Drafting Product Distribution Agreements: Allocating Supplier...

Drafting Product Distribution Agreements:

Allocating Supplier and Distributor Risks

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THURSDAY, FEBRUARY 15, 2018

Presenting a live 90-minute webinar with interactive Q&A

John M. Scannapieco, Shareholder, Baker Donelson Bearman Caldwell & Berkowitz, Nashville, TN

Andre R. Jaglom, Partner, Tannenbaum Helpern Syracuse & Hirschtritt, New York

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Providing Solutions®

The Distribution Contract Drafting Issues

Andre R. Jaglom

New York, New York

[email protected]

February 15, 2018

© 2012, 2013, 2015, 2018 Andre R. Jaglom All rights reserved.

For reprint permission e-mail [email protected]

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Ensure satisfactory performance or a right to terminate

Identify and quantify performance levels

Identify all possible reasons for dissatisfaction

Specify expectations for sales, advertising, promotion, service, etc.

Supplier Objectives

© 2012, 2013, 2015, 2018 Andre R. Jaglom All rights

reserved.

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Consider whether you want control over resale prices, whether any Leegin risk factors are present, and what applicable state law may say

Many states still prohibit RPM, as does Europe

Supplier Objectives


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Distributor Objectives

Define support needed

─ Advertising and promotion

─ Delivery

─ Support services – accounting, training, etc.

Determine reasonable performance levels


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Distributor Objectives

Specify price and quantity guarantees, any limits on price changes ─ Notice

─ Frequency

─ Amount

─ Most favored customer – but may be an issue

if there is market power – U.S. v. Blue Cross Blue Shield of Michigan (survived motion to dismiss; State then prohibited MFC in health insurance); or

If it facilitates price-fixing – U.S. v. Apple, Inc. (2d Cir. 2015)

Compensation on termination


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Exclusive or Not?

Distributors generally want exclusivity

─ Avoids competition for same products

─ Avoids free-riding

─ Allows coordinated marketing of portfolio

─ Allows focus on interbrand competition with competing brands instead of intrabrand competition


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Exclusive or Not?

Should suppliers want exclusivity? ─ Do you want distributors competing with each other

or with your competitors? On price or other metrics?

─ For commodity products, non-exclusive territories may be preferred

─ But for products requiring investment in:

Marketing and promotional events

Education and other pre-sales service

Warranty or other service

exclusivity can avoid free-rider problems that disincentivize desirable non-price competition

─ Allows coordinated marketing to national and regional chain accounts


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Scope of Agreement: Product and

Territory

Product Definition

─ Specified brands and packages

Distributors should avoid

─ All products using Trademark X

─ All products meeting defined specifications

─ All products of this supplier

Rights/obligations as to new products

─ Same TM

─ Different TM


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Territory

Restrictions on competing products: Define it! E.g., is it

─ Beverages

─ Alcoholic beverages

─ Beer

─ Imported beer

─ German beer

─ Dark beers from Germany

─ Munich Oktoberfest style beers

─ Bottled Munich Oktoberfest style beers


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Territory

Territory or Customer Restrictions

─ By geography, by category, by account

─ Transshipment restrictions

Direct and indirect

Know or have reason to believe

Kirtsaeng v. John Wiley & Sons, Inc. (Sup. Ct. 2013) First sale, even abroad, exhausts © owner’s distribution right, lawfully made goods can be imported

TM goods can be blocked if differ materially (Original Appalachian Artworks v. Granada Electronics) or foreign source is unaffiliated (Tariff Act § 526(a))

Transshipment fines – who receives?

─ National accounts

Invasion fees?


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E-Commerce Issues

Online sales by distributor

Online sales by supplier

Sales to e-commerce intermediaries (Amazon, jet.com, etc.)

─ Is distributor losing sales

─ Is distributor incurring costs re goods it did not sell? Who provides warranty service?

Who redeems empty containers for beverages

─ Can invasion fees compensate? Is online sales reporting available to calculate?

Are there other ways to estimate impact?

© 2012, 2013, 2015, 2018 Andre R. Jaglom All rights

reserved.

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Non-Compete Clauses

During term ─ In territory only or everywhere?

Post-term ─ Reasonableness

Geography

Scope of activities – define clearly!

Duration

─ Independent agreement in consideration of disclosures (bankruptcy issue), but not IP licenses (misuse issue)


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Termination Provisions

Term

─Specified or indefinite?

