Distribution, Competition, and Antitrust / Intellectual Property (IP) Law

Selling Direct to End-Users Does Not Equal Unfair Competition

So the court held in Weco Supply Co., Inc. v. The Sherwin-Williams Co., No. 1:10-CV-00171 AWI BAM (E.D. Cal. May 25, 2012) (Ishii, J.).

The plaintiff, a “jobber” (i.e., a non-exclusive distributor), complained when its supplier began selling directly to its end-user customers. (The supplier argued it did so to preserve the end-users’ business after the distributor began offering other manufacturers’ products.)

The court held that although Sherwin-Williams’ conduct undoubtedly harmed Weco’s commercial interests, a factfinder could not reasonably find that Sherwin-Williams engaged in “unfair competition” under the California Supreme Court’s Cel-Tech standard. Weco presented no evidence tending to show that Sherwin-Williams’ conduct raised the price to consumers, harmed allocative efficiency, or diminished the quality of paint sold. In fact, prices offered by Sherwin-Williams to end-users were lower than the prices offered by Weco. (Nevertheless, Sherwin-Williams’ sales to the end-users were profitable.)

In short, there’s nothing unfair about a manufacturer selling directly to customers in competition with its distributor.  Of course, contractual rights, if they exist, can give rise to particular supplier obligations.

Can My Supplier Refuse to Sell Products to Me?

Supply Chain

Wholesalers, distributors, and retailers are dependent upon their suppliers for a supply of products. What happens when your supplier decides it no longer wants to deal with you? Is that lawful?

The answer, of course, depends on the facts. Let’s break the question down into various possibilities. The main dividing line is between unilateral actions by the supplier and “concerted” actions (that is, actions in furtherance of an agreement or understanding with other firms or companies).

I’ll cover basic competition law here; keep in mind that you may also have contract or promissory estoppel claims.

Unilateral action

If your supplier decides all by itself that it no longer wants to do business with you, it is generally within its rights to do so under the competition laws if it does not have “market power.” The concept of market power can become technically complicated, but it essentially means the power to raise prices above competitive levels for some significant period of time. Market power may not be immediately obvious, so we often use market share as a simple proxy for market power, at least to obtain a quick sense of the situation.

So how does this work in practice? If you are buying widgets, your supplier accounts for 90% of the widget market, and it suddenly decides to stop selling to you, it is possible you are looking at an anti-competitive action that might violate the special rules that apply to monopolists or would-be monopolists. You would have to develop more facts to assess the strength of any such argument.

If your supplier’s market share is less than 40%, it is very unlikely that you have such a claim. Above 60% to 70%, you may, and in between 40% and 60% is a bit of a grey area (although some courts have held that certain percentages in this range either are, or are not, sufficient). Details of the market structure (are there significant barriers to entry? are there significant barriers to other firms’ expansion?) may be important.

Just because your supplier has market power and has terminated you, however, does not necessarily mean that you have a good claim. You would still need to prove that the termination has harmed competition; harm to your business is not by itself enough. For example, all things being equal, the termination of one of many distributors may not be competitively significant. On the other hand, if a supplier terminates all distributors that carry products of the supplier’s competitor – and the supplier has market power – then a claim is in theory possible. But again, proving harm to competition can require a detailed understanding of the marketplace and the distribution system.

Lacking market power, however, a supplier generally has the right to do business with whom it pleases. That’s the “American way.”

Concerted action

What if your supplier terminates you because your competitors complain to the supplier? For example, they might complain that your pricing is “too low” and is hurting the market or their business.

The central principle remains that a supplier can do business with whom it likes. It can terminate a distributor for pricing reasons – even if it has previously received complaints from other distributors. Such a sequence of events is not by itself sufficient to establish an unlawful agreement or concerted action.

But if there is evidence of an actual agreement between a supplier and some distributors to terminate another price-cutting distributor in order to raise, maintain, or stabilize pricing, such an agreement may be illegal. Developing the evidence of such an agreement in order to establish something more than dealer complaints followed by a termination can be challenging, but it is not impossible.

Concerted action involving multiple suppliers can also pose competition law issues. Such an agreement may amount to a “group boycott” that could be challenged under federal or state antitrust law.

Summary

Most supplier terminations are entirely lawful. But occasionally some cross the line, either because the supplier has market power and the supplier is exercising it to harm competition, or because the supplier has agreed with other firms to terminate a price-cutting distributor. In such cases, a careful analysis of the facts is required.

Even the Girl Scouts Can Violate Fair Dealership Laws

In a very interesting opinion, Judge Posner of the Seventh Circuit last week ruled that the Girl Scouts could violate Wisconsin’s Fair Dealership Law, and that they were not immune to that law’s reach by virtue of the First Amendment.  See Girl Scouts of Manitou Council, Inc. v. Girl Scouts of the United States of America, Inc., No. 10-1986 (7th Cir. May 31, 2011).

The national Girl Scouts organization granted exclusive territories to some 300 local “councils.”  Each council was authorized to sell Girl Scouts cookies and other merchandise under the Girl Scout trademark.  The councils earned income from the sales of cookies and merchandise, as well as from charitable donations, and paid membership fees to the national organization.  The national organization concluded that there were too many councils, and so decided to dissolve the Manitou Council and reallocate its entire territory to other councils.  This plan would not have put the Manitou Council out of business per se, but it would have precluded it from using the Girl Scout trademark or representing itself as a Girl Scout organization.

