USA – Commercial Agency Agreement

21 9 月 2017

美国

分销协议

The interplay between federal and state statutory and common law in the US legal system is important to understanding the regulation of franchise agreements in the US. However, contrary to the US state law governing commercial agency and distribution agreements, franchise arrangements in the US are regulated at the federal and state levels. At the federal level, franchise arrangements are regulated by the US Federal Trade Commission (“FTC”) under the so called “FTC Franchise Rule,” while at the state level franchise arrangements are typically regulated by state agencies. In New York, franchise arrangements are regulated by the New York Antitrust Bureau under New York’s General Business Law. The FTC Franchise Rule applies everywhere in the US, while generally state franchise legislation requires contact with the state (e.g., the offer or sale of the franchise be made in the state, the franchised business be located in the state or the franchisor or the franchisee be a resident of the state).

Franchise law and regulation also provides, to some degree, an exception to the general freedom of contract doctrine that underlies US state law on contracts, as these relationships are subject to significantly greater regulation than commercial agency and exclusive distribution arrangements. Indeed, under so-called relationship laws (discussed below), some US states impose certain mandatory commercial terms, usually relating to notice periods and grounds for termination, on the franchise relationship. More commonly, federal and state franchise laws require that the franchisor provide the franchisee with extensive disclosure with respect to the key elements of the proposed franchise and/or effect certain registration filings with respect to the franchise. This greater degree of regulation at the state and federal levels is based on the view that the franchisee in a franchisor-franchisee relationship requires greater protection than parties to commercial agreements generally, owing to disparities in experience, sophistication and resources between franchisor and franchisee.

Under the FTC Franchise Rule, a franchise exists if the following elements exist: (i) the franchisee is given the right to distribute goods and services that bear the franchisor’s trademark, service mark, trade name, logo or other commercial symbol; (ii) the franchisor has significant control of, or provides significance to, the franchisee’s method of operation; and (iii) the franchisee is required to pay the franchisor (or an affiliate of the franchisor) at least US$USD 500 before (or within six6 months after) opening for business. Whether the control element in (ii) is satisfied will depend on such factors as whether the franchisor must approve the site, whether the franchisee is subject to requirements for site design and appearance, hours of operation, production techniques, accounting practices and promotional or training activities. In relationships that purport to be trademark licenses rather than franchises, licensors often require that a licensee agree to limit its use of a mark to a certain quality or type of goods and provide the licensor with the right to inspect the quality of the goods and services offered under the licensor’s trademark, as the FTC does not consider trademark control designed solely to protect the trademark owner’s rights to constitute the “significant” control necessary to find a franchise. As typically this control element (ii) is found to exist, often franchisors seek to avoid regulation as a franchise by seeking to avoid the existence of the “fee” element in (iii). A court may look at a host of payment obligations from franchisee to franchisor to see whether a so-called “hidden” franchise fee exists, including actual up-front fees, training fees, payments for services and payments from the sale of products (unless reasonable amounts are sold at bona fide wholesale prices). Many states have adopted the FTC Franchise Rule’s definition of a franchise, or variations of it. In New York, a franchise is deemed to exist if only the first and third (trademark grant and franchise fee) are found to exist. The majority of other states, including California, require the same two elements as well as a so-called “marketing plan” element, under which the franchisee is granted the right to engage in the offering, selling or distribution of goods or services under a marketing plan or system substantially prescribed by the franchisor.

If a franchise is deemed to exist under the FTC Franchise Rule or under state law (and an exemption under such law is unavailable), the franchisor is required to comply with requirements that generally fall into three categories: disclosure laws, registration laws and relationship laws. Disclosure and registration laws are pre-sale laws that govern the franchisor’s conduct in making the franchise sale (including, in the former case, the obligation to provide an extensive disclosure document), while relationship laws govern the terms of the relationship between franchisee and franchisor after the parties have begun their contractual relationship (e.g., notice periods and grounds for termination).

Formalities (registration, etc.)

Registration laws like disclosure laws are pre-sale laws. There is no federal registration requirement. However, fourteen US states have registration laws (including California and New York). In the remainder of states, franchisors that comply with the Franchise Rule’s disclosure requirements can sell in states that do not require registration without having to file their document with any governmental authority.

