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.

The battle in arbitration under Law 75 between Puerto Rico’s largest distributor and the world’s leading producer of rum reaches federal district court

The Puerto Rico sub-distributor V. Suarez filed an action in local Bayamon court, where it has its principal place of business, seeking to vacate a commercial arbitration award under Puerto Rico law. The principal Bacardi countered with a removal of the action to federal court and the filing of a separate federal action to confirm the award under the Federal Arbitration Act.

As reported in my previous blog, a commercial arbitration panel of the AAA ruled in favor of Bacardi, as a matter of first impression, that sophisticated parties may, by contract, predetermine the methodology to value the principal’s direct contribution and goodwill associated with the line and set off that value from the distributor’s actual damages in the event of an unlawful termination under Law 75.

The award is part of the public record in the proceedings to vacate and confirm the award. The cases pending in the U.S. District Court of Puerto Rico are styled V. Suarez & Co. v. Bacardi International Limited, No. 11-01858 (GAG) and Bacardi International Limited v. V. Suarez & Co. Inc., No. 11-01871. Stay tuned.

In a case of first impression, a commercial arbitration panel of the AAA validates provisions for the computation of damages in a distribution agreement governed by Law 75

In a watershed ruling, a commercial arbitration panel of the American Arbitration Association has decided that sophisticated corporations may pre-determine the methodology for computing actual damages in the event of a future termination of the business relationship without violating Law 75.

There, a renowned worldwide producer of liquor entered into a distribution agreement with a Puerto Rico distributor. The brands and products that were subject to the agreement were famous, had an established goodwill in the Puerto Rico market, and produced significant annual revenues to the previous distributor, an entity affiliated to the producer. The agreement did not require the new distributor to pay a franchise fee, make any capital investments, or provide any consideration in exchange for the exclusive distribution rights.

The parties negotiated at arms-length with the advice of counsel and agreed on the formula to compute damages in the event of a termination without just cause. Essentially, the agreement established the annual distribution value of the exclusive distribution rights owned by the producer that would be conditionally granted to the distributor. The distribution value was based on actual historical data of revenues generated by sales of the products in the Puerto Rico market and an estimate of the new distributor’s direct costs. If the measure of actual damages under Law 75 was less than the distribution value, the distributor would recover zero damages in the event of an unjustified termination. Under the agreement, the distributor could only recover the excess profits generated by its efforts to the extent that those exceeded the distribution value.

The distributor argued that the damages provisions infringed Law 75 as a waiver of rights, but a majority of the panel disagreed. The Panel recognized that the Puerto Rico distributor cannot recover for the franchisor’s goodwill and value of its trademarks. Further, the measure for computing damages did not violate Law 75 because there is no prohibition from valuing the manufacturer’s goodwill (which the distributor did not create or contribute) and setting off that value from the measure of actual damages under Law 75. Damages under Law 75 are not automatic or mandatory, ruled the panel in favor of the producer.

This decision may have a significant impact in the way that distribution agreements are negotiated and executed, especially for famous brands that have an established clientele and goodwill in the Puerto Rico market.

Author’s note: The undersigned is lead counsel for the producer in the arbitration proceedings, with Rosalie Irizarry participating as trial counsel and Natalia Morales for research and motion practice.

First Circuit vacates final judgment for a supplier in a Law 75 case after consolidation of a preliminary injunction hearing with a bench trial on the merits did not provide adequate prior notice.

In Lamex Foods v. Audeliz Lebron, No. 10-1677 (1st Cir. June 27, 2011), the First Circuit vacated the District Court’s (Fusté, J.) Judgment holding that consolidation of a preliminary injunction hearing with a bench trial on the merits without providing adequate and clear prior notice violated the constitutional right to a jury trial.

Plaintiff Lamex is a Minnesota corporation that facilitates the sale of food from manufacturers to suppliers and vendors worldwide. Plaintiff entered into a “business relationship” where it purchased frozen chicken for resale to Defendant ALC, a Puerto Rico corporation, that supplies product to supermarkets and retailers in Puerto Rico. In 2009, after failed collection attempts, ALC fell behind in its payments for poultry sold and delivered totaling $1.2 million. Lamex, among other actions, canceled ALC’s account and cashed in on a letter of credit tendered as security.

ALC sued Lamex first in local court alleging violations of Law 75. Before Lamex was served, it sued ALC in federal court naming ALC and its President as defendants. Lamex sought to recover payment of unpaid monies due and to pierce the corporate veil to hold the President personally liable. Lamex also sought a declaration that it was not a principal under Law 75, and even if it was, it had just cause to terminate the relationship.

