Plaintiff, like Rip Van Winkle, slept on its rights and the First Circuit affirmed the dismissal of a Law 75 case on statute of limitations grounds

The reader might recall the story of Rip Van Winkle where this character drank moonshine to the point of falling asleep for roughly 20 years only to find that the American Revolution had passed, among other personally more important things. In the case before us, Quality Cleaning Products S.C. v. SCA Tissue N.A., 794 F. 3d 200 (1st Cir. 2015), a distributor of cleaning products sued the principal under Law 75 eleven years after an alleged breach of the distribution agreement. The distributor basically alleged that the principal breached the agreement by selling certain products to other distributors at reduced and preferential rates and granting price discounts to its competitors. Not surprisingly, the principal’s primary defense was that the action was time barred by Law 75’s three year statute of limitations. The district court dismissed the case as time barred and the First Circuit affirmed the judgment below.

The First Circuit’s decision has a number of interesting substantive issues regarding accrual and tolling of statutes of limitations and procedural waivers in the context of actions brought under Law 75. The first issue, whose result did not favor the distributor, was that the “continuing violation doctrine” did not apply to prevent the accrual of the Law 75 claim from the time that the distributor first became aware of the principal’s breach at least ten before filing suit. After a thoughtful and complete consideration of the issue, the court held that a federal court sitting in diversity must apply the relevant state’s statute of limitations (not federal law), including the state’s accrual rules. And, finding no authority on point under Law 75, the First Circuit predicted that the continuing violation doctrine has been largely confined to civil rights cases and Puerto Rico’s Highest Court has not applied it in contract cases. The court also found support not to apply the doctrine from the “need for expeditious resolution of commercial disputes.”

But plaintiff was not to be outdone. Plaintiff alleged that under the “discovery rule” it did not have knowledge of the breach- for reasons unknown- until 2011, but the record did not help plaintiff on this issue. The court left open the question whether the discovery rule applies in Law 75 cases. It left the issue undecided because plaintiff failed to raise the discovery rule in its opposition to the motion to dismiss but brought it only in a Rule 59(e) motion for reconsideration. But that doomed consideration of the alleged error because judicial review of a denial of the Rule 59(e) motion is for abuse of discretion, not an issue susceptible of plenary or de novo review. Finding no abuse of discretion, the court affirmed the dismissal.

Courts are mindful of commercial "reality" when deciding competing summary judgment motions in Law 75 cases

In Casco Sales v. John Deere, 2014 WL 4233241 (D.P.R. Aug. 26, 2014)(Gelpi, J.), the dealer sued the principal for constructive termination, impairment, and unjustified termination of contract under Law 75 and for fraudulent inducement or "dolo" to enter into a settlement agreement. Plaintiff Casco Sales had been the exclusive dealer in Puerto Rico of the John Deere construction equipment line for decades.

Supported by an expert report, Casco claimed damages of $1.6 million for five years of net profits and loss of goodwill if the termination occurred in March, 2013. Had the base period of the termination been in 2009, damages computed under Law 75 were $4.6 million. A steep decline in the construction industry and the demand for construction equipment over that recessionary five year period explain the discrepancy in the financial results and the significantly lower measure of damages.

Casco Sales alleged that John Deere had fraudulently induced it to settle a prior Law 75 federal case in 2009 based on representations in the settlement agreement that it would cooperate to grow sales and it breached those representations. Thus, recovery for fraud (dolo) includes all damages whether or not foreseeable, including the actual damages Casco Sales would have recovered under Law 75 had the case not settled with 2009 as the base period. It is a fraud claim under the Civil Code that is related to the success of a showing of impairment under Law 75.

What triggered the second lawsuit was that in March, 2013, John Deere notified the unilateral termination of the distributor agreement. John Deere alleged that failure to pay bills on time, failure to comply with new model qualification requirements, among other alleged breaches of contractual provisions, were just cause for termination.