Under most state registration laws, a franchisor must: (i) register in the jurisdiction before offering to sell or selling franchises in the jurisdiction by filing its FDD (or FOP), plus various application forms with the jurisdiction’s applicable regulatory agency, and (ii) update or renew its registration annually. The typical consequences for failing to register are that a franchisor will not be able to offer to sell or sell a franchise in the registration jurisdiction. As of 2016, franchise registration initial filing fees range from USD $250 (Hawaii, Michigan, North Dakota and South Dakota) to USD$ 750 (New York).

Sub-franchisee

There are two typical structures for franchise agreements: (i) a one tier structure consisting of a franchise agreement between a franchisor and a franchisee, or (ii) or a two-tier structure through a master franchise agreement where the franchisor grants the right and imposes a duty on a franchisee to operate the franchise itself within a particular territory, and to grant sub-franchises to third parties within that territory.

Sub-franchisors are subject to the same disclosure rules indicated above. However, in New York when the person filing the application for registration of FOP is a sub-franchisor, the FOP shall also include the same information concerning the sub-franchisor as is required from the FOP of the franchisor.

Rights and Obligations of the Franchisee

Fees and Royalties: under a typical franchise arrangement the franchisee is required to pay the franchisor an up-front franchise fee and royalties over time, in order to join the franchise network. Franchise fees can be large with a substantial profit element, or smaller (and linked to franchisee start-up costs) to assist the franchisee to set up the franchise in a target territory. Because a franchise fee is a requirement under the FTC Franchise Rule and the laws of many states in order for a franchise to be deemed to exist, there is considerable jurisprudence on the question of what is considered to be a “franchise fee” for these purposes, typically in cases in which the franchisor seeks to avoid regulation as a franchise for lack of the existence of this element. While traditional royalties for the sale of the product or service offered are not considered to constitute a “franchise fee,”, certain required payments for rent, advertising contributions, training, equipment, software and copies of manuals may.
Marketing: typically a franchisee is required by the provisions of a franchise agreement to undertake advertising of the products in strict accordance with the franchisor’s instructions. A franchisor normally is prohibited from carrying out advertisement and promotional activities in a manner that could harm the franchisor’s brand or is inconsistent with the franchisor’s other advertising efforts.
Compliance with the franchisor’s standards: maintenance of consistent appearance, operations and array of products and services across multiple franchises is a hallmark of franchise arrangements in the US Most franchise agreements require that franchisees strictly abide by specifications, standards and operating procedures, each of which is built into the agreements. Given the difficulty of providing for all of these standards in a franchise agreement, many franchise agreements afford franchisors the right periodically to modify and increase the applicable specifications, standards (e.g., accounting, record-keeping and reporting requirements, as explained below) and operating procedures, usually by providing updates to the base operating manual.

Rights and Obligations of the Franchisor

Communication of know-how: initial know-how that may be communicated from franchisor to franchisee often relates to the specifications, standards and operating procedures that relate to the products to be sold and related site that are built into franchise agreements, as discussed above.
Ownership of improvements and modifications: franchise agreements typically contain acknowledgement by the franchisee that the trademark (and intellectual property generally) licensed under the franchise agreement and all related goodwill are property of the owner of the trademark (usually the franchisor). Therefore, all improvements to such intellectual property are property of the licensor. In this regard, we note that it is typical for a franchise agreement to prohibit any modification of franchisor intellectual property.
Assistance to the benefit of the franchisee: there are no statutory obligations on the federal and state level for initial or continuing assistance by the franchisor for the benefit of the franchisee. As in other cases, such an obligation can be provided for contractually in the franchise agreement.

Undertaking not to compete (by franchisee)

In most states, the courts have not expressly distinguished between non-compete covenants that apply during the existence of the franchise agreement and those that apply after its expiration or termination. Where the courts have made this distinction, they have applied more lenient standards toward in-term covenants in contrast to those that apply after termination. With respect to such provisions that apply to the post termination period, most courts evaluate their reasonableness in terms of duration, geographic scope and activities prohibited. On duration, post-term covenants of one to two years have generally been deemed to be reasonable in the franchise context. Regarding geographic scope, post-term covenants limited to the area of operation of the franchise have also generally been deemed reasonable. However, post-term covenants are sometimes drafted to prohibit competition with other franchised or company owned locations or in what is called a “buffer” zone outside the franchise’s area of operation. In such cases, some state courts have been willing to enforce post-term covenants with these broader types of geographic scope, while other state courts have not.

