Monday, November 19, 2012

After proving just cause, supplier wins on summary judgment to dismiss Law 75 federal action

In one of the most noteworthy Law 75 cases for suppliers since the Medina and Nike decisions of the 1980’s, the federal district court in Casco Sales v. Maruyama, No. 10-1145 (SEC)(D.P.R. Nov. 2, 2012), granted the supplier’s MSJ finding just cause for termination of an exclusive distribution agreement for the sale of landscape equipment.

The case is significant for respecting liberty of contract and sweeping aside multiple factors that in the past have been obstacles precluding summary judgment in Law 75 cases, such as: the materiality of essential contractual obligations, acceptance of late payments vs. acquiescence or tacit consent, the dealer’s knowledge of the grounds or basis of the termination and the sufficiency of the termination letter, cumulative effect of arguably non-essential breaches and the meaning of the statutory just cause prong of substantial and adverse effect to the principal’s interests, and whether looking for another distributor is sufficient to prove a pretext for the termination.

Endorsing the clear terms of the contract subscribed by the parties, the court found just cause for termination based on: 1) the dealer’s consistent breach of the payment terms; 2) the dealer's failure to provide inventory and sales reports as required by the agreement; 3) refusal to participate in the supplier’s “booking program”, and 4) the dealer’s failure to hire and train sales personnel to market the principal’s products and to maintain an adequate sales force.

Late payments. The court distinguished First Circuit precedent holding that summary judgment is inappropriate in “abnormal circumstances” where the supplier “does not care” about late payments. The court found that the contractual terms were essential obligations and the principal had not waived the payment terms or acquiesced to accepting late payments. According to the Court, accepting late payments is different from acquiescing or tacitly consenting to them. Failure to pay on time affected the principal’s ability to sell equipment and led to credit holds which satisfied the “independent ground” for just cause in Section 278. In sum, accepting late payments did not operate to novate the payment terms in the agreement. Nor does providing a payment plan proscribe the principal from terminating the agreement in the future. It certainly did not help the dealer that, at the time of termination, it owed the principal $57k in unpaid invoices.

Notice of termination. The Court rejected an argument that Law 75 or the agreement required a “warning” or “threat” that the dealer’s contractual non-compliance would be a ground for termination. Although the termination letter “could have been better drafted” to provide “a succinct explanation” of the breaches of the agreement, there is no requirement in Law 75 that the supplier send the dealer written notice detailing every possible basis for termination. The only requirement is the existence of just cause and the agreement provided notice of the grounds for termination. The court held that the “cumulative weight” of the dealer’s “other contractual breaches” even if deemed non-essential (besides failing to pay on time that breached an essential obligation), was detrimental to the parties’ relationship and adversely and substantially affected the principal’s interests (and proved just cause).

Pretext. The Court rejected the dealer’s argument that the termination was a pretext to switch distributors. The Court found nothing wrong that the principal, to avoid a serious disruption in sales, had been looking for other distributors at the time of termination. “Prohibiting such a sensible approach...would deal a severe blow to our free enterprise system.”

Note: Before discovery and the filing of the MSJ, the Author served as the mediator in the case.

Sunday, October 14, 2012

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.

Friday, September 21, 2012

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.

Tuesday, August 28, 2012

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.

Tuesday, August 7, 2012

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.

Saturday, July 28, 2012

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).

Monday, April 9, 2012

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.

Monday, February 27, 2012

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.

Sunday, January 8, 2012

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.