The dealer's termination had a tormented history of its own. As noted, in 2009, Casco Sales sued John Deere in federal court for impairment of contract under Law 75 alleging that John Deere had unilaterally altered credit or sales terms and had been arbitrary in their business dealings. In 2009, the case settled and the parties resumed their business relationship. Three years later, and coincidentally after the three-year caducity period in Law 75 expired, in December 2012, John Deere refused to honor a substantial purchase order of $264,000 placed by Casco Sales for the sale of an excavator because it claimed that the dealer was not qualified to serve that machine. Yet, two months later, John Deere would have sold through Casco Sales a similar machine to one of its national accounts in Puerto Rico, although Casco Sales had not completed the same training requirements. Casco alleged that this refusal to deal affected its cash flow and the ability to pay bills in full and was an unjustified impairment and constructive termination of contract.

The Court denied the parties' competing motions for summary judgment finding genuine and material disputes of fact and citing the First Circuit's Welch case for the proposition that just cause generally involves issues of fact precluding summary judgment. Because the Court understood that the fraud claim under the Civil Code was tied to the success of the Law 75 impairment claim it also survived summary judgment.

The decision is notable for a few other points.

First, when it is alleged that the principal refuses to honor a purchase order without just cause, Law 75 activates the rebuttable presumption of lack of just cause. Thus, the principal has the burden of proof of justifying its decision to refuse to deal and the actual subsequent termination.

Second, the Court declined to accept Casco Sales' invitation to navigate unchartered waters and hold that Law 75 recognizes a right of action for constructive termination. In dicta, the Court opined that such a claim would require a court to legislate for it does not appear to be codified in the statute. The Court construed Casco Sales' constructive termination claim as "emphasizing" the extent or degree of the impairment.

Third, and perhaps most important when it comes to surviving an MSJ for alleged lack of timely payment, the Court held "...to ignore the possibility that John Deere’s refusal to honor the purchase order (in December 2012) may have impacted Casco’s ability to timely pay its debt (before the termination in March 2013) would ignore reality. This is yet another issue that turns on fact."

Casco Sales alleged that the dealer's contract in this case did not define payments on time as an essential obligation. The Court cited First Circuit precedent under Law 75 excusing the timeliness of payments where there has been some conduct attributable to the principal that has contributed to payment delays. The Court denied the parties' "substantial" and competing MSJ's.

This author represents Casco Sales in that case.

The tide is turning and our local civil courts are making great strides

Our local courts are making significant progress in the efficient administration of justice in civil cases. Speaking as a civil practitioner, I’ve been one to say and still do that the federal district court in Puerto Rico is efficient and produces consistently uniform and predictable outcomes. Despite the “specter” of a jury, a stateside or foreign defendant would invariably prefer to litigate in the federal court if it had a choice of forum. Our federal judiciary is top notch and judicial review in the First Circuit stands as a reliable safety net to correct legal errors in the court below. And, lifetime appointments are designed to guarantee judicial independence in the decision-making process.

But, over the last ten years, the federal bench in Puerto Rico has been swamped by multi-defendant criminal cases which, adding to budget constraints, have created a backlog in the resolution of civil cases. Dispositive motions in federal court may stand submitted for six months or more without a ruling. Dispositive motions are rarely heard for oral argument and the pretrial conference may be the only or the final resting place to argue motions. Jury trials are two or three years down the road, if not more. To be sure, experiences vary depending on the judge and the complexity of the case. There is an increasing pressure to mediate and settle cases or to consent to the jurisdiction of U.S. Magistrate Judges. That is fine to deal with heavy caseloads but may not be the best or most effective solution for a litigant that needs emergency relief to save its business.

Should a party needing emergency relief go to federal court or try our local courts? My “default or automatic setting” primarily for the defense had been a preference for the federal court at least in Law 75 cases. But if you represent a client who is a dealer in a Law 75 case or a sales representative in a Law 21 case, think twice, for the local courts may be your best option, even without the right to trial by jury. If a dealer needs emergency or equitable relief, the local court, specially in San Juan, may be your best option. The defendant could benefit from an expedited proceeding too.

