Termination Of A Franchise

When Is A Termination Of A Franchise Or Distributor With Cause?

By Douglas R. Luther on July 22, 2016

Legal Considerations From A Recent Jury Verdict Against John Deere

Potential liability arising out of the termination of a franchise or distributor agreement can be a murky area of law with no clear answers. Nebulous “for cause” terminations are often highly contested. A recent trial in the Puerto Rico dealer termination case of Casco, Inc. v. John Deere Constr. Co. & Forestry Co. provides some insight into when a “for cause” termination may be legally sound.

John Deere came out on the wrong side of a $1.76 million judgment after a jury found it had violated the Puerto Rico Dealers Act[1] by terminating its Puerto Rico distributor, Casco, without cause. The trial – and pleadings before it – explored (1) what constitutes cause, and (2) how termination protection statutes are interpreted.

The relevant facts of the matter were identified by the parties in dueling motions for summary judgment – each of which were denied by the Court[2]>. Casco and John Deere executed an agreement for the sale and distribution of John Deere construction equipment and parts in Puerto Rico and the Virgin Islands in 1986. Casco’s main business was the sale, distribution, service and rental of construction equipment and parts. As might be expected, the parties disputed the proportion of the business the John Deere products represented. John Deere argued that the Casco business also extended to industrial, agricultural, gardening, golf and turf equipment. Casco disputed this and argued it was focused on construction equipment and parts and primarily John Deere products, describing it as the livelihood of its business.

The lawsuit centered on the termination of Casco as a John Deere distributor following John Deere’s cancellation of a large purchase order placed by Casco. Casco argued the cancellation and termination were without cause in violation of the Puerto Rico Dealers Act commonly known as Law 75. John Deere argued that Casco had violated multiple material obligations in the distributor agreement and had otherwise failed to perform as a distributor. Below is a discussion of the court’s treatment of these competing arguments and the consequent lessons that can be learned from it.

Puerto Rico’s Termination Protection Statute Law 75

Law 75 was designed to “remedy the abusive practices of suppliers who arbitrarily eliminated distributors after they had invested in the business and had successfully established a market for the supplier’s product or service.” Re-Ace, Inc. v. Wheeled Coach Industries, Inc., 363 F.3d 51 (1st Cir. 2004). It acts “regardless of any unilateral right to terminate present in a contract.” Id.

Law 75 encompasses not only terminations but any conduct wherein the principal acted to the detriment of a distributor. It provides that no manufacturer may directly or indirectly perform any act detrimental to the established relationship except for just cause. 10 P.R. Laws § 278a.

The Court’s Treatment Of Law 75

In evaluating Law 75 the Court identified certain circumstances where a rebuttable presumption exists that the distribution relationship was impaired without cause. These circumstances include “whenever a principal bypasses a dealer by distributing merchandise directly; appoints additional dealers in contravention of the agreement; fails to adequately fill orders; or arbitrarily changes the transportation and/or payment terms.” In such a circumstance, absent other important factors, a court is likely to find a violation of Law 75.

The Court then proceeded to discuss the test for what constitutes “just cause.” It cited to R.W. Int’l Corp. v. Welch Foods, 88 F.3d 49, 51-52 (1st Cir. 1996), for the proposition that “[u]ltimately, just cause under Law 75 is a question of fact, and so are the subsidiary issues of whether the contracting parties considered the particular contract obligation allegedly breached by the dealer to be essential and whether any other non-breaching acts or omissions by the dealer were nonetheless sufficiently egregious to have adversely and substantially affected the interest of the principal or grantor in promoting the marketing or distribution of the merchandise or service.” Once a dealer demonstrates that its principal unilaterally terminated their contract, the principal must carry the burden of persuasion on the factual elements of the "just cause" showing. Id.

Breaking Down The Law 75 Test

There are a lot of component parts to the Law 75 test.

First, the language of the distribution agreement is critical. A manufacturer or principle will be in a stronger position if the distribution agreement lays out the distributor’s obligations in specific and explicit terms. It is also helpful if certain obligations are noted as essential or material. In such a circumstance, a manufacturer could point to those obligations as the rationale for a termination.

Where the contractual terms are less specific, deciding whether a term is essential may be more challenging. It would involve looking into the contracting parties’ history including the negotiations for the agreement, how other distributors are treated as well as industry customs.

However, it is important to note that even explicit contractual language may not be outcome determinative. The Court gave a specific example along these lines in noting that the “failure to meet a distribution quota will only constitute just cause for impairment under Law 75 if that quota is shown to be ‘reasonable’ given the state of the Puerto Rico market at the time of the alleged violation.” So if the Court determines that certain contractual obligations are explicit and applicable it also must consider whether such contractual obligations can reasonable. This leaves the distributor room to argue its way out of specific contractual obligations especially if its actions are in part a response to market conditions.

Second, the test goes beyond the contract to look at “non-breaching acts or omissions by the dealer”. The test here looks at whether acts are “sufficiently egregious to have adversely and substantially affected the interest of the principal or grantor in promoting the marketing or distribution of the merchandise or service.” Thus, in determining whether to terminate a distributor, a manufacturer can look to whether a contractual violation is compounded by a distributor’s other acts whether or not those acts are proscribed or prohibited in the distribution agreement.

Casco Claims John Deere Terminated Without Cause

In Casco’s case, it alleged that John Deere impaired the distribution agreement and relationship when it unilaterally cancelled a purchase order for a John Deere excavator sold by Casco for $264,000. The alleged impairment precipitated the termination of the distribution agreement a few months later. For damages, Casco sought five years of lost profits, loss of goodwill as well as the recovery of other consequential damages and expenses.

