Appeals Court affirms judgment under Law 75 awarding damages for five-years of lost benefits and goodwill to exclusive distributor for constructive termination or impairment.

Appellate court decisions in Puerto Rico are persuasive authority in the application and interpretation of Law 75. One such case is Cadierno Corporation v. Rowland Coffee Roasters, 2010 WL 3168203 (TCA April 30, 2010) where plaintiff Cadierno, an exclusive distributor of branded Café Estrella premium coffee, brought a claim for damages under Law 75 against its principal Rowland when the latter introduced Café Pilon, an essentially identical branded premium coffee, through a subsidiary at prices below the distributor’s costs. The distributor opened the market and clientele for Café Estrella, as the exclusive distributor, with the expectation that, once a controversy as to the ownership of the Café Pilon brand was resolved, it would also distribute Café Pilon in Puerto Rico. The parties negotiated the exclusive distribution of Café Pilon, but did not reach an agreement. After Rowland introduced Café Pilon in Puerto Rico through a subsidiary at predatory prices, the distributor decided to discontinue purchases of Café Estrella for it alleged that it was driven out of the market and sales of Café Pilon has in effect cannibalized sales of Café Estrella.

Claiming that the principal’s acts impaired and terminated the exclusive relationship by appropriating the goodwill and clientele created for Café Estrella, the distributor sued in local court under Law 75. After trial, the local court (Bayamon Part) found in favor of the distributor, credited the testimony of the distributor’s expert (Ronald Martinez), and awarded damages for lost benefits, loss of goodwill, attorney’s fees and costs.

Interestingly, the distributor’s expert computed lost benefits from the impairment based on the criteria normally used in termination cases under Section 278c, by computing profits on the line for the prior five years and discounting, as mitigation, the profits realized on sales of Café Estrella until the distributor abandoned the line.

The principal challenged on appeal the sufficiency of the evidence of impairment and constructive termination; the finding of lack of just cause; the determination of damages from the trial court’s decision not to impute fixed and administrative costs from the award of damages; the finding of loss of goodwill; finally, it contested the imposition of attorney’s fees, expert witness fees and costs.

The principal lost as the appellate court affirmed the judgment on all counts. The court held that the decision to introduce Café Pilon, a premium coffee that was substantially the same as Café Estrella, through a subsidiary at prices below the distributor’s costs impaired the exclusive contract over Café Estrella and caused damages to the distributor in violation of both Law 75 and the principle of good faith and fair dealing.

Note: Cadierno reinforces Law 75’s remedial purpose when the principal seeks to appropriate the clientele and goodwill created by the exclusive distributor by introducing a new brand or product line extension through a third party or an affiliate. It is even more significant considering that the distributor abandoned the line voluntarily and was not terminated in fact by the principal. It should be noted that Cadierno finds an impairment of an exclusive contract although the parties had not reached an agreement over the new brand or product line extension. The impairment with the exclusivity over Café Estrella came about because of cannibalism that resulted when the principal introduced Café Pilon to compete and displace Café Estrella in the territory. Finally, Cadierno validates the distributor’s expert’s methodology that five-years of benefits are not limited to termination cases.

Part 2: Is a constructive or de facto termination of a distribution agreement actionable under Law 75 after the Supreme Court’s decision in Mac’s Shell Service v. Shell Oil Products?

In Mac’s Shell Service v. Shell Oil Products, No. 08-240, slip op. (March 2, 2010), the Supreme Court of the United States held that a constructive termination claim was not actionable under the PMPA, the federal law protecting petroleum franchisees, unless the retailer-operator voluntarily has abandoned the franchise. The Court reasoned that both the plain language of the PMPA, and analogous federal employment law jurisprudence, do not support the First Circuit’s reasoning that a franchisor’s breach of an essential contractual term made it actionable as a constructive termination under the PMPA. The PMPA’s comprehensive scheme for compensation, including awards of punitive damages for violations, also made the Court reluctant to expand the reach of the statute for all breach of contract claims. A termination claim under the PMPA, said the Court, requires an end to the relationship of the parties. While the Court refused to federalize claims not involving a complete rupture of the business relationship, the Court held that the PMPA does not disturb state laws that provide remedies for wrongful practices, including a franchisor’s breach of contract short of termination. Thus, the Shell Oil Products decision does not foreclose claims under Puerto Rico law for de facto or constructive termination of franchise and distribution agreements.

That’s where Law 75 comes in as it was enacted to compensate for abusive practices by principals designed to appropriate the goodwill created by the Puerto Rican distributor. And, Puerto Rico’s Article 1077 of the Civil Code supplements the remedies available for resolution of contracts arising from breaches of essential and material terms.

Specifically, the type of claim that was not actionable in Shell is actionable on the face of Law 75 as it codifies a claim for impairment of contractually acquired rights and expectations short of a complete cessation of the relationship (a “menoscabo”). Moreover, Law 75’s definitions of termination without just cause and the measure of damages for termination expressly include a remedy for acts detrimental to the established relationship (“menoscabo”). Thus, from Law 75’s plain language and its interpretive case law (including a series of federal cases and the PR’s appellate court’s opinion in Maderas Alfa), a principal’s impairment of an established relationship with the distributor may operate as the functional equivalent of a termination requiring consideration of the statutory criteria for termination damages, including loss of goodwill and five-years of lost profits, among other factors. Compare Maintainco, Inc. v. Mitsubishi Caterpillar Forklift, CCH Business Franchise Guide ¶14,195 (holding that a dealer's loss of an exclusive territory, in and of itself, could qualify as a constructive termination under New Jersey’s Franchise Practices Act which, like Law 75, requires good cause for termination; affirmed the trial court’s ruling and its award of compensatory damages for lost profits to the dealer in the amount of $679,414. Additionally, the trial court's substantial award of attorney fees to the dealer in the amount of $3,533,642 was also upheld, but an award of $477,611 in expert witness fees was reversed).

Is a constructive termination actionable under Law 75?

Law 75 contemplates liability in three circumstances, one, when the principal terminates the relationship for lack of just cause, two, when the principal refuses to renew the relationship (in effect, a termination), and three, when the principal impairs the relationship. The difference between impairment and termination is significant as it influences the measure of damages.

The underpinning of impairment is a breach of contractually-acquired rights. This means that the relationship continues but some essential and material contractual right of the distributor has been prejudiced by the principal’s actions. The notion of termination, however, presupposes on its face a rupture in the relationship. Conceivably, an impairment could be a termination when the essence of the agreement vanishes from the unjustified act by the principal, such as the unilateral conversion of an exclusive agreement into a non-exclusive relationship. At least one appellate decision has held that some types of impairments, for example, a principal’s termination of an exclusivity provision, are constructive terminations. “Constructive” in the sense that an essential component of the agreement has been canceled, but the relationship continues albeit in an impaired or lesser form. In these situations, the distributor has been able to claim the full measure of Law 75 damages from a termination. The impairment component of damages comes in by reducing the compensation by the benefits realized by the distributor from sales of the lines or products that continue despite the termination of the exclusivity.

In a related context, the U.S. Supreme Court in Mac's Shell Service Inc. v. Shell Oil Products Co., a franchise termination case brought under the federal PMPA (originating in the First Circuit) granted certiorari to consider whether the PMPA contemplates a claim for constructive termination and constructive non-renewal. Oral argument will be heard in January, 2010.

Is constructive termination actionable under Law 75, and if so, the scope of what it means, are unanswered questions by the federal courts and the Puerto Rico Supreme Court.