The Court of First Instance in San Juan has two civil trial judges assigned solely to hear requests for equitable relief, such as injunctions, mandamus etc. These experienced civil judges have become specialized in matters that require urgent and immediate attention. There is no room for delay. Just this month, it is commendable that our local judiciary implemented an electronic filing system for the special emergency courts which should expedite the filings and make litigation more cost effective. Although the civil dockets of the judges in the emergency court are huge and they lack the resources that federal judges have with multiple law clerks and unlimited access to electronic research, the cases in these special civil local courts are being heard and resolved quickly. Dispositive motions are heard with oral arguments in which counsel for both sides are afforded an adequate opportunity to argue (not counted in minutes) and the judges are keen, prepared and ready to grill the lawyers on the facts and the law. The long-established practice endorsed by the Supreme Court of P.R. of lawyers drafting opinions and orders to assist the local court judges certainly helps to expedite resolution of disputes and make up for the limited resources that our local court judges have.

Local judges in these emergency or special civil local courts are getting things done and quickly with limited resources. There are still situations in Law 75 cases where no matter what a defendant would prefer the federal forum because there is a body of developed federal case law or there is a federal question in the pleadings.

Winds are changing. There is reason for defendants to rethink before removing a case to federal court. Our local courts can be the right forum selection for a fair, prompt, and cost effective resolution of commercial disputes.

During 2013, local intermediate appellate courts remained active in Law 75 cases

In Marchosky Kogan v. Antillas Marketing, 2013 WL 5522664 (TCA Aug. 20, 2013), the local appellate court affirmed the dismissal of a tortious interference and damages action finding just cause under Law 75 for termination of a sub-distribution agreement.

Plaintiff Marchosky, an individual, was a sub-distributor of Defendant Antillas Marketing, the defendant and the distributor-grantor. The principal Golden Omega Inc. had appointed Antillas as the exclusive distributor of Linoflax products in Puerto Rico. A google search of Linoflax USA reveals that Linoflax products are health and nutritional supplements. The sub-distributor filed suit in the Court of First Instance Humacao Part against the distributor and others (apparently not against the principal) alleging a breach of exclusive sub-distribution rights in a designated region. The claims sounded in tortious interference and damages for emotional distress. In the answer and counterclaim, Defendants denied the existence of an exclusive contract, asserted just cause, and that plaintiff’s acts breached Antilles’ agreement with its principal.

After a bench trial, the trial court found for defendants and dismissed both the complaint and the counterclaim for damages. The judge determined that there was an insufficient basis to pierce the corporate veil and no actionable claim existed under Law 75 as there was just cause and no evidence of actual damages. It is unclear from the opinion if the issue of just cause should have been decided without joinder of the principal as a party or if the distributor had standing as the grantor to allege just cause (sub silentio it did). Plaintiff appealed. The appellate court affirmed the dismissal of the action. The appellate court determined that the trial court had correctly found just cause for termination based on a breach of an essential contractual obligation or acts that adversely and substantially affected the principal’s or grantor’s interest in Puerto Rico.

The sub-distributor had encroached upon an exclusive territory of other resellers which affected the marketing activities of other distributors. The sub-distributor had also refused to collect and administer payments by certain customers within the assigned territory; issued post-dated checks; and made hiring decisions and negotiated prices with pharmacies without obtaining the distributor’s authorization. It is unclear if any of those actions breached an essential contractual obligation. After applying a deferential standard of review to factual determinations and judgments about the weight or credibility of the evidence, the court held that the totality of the circumstances established that plaintiff’s actions and omissions caused the defendant-grantor to suffer financial harm and cash flow problems which adversely affected the “good functioning of the business.”