In some states, statutory provisions govern the enforceability of restrictive covenants. A notable example is California, whose statute of general applicability voids any post-term covenant not to compete unless specifically exempted by the statute. The statute contains no exemption for franchise agreements. However, the California courts have held that a franchisor may nevertheless enforce post-term obligations not to use its confidential know-how and not to solicit persons who were customers of the franchise. In contrast, in New York, courts generally uphold post-termination non-compete agreements if they protect trade secrets, customer lists or some another legitimate business interest. States differ in their approach to restrictive covenants that are found to be too broad and unenforceable as written. In a few states, if a covenant is deemed to be too broad it will not be enforced at all. Other states (including New York) take a “blue pencil” approach, under which the court will amend the provision in order to make it enforceable.

To understand the regulation of commercial agency agreements in the US, it is helpful to remember the interplay between federal and state statutory and common law in the US legal system. Under the US Constitution, all power not specifically reserved for the federal government resides with the states. Federal law has exclusive jurisdiction only over certain types of cases (e.g., those involving federal laws, controversies between states and cases involving foreign governments), and share jurisdiction with the state courts in certain other areas (e.g., cases involving parties that reside in different states). In the vast majority of cases, however, state law has exclusive jurisdiction.

Commercial agency is regulated at the state level rather than by US federal law. Almost two-thirds of the US states have adopted specific legislation for commercial agency relationships with non-employees. Most state statutes regulating commercial agency relate to the relationship between a principal and an agent that solicits orders for the purchase of the principal’s products, mainly in wholesale rather than retail transactions (although state law often has special rules for agency relationships with respect to real estate transactions and insurance policies). Typically, state law in this area follows the common law definition of agency, which imputes a fiduciary duty upon the agent for the benefit of the principal to act on the principal’s behalf and subject to the principal’s control.

A second, overarching theme of note to understand the regulation of commercial agency agreements in the US is the primary importance of the doctrine of freedom of contract under state law jurisprudence. As the doctrine’s title suggests, as a matter of policy, courts interpreting a contract generally will seek to respect its terms. Exceptions exist where public policy requires otherwise (e.g., in the consumer or investor context, in cases of adherence contracts or where unconscionable terms are found to exist). As a result, state law generally contain few mandatory, substantive terms that are superimposed on the relationship between principal and agent in an agency arrangement. With certain exceptions (i.e., under certain state franchise regulation where the relationship is deemed to be a franchise under such law), the parties are generally free to contract as they wish in areas ranging from terms of payment to risk allocation to other commercial terms.

General Legal Provisions Applicable to Agency Agreements

As noted, commercial agency is mostly regulated at the state level in the US State laws on agency mainly address commissioned agency, and, where in force, is primarily aimed at ensuring that the principal timely pays the agent the commissions that are owed by imposing liability on the principal for a multiple (often two to four times) of unpaid commissions, as well as for reimbursement of the agent’s attorneys’ fees and costs incurred in collecting the unpaid amount. Other states further require that agency agreements satisfy certain formalities, including that they be in writing (under the so-called “Statute of Frauds” in force in most states) and that they contain specified information (i.e., how earned commissions will be calculated). A minority of states further impose substantive requirements, such as a minimum notice period for termination, the obligation to payment commissions on certain post-term shipments or those in process at expiration or termination of the agency agreement.

Formalities for the Creation of an Agency

New York law does not impose particular formalities for the creation of an agency relationship. In fact, under New York law, absent circumstances under which New York’s general Statute of Frauds rules apply as set forth in § 5-701 of the General Obligations Law, parties may be deemed to be in an agency relationship even without signing an agreement evidencing the agreement consideration or any writing which evidences their agreement. New York law does regulate the payment of sales commissions under New York labor law. New York labor law defines a sales representative as an independent contractor who solicits orders in New York for the wholesale purchase of a supplier’s product or is compensated entirely or partly by commission. However, New York labor law does not otherwise regulate meaningfully the actual sales representative relationship.