There were mixed or contradictory signals on the record whether the court had in fact consolidated the case. After an evidentiary hearing, the District Court found for Plaintiff in all respects on its complaint except that it disallowed the request to pierce the corporate veil.

Defendant appealed and argued that the court erred in consolidating the preliminary injunction hearing with a bench trial on the merits. The First Circuit accepted, without deciding, an argument for the present case that Law 75 actions are essentially legal to which the Seventh Amendment attaches. Despite Defendant’s counsel’s failure to object to consolidation, the First Circuit held that the court’s failure to give unequivocal and adequate prior notice did not comply with the heavy burden to show a waiver of the constitutional right to a jury trial.

Thus, the court vacated the judgment with respect to the claims for declaratory relief and to pierce the corporate veil and remanded the action for further proceedings. Significantly, because Defendant conceded the amount and existence of the debt owed to Plaintiff, it affirmed the court’s monetary judgment in Plaintiff’s favor. As to the appeal from a discovery sanction, the court affirmed the court’s imposition of sanctions against Defendant for its President’s evasive and non-responsive answers during his deposition.

Dealers beware: is acceptance of commissions for direct sales by supplier in contravention of exclusive distributorship agreement by itself a waiver of a breach of contract claim under Law 75?

The issue often arises when a dealer claims that payment of commissions by its principal for direct sales made by another distributor (or retailer) to its customers in the exclusive territory is proof of an exclusive distributorship. Case law in Puerto Rico is mixed on the issue. One First Circuit case holds that payment of commissions does not legally modify the terms of a clearly non-exclusive distributor agreement. Problems arise (for the supplier) when a clearly non-exclusive distributorship agreement has expired or there is no written agreement at all. In those circumstances, as in a reported federal district court case, the payment of commissions may create a genuine triable issue of fact on the existence of exclusivity. In their commercial dealings parties may contractually agree that payment of commissions is the quid pro quo or consideration for exclusive distribution rights. But, absent a contract, it is by no means settled that payment of commissions is per se proof of exclusivity.

Picking up where I left off in my prior blog that common law authorities may be persuasive when interpreting Law 75, at least in the State of Ohio, an appellate court (but reversed on other grounds) held that payment of commissions is a waiver of a breach of contract claim. In Miller v. Wikel Manufacturing Company, 545 N.E. 2d 76 (Ohio 1989), a jury found that a principal had impaired and terminated an exclusive distributorship agreement and awarded damages of $1.5 million for breach of contract.

On the relevant issue, the appellate court reversed the verdict and reasoned:

“It was proven at trial that the Millers [the distributor] had been aware of direct sales by Wikel Mfg. [the principal] in Michigan since 1971 and that the Millers had accepted commissions on these sales. Such sales were in contravention of the exclusive distributorship contract. The court of appeals reasoned that the Millers’ election to continue as Wikel Mfg’s distributor, notwithstanding Wikel Mfg’s actions, constituted a waiver of their rights under the agreement, and thus, that they were estopped from asserting a breach of contract claim on this basis.” See 1998 WL 62980 Ohio App. 1988, citing, Section 683 of Williston on Contracts (“….where a contract is breached in the course of its performance, the injured party has a choice presented to him of continuing the contract or refusing to go on.”), reversed on other grounds, 545 N.E. 2d 76.

These facts depict a scenario of “willful blindness”, “deliberate acquiescence”, or “laches” by a distributor who has knowledge of the breach for years but elects to continue the relationship receiving benefits under the contract in exchange for additional consideration consisting of commissions. Unless the dealer protects itself with contractual language to ensure that the commissions do not novate (or affirmatively ratify) existing exclusive rights, there is a risk of waiver or estoppel from accepting commissions in the face of a clearly exclusive contract.

Right or wrong, this is all dicta as the appellate court’s holding never became law of the case. The Supreme Court of Ohio did not reach the waiver issue on the merits for it reversed the appellate court, reinstated the verdict, and held that waiver and estoppel are affirmative defenses which were waived in the case. Thus, the appellate court erred in raising the issue sua sponte.

The interplay of comparative law and Law 75: is it appropriate for guidance?

“[A] U.S. Court interpreting a federal statute or constitutional provision can look at the reasoning of a foreign or international tribunal on similar issue.” Al-Bihani v. Obama, 619 F.3d 1, 33 n. 18 (D.C. Cir. 2010)(Kavanaugh, J., concurring), citing Ruth Ginsburg, “A decent respect to the Opinions of [Human] kind”; The Value of a Comparative Perspective in Constitutional Adjudication, Address to the International Academy of Comparative Law (July 30, 2010). While foreign decisions do not rank as precedent, they can be informative and just as persuasive as reasoned law review articles or commentators on the subject matter. See, i.d.