An interesting and unusual case came up in Jimenez Ayala v. BC Services, Inc., 2013 WL 4073349 (TCA May 31, 2013). The case involves the issue whether a Law 75 counterclaim may be interposed to defeat a summary procedure to adjudicate an eviction action. There, BC Food Services signed Lease and Operating Business Agreements (“acuerdos de negocio en marcha”) to lease real property and operate the restaurant franchise of Bebo’s Café in Condado. Plaintiff paid money of what was ostensibly a royalty or license fee to use the mark or brand of Bebo’s Café. After expiration of the agreement, Plaintiff filed suit under Law 75 for injunctive relief to compel the lessor or franchisor to renew the agreements. The case settled by stipulation and a dismissal without prejudice. The stipulation required the lessee to pay back rent and commit to pay monthly rent in consideration for a renewal of the agreements. The lessor filed an eviction action when the lessee fell behind in its payments and invoked the summary procedure which does not legally permit any defenses other than proof of payment of rent. Lessee counterclaimed for wrongful termination under Law 75. The trial court in San Juan found for plaintiff and evicted defendant which appealed. On appeal, the lessee argued that the trial court erred when it failed to convert the action into an ordinary proceeding to adjudicate the Law 75 claim. The trial court found that the lessee breached the settlement agreement by issuing rent payments with insufficient funds. The appellate court affirmed and ruled that the Law 75 counterclaim would be decided in the ordinary course and was legally inadmissible to convert the summary eviction procedure into an ordinary action. The majority opinion did not decide any issues under Law 75.

One judge (Hon. Migdalia Fraticelli Torres) dissented. The dissent reasoned at length that the lease agreements were also license or franchise agreements that deserved special protection under Law 75. The dissent reasoned that, as a matter of public policy, the counterclaim under Law 75 should receive treatment as an ordinary action when joined in a summary eviction proceeding. The dissent emphasized that market conditions and the diminished value of rental properties required the lessee to renegotiate the monthly rent of $52,000 and that the lessor’s refusal to negotiate in good faith was not just cause for termination under Law 75. The claims, said the dissent, should have been consolidated and allowed both to proceed in the ordinary course.

In V. Suarez v. Bacardi Corporation, 2013 WL 4037215 (TCA June 25, 2013), cert. pending, the appellate court affirmed the trial court’s confirmation of a final partial arbitration award in favor of Bacardí and dismissal of the sub-distributor’s motion to vacate. A Panel of the AAA determined that contractual provisions for the computation of damages in the event of an unjustified termination of the sub-distribution agreement were valid and enforceable under Law 75 and did not have the effect of waiving any rights. The local appellate court ruled that there was no cause under the Federal Arbitration Act, which was the exclusive procedure, to set aside the award. The sub-distributor filed a petition for certiorari in the Puerto Rico Supreme Court. On related note, the U.S. Supreme Court denied certiorari of the Judgment of the First Circuit in Bacardí International Limited v. V. Suarez & Co., 719 F. 3d 1 (1st Cir. 2013) abstaining under Colorado River from deciding Bacardi’s parallel federal proceeding to confirm the award. Note: the author is lead counsel for Bacardi in these cases.

Law 75 case gets thrown out of federal court for failing to meet the jurisdictional amount requirement

I don’t recall a single case, but this one, dismissing a Law 75 action for not meeting the jurisdictional amount requirement for diversity jurisdiction. This one, Industria de Refrigeracion v. Gutierrez, 2013 WL 2378580 (D.P.R. June 3, 2013)(FAB) was skeletal from the start. But see General Motors v. Royal Motors Corp., 769 F. Supp. 2d 73 (D.P.R. Feb. 1, 2011)(Gelpí, J.)(reported on 12/5/2011); Ramirez de Arellano v. Budenheim USA, Inc. 2010 WL 3810078 (D.P.R. Sept. 22, 2010)(Perez-Gimenez,J)(reported on 11/23/2010).

There, plaintiff-supplier, a Colombian corporation, filed suit against a Puerto Rico distributor for breach of contract and collection of moneys of past due bills of lading totaling $45,653 and for declaratory judgment that termination of the non-exclusive distribution contract was with cause. Defendant’s sales of plaintiff’s products exceeded $300,000 over the past five years.