Agency Elements and Purpose

Under the law of New York and the majority of states, an “agent” is a person or entity who, by agreement with another called the “principal,” represents the principal in dealings with third persons or transacts business, manages some affair or does some service for the principal. The key elements of an agency are: (i) mutual consent of the parties; (ii) the agent’s fiduciary duties, and (iii) the principal’s control over the agent. A principal may act on a disclosed, undisclosed, or partially disclosed basis in dealing with third parties.

The purpose of an agency may be broadly defined, and ultimately a principal may appoint an agent to perform any act except those which by their nature require personal performance by the principal, violate public policy or are illegal.

A defining element of agency under New York law and the law of the majority of states is the principal’s control over the agent. Indeed, whether the principal will be bound by the agent’s acts will depend, in large part, on whether the agent had actual or apparent authority to act on behalf of the principal. Separate from the question whether an agent’s acts bind the principal is the question whether the agent’s actions create a permanent establishment of the principal under applicable rules of taxation and/or an employer-employee relationship under applicable employment law in the agent’s jurisdiction, thereby potentially subjecting the principal to onerous state and federal tax and employment law obligations.

Factors taken into account in whether the relationship could give rise to a permanent establishment include, among others, the degree to which the agent has the authority to bind the principal and whether the agent carries out a material portion of contract negotiation ultimately signed by the principal. Two of the many factors taken into account in determining whether such a relationship could be characterized as one of employment include whether the agent: (i) provides the services according to her own methods and (ii) is subject to the control of the principal (other than with respect to the results of the agent’s work). Both analyses are specific to fact and circumstances.

Appointment of Sub-agents

Under New York law and the law of the majority of states, a principal may authorize an agent to appoint another agent to act on the principal’s behalf. The second agent may be a subagent or a co-agent. A “subagent” is commonly defined as a person appointed by an agent to perform functions that the agent has consented to perform on behalf of the agent’s principal and for whose conduct the appointing agent is responsible to the principal. Thus, an agent who appoints a subagent delegates to the subagent power to act on behalf of the principal that the principal has conferred on the agent. Appointment of a subagent requires that the appointing agent have actual or apparent authority to do so, and it may be inferred in certain circumstances. As an example, in one case from New York, a claims adjuster hired by an insurance company (acting as agent of the insured) was held to be a subagent of the insured because it was common practice for insurance companies to retain adjusters to aid them to pursue insurance investigations.

With respect to subagents, we note that the relationship between an appointing agent and a subagent is also one of agency. A subagent acts subject to the control of the appointing agent, and the principal’s legal position is affected by action taken by the subagent as if the action had been taken by the appointing agent. As such, in most states, a subagent typically has two principals: the appointing agent and that agent’s principal. In New York and a limited number of other states, by contrast, the agency relation does not exist between the principal and a subagent. Under New York law, a subagent that has been appointed with proper authority will owe the principal the same duties as would the agent; however, for the subagent to have a fiduciary duty to that principal, the subagent must be aware of the identity of the ultimate principal. An agent may appoint a subagent only if the agent has actual or apparent authority to do so.

Rights and Obligations of the Agent

Generally, the following are the most important duties of the agent under state common law:

Agent must not act outside of its express and implied authority.
Agent must use care, competence and diligence in acting for the principal.
Agent must obey the principal’s instructions as long as they are legal.
Agent must avoid conduct which will damage the principal’s business.
Agent must not act for an adverse party to a transaction with the principal.
Agent cannot compete with the principal in the same business in which the agent acts in such capacity for the principal without the principal’s consent.
Agent must provide the principal with information relevant to the marketing of the principal’s products.
Agent must separate, account for and remit to the principal all collections for the principal’s account and other property of the principal.
Agent must not receive compensation from any third party in connection with transactions or actions on which the agent is acting on behalf of the principal.
Agent must maintain the confidentiality of, and not misuse, the principal’s confidential information.

The agent is subject to a general duty of good faith in the performance of its responsibilities and dealings carried out on behalf of the principal under an agency agreement. However, the agent’s duty generally will not override the specific terms provided for in the agreement between the parties. Under New York law, the agent owes the principal duties of loyalty, obedience and care. Under these duties, an agent cannot have interests in a transaction that is adverse to its principal (e.g., self-dealing or secret profits), the agent must obey all reasonable directions of the principal and the agent must carry out its agency with reasonable care (which includes a duty to notify the principal of all matters that come to the agent’s knowledge affecting the subject of the agency).