When interpreting Law 75 it is advisable to resort to common law and civil law jurisdictions for their persuasive value. Foreign jurisdictions which can be persuasive include Spain, Cuba and the Dominican Republic, the last two have statutes similar and preceding ours. But common law jurisdictions have also shaped many of the amendments to the presumptions of lack of just cause in Law 75, including California, Colorado, Florida, Georgia, Illinois, Indiana, Kentucky, Maine, Massachusetts, Mississippi, North Carolina, Nevada, New Hampshire, New Jersey, New Mexico, Ohio, Rhode Island, South Carolina, Tennessee, Texas, Vermont, and possibly, Wisconsin. See Report of the Chamber of Commerce of Puerto Rico, P. of C. 774, at 3, April 23, 1986; Report of the Chamber of Commerce of Puerto Rico, P. of. C. 774, at 4 May 10, 1998.

Delaware enacted a “Franchise Security Law” on July 8, 1970 protecting certain franchisees with a place of business within the state from unjustified terminations. Damages include lost profits and loss of goodwill. “[Delaware law], within the ambit of legislation in the United States, is closest in its focus to Law 75.” See 97-page Study about Law 75 of 1964, Chamber of Commerce of Puerto Rico (undated)(translation ours).

In future blogs, I will comment about noteworthy state and foreign decisions which may be helpful to resolve open issues under Law 75.

Law 75 protects dealers who develop the “market” in Puerto Rico. But, does the “market” include federal military installations, cruise ships, or duty free shops?

There are two elements for Law 75 to apply, prima facie, first, the statute protects a Puerto Rico dealer, and who qualifies as a dealer is a highly factual question; second, the business activities of the dealer must be directed to promote the sale or service of the principal’s products or services within the Puerto Rico market. Thus, the statute does not extend coverage to stateside or foreign distributors at least to those that have no sales or distribution offices or operations within Puerto Rico. Nor should Law 75 have an extraterritorial reach for sales made outside of the Puerto Rico territory. Accordingly, the measure of damages in Law 75 should not include any sales made by a Puerto Rico distributor outside the Puerto Rico market. That should be straightforward enough.

But, what is the market within the geographic boundaries of Puerto Rico that is covered by Law 75? Plain language of Law 75 does not help to answer that question. Are sales made to federal military customers within federal military installations in Puerto Rico covered? In Patterson v. Ford Motor, 931 F. Supp. 98, 102 (D.P.R. 1996), the issue was raised but the court did not answer the question ruling instead that Plaintiff, a sales representative, did not qualify as a Law 75 dealer. Would sales made by Puerto Rico distributors to cruise ships that dock within Puerto Rico’s territorial waters be covered by Law 75? Are duty free sales at the LMM international airport covered? Does the answer to these questions turn on constitutional or quasi-political definitions of what is a “territory”? If that’s the right test then arguably sales to U.S military installations within Puerto Rico may not be covered. Or does the answer turn instead on the practical import of who is the ultimate consumer for the products (understanding that many but not all consumers are Puerto Rico residents) and what benefits does the principal derive from sales by Puerto Rican distributors to these outlets (military bases, cruise ships, and duty free shops) all of which have a nexus to Puerto Rico? Either way there is no definitive answer on point in the case law to these questions.

Puerto Rico distributors: beware of ICC arbitration clauses in distribution agreements

International arbitrations are a common ADR procedure to resolve commercial disputes, including Law 75 actions. There are many reasons to choose arbitration: no jury trial…the blessing of Supreme Court precedent and FAA preemption, a panel of experienced professionals, and presumably a quicker and more cost effective mechanism etc. It is no secret, however, that arbitration can be expensive, and often more so than court cases, but rarely do the parties foresee, at the time of contracting, the substantial costs and fees that must be advanced by the claimant to initiate an international arbitration.

For arbitrations under the International Chamber of Commerce (ICC), for example, the initiating party, which may be the aggrieved distributor, must advance up front the administrative fees to cover the expenses of the ICC and the arbitrator(s). When those fees approach 10% of the face amount of the distributor’s claim, well if you do the math, those fees can be substantial just to get “your day in court”.

So far, at least in commercial disputes, courts have been reluctant to invalidate ICC arbitration clauses as substantively unconscionable because of the substantial costs to arbitrate the dispute. Kam-Ko Bio-Pharm v. Mayne Pharma, 560 F. 3d 935 (9th Cir. 2009), citing, Green Tree Fin. V. Randolph, 531 U.S. 79 (2000).

Would Puerto Rico Law 75 override a Delaware choice of law clause?