The court entered an order to show cause why the complaint should not be dismissed and the defendant followed with a motion to dismiss. Plaintiff opposed dismissal arguing that aggregation of the two claims exceeded the jurisdictional amount. See FRCP 18. The claim for declaratory judgment had to exceed $29,347 to establish jurisdiction, and it did not. The court framed the test as whether the “object giving value to plaintiff’s claim for declaratory judgment is the economic stake in the agreement.” To meet its burden, plaintiff filed an affidavit “on information and belief” attesting that the value of the agreement exceeded $40,000 based on sales of $300,000. Trouble loomed on the horizon. The Court disregarded the affidavit holding that it contained “bald statements based on round numbers as to the value of the contract.” Finally, it dismissed the action holding that “anyone familiar with the applicable law could [not] objectively view that the aggregate claims reach the jurisdictional minimum.”

First Circuit overturns jurisdictional dismissal in a Law 75 case

In Bacardi Intern. Ltd. v. V. Suarez & Co. Inc., 2013 WL 1919578 (1st Cir. May 8, 2013), the parties filed parallel proceedings in local and federal court to vacate and confirm a commercial arbitration award in a Law 75 dispute. An arbitration panel of the AAA had issued a partial final award in a bifurcated arbitration concluding that offset provisions in a sub-distributor agreement of the measure of damages were valid and enforceable under Law 75. The sub-distributor sought to vacate the award in the local court, a case that Bacardi removed and was remanded, and Bacardi filed a separate motion under Title 9 of the FAA to enforce it in federal court. It turned out that the federal court dismissed Bacardí’s proceeding for lack of jurisdiction and the local court confirmed the Award under the FAA. The sub-distributor appealed the local court’s judgment.

The First Circuit did not find it necessary to reach Bacardí’s “lively” argument that Titles 6 and 9 of the FAA preempt FRCP 19 by virtue of FRCP 81. Instead, the court concluded that the lower court had abused its discretion by dismissing the action for lack of jurisdiction because Bacardí Corporation, an affiliate, was not an indispensable party. Significantly, the First Circuit made a preliminary assessment of the merits of the motion to confirm to make a pragmatic determination that there was no risk of inconsistent obligations from Bacardi Corporation’s absence. After all, Bacardi International had been vigorously defending its identical interests to confirm the Award in their favor, the affiliate had not moved to intervene, and “review of arbitration awards is extremely narrow and exceedingly deferential” under the FAA. Touching but not deciding the broader preemption argument, the court rejected a blanket rule that would make indispensable all the parties to the arbitration in order to decide a motion to confirm. The court found that subject matter jurisdiction existed.

The First Circuit reversed the judgment and remanded to the federal court with instructions to stay pending the parallel certiorari proceeding in the local appellate court. Bacardi filed a petition for rehearing en banc of the decision to stay the motion to confirm and V. Suarez moved to reconsider the finding that Bacardi Corporation was neither required nor indispensable.

The author argued the appeal as lead counsel for Bacardí International.

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.

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.

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.

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.

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.

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.

Supplier is barred from creating obligations not specified within the four corners of an integrated distribution agreement to prove just cause under Law 75

Plaintiff, a Puerto Rico distributor, sued in federal court a stateside supplier of Florida’s Natural orange juice for termination under Law 75. Plaintiff alleged that it complied with its obligations in the one and only written distribution agreement, including with each of the annual purchase requirements. Defendant unilaterally terminated the agreement and appointed a new distributor. As an affirmative defense, Defendant alleged that Law 75 did not apply as the agreement had expired, though there were e-mails in which Defendant acknowledged that the agreement continued in effect on the same terms and conditions. Defendant also alleged that Plaintiff’s delay in submitting requests for reimbursement of marketing expenses was a ground for just cause. Plaintiff filed a motion for partial summary judgment for the court to declare that the agreement continued in effect as an integrated agreement and the Civil Code precluded extrinsic evidence of alleged side agreements or obligations to prove just cause.