─Automatic renewal or not?

─Uniform termination date (risk of group leverage) or Dealer anniversary date (administrative burden)


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Cause ─ Without cause

─ Performance standards

─ Non-payment

─ Change in ownership, management or control

─ Injury to business reputation

─ Financial instability (Act before bankruptcy!)


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Notice

─Cure periods

Inventory repurchase

─Mandatory

─One party’s option

─Mutual option

─As agreed


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Compensation

─Formula Sales multiple

Profit multiple

Others

─Fair market value

─Fair compensation encourages distributor investment

─New distributor more likely to pay for rights


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FCPA Compliance

Foreign Corrupt Practices Act prohibits bribery of foreign officials, political parties, candidates

Strict liability for acts of controlled joint venture

Liability for 3rd party acts – e.g., agents, distributors – if knowledge

─ Constructive knowledge, willful blindness, deliberate ignorance


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FCPA Compliance

Take steps before, in and after contract ─Due diligence to vet potential partners

─Contract provisions Representation that have not violated

Agreement to comply – spell it out

Reporting obligations, audit rights

Subdistributors require due diligence, approval

Provisions are material, ground for termination

─Ongoing training, monitoring, audits


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Other Compliance Areas

Employment practices

─ Discrimination

─ Harassment

Advertising

─ Substantiation

─ FTC Endorsement Guidelines – Disclose connections with endorsers

Bloggers, comments on social media

Use of Intellectual Property


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Other Compliance Areas

Environmental, Health and Safety Issues

Securities Laws

Conflicts of Interest

and more…


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Indemnification

Supplier indemnification of distributor

─Breach of contract, reps, misconduct

─Breach of warranty

─Product liability

─Use of IP

─Claims of prior distributors

─Supplier’s other activities


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Indemnification

Distributor indemnification of supplier

─Breach of contract, reps, misconduct

─Product liability from modification, improper storage or handling

─Misuse of IP contrary to agreement/instructions

─Distributor’s other activities


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Indemnification

Third party claims only or all losses?

Who pays cost of defending meritless suit alleging indemnifiable claims?

Costs of recall

─ Customers may demand full retail, not just their cost or replacement product

Insurance – who must obtain?

─ Maybe both

─ Additional named insured provisions


Providing Solutions®

Thank you!

Disclaimer The information presented in this presentation does not represent legal advice, which should come from a legal

adviser with knowledge of specific facts and circumstances.

About Tannenbaum Helpern Syracuse & Hirschtritt LLP Since 1978, Tannenbaum Helpern Syracuse & Hirschtritt LLP has combined a powerful mix of insight, creativity, industry knowledge, senior talent and transaction expertise to successfully guide clients through periods of challenge and opportunity. Our mission is to deliver the highest quality legal services in a practical and efficient manner, bringing to bear the judgment, common sense and expertise of well trained, business minded lawyers. Through our commitment to service and successful results, Tannenbaum Helpern continues to earn the loyalty of our clients and a reputation for excellence. For more information, visit www.thsh.com or follow us on Twitter: @THSHLAW.

900 THIRD AVENUE, NEW YORK, NY 10022 • 212-508-6700 • WWW.THSH.COM • @THSHLAW

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Product Distribution Agreements

John M. Scannapieco Co-Chair, Global Business Team

Shareholder

Baker, Donelson, Bearman, Caldwell & Berkowitz, PC

615.726.5648 | [email protected]

Performance Obligations

• Measuring success or failure

• Metrics that match the business

• Adjustment

• Duty of Care - Ford Truck Sales, Inc. v. Sterling Truck Corp., 341 Ill. App. 3d 438 (4th Dist. 2003)

• Period for change and implementation

• Collaboration & Consensus

• Disagreement & Default

• Incentives and benefits – rebate pricing, additional territory, priority delivery

• Remedies - Default, territory loss, or loss of exclusivity

• Commercial reasonableness is a trap for judicial intervention

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Performance Obligations

• If manufacturer can send an underperforming dealer a "nasty surprise" in the form of a notice of termination, it is not impermissible to require the dealer to acknowledge the standards of performance the dealer must meet to prevent a "nasty surprise."