A series of published federal cases hold that Puerto Rico Law 75 displaces contractual choice of law clauses of certain common law jurisdictions in distribution agreements, notably New York (among others). Many of those cases have applied the Restatement of Conflict of Laws to conclude that Law 75 is vested with public policy and Puerto Rico has a significantly greater interest in applying its laws over the transaction. Would the result be the same in all common law jurisdictions?

When drafting distribution agreements one should consider the possibility that not all States would necessarily enforce Law 75 and override a freely-executed choice of law clause. There are States which hold themselves out as having a body of fair and efficient substantive commercial laws that offer uniformity and predictability to business actors. The State of Delaware is one of those jurisdictions with a choice of law enactment that values the parties’ freedom of contract. 6 Del. C. Sec. 2708 (a)(2005) provides that: “[t]he parties to any contract, agreement or other undertaking, contingent or otherwise, may agree in writing that the contract, agreement or other undertaking shall be governed by or construed under the laws of this State, without regard to principles of conflict of laws, or that the laws of this State shall govern, in whole or in part, any or all of their rights, remedies, liabilities, powers and duties if the parties, either as provided by law or in the manner specified in such writing are, (i) subject to the jurisdiction of the courts of, or arbitration in, Delaware and, (ii) may be served with legal process. The foregoing shall conclusively be presumed to be a significant, material and reasonable relationship with this State and shall be enforced whether or not there are other relationships with this State.”

While Section 2708 has not been interpreted in the context of either Law 75 or franchise or distribution agreements, it applies to contracts of $100,000 or more as a matter of public policy where Delaware law has a material relationship to the transaction. As Delaware’s Court of Chancery noted in Abry Partners v. F&W Acquisition LLC, 891 A. 2d 1032, 1050 (Del. Ch. 2006), when enforcing a Delaware choice of law provision in a stock purchase agreement, “[t]o enter into a contract under Delaware law and then tell the other contracting party that the contract is unenforceable due to the public policy of another state is neither a position that tugs at the heartstrings of equity nor is it commercially reasonable.”

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.

Federal Court refuses to compel arbitration of claim ostensibly brought under Law 21

This is yet another case underscoring the risks and liabilities to a principal of doing business with an expired contract.

In a case with an unusual set of facts, in Gonzalez v. Hurley International Inc., 2011 WL 445833 (D.P.R. Feb. 9, 2011)(Casellas, J.), Plaintiff, a sales representative, successfully defeated a motion to compel arbitration convincing the court that her written agreement had expired, was not renewed in writing, and there was no written obligation to arbitrate.

Plaintiff filed suit under Law 21 claiming that she was an exclusive sales representative and Defendant had terminated the agreement without just cause. Plaintiff also alleged that, from a course of dealings, a new and exclusive sales representative agreement arose after expiration of the old contract. The expired agreement had a choice of law clause providing for California law and arbitration in California.

Defendant moved to compel arbitration and responded that the parties continued doing business under the same terms and conditions of the expired agreement. If the agreement continued in effect at the time the claim arose in December 2009, noted the court, Plaintiff would not have an actionable claim under Law 21 because the agreement was expressly non-exclusive and Law 21 requires exclusivity as an element of the claim.

The court held that the agreement was extended once in writing but was not thereafter renewed. Thus, the court concluded that there was no obligation to arbitrate as the agreement expired, and distinguished Gemco v. Seiko, 623 F. Supp. 912 (D.P.R. 1985)(holding that Law 75 extends an agreement indefinitely and denying motion to stay arbitration), on grounds that the agreement at issue was never within the scope of Law 21 as the relationship was non-exclusive.

The court denied the motion to compel but set the tone for a possible motion to dismiss for failure to state an actionable Law 21 claim: “[a]lthough a business relationship between the parties apparently continued, the complaint fails to set forth sufficient facts to determine whether Plaintiff became Hurley’s exclusive sales representative.”

Note: One would have thought that the court had ample grounds to order cause as to why the complaint should not be dismissed for lack of a plausible Law 21 claim and require proof that there was an extinctive novation to create a new exclusive relationship after expiration of the agreement. While Plaintiff may be better off without arbitration, at the end, unless there is extinctive novation, her Law 21 claim may be doomed under Iqbal and Twombly Supreme Court precedent.

Federal Court enforces mandatory forum-selection clause in a distribution agreement despite Law 75’s provision that litigation outside of Puerto Rico violates public policy.