Rights and Obligations of the Principal

The following are the most important duties of the principal under state common law:

Principals must promptly pay terminated agents the commissions that they are owed; in most states, failure to pay can result in penalties, including multiple-damages. Some states apply similar penalties to failures to pay commissions in a timely fashion during the term of the relationship; in contrast, a few states require that a commission be paid on transactions in the pipeline at the time of termination.
Under the law of some states, an agency arrangement must be in writing, and certain formalities complied with, for the agency arrangement to be binding.

Generally under state law, principal and agent alike are required to act in good faith in performing their obligations in an agency relationship, subject to the express terms agreed to in the agency agreement. Additionally, under the law of some states, the principal is required to indemnify the agent against liabilities vis-à-vis third parties arising out of the performance of the agent’s duties, to compensate the agent reasonably for its services and to reimburse the agent for the reasonable expenses it incurred in carrying such service. New York law does not provide for any mandatory obligations by the principal in favor of the agent in this regard (New York courts having constantly held an agent’s right to indemnification from a principal is based on contract).

Exclusivity

State law generally does not contain mandatory provisions on exclusivity. Indirectly, certain rules (such as the Statute of Frauds under New York law that requires that exclusivity provisions be in writing if they will exceed one year) may apply. Otherwise, parties to a commercial agency arrangement generally may agree contractually on the terms of exclusivity, including whether: (i) to prohibit the agent from entering into agency arrangements with other principals covering the same subject matter within the same territory; (ii) to allow the principal to deal directly with customers located in the same territory without the agent’s involvement; (iii) to limit marketing and sales through the internet (including whether to prohibit the same through the principal’s website and/or whether the agent may do so through its own website); and (iv) a commission is due to the agent on sales made by the principal online to customers in the territory.

Remuneration

There are no specific federal or state regulations regarding commissions or stock consignments generally in commercial agency agreements. Generally, provisions regarding commissions, including the right to the same at and after contract termination or expiration, loss of commission rights and the right to inspect the principal’s books are provided for contractually. We do note an exception: in some US government contracts suppliers are required to certify that they are not paying commissions to non-employees. Furthermore, some federal funding of purchases by foreign buyers carry with them restrictions on commissions payable by the sellers.

Understanding the interplay between federal and state statutory and common law in the US legal system is important to understanding the regulation of exclusive distribution agreements in the US.

Under the US Constitution all power not specifically reserved for the federal government remains with the states. Federal law has exclusive jurisdiction only over certain types of cases (e.g., those involving federal laws, controversies between states and cases involving foreign governments), and share jurisdiction with the states courts in certain other areas (e.g., cases involving parties that reside in different states). In the vast majority of cases, however, state law has exclusive jurisdiction. Similarly, the doctrine of freedom of contract under US law also directly affects how distribution agreements are regulated in the US.

Furthermore, because a distributor is typically an unaffiliated third party acting on its own account rather than on behalf of the supplier as principal, distribution agreements are subject to greater regulation under US federal and state antitrust law. Such law, among other things, (i) regulates whether and the degree to which a supplier in a distribution arrangement may seek in a contract or otherwise to dictate the price at which the distributor will resell products supplied; (ii) imposes restrictions on suppliers that engage in “dual distribution” (selling product directly as well as through a distributor); and (iii) may limit the suppliers’ ability to sell product to different distributors at a different price. Antitrust law also regulates exclusivity and selective distribution arrangements, as well as distribution relationships in certain industries (e.g., federally: automobile manufacturers and petroleum; at the state level, heavy equipment, liquor and farm equipment industries). Furthermore, distribution agreements often may resemble franchise arrangements, subjecting those arrangements to extensive federal and state regulation.

