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].

Monday, September 14, 2009

Legislature of Puerto Rico tackles a perceived problem of parallel imports potentially implicating the Law 75 interests of exclusive distributors

Judicial decisions have not conclusively put an end to litigation on whether (or when) an exclusive distributor would state a Law 75 claim for impairment (or for tortious interference) when its principal sells a product covered by the exclusive agreement to a third party (usually a stateside wholesaler or broker) who then sells the product for resale, consumption, or use by customers within Puerto Rico.

In P. of C. 1945 of August 27, 2009, the House of Representatives of Puerto Rico (Jimenez-Negron), drafted legislation to remedy what is perceived as a loophole in Law 75 caused when “foreign companies that are established in Puerto Rico bring products whose exclusivity is protected by distribution contracts registered (sic, protected) by Law 75” and these companies “profit from the efforts of persons that have exclusive rights…”.

The proposed legislation would amend the just cause protection in Article 2-A (b)(5) of Law 75 by establishing an additional presumption of lack of just cause “when the principal permits another client to establish in Puerto Rico the sale of a product that is protected by an exclusive agreement (translation ours).” The project was referred to the Commission for Economic Development, Planning, Commerce, Industry and Telecommunications.

Monday, September 7, 2009

Unclean hands and illegal activity won’t get you a preliminary injunction under Law 75

In Prime Wholesalers v. Fields Motorcars of Florida, 08-1640 (ADC), 2009 WL 2612519 (D.P.R. Aug. 17, 2009), Prime Wholesalers, a car retailer in Puerto Rico, sued Fields Motorcars, a Florida wholesaler, in federal court for alleged violation of Law 75. Prime moved for a preliminary injunction when Fields refused to continue selling it new BMW vehicles, which represented 90% of Prime's sales. During years of dealings, a car salesman of Fields sold new BMW cars to Prime in a scheme to deceive the manufacturer BMW that prohibited wholesalers from selling new cars to brokers or dealers except to end users. BMW NA had appointed a retailer Autogermana as the exclusive distributor in Puerto Rico (exclusive in the sense that only sold BMW vehicles). BMW NA later sought to stop the practice of unauthorized sales into the territory. Prime and Fields devised a scheme that induced BMW NA for years into believing that Fields sold the vehicles directly to customers, practices that the court found “outrageous.” Unauthorized sales by Fields to brokers or dealers would expose Fields to breach of contract in its agreement with BMW NA and a potential termination.

The court assumed, for argument, that Prime qualified as a Law 75 dealer. While Prime satisfied some of the threshold requirements to qualify for Law 75 protection, “Prime could have stopped purchasing vehicles from Fields anytime, with no negative consequences” and the court found this “extremely problematic” to qualify as a dealer.

The case turned on the court’s findings, after an evidentiary hearing, that Prime did not establish likelihood of success on the merits and irreparable harm. Fields argued that Prime could not prevail on a Law 75 claim because the underlying distribution agreement with Fields was contrary to law. The court held that an injunction would harm BMW NA’s contractual rights and would expose Fields to breach of contract so Prime could not prove likelihood of success of establishing lack of just cause. The court rejected in a footnote the argument that BMW NA's non-price restrictions violated the antitrust laws.

The court also held that Prime’s argument that 90% of its sales were derived from Fields was an economic injury which by itself was insufficient for a showing of irreparable harm. Reputation damages can also be redressed by a monetary award.

When it came to balancing the equities, the court was not too considerate either for Prime or Fields. The court found that the public interest would not favor an injunction for it “would promote and condone” both Prime’s “illicit activity” and Fields’ ”willful blindness.” A showing of Prime’s unclean hands was sufficient by itself to deny equitable injunctive relief as it did.

Editor’s note: Although a court’s findings at the preliminary injunction stage are not binding on the merits, the court’s opinion in Prime Wholesaler about a party’s inability to assert a Law 75 claim when it has participated in illicit activity has undertones that may, and should, influence the adjudication of merit issues under Law 75.

For instance, one issue that comes up frequently in Law 75 litigation is a dealer’s standing to claim actual damages for impairment or termination when it has underreported its income or overstated its expenses in the relevant tax returns or audited financial statements. Dealers have alleged that their actual damages under Law 75 are greater than the net income reported in their returns or audited statements. To be sure, there are legitimate instances where the dealer reports total company losses in its operations but is able to prove that the line was profitable. In that scenario it would not be necessarily inconsistent to claim actual damages when the company as a whole reported a loss. Courts have not been uniform when dealing with disparities between actual and “official” damages. Some courts admit the evidence under the premise that it is a credibility issue for the jury or trier of fact. This line of thinking holds that reporting a loss in the official business records does not prove that the dealer suffered no actual damages from a termination or impairment of a product line. While that may be so, it is difficult to ignore that a party may abuse the legal system as a tool to benefit from what is potentially fraudulent conduct. Other courts admit the evidence but report the dealer’s purported tax evasion to the authorities. But few, or none, disallow the claim under the notion that a party cannot recover from potentially illicit activity or should be estopped from asserting a claim under Law 75. Is it for the Legislature to add an unclean hands defense in Law 75 or for the courts to deal with this issue? The question is open for debate.