In Méndez & Co. Inc. v. Citrus World Inc., 2011 WL 1362468 (D.P.R. March 24, 2011)(Fusté, J.), the federal court sided with Plaintiff and granted its motion for partial summary judgment. The court held that Plaintiff qualified for protection as a Law 75 dealer, and found that the agreement was clear and unambiguous. The court held that, with or without the integration clause, under the Civil Code Defendant was barred from introducing any evidence to prove that Plaintiff had an obligation not specified in the contract to “submit annual marketing plans and budgets…to receive reimbursements of marketing expenses.” This had the effect of precluding an argument at trial that Plaintiff’s alleged failure to submit the required documentation to receive reimbursements (even if the party prejudiced by that failure would have been the distributor) could be grounds for just cause. The parties agreed to mediation. The case is scheduled for trial on May 9, 2011.

Note: the author’s law firm represents Plaintiff in the case.

The First Circuit applies Iqbal’s plausibility standard to affirm the dismissal of a Law 21 claim and compel arbitration of claims for breach of contract and implied duty of good faith and fair dealing.

In Ashcroft v. Iqbal, 129 S. Ct. 1937 (2009) the Court heightened pleading requirements holding that “threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice.”

In IOM Corporation v. Brown Forman, slip op., No. 09-1672 (1st Cir. Dec. 2, 2010), the opportunity presented itself for the First Circuit to review an order granting a motion to dismiss under FRCP 12(b)(6) a claim brought under Law 21. A detailed recital of the facts is appropriate as this noteworthy case presents a host of issues that come up regularly in distribution cases in Puerto Rico involving allegations of exclusivity, parole evidence, and integration clauses.

There, the broker Caribbean alleged that it had entered into oral agreements with Brown Forman’s predecessor to promote Finlandia vodka and Jack Daniels whisky in Puerto Rico. Subsequently, the parties entered into promotion agreements on a commission basis. The promotion agreements had integration and completeness clauses which, in effect, superseded the prior oral agreement with Brown Forman’s predecessor.

What prompted the lawsuit was that Brown Forman decided to restructure its operations in Puerto Rico and offered Caribbean to serve as its exclusive broker, but this arrangement would have permitted Brown Forman to open a sales office in Puerto Rico. Negotiations failed and Caribbean brought suit in local court since removed to federal court. Caribbean asserted claims for breach of an alleged oral exclusive contract, wrongful termination under Law 21, breach of contract and breach of the duty of good faith and fair dealing. After holding a hearing on Caribbean’s application for a preliminary injunction and denying injunctive relief, the federal court (Besosa, J.) dismissed the Law 21 claim and ordered arbitration of the remaining claims.

The First Circuit agreed with the District Court that the Law 21 claim was not plausible on the facts alleged. The court, citing Puerto Rico Supreme Court precedent, noted that the elements of a Law 21 claim require obligations to promote and expand the market in a territory for the principal’s products in exchange for a commission, as well as an appointment of exclusivity.

First, the court concluded that the promotion agreements met none of the elements except the payment of commissions. Caribbean attempted to vary the clear terms of the agreements with extraneous evidence. Though the court recognized that the parole evidence rule had been repealed, in dicta, it suggested that the legal effect would be the same under Article 1233 of the Civil Code whose mandates requires observing the literal terms of a clear and unambiguous agreement. Even considering extrinsic evidence, the court concluded that Caribbean did not have authority to close sales orders on Brown Forman’s behalf, an essential element of a Law 21 claim, and did not allege sufficient facts to prove that the relationship was exclusive.

On the exclusivity element, the court held that it is “generally apparent either from the contract or from the arrangements agreed upon by the parties.” Where Iqbal comes in, is that the court concluded that the allegations of exclusivity were conclusory. There were no facts pleaded as to the scope of exclusivity and no allegation was made that Brown Forman had made any “assurances” that would support the contention that “no other sales representatives were allowed to sell the products in Puerto Rico.” The integration and completeness clauses were material to defeat the argument that extrinsic evidence existed that contradicted the plain terms of the promotion agreements (which were not exclusive on their face). On these facts the court affirmed the dismissal of the Law 21 termination claim of a purportedly oral exclusive agreement.