Under the law of most states (including New York), exclusive distribution exists when a supplier grants a distributor exclusive rights to promote and sell the contract goods or services within a territory or to a specific group of customers. Exclusive rights in a distribution arrangement are often granted by the supplier for the distribution of high quality or technically complex products that require a relatively high level of expertise by the distributor, including staff that is specially training to sell the goods or specialized after-sales repair and maintenance or other services. Distribution agreements differ from commercial agency agreements in several respects. In contrast to a distributor, a commercial agent does not take title to product, does not hold inventory and typically has no contractual liability to the customer (including risk of customer non-payment). Conversely, a distributor, in line with the greater risk of its activities, typically can expect greater upside economically in terms of margins on resale relative to an agent’s profit through earned commissions.

Sub-distributors

Under the law of most states (including New York), a distributor may appoint sub-distributors absent any restrictions to the contrary in the agency agreement. Commercially, the appointment of a sub-distributor may have an adverse effect on the supplier by reducing the supplier’s control over its distribution channel activities or increasing the supplier’s potential liability exposure given the increased number of distributors whose actions may be attributed to the supplier. A supplier that does not manage properly the appointment of sub-distributors may also lose valuable product knowledge with respect to the distributed goods (particularly if the goods are novel or complex in nature). Advantages to sub-distributor appointments for the supplier may include a more effective overall marketing presence with enhanced local market knowledge, a broader geographic scope, a potentially lower costs as a result of the sub-distributors’ expertise and efficiencies, etc.

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Rights and Obligations of the Exclusive Distributor

Sales organization: suppliers are not required to establish sales organizations in exclusive distribution agreements.
Sales’ target: there are no mandatory rules under federal law or state law (including New York) generally regarding sales targets in exclusive distribution agreements. However, such provisions are common in exclusive distribution agreements.
Guaranteed minimum target: minimum sales requirements are common in exclusive distribution agreements. As a commercial matter, a supplier as a requirement to give, or maintain, exclusivity with one distributor, will seek through such requirements to ensure that economically the distributor is performing satisfactorily. Often failure to meet sales targets may entitle a supplier to rescind the exclusivity, terminate the agreement or reduce the portion of the territory to which the exclusivity applies. We note that minimum sales requirements in an exclusive distribution arrangement may, in certain cases, be subject to challenge under antitrust law as having an undue anticompetitive effect by preventing a distributor from purchasing products from a competitive supplier.
Minimum stock: there are no mandatory rules in federal law or the law of the majority of states (including New York) regarding minimum stock. A supplier may seek to have the distributor agree, contractually, to maintain adequate levels of stock relative to market demands as well as to store the product properly.
After-sales service: the parties to a distribution agreement are generally free to agree as they deem appropriate with respect to after-sale service regarding products.
Resale Prices: the Exclusive Distributor is free to fix the resale prices. State law (including New York law) generally does not limit the ability of an exclusive distributor to fix resale prices. […] A supplier’s ability to set resale prices for distributors is subject to limitations under federal and state antitrust law. Many state antitrust laws (including New York’s) closely resemble the federal antitrust laws. However, differences exist such that certain conduct may be found not to violate federal antitrust law but still be found to violate state antitrust law (or vice versa). Because the distributor (contrary to an agent) is acting on its own behalf, an agreement between supplier and distributor to maintain certain prices (or if a distributor is deemed to have been coerced by the supplier to follow certain prices), may be a per se price-fixing violation under federal and state antitrust law. Under federal antitrust law, vertical price-fixing until 2007 had been illegal per se. This per se rule was overturned by the Supreme Court. Horizontal price fixing remains per se illegal under the Sherman Act (see below).