• Not coercion to require a dealer to sign and comply with annual reset of "expectations" or "goals.“

• The same potential outcome looms for the nonfulfillment of an addendum or an expectation: termination of the franchise, subject to commercial reasonableness

Crossroads Ford Truck Sales, Inc. v. Sterling Truck Corp., 341 Ill. App. 3d 438, 445 (4th Dist. 2003)

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Payment Plan

• Credit terms

• Security interest

• Purchase money

• Broader scope of collateral

• Consignment

• Credit enhancement

• Letter of credit

• Personal guaranty

• Floor plan floating lien

• Monitoring financial health

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Reporting Activity

Wholesale Side:

• Inventory monitoring/RFID tags

• Distributor support activity

• Warranty claims and exchanges

• Advertising activity/approvals

• Cooperative claims

• Financial statements

• Retailer census

• Display locations

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Reporting

Finance Side:

• Financial Statements

• Frequency

• Slow pay triggers

• Inventory & Accounts Financing

• Customer Invoicing and Accounts

• Lender default notices

• What triggers COD or Cash with order?

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Reporting

Retail Side:

• Retailer Data

• End User Data & Warranty Registrations

• Data Ownership & Licensing

• Privacy Rights

• Confidentiality & Use Rights

• Marketing & Pricing

• Competition

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Trademark License

• Distributors who simply resell branded and labeled goods obtained from the trademark owner do not need a trademark license . Star-Kist Foods, Inc. v. P.J. Rhodes & Company 769 F2d 1393 (9th Cir. 1985)

• Marketing use beyond mere cataloguing argues for a limited license and strict controls on use of marks

• Processing and finishing so that some variation in product quality occurs requires a license

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Trademark License

• Limited license with minimum controls

• Common identity standards for mark presentation

• Avoid “naked license” or “license in gross”

• Leads to loss of rights in mark under Lanham Act and case law

• [T]he Lanham Act places an affirmative duty upon a licensor of a registered trademark to take reasonable measures to detect and prevent misleading uses of his mark by his licensees or suffer cancellation of his federal registration. 15 U.S.C.§§ 1064, 1127

-- Dawn Donut Company v. Hart’s Food Stores, 267 F.2d 358 (2nd Cir. 1959)

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Trademark License

• Avoid conversion of a license or distributorship into franchise

• Federal Trade Commission – 16 CFR 436.1(h):

• Substantial association with mark of licensor

• Satisfied by branded product

• Substantial controls or significant assistance in marketing

• Required payment

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Trademark License

• Required Payment

• At least $570 within 6 months after signing;

• Examples:

• initial fee;

• Fee for service not based on T&M or some variable of actual cost;

• advertising program;

• equipment and supplies (including such purchases from third parties if the franchisor or its affiliate receives payment as a result of the purchase);

• training fees;

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State Laws

• General & Industry Specific laws

• Cover distributors, non-stocking distributors, retailers (dealers)

• Covered by broadly defined franchise relationship laws

• Good cause for termination and non-renewal

• Makes performance clauses imperative

• Notice of default and opportunity to cure

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State Laws

Wisconsin Fair Dealership Law 135.02(3):

− "Dealership" means any of the following:

− (a) A contract or agreement, either expressed or implied, whether oral or written, between 2 or more persons, by which a person is granted the right to sell or distribute goods or services, or use a trade name, trademark, service mark, logotype, advertising or other commercial symbol, in which there is a community of interest in the business of offering, selling or distributing goods or services at wholesale, retail, by lease, agreement or otherwise.

− “Community of interest” exists (1) when a large proportion of an alleged dealer’s revenues are derived from the dealership, and (2) when the alleged dealer has made sizable investments (in, for example, fixed assets, inventory, advertising, training) specialized in some way to the grantor’s goods or services.

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State Laws

• Wisconsin Fair Dealership Law 135.03

− No grantor, directly or through any officer, agent or employee, may terminate, cancel, fail to renew or substantially change the competitive circumstances of a dealership agreement without good cause. The burden of proving good cause is on the grantor

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State Laws


− (4) "Good cause" means:

(a) Failure by a dealer to comply substantially with essential and reasonable requirements imposed upon him by the grantor, or sought to be imposed by the grantor, which requirements are not discriminatory as compared with requirements imposed on other similarly situated dealers either by their terms or in the manner of their enforcement; or

(b) Bad faith by the dealer in carrying out the terms of the dealership.