Turning to the arbitration issue, the court rejected the argument that the breach of contract claim arose from a non-arbitrable oral agreement. With the broad "arising under and related to" arbitration clause in the promotion agreements, all related claims of breach of contract and bad faith were arbitrable under the AAA in Louisville, Kentucky. The court held that all claims arose from the termination of the promotion agreements which have valid and enforceable arbitration clauses. As to the choice of forum, the court found that Caribbean had waived the argument that it was unenforceable under Law 21 for lack of a developed argumentation. As a matter of law, the court enforced the arbitration agreements and dismissed the claims.

Last but not least important, the court affirmed an award of attorney’s fees of $23,456 for temerity against Caribbean. It was significant to affirm the award under plain error review since Caribbean failed to object to the itemized and verified statement of fees. The court affirmed the judgment in its entirety.

Puerto Rico's Dealer and Franchise Statute Adapts to the Latest Developments in Law, Commerce and Technology

My partner Manuel Pietrantoni and this author published the referenced article on Law 75 in Volume 30, Number 1, of the Franchise Law Journal of the American Bar Association (Summer 2010). The legal currents under Law 75 addressed in the article include transfers, assignments or acquisitions, product sales diversion, constructive termination and preemption under federal copyright and trademark laws.

For those curious about the topics covered in the article, feel free to contact us at mpietrantoni@cabprlaw.com or rcasellas@cabprlaw.com

Stay current stay relevant!

Puerto Rico’s Legislature moves to regulate franchising: is Law 75 inadequate?

El Nuevo Dia, Oct. 9, 2010 at 44, reported that representatives of a group of eight McDonald’s franchisees testified at a Commission of the House of Representatives to urge the passage of legislation to regulate unfair franchising practices. The hearing came about because McDonald’s franchisor sold its franchise rights or assets in Puerto Rico to “Arcos Dorados” an entity who is said to have refused to renew the franchise agreements and retaliated against the eight franchisees that complained to the press about alleged abusive franchising practices. There is ongoing litigation in Puerto Rico’s Court of First Instance, San Juan Part over this subject matter, including allegations that Arcos Dorados has failed to participate in coop advertising programs and allowed the establishment of competing restaurants in the territories of the existing franchisees. The Committee’s President allegedly remarked that the need to regulate franchising in Puerto Rico is “urgent and necessary.”

Is it urgent and necessary? Many states have statutes with disclosure requirements when franchisors offer to sell franchise rights for a fee. But problems with disclosures do not appear to be prominent in the McDonald’s dispute, at least as far as we are able to tell from the article. Many statutes in the states similar to Law 75 regulate abusive or unfair practices in dealer relationships, including franchising. Is the necessity to regulate a franchise based on a perceived notion that retail food establishments lack the protection of dealers under Law 75? It could be. But, there is no hard, fast, and absolute rule or statutory exclusion that retailers do not qualify for protection as Law 75 dealers. Who is a dealer turns on the facts and circumstances of each case. Is there another concern that an acquiring franchisor (or the seller) may impair at will the existing franchise agreements without violating Law 75? On this point there is a body of developed case law under Law 75 defining the rights and obligations of those selling and acquiring dealership rights.

Before the Legislature moves hastily to pass legislation it should consider whether or not Law 75, as enacted, is sufficient to protect the rights of franchisees.

