Impairment, de facto exclusivity, nature of relationship, business terms after expiration of written agreement and assumption by successor in interest, present triable issues of material fact precluding summary judgment for the principal under Laws 75 and 21.

Beatty Caribbean, Inc. v. Nova Chemicals, 2010 WL 2697163 (D.P.R. July 6, 2010)(CVR), underscores the risks under Puerto Rico’s distribution laws that a principal assumes from doing business with an agent after expiration of a written agreement.

Beatty filed suit in federal court for impairment of an alleged verbal exclusive agreement when the principal, the successor in interest, sought to reduce the payment of commissions on the sale of Styrofoam products from 5% to 3% allegedly without just cause under Laws 75 and 21.

Beatty had been a non-exclusive representative of non-party Arco under a written agreement for many years until defendant NOVA later acquired Arco’s assets in 1996. The agreement provided a 5% commission and had a term of one year. Beatty’s 1990 agreement with Arco was not part of the assumed contracts in the acquisition.

Without entering into a new written agreement and not expressly assuming the expired contract between Arco and Beatty, NOVA and Beatty allegedly entered into a verbal exclusive agreement in the 1990’s. Beatty’s proof of exclusivity relied on a course of dealings as it alleged that it was de facto the sole distributor in the Caribbean and Puerto Rico and NOVA had not appointed another distributor in the exclusive territory. The court found it was undisputed that when NOVA acquired Arco’s assets “there was no change or alteration in any of the terms and conditions of dealings with Beatty.”

Nova moved for summary judgment on two grounds, one that Beatty did not qualify as a Law 75 dealer and two, it was not an exclusive sales representative for coverage under Law 21. The court found there were controversies of material fact precluding summary judgment. “Since there is no written contract in effect as to what was the extent, provisions or understanding of the verbal contract between the parties in the present controversy, once it is ruled and determined based on credibility determination, it would then be legally possible to determine if their business relation may fall under Law 75 or 21, or none.”

Where there is no integrated written and expressly non-exclusive agreement in effect at the relevant time of the impairment or termination by the successor in interest, this and other cases prove that an agent claiming protection under Laws 75 and 21 may avert summary judgment with extrinsic evidence of a verbal distribution or representation agreement and a course of dealings of de facto exclusivity.

Puerto Rico Law 75 and changes in control or ownership of the distributor without prior notice and consent of the supplier

It is customary to secure the supplier’s consent when a distributor sells its assets, including its distribution rights, to a successor distributor. It is equally customary for written distribution agreements to require the supplier’s consent for the distributor’s assignment or transfer of the agreement.

Better business practices to avoid litigation suggest giving notice to obtain the supplier’s consent when the distributor sells its assets. After all, the buyer-distributor will normally dish out valuable consideration for the transfer or the assignment of rights and obligations that include or implicate the supplier or manufacturer’s ownership interests or goodwill. And, the manufacturer, as the trademark holder, has legitimate interests to ensure that the new distributor meets all the requirements for the sale or service of its branded products. It is said that a Law 75 relationship is like a partnership. Imagine becoming a partner without the co-partner's consent. Thus, problems arise when a distributor transfers or assigns its rights, whatever those rights may be, and the new distributor assumes the risk of paying valuable consideration for those rights, without the manufacturer’s consent. The case law on the topic of changes in the distributor’s control is scarce. And, Law 75 suggests an answer to only part of the issue.

Section 278(a)-1 of Law 75 provides:
"For the purposes of this chapter and specifically for the effects of § 278a of this title:

(a) The violation or nonperformance by a dealer of any provision included in the dealer's contract to prevent or restrict changes in the capital structure of the dealer's business, or changes in the managerial control of said business, or the manner or form of financing the operation, or to prevent or restrict the free sale, transfer or encumbrance of any corporate action, participation, right or interest that any person could have in said distribution business, shall not be considered as being just cause unless the principal or grantor shows that such nonperformance may affect, or has truly and effectively affected the interests of such principal or grantor in an adverse or substantial manner in the development of the market, distribution of the merchandise or rendering of services."

While no Puerto Rico state or federal court has interpreted or otherwise applied Section 278a1(a) of Law 75, the manufacturer could argue and attempt to prove that the transfer or assignment of a distribution agreement to a third party (who is not an affiliate of or controlled by the existing distributor) without its consent affects its interests adversely and substantially allowing it to terminate the agreement.

What happens between the manufacturer and the new distributor or the successor after the sale has been consummated? Most certainly, the manufacturer should not be bound to continue the relationship automatically, without more, as case law holds that Law 75 is not a straightjacket for a distributor to impose its will over the manufacturer.

Based on cases dealing with analogous issues, a principal has an interest to pursue good faith negotiations with the new distributor based on reasonable expectations regarding essential elements of the dealership, and terminate the relationship for “just cause” if the parties reach a bona fide impasse. R.W. Intern. Corp. v. Welch Foods, Inc., 88 F.3d 49, 53 (1st Cir. 1996), is instructive. There, the First Circuit affirmed summary judgment in favor of the principal after the latter proved that the parties had reached a bona fide impasse on an essential modification to the terms of their ongoing contract (i.e., whether the successor distributor would continue to handle competing product lines) and terminated the successor distributor. The court reached this conclusion after quoting its earlier decision in the same case, in which it stated:

“[A] supplier has just cause to terminate if it has bargained in good faith but has not been able to reach an agreement as to price, credit, or some other essential element of the dealership. This would be true at least where, as here, the supplier's market in Puerto Rico was well established before the current dealer relationship and the supplier's action therefore is not aimed at reaping the good will or clientele established by the dealer.”  R.W. Intern. Corp., 88 F.3d 49, 53 (internal quotation marks omitted), citing, R.W. Int'l Corp. v. Welch Foods, Inc., 13 F.3d 478, 484 & n. 4 (1st Cir. 1994).

Lessons learned:

Distributors beware! Seek the manufacturer’s consent to ratify existing agreements or enter into new distribution agreements before paying any money for transfers or assignments of distribution rights. Principals beware! In some circumstances, doing business with a new distributor without a formal written agreement may implicate Law 75 issues, provoking contract negotiations and litigation. It goes without saying that timely and competent legal advice will avoid many potential problems.