Many situations arise that may necessitate a company terminating one, some, or all of the companies that distribute its products to end-users. For example, you may be looking to sell a division or product line to a purchaser with its own distribution network, or the company's business strategy may involve moving away from brick-and-mortar sellers to online sales, or moving to a captive distribution system. In the United States, the termination of a dealer potentially raises a whole host of legal issues and may expose the terminating supplier to liability under many different legal theories.

This article sets forth a checklist in-house counsel can consult when faced with a dealer-termination scenario. This brief article necessarily is not comprehensive (depending on what jurisdiction(s) you are in, there may be other potential sources of risk), but it provides a framework for spotting issues.

What does the distribution agreement say? Obviously, the contract provides the starting point for assessing the limits and conditions on your right to end the relationship. Before going any further, be sure to understand whether the contract provides for: a notice period; the right of the distributor to cure a breach; the right of the distributor to continuing purchasing product during the notice period (if so, on what terms?); and whether you are required to repurchase the dealer's inventory. Also be sure to consult the agreement's choice of law clause. As explained below, some states' laws may override supplier-friendly contractual provisions.

Will the distributor be able to enforce oral or written promises? You may be surprised to discover that, in addition to the terms of the distribution agreement, you have obligations as the result of representations made to the dealer—either when negotiating the contract itself or after it was executed. Potential sources of liability include the doctrines of promissory estoppel/detrimental reliance or equitable estoppel. Although it may be difficult for a dealer to enforce a promise made during negotiation of a fully integrated contract unless it can establish fraud in the inducement (Kreutzer v. Monterey County Herald, 747 A.2d 358 (Pa. 2000), if the contract is not fully integrated, the dealer may be able to introduce and enforce parol evidence of preliminary representations, as in, DiPalma v. LaLiberte, 1996 WL 480729 (E.D. Pa. Aug. 16, 1996). Oral representations made after the contract was executed may be easier for the dealer to enforce, even if the contract provides that modifications must be made in writing. Carlos R. Leffler v. Hutter, 696 A.2d 157 (Pa. Super. 1997); In re Spagnol Enterprises, 81 B.R. 337 (Bankr. W.D. Pa. 1987) (the modification must be established by precise and convincing evidence); Empire Properties v. Equireal, 674 A.2d 297 (Pa. Super. 1996) (the dealer must show the parties clearly intended to waive the “no oral modifications” provision).

Will the dealer be able to take advance of a state's dealer termination or franchise statute? Although Pennsylvania has statutes that regulate the termination of dealers and distributorships in specific industries (e.g., gasoline service stations, agricultural equipment, vehicles and trailers, malt beverages), Pennsylvania does not have a statute of general applicability governing the termination of dealers. However, other states do have such statutes (e.g., Idaho, Wisconsin and Puerto Rico prohibit a supplier from terminating a dealer except for “just cause” or “good cause”). If the distributor sells products in many states and if the contract does not contain a choice of law clause, be sure to evaluate the likelihood that the distributor could invoke rights under a statute of a distributor-friendly state. And, of course, if the distributor sells outside of the United States, you will want to assess its (and your) rights and obligations under the operative foreign law.

You also need to ascertain whether the distributor could invoke rights as a franchisee. Courts may find that a relationship is a franchisor/franchisee relationship even if the parties described the arrangement otherwise, as in Wilderness Inc. of Maryland v. Commonwealth, 427 A.2d 1235 (Pa. Commw. 1981) (a franchise may exist if the parties' conduct “conforms in actual practice to that of a franchise relationship”); Atlantic Richfield v. Razumic, 390 A.2d 736 (Pa. 1978) (a purported “lease” by a gasoline supplier to a service station operator was a franchise agreement); Bush v. National School Studios, 407 N.W.2d 883 (Wis. 1987) (“courts should not focus solely on identifying tell-tale trappings of the traditional franchise; rather, courts should consider the overriding principle of whether the business' status is dependent upon the relationship with the grantor for its economic livelihood”). This is important because most state franchise statutes require “good cause” for termination or nonrenewal of a franchise relationship.