The Manitou Council sought a preliminary injunction to prevent its exclusive territory from being dissolved.  It lost in the district court, but that decision was reversed in the Seventh Circuit in 2007.  Later, the district court granted the national organization summary judgment, reasoning that to apply the Fair Dealership Law to the national organization would violate the organization’s freedom of expression guaranteed by the First Amendment to the United States Constitution.

The Seventh Circuit disagreed.  The Wisconsin Fair Dealership Law is a state law of general applicability with only a remote, hypothetical impact on the organization’s message.  Originally, the national organization justified its reorganization plan on the basis that it would improve marketing of cookies, exploit economies of scale, and promote effective fundraising.  These justifications did not directly implicate First Amendment concerns.  On appeal, the national organization emphasized a goal of increasing the racial and ethnic diversity of the Girl Scouts (picking up on the district court’s First Amendment reasoning).  However, the Seventh Circuit found no evidence of a connection between realignment of the councils and the promotion of diversity.  “How changing the territorial boundaries would increase the recruitment of girls from minority groups is nowhere shown.”  The possibility that a law of general application might indirectly and unintentionally impede an organization’s efforts to communicate its message effectively cannot be enough to condemn the law.

The Seventh Circuit also addressed several arguments relating to the Fair Dealership Law itself.  First, the court rejected the argument that the statute is inapplicable to nonprofit entities.  “No gulf separates the profit from the nonprofit sectors of the American economy.”  The principal objective of dealer protection laws is to prevent franchisors from appropriating good will created by their dealers.  That concern is applicable to nonprofit enterprises that enter dealership agreements.

Second, the Seventh Circuit rejected the national organization’s argument that its alteration of the Manitou Council’s territory did not change the competitive circumstances of the dealership agreement.  “Altering a franchisee’s territorial boundaries can have the same effect as opening new stores in his territory; the narrower those boundaries, the less protection the franchisee has against competition from other franchisees.  But when as in this case the franchisor, though authorized to alter boundaries, attempts to use that authority to terminate the franchise altogether, he runs up against the provision of the Wisconsin act that requires ‘good cause’ to cancel a dealership.  Wis. Stat. § 135.03.”  Although the franchisor’s goal of increasing sales constitutes “good cause” under various franchise laws, the national organization rested its good-cause argument on the proposition that realignment was necessary to its expressive activity – an argument that the Court had already rejected.  “The purpose of the realignment remains an enigma; like many corporate and governmental reorganizations, it may reflect internal bureaucratic pressures unrelated to the organization’s professed legitimate concerns.”

* * *

So what is the take-away from the Seventh Circuit’s decision? I think there are four fundamental points.

First, state franchise statutes and fair dealership laws can have wide application – sometimes much wider than you might think.  They can even apply, for example, to the distribution of Girl Scout cookies.

Second, courts are not very receptive to the argument that nonprofits are exempt from the reach of these statutes.

Third, creative arguments – such as application of one of these statutes would interfere with First Amendment rights – must be backed up by actual (and probably compelling) evidence, otherwise they will be easily dismissed.

And fourth, franchisors’ significant decisions that may effectively amount to a de facto termination should be supported by solid, and adequately documented, business reasons.

Special Franchise Statutes

Franchise relationships can be subject to various special statutes. One such statute is the Petroleum Marketing Practices Act (PMPA), 15 U.S.C. §§ 2801, et seq.  Unsurprisingly, the PMPA applies to gasoline stations.  Among other things, it prohibits gasoline refiners and distributors from terminating, or failing to renew, franchises absent the fulfillment of certain conditions, and unless one or more enumerated grounds for termination or non-renewal is met.

Of course, if a franchisee is offered and signs a renewed franchise agreement, the franchisee probably cannot maintain a claim for unlawful renewal under the PMPA.  See Poquez v. Suncor Holdings-CPOII, LLC, N.D. Cal., No. 3:11-cv-328-SC (5/26/11) (no public link available yet).

Bottom line, make certain you understand what statutes apply to your business relationship, and whether actions you have taken allow you to establish, or preclude you from establishing, elements of statutory claims.

If you’re going to defend a manufactuer’s charge that you’ve materially breached a dealership agreement . . . .

Make sure you haven’t seriously underperformed your peers and your prior distributors, according to the express terms of your dealership agreement.

Don’t Forget About State Fair Dealership Laws

Many states have “fair dealership laws.”  These laws can trigger special duties for suppliers or manufacturers and can support claims by dealers.

But it’s not always easy for a dealer to establish that one of these laws applies.  In a recent decision, the court dismissed a claim under the Wisconsin Fair Dealership Law.  See Stucchi USA, Inc. v. Hyquip, Inc., Case No. 09-CV-732 (E.D. Wis. Apr. 20, 2011).

This decision is also interesting in its dismissal of a breach of contract claim (alleged breach of an oral agreement to appoint a distributor as an exclusive distributor).  “Unfortunately for [the distributor], the June 18, 2009 termination did not constitute a breach of contract on the part of the Stucchi companies because the right to terminate at will was inherent in the nature of the contract, due to the contract’s indefinite duration.”  Distributors wanting to avoid the same fate will want to point to a definite term.

 

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