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State Laws


− at least 90 days' prior written notice of termination, cancellation, nonrenewal or substantial change in competitive circumstances. The notice shall state all the reasons … and shall provide that the dealer has 60 days in which to rectify any claimed deficiency. If the deficiency is rectified within 60 days the notice shall be void.

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State Laws


− If a dealership is terminated by the grantor, the grantor, at the option of the dealer, shall repurchase all inventories sold by the grantor to the dealer for resale under the dealership agreement at the fair wholesale market value. This section applies only to merchandise with a name, trademark, label or other mark on it which identifies the grantor.

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State Laws

• New Jersey Franchise Practices Act NJSA 56:10-3

− a. "Franchise" means a written arrangement for a definite or indefinite period, in which a person grants to another person a license to use a trade name, trade mark, service mark, or related characteristics, and in which there is a community of interest in the marketing of goods or services at wholesale, retail, by lease, agreement, or otherwise.

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State Laws

• New Jersey Act applies to Distributorships

• Instructional Systems, Inc. v. Computer Curriculum Corp., 614 A.2d 124 (N.J. 1992)

• Brand specific investments produce a community of interest

• Cooper Distributing Co., Inc. v. Amana Refrigeration, 63 F.3d 262 (3d Cir. 1995)

• California Franchise Relations Act held to apply to distributor required to buy an “ample stock” of product

• H.C. Duke & Son, LLC v. Prism Marketing Corp., 2013 WL 5460209 (C.D. Il. 2013)

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State Laws: General Distribution Relationship Laws

• Arkansas

• California

• Connecticut

• Delaware

• Hawaii

• Idaho

• Illinois

• Indiana

• Iowa

• Michigan

• Minnesota

• Mississippi

• Missouri

• Nebraska

• New Jersey

• South Dakota

• Virginia

• Washington

• Wisconsin

• Puerto Rico

• Virgin Islands

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State Laws: Industry Specific

• Motor vehicles

• Gasoline

• Farm Equipment

• Construction Equipment

• Electrical Equipment

• Liquor & Beer

• Recreational Vehicles & Boats

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Dispute Resolution

• Choice of law

• Home state v. neutral state

• Consistency of interpretation

• Statutes are fundamental public policy

• Forum Selection & Venue

• Home office jurisdiction

• What about relocation?

• Exclusive v. non-exclusive personal jurisdiction

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Dispute Resolution

• Internal Appeals Procedure

• Senior Management Meeting

• Mediation

• Arbitration

• Arbitrator Qualification

• Select Commercial Rules

• Bet the company on a single arbitrator with no right to appeal on the merits?

• Private record

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Dual Distribution Perils

• Sleepy’s LLC v. Select Comfort, 779 F.3d 191 (2nd Cir. 2015)

• Dual distributor secret shopped company stores of manufacturer

• Sales people disparaged dealer stores after expiration during holdover period

• Troubled relationship with “hostile conduct”

• dealer terminated and filed suit for breach

• bench trial found for manufacturer

• 2nd Circuit reversed

• Expiration ≠ Termination

• Conduct can extend term

• Puffery can be slanderous if pattern and practice of disparaging comments

Agreement Checklist

• Parties

• Appointment

• Territory/Channel

• Product Scope/Exclusions

• Exclusivity

• Reserved Rights

• Customer Definitions/limitations

• Term & Renewal

• Non-competes: in-term/post-term

• Performance Standards

• Supplier Support

• Distributor Obligations

• Order Documents/ Process/Forecasts

• Pricing, Payment & Security

• Reporting

• Product Warranties

• Service Obligations

• Returns and Recalls

• Indemnities

• Insurance

• Intellectual Property/Licenses

• Internet Parameters

• Customer Data

• Brand Migration

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Agreement Checklist

• Termination Rights

• Post-termination process

• Inventory buyback/sellback

• Purchase rights & options

• Post-term service

• Assignments

• Reps, Warranties, Covenants

• Relationship Limits

• Choice of law

• Dispute resolution

• Waiver Limits

• Confidentiality

• Amendments & Unilateral Rights

• Integration

• Severability

• Counterparts

• Third Party Beneficiaries

• Notices

• Language

• FCPA/OFAC

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Thank You

John M. Scannapieco Co-Chair, Global Business Team

Shareholder

Baker, Donelson, Bearman, Caldwell & Berkowitz, PC

615.726.5648 | [email protected]

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