Also keep in mind that the factors for determining whether a relationship is an “accidental” franchise vary from state to state, see Cooper Distribution v. Amana Refrigeration, 63 F.3d 262 (3d Cir. 1995) (an exclusive regional distributor was a franchisee under New Jersey's statute where it made substantial franchise-specific investments that created franchise-specific goodwill); Bly & Sons v. Ethan Allen Interiors, 2006 WL 2547202, *3 (S.D. Ill. Sept. 1, 2006) (a furniture distributor's relationship with a store owner was a franchise under the Illinois statute because the dealer was charged an indirect franchise fee, namely, a 2 percent advertising contribution); Petereit v. S.B. Thomas, 63 F.3d 1169 (2d Cir. 1995) (route distributors for a baked goods manufacturer were franchisees under the Connecticut statute due to the amount of control the manufacturer exerted over their operations, including control over prices, promotions and discounts, product placement, and performance standards and procedures).

Are you under a common law requirement to have “good cause” before terminating? Even in the absence of a statute requiring good cause for termination or nonrenewal, the common law may impose an obligation for you to deal with the dealer in good faith and in a commercially reasonable manner. However, a common law duty should not (at least in Pennsylvania) either override the express terms of an agreement or create an independent duty that is divorced from the specific terms of the agreement. Again, if you determine that it is possible that the dealer will be able to take advantage of other states' laws, you need to research whether and to what extent that state implies a common law duty of good faith and fair dealing in the supplier-distributor context.

When evaluating the operative statutes and common law doctrines, look at (among other things): Whether you have an obligation to give the dealer an opportunity to cure the defects in its performance, and whether there is a statutory notice period under, e.g., a dealer or franchise practices statute or the UCC. For example, 13 Pa. C.S. ¶ 2309(c) provides that “termination of a contract by one party except on the happening of an agreed event requires that reasonable notification be received by the other party and an agreement dispensing with notification is invalid if its operation would be unconscionable.”

Does the termination raise antitrust concerns? You also need to evaluate whether the termination of the dealer could expose your company to liability under federal or state antitrust laws. For example, will the dealer be able to establish that competing dealers influenced (or participated in) your termination decision? Might the dealer be able to credibly allege that it was terminated because it refused to charge your company's suggested resale prices or engaged in (or refused to engage in) other pricing practices? Has the dealer been singled out for less-preferential treatment than other similarly situated dealers? Here, as always, it is important to know what's in the file: What are the business people saying among themselves? Have they been discussing the termination with other current or potential dealers?

What is the likelihood the dealer will sue? In addition to evaluating your company's legal risks, you also need to assess the practical likelihood that the dealer will pursue damages or injunctive relief. In assessing that risk, consider the business realities of the situation: What volume of business does the dealer do with you? Are orders trending upward or downward? How longstanding is the relationship? Is the dealer exclusive or nonexclusive? What percentage of the dealer's business does your company's products represent? Does the dealer have access to another source of products? Is the notice period long enough to give the dealer time to contract with another supplier? Does the dealer have extensive inventory of your products?

The termination of even one distributor is a significant decision. As in-house counsel, you need to be sure the workforce understands the importance of involving the legal department in that decision before a dealer is terminated. And, as with many things in the law, the devil is in the details. Before approving a termination of a major distributor, a longstanding distributor, or a distributor that views your company as critically important to its business, review the files, check the emails, consult key personnel who interact with the distributor, and, of course, research the law. The investment of time and effort up-front can ensure that the termination process is handled in a reasonable, even-handed way that minimizes the prospect of litigation.

Donna M. Doblick is a litigator with Reed Smith in Pittsburgh. She has more than 25 years' experience litigating many types of complex and high-stakes commercial disputes, defending class actions, advising on supplier-dealer issues, and handling post-trial motions and appeals. Doblick also is pursuing her LLM in compliance studies at Loyola University of Chicago. Contact her at [email protected]