“Muddied waters” or not, Law 75 claims for termination of exclusive distributorship and tort damages are arbitrable

It is unremarkable that the Federal Arbitration Act enforces written arbitration agreements involving Law 75 claims. Unless the movant (the dealer) seeks to invoke the district court’s limited power to issue a Teradyne injunction in aid of arbitration, claims for injunctive relief fall in the hands of the arbitrator. Next Step Medical Co. v. Johnson & Johnson International, No. 09-2077 (1st Cir. Aug. 30, 2010) is one of those cases. What is peculiar about the case is the appeal from the District Court’s judgment dismissing with prejudice a tort claim for emotional distress as not viable in a contract action, despite a Magistrate’s prior recommendation that the entire action was arbitrable. Despite the First Circuit's statement that the district judge “muddied the waters” by dismissing the arbitrable claims with prejudice, the appellate court sanitized the Judgment and concluded that the dismissal with prejudice meant the claims could not be brought in court; but rather, the claims survived on the merits for arbitration. After a removal to federal court, a still born request for injunctive relief, the lost appeal, years of litigation, the dealer was forced to arbitrate as required by the clear and broad arbitration agreement.

First Circuit enforces forum selection clause in agreement protected by Law 21

Puerto Rico Law 21 protects sales representatives from unjustified actions by their principals, much like Law 75 protects dealers. Law 21 provides that, regardless of a contractual provision to the contrary, sales representation agreements covering the Puerto Rico territory shall be governed by Law 21 and no such agreement can be terminated without just cause.

The agreement in the case had both a choice of law clause providing for North Carolina law and a compulsory choice of forum provision for litigation in North Carolina. The principal terminated the agreement and, after removal of the dealer’s complaint to federal court, the district court enforced the choice of forum clause granting a Rule 12b6 motion and dismissed the action without prejudice.

In Barril v. Combraco Industries, No. 09-2163 slip op. (Sept. 8, 2010), the First Circuit affirmed. The court followed the federal standard in Bremen v. Zapata, 407 U.S. 1 (1972), and skirted the issue whether enforcement of a forum selection clause is procedural or substantive, noting that both Puerto Rico and North Carolina follow the Zapata standard. Appellant argued that enforcement of the clause, under Zapata’s fourth prong, was invalid because it contravened the strong public policy of the forum behind Law 21. The court disagreed. The court noted that Law 21 does not by its terms forbid the enforcement of a choice of forum clause, but only a choice of law clause insofar as it “would prevent Law 21’s substantive protections from being given effect.” (citation omitted). The court rejected the argument that North Carolina law precludes courts from giving effect to the laws of another state or territory, so that North Carolina courts are just as capable to enforce Law 21 to the extent that it otherwise applies despite the choice of law clause.


Author’s note: Combraco paves the way to enforce choice of law clauses of states other than Puerto Rico to the extent those laws otherwise apply. PR Law 21 presumptively governs the substantive aspects of the contract’s termination and resulting damages, but other substantive aspects governing other claims or the interpretation of the agreement would be governed by the chosen law when not offensive to Law 21. As to Law 21’s preemption, the analysis is circumscribed to contractual provisions that render Law 21’s substantive protections inoperative. That is, where an agreement permits termination without cause or disallows any recovery of compensatory damages to an exclusive sales representative there would be preemption under Law 21. Where the agreement is not contrary to express substantive provisions in Law 21 (or Law 75 for that matter) or when consistent with those laws, it is likely that the chosen law of another state will apply to govern the enforcement of those other provisions in the agreement. If the agreement were to be governed by Puerto Rico law, then the Civil Code, or other provisions of the Commerce Code, would oversee the enforcement of provisions not expressly governed by Laws 21 or 75. An example is the Supreme Court of Puerto Rico’s recent case holding that the enforcement of a non-compete provision in a franchise agreement (to which Law 75 applies on its face) is governed by the Civil Code as Law 75 is silent on the issue. With Combraco, it remains to be seen if there is a change in the body of federal cases enforcing forum selection clauses despite Law 75’s express prohibition and what weight will be given to Law 75 under Zapata. My prediction is that the strong federal law interest to enforce reasonable forum selection clauses under Zapata (and the Federal Arbitration Act when the clause requires arbitration outside Puerto Rico) will continue to continue to override Law 75’s public policy interests.