The excavator order cancellation was allegedly based on Casco’s purported failure to comply with John Deere’s new model qualification (“NMQ”) requirements. Casco made three arguments in opposition.

One, it argued that there was no cause for cancelling the order as the NMQ’s were not essential obligations. In the parties’ agreement, there was a section which described certain essential obligations. NMQ compliance was not listed there. Two, Casco also pointed to a 90 day grace period that John Deere typically gave distributors to complete the NMQ and noted that Casco could have cured this issue had it been given the same treatment. Three, Casco argued that non-compliance with NMQ requirements did not adversely impact John Deere’s interests in Puerto Rico.

In response, John Deere argued it had just cause for the termination and its cancellation of Casco’s purchase order. It maintained that NMQ compliance was essential. John Deere also pointed to a litany of other reasons including that: (1) Casco failed to make a payment of $149,267 in past due fees; (2) Casco did not maintain adequate net worth; (3) Casco failed to maintain an adequate inventory of parts and equipment; (4) Casco failed to maintain adequate and trained personnel; (5) Casco failed to actively promote sales of John Deere products; (6) Casco failed to display proper identification; (7) Casco failed to provide a business plan between 2009 and 2013; and (8) Casco failed to provide financial information. Most of these obligations were listed as “essential” under Casco’s distribution agreement. Based on the totality of those factors, John Deere argued it had just cause for cancelling the order and terminating the distribution agreement.

After considering the competing arguments, the Court first noted that the failure to fulfill an order gives rise to the rebuttable presumption that there was an impairment without cause under Law 75. Whether John Deere could rebut this presumption turned on (1) whether Casco breached other contractual terms, (2) whether those were essential obligations, (3) whether compliance was reasonable in light of the market and industry, and (4) whether the breach thereof adversely affected John Deere’s interests. The Court noted that there was a common theme to looking at each of the purported breaches: “resolving whether a breach of contract occurred requires assessing the adequacy or reasonableness of Casco’s performance and course of conduct, an investigation which turns entirely on fact.”

Further, the Court noted that whether NMQ compliance was an “essential obligation” and prerequisite to filling a purchase order was a genuine issue of fact. Consequently, both motions for summary judgment were denied. Essentially, the Court left it up to the jury to decide whether John Deere had relied upon valid, essential and reasonable reasons for cancelling the order and terminating the agreement.

The Jury Finds In Favor Of Casco

With the Court unable to adjudicate the case by summary judgment, it proceeded to trial. Following a two week trial, the jury entered a verdict finding in Casco’s favor on the Law 75 claims.

In a blog posting[3], the attorney for Casco, Ricardo Casellas noted that the “the Jury must have found that John Deere's ostensible reasons stated in two letters for the impairment and subsequent termination were false or a pretext. The jury credited Casco's version of the events that John Deere retaliated or discriminated against its Puerto Rican dealer over many years as a vendetta for the dealer's owner's business affiliation with Volvo Construction, a competitor.”

What might have been particularly important to the jury was the history of disputes between Casco and John Deere that had resulted in earlier litigation. The risk for a manufacturer or supplier is that in such a situation, a jury may see the manufacturer’s reasons for terminating as pretextual and retaliatory. This can be particularly so when other distributors were getting favorable treatment while the terminated distributor, Casco, was held strictly to its contractual obligations.

Takeaways From John Deere Jury Verdict

To account for the jury’s negative perception of John Deere’s divergent treatment of its distributors’ obligations, manufacturers and franchisors should take care in consistently enforcing the legal obligations of their distributors and franchisees. Doing so will keep the manufacturer and/or franchisor on more solid legal footing.

This is especially so where the contract specifically sets out what the essential terms are. A jury may not find such terms “essential” if the manufacturer and/or franchisor looks the other way when they are breached and doesn’t enforce the contract. If a manufacturer and/or franchisor wants more flexibility with regard to enforcing certain contract terms, then it may want to limit which obligations are characterized as “essential” or “material” obligations.

Manufacturers and franchisors operating under statutes such as Law 75 must analyze not only whether there has been a breach of the agreement but whether the breach resulted from market conditions out of the control of the franchisee or distributor. Prior to termination, manufacturers and franchisors also must consider if they have any other evidence that the distributor adversely and substantially affected their interest in promoting the marketing or distribution of the merchandise or service.

Ultimately, the John Deere/Casco case shows us that while it can be difficult for sides to ascertain whether a termination is with or without cause, there are certain steps that can be taken to strengthen a manufacturer and/or franchisor’s position.

This article was prepared by Douglas R. Luther (dluther@mulcahyllp.com), of the Irvine law firm of Mulcahy LLP. Mulcahy LLP is a boutique litigation firm that provides legal services to franchisors, manufacturers and other companies in the areas of antitrust, trademark, copyright, trade secret, unfair competition, franchise, and distribution laws.

Disclaimer: While every effort has been made to ensure the accuracy of this article, it is not intended to provide legal advice as individual situations will differ and should be discussed with an experienced franchise lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.

[1] P.R. Laws Ann. Tit. 10 §§ 278 et seq.
[2] Casco, Inc. v. John Deere Constr. Co. & Forestry Co., 2014 U.S. Dist. LEXIS 120472 (D.P.R. Aug. 26, 2014).
[3] http://cabprlaw.blogspot.com/2016/03/john-deere-construction-and-forestry.html




Articles by Douglas Luther


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