Rights and Obligations of the Supplier

Exclusive Distributor undertaking to supply: generally, state statutes do not specifically provide that a supplier in a distribution relationship has a duty to supply specific levels of product to a distributor, with such obligations generally be established by contractual provision. However, a supplier does have an implied covenant of good faith and fair dealing toward the distributor under state law generally, which generally requires that a party to a commercial agreement not do anything which injures the right of the other to receive the benefits of the agreement). Under the foregoing, a supplier may be deemed to have an obligation to supply product to a distributor (or be found to have violated the implied covenant of good faith and fair dealing in the event that the supplier, although able, decided not to provide a distributor with product without any other contractual justification for not doing so). However, even where such a duty were found to exist, the quantity and frequency of product supply and other details often remain unclear. To avoid uncertainty, distributors often seek to have a specific provision included in the distribution agreement, providing at least for the supplier to be required to use some degree of effort (e.g., “best efforts,”, “reasonable best efforts” or “reasonable efforts”) to supply product responsive to distributor’s submitted purchase orders. On a related topic, generally a distributor typically is only required to inform the supplier of lower purchase estimates if the distributor undertakes to do so (or undertakes a more general obligation with respect to the market) in the distribution agreement. However, even if the supplier is not, under an exclusive distribution agreement, required to supply the distributor with product, the supplier may still be subject to a contractual or common law obligation not to sell to third parties in the territory. New York courts held that suppliers that make direct sales to customers in the territory under an exclusive distribution agreement have breached their duties to the exclusive distributor.
Retention of title: typically, in sales transactions on credit in the US, title is passed at the moment of initial sale. The buyer typically grants the supplier a security interest in the goods purchased, which if proper perfected under state law, affords the supplier with a priority position relative to other creditors with respect to the products provided (inventory) in the event of non-payment and enforcement.

Construction defects warranty

The law of “products liability” in the US is based on the law of torts. Under New York law, in cases of where an end user is injured by a defective product which was sold by the distributor under a distribution agreement, the end user generally is able to sue the distributor and the supplier of the product under one or more of the following theories: (i) strict liability; (ii) negligence; or (iii) breach of warranty. The usual theory of recovery against a distributor is strict liability. Under a strict liability theory, a supplier or distributor that sells a defective product while engaged in its normal course of business shall be liable for injuries it causes to customers, regardless of privity, foreseeability or the exercise of due care. Product liability cases also are brought under breach of warranty claims. Breach of warranty claims can be based on express warranties (e.g., from advertisement or a product label) and on implied warranties (typically, warranties of merchantability and fitness for a particular purpose under the provisions of the Uniform Commercial Code as adopted by the states). Lastly, negligence claims brought by plaintiffs are based on the improper conduct of the defendant, whether supplier or distributor or other participant in the distribution chain, with respect to the manner of distribution or care of the product sold (examples include improper storage or transport).

Under New York law, exceptions based on misuse, neglect or abuse by the suing party generally apply as defenses against liability under theories of strict liability, negligence or breach of warranty.

The supplier and distributor can allocate third-party liabilities (e.g., potential losses to be paid to plaintiffs in a products liability law suit) and related attorneys fees as between themselves through warranty and other indemnification provisions. Parties to a distribution agreement in the US often seek to put in place such re-allocation provisions not only because of potential liability resulting from a final, unfavorable judgment, but also because of the sizeable legal fees that litigants in the US often incur. In this regard, we note that in the US litigation costs are generally born by all of the litigating parties and not by the losing party as is common in many other countries. Such provisions may include indemnification provisions relating to product liability or trademark infringement claims brought by third parties, limitations on liability provisions (based on monetary caps and exclusions as to the types of damages that may be recovered, such as consequential, punitive, special and indirect damages) and disclaimers in respect of express or implied warranties that may otherwise apply under state law applicable to the distribution agreement.

Exclusivity

Exclusive-dealing provisions – under which the distributor undertakes not to distribute competing products in the territory – are quite common in distribution agreements. However, although it is not easy for a plaintiff to prevail, such a provision may be subject to challenge as an unlawful restriction on competition under federal and state antitrust law, typically under the following federal antitrust laws: (i) section 1 of the Sherman Act, which prohibits contracts “in restraint of trade;”; (ii) section 2 of the Sherman Act, which prohibits “attempt[s] to monopolize” and monopolization; (iii) section 3 of the Clayton Antitrust Act of 1914 […], which prohibits exclusivity arrangements that may “substantially lessen competition” or tend to create a monopoly; and, finally, (iv) section 5 of the Federal Trade Commission Act […], which prohibits “[u]nfair methods of competition.” In deciding these cases, typically courts apply the “rule of reason analysis” under which the exclusive dealing arrangements is analyzed considering a host of factors, including: (a) the defendant’s market power; (b) the degree of foreclosure from the market and barriers to entry; (c) the duration of the contracts; (d) whether exclusivity has the potential to raise competitors’ costs; (e) the presence of actual or likely anticompetitive effects; and (f) legitimate business justifications.

Eric Kuhn

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