal’s products or services within the Puerto Rico market. Thus, the statute does not extend coverage to stateside or foreign distributors at least to those that have no sales or distribution offices or operations within Puerto Rico. Nor should Law 75 have an extraterritorial reach for sales made outside of the Puerto Rico territory. Accordingly, the measure of damages in Law 75 should not include any sales made by a Puerto Rico distributor outside the Puerto Rico market. That should be straightforward enough.

But, what is the market within the geographic boundaries of Puerto Rico that is covered by Law 75? Plain language of Law 75 does not help to answer that question. Are sales made to federal military customers within federal military installations in Puerto Rico covered? In Patterson v. Ford Motor, 931 F. Supp. 98, 102 (D.P.R. 1996), the issue was raised but the court did not answer the question ruling instead that Plaintiff, a sales representative, did not qualify as a Law 75 dealer. Would sales made by Puerto Rico distributors to cruise ships that dock within Puerto Rico’s territorial waters be covered by Law 75? Are duty free sales at the LMM international airport covered? Does the answer to these questions turn on constitutional or quasi-political definitions of what is a “territory”? If that’s the right test then arguably sales to U.S military installations within Puerto Rico may not be covered. Or does the answer turn instead on the practical import of who is the ultimate consumer for the products (understanding that many but not all consumers are Puerto Rico residents) and what benefits does the principal derive from sales by Puerto Rican distributors to these outlets (military bases, cruise ships, and duty free shops) all of which have a nexus to Puerto Rico? Either way there is no definitive answer on point in the case law to these questions.

Puerto Rico distributors: beware of ICC arbitration clauses in distribution agreements

International arbitrations are a common ADR procedure to resolve commercial disputes, including Law 75 actions. There are many reasons to choose arbitration: no jury trial…the blessing of Supreme Court precedent and FAA preemption, a panel of experienced professionals, and presumably a quicker and more cost effective mechanism etc. It is no secret, however, that arbitration can be expensive, and often more so than court cases, but rarely do the parties foresee, at the time of contracting, the substantial costs and fees that must be advanced by the claimant to initiate an international arbitration.

For arbitrations under the International Chamber of Commerce (ICC), for example, the initiating party, which may be the aggrieved distributor, must advance up front the administrative fees to cover the expenses of the ICC and the arbitrator(s). When those fees approach 10% of the face amount of the distributor’s claim, well if you do the math, those fees can be substantial just to get “your day in court”.

So far, at least in commercial disputes, courts have been reluctant to invalidate ICC arbitration clauses as substantively unconscionable because of the substantial costs to arbitrate the dispute. Kam-Ko Bio-Pharm v. Mayne Pharma, 560 F. 3d 935 (9th Cir. 2009), citing, Green Tree Fin. V. Randolph, 531 U.S. 79 (2000).

Would Puerto Rico Law 75 override a Delaware choice of law clause?

A series of published federal cases hold that Puerto Rico Law 75 displaces contractual choice of law clauses of certain common law jurisdictions in distribution agreements, notably New York (among others). Many of those cases have applied the Restatement of Conflict of Laws to conclude that Law 75 is vested with public policy and Puerto Rico has a significantly greater interest in applying its laws over the transaction. Would the result be the same in all common law jurisdictions?

When drafting distribution agreements one should consider the possibility that not all States would necessarily enforce Law 75 and override a freely-executed choice of law clause. There are States which hold themselves out as having a body of fair and efficient substantive commercial laws that offer uniformity and predictability to business actors. The State of Delaware is one of those jurisdictions with a choice of law enactment that values the parties’ freedom of contract. 6 Del. C. Sec. 2708 (a)(2005) provides that: “[t]he parties to any contract, agreement or other undertaking, contingent or otherwise, may agree in writing that the contract, agreement or other undertaking shall be governed by or construed under the laws of this State, without regard to principles of conflict of laws, or that the laws of this State shall govern, in whole or in part, any or all of their rights, remedies, liabilities, powers and duties if the parties, either as provided by law or in the manner specified in such writing are, (i) subject to the jurisdiction of the courts of, or arbitration in, Delaware and, (ii) may be served with legal process. The foregoing shall conclusively be presumed to be a significant, material and reasonable relationship with this State and shall be enforced whether or not there are other relationships with this State.”

While Section 2708 has not been interpreted in the context of either Law 75 or franchise or distribution agreements, it applies to contracts of $100,000 or more as a matter of public policy where Delaware law has a material relationship to the transaction. As Delaware’s Court of Chancery noted in Abry Partners v. F&W Acquisition LLC, 891 A. 2d 1032, 1050 (Del. Ch. 2006), when enforcing a Delaware choice of law provision in a stock purchase agreement, “[t]o enter into a contract under Delaware law and then tell the other contracting party that the contract is unenforceable due to the public policy of another state is neither a position that tugs at the heartstrings of equity nor is it commercially reasonable.”

Some pitfalls that suppliers should avoid when doing business with distributors or representatives in Puerto Rico

Having counseled suppliers and distributors in Puerto Rico for over two decades has given me an insight of the most common pitfalls in distribution practice. The list below is by no means exhaustive and there are many variations or nuances.

First and foremost, doing business without a contract (or verbally) when combined with failing to procure timely legal advice from local counsel, is a time bomb waiting to go off. This by itself creates a host of problems to a supplier and often will land you into litigation and then at the mercy of a jury of the distributor’s peers. Having no contract exposes the supplier to claims of indefinite or exclusive contracts with open ended or ambiguous terms, among other risks.

Second, there is an assumption that many agents are not distributors when they could qualify for protection under Law 75. In Puerto Rico a number of representatives throughout the distribution chain could serve as distributors though one would not think so from their corporate form alone. For instance, some retailers could qualify as Law 75 dealers if they meet the legal standards.

Would you think that an independent retail store selling or servicing your branded products in Plaza Las Americas could claim protection as a Law 75 dealer, or an exclusive representative promoting your branded medications on a commission basis to doctors and hospitals? Would the transfer of title of products outside PR by itself exempt you from Law 75's reach? Think again.

Third, there is a misconception that PR is unique in protecting dealers when that is not necessarily so. By my last count 18 states have laws similar to PR. This misconception acts as a deterrent to many companies from doing business in PR. Opportunities are lost when all they need is the right lawyer and the right contract.

Fourth, and this is not unique to PR, time and again we see a failure to document performance issues during the course of the relationship. You may have the right contract but if the obligations are not monitored and enforced properly it is an empty piece of paper.

Fifth, mergers and acquisitions are a minefield for all parties concerned and replete with Law 75 issues which are often discovered after the fact when the successor assumes the obligations directly or appoints a new distributor to take over the distribution.

Sixth, and this relates to my first point, do not assume that if you think you have the “right contract” that it will be automatically enforced under Puerto Rico law. The most common situation is with stateside choice of law clauses in common law jurisdictions that allow termination at will of indefinite contracts. Business decisions have been made to terminate Puerto Rico distributors under the assumption that there is no obligation to renew the contract at its expiration or that no cause is required for termination. Your client may be in for a surprise. Generally, a stateside or foreign choice of law clause in a distribution agreement governed by Law 75 is unenforceable as a matter of public policy. Again, you may think you have the “right” contract and act on it when you should not.