While Law 75 is a remedial law of public order, courts harmonize the interest to protect Puerto Rico distributors from unjustified terminations after they create a favorable market for the principal’s products and the competing interest behind the enforcement of forum-selection clauses that “increase convenience and predictability for business actors.” Marpor Corporation v. DFO, LLC and Denny’s Inc., No. 10-1312 (D.P.R. Dec. 2, 2010)(Perez-Gimenez, J.). In Marpor, Plaintiff, a Denny’s franchisee, brought an action to declare that the franchisor had terminated an exclusivity provision without just cause. The District Court noted that both federal and Puerto Rico courts generally enforce forum selection clauses in the absence of fraud, bad faith, or overreaching. The court found that the South Carolina forum selection clause in the agreement was mandatory, not permissive. Further, the court held that the legitimate interest of providing convenience and uniformity to business actors as to the locale for resolving their disputes outweighs Law 75’s express provision that dealer disputes must be litigated (and arbitrated) solely in Puerto Rico. Accordingly, the court granted Defendant’s Rule 12(b)(6) motion to dismiss.

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.

A complaint with a Law 21 claim was properly removed to federal court after satisfying the minimum jurisdictional amount for diversity jurisdiction.

I have witnessed a trend by franchisees, distributors, and sales representatives of doing everything in their means to avoid litigation in federal court of their claims brought under Laws 75 and 21. At first glance, the strategy seems perplexing particularly when there is a right to trial by jury in federal court (but not in local Puerto Rico courts); and generally, federal courts are quicker to judgment. Deep down, however, the issue of forum selection is more complex and the decision of where to sue is influenced by many factors. For example, local courts are more inclined to deny motions for summary judgment in part due to the Supreme Court of Puerto Rico’s procedurally stringent standard for summary disposition. By the same token, federal courts have developed over the years a body of jurisprudence in distribution cases that provide support for the granting of motions in limine to exclude or limit expert testimony and allow more readily summary judgment for principals in certain cases. Whether it is perception or reality the fact remains that Plaintiffs implement a number of tactics to avoid the federal court in these cases including the “fraudulent” joinder of a diversity-defeating co-defendant, a Puerto Rico distributor, or the subsequent filing of a similar action in local court when a “first-filed” case was pending in federal court against the same parties. And, suing for less than the jurisdictional amount may get a party out of federal court, too (or not!).

The case under discussion, Ramirez de Arellano v. Budenheim USA, Inc. 2010 WL 3810078 (D.P.R. Sept. 22, 2010)(Perez-Gimenez,J), presents the anomaly where the Plaintiff alleged that his damages were lower and the Defendant alleged that his actual economic damages were higher. There, Plaintiff, a sales representative in a case brought under Law 21, alleged on the face of the complaint less than the jurisdictional minimum of $75,000 when Law 21 would have allowed a claim for recovery of a greater amount of damages. Defendant removed the case to federal court. Plaintiff moved to remand alleging there was no subject matter jurisdiction. Defendant opposed the remand contending that, at relevant times, Plaintiff had a sales volume of $1.6 million and that Law 21 permitted recovery of 5% the total sales volume plus loss of goodwill and other damages.

Faced with conflicting allegations, the court determined that Plaintiff, who represented Defendant over a 20 year-relationship (presumably Law 21 would not have applied unless an extinctive novation occurred-an issue not addressed by the parties or the court at this time), would be entitled to potential recovery of at least $80,000. Since it is not a legal certainty that the claim involves less than the jurisdictional minimum, the court denied Plaintiff’s motion to remand and set a briefing schedule for Defendant’s motion to dismiss.

Another victory for principals: are forum selection clauses enforceable in Law 75 cases?

Not automatically, but almost always. Puerto Rico Surgical Technologies, Inc. v. Applied Medical Distribution Corp., 2010 WL 4237927 (D.P.R. Oct. 26, 2010)(Pieras, J.) is no exception. There, the parties executed a distribution agreement with a California choice of law clause and a mandatory forum selection clause vesting California federal and state courts with exclusive jurisdiction. Plaintiff filed an action for damages under Law 75 in local court, which was then removed to federal court. Finding no difficulty in enforcing the forum selection clause under federal or Puerto Rico law, the court granted a motion to dismiss the complaint without prejudice. Distinguishing the First Circuit’s Combraco decision as dicta (reported in my previous blog) suggesting that Law 75’s public policy disfavoring litigation outside Puerto Rico may outweigh the federal interest in enforcing a forum selection clause, the district court held that enforcement of the forum selection clause in this case did not contravene an important public policy of Puerto Rico, was negotiated freely, and was not otherwise unreasonable. At least where the parties and the facts underlying the claims have a sufficiently close nexus to California, the court will not invalidate a forum selection clause simply because of Plaintiff’s inconvenience in litigating outside Puerto Rico.

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

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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.