Subject: Dealer Terminations

Every business that operates through a vertical dealer or distribution network faces the decision to terminate a dealer or distributor. How it is handled is important. An error may cost a fortune in legal fees and a verdict against your company.

The steps that need to be taken are:

• Objectively analyze your reasons for the termination or nonrenewal.
• Carefully review and understand the dealer agreement.
• Understand any antitrust issues that could arise from the termination or nonrenewal.
• Consider the effect of dealer protection and franchise laws.
• Consider contract and tort claims.
• Conduct the termination or nonrenewal in an objective, professional manner.

Analyze The Underlying Reasons
Any decision to terminate or not renew a dealer should be made without emotion. Typically, managers are personally and emotionally involved in the dealer's prospective termination or nonrenewal, and the events leading up to it. You must filter out any emotion from the termination or nonrenewal decision.

Objectively decide whether the dealer is hurting your profits or is a roadblock to a more efficient distribution network. Make sure you understand why you are considering nonrenewing or terminating a dealer. Identify the business motive for doing this.

Is the reason really a mask to not deal with another problem? If, for instance a dealer has not performed and has not met quotas, and this is quantifiable and verifiable, you should not use nonrenewal to rid yourself of a nonproducing dealer because you are afraid of a lawsuit. Likewise, if you miss the contract notice window for nonrenewal, forget forcing a termination.

You should carefully review your dealer files for documents that may have altered the terms of the written agreement. You also need to understand the effect of oral modifications or understandings together with the course of performance and course of dealing between you and the dealer. These can often hurt you in litigation.

Have you in any way caused the dealer to be in the circumstance that has brought you to the point of terminating or nonrenewing the dealer? Have you given the dealer reasonable, customary and nondiscriminatory assistance, training and support?

Are you trying to terminate the dealer because of complaints from competing dealers? Are you trying to punish the dealer for carrying competitive lines?

Understand The Agreement
Read the termination provisions of your contract. Take the opportunity to scrutinize provisions that impose restrictions on the dealer, like exclusive territories, location restrictions, customer classifications, reservation of house accounts, limitations on product shipment, service, allowances, inventory buy-backs and obsolescence. Remind yourself of the purpose for the restrictions and how each restriction actually operates in your business. Are these contractual restrictions enforced consistently, selectively or are they generally ignored? Be honest with yourself in assessing these questions because you may face a litigation where these issues will come up and be decided by a third party.

Antitrust
When evaluating a termination or nonrenewal decision, understand it is possible that antitrust allegations may be made against you.

The terminated or nonrenewed dealer typically raises four antitrust claims you will have to address and rebut with documentary evidence and cogent, well-reasoned business decisions.

First, the dealer may claim that you "tied" the sale of the desired product to the sale of a less desirable product. Can the two products be purchased separately; and, if so, is it significantly more expensive to purchase the products separately?

Second, the dealer may claim that you engaged in resale price maintenance, and terminated because he or she cut prices below other dealers, some of whom may have complained to you about what the terminated dealer was doing. How do you handle price cutters? Have you acted on complaints from other dealers? What's in your files on these issues?

Third, the dealer may argue it was terminated for selling outside its prescribed territory violating an allegedly illegal horizontal market allocation between you and other competing dealers. How have you addressed these issues in the past? Do you compete with your dealers in any way by dual distribution of product?

Fourth, the dealer may complain that you have engaged in discriminatory pricing or provision of services, or discriminatory advertising or promotional allowances. You should thoroughly review your pricing program. Are there any special prices for certain customers, or secret rebates. Is your promotional and advertising allowance program administered fairly? Is it available to all dealers?

Franchise Laws
Many states have enacted statutes governing franchise relationships which often prohibit termination of the franchise except for good cause. They may also require that a poor-performing dealer be given an opportunity to cure his or her default. Some states have applied these laws to the dealer-manufacturer relationship. The practical effect of this can be that your contract's termination provisions may be read to require good cause and an opportunity to cure.

If you decide to terminate a dealer for cause, you must, contemporaneous with the action, (not after the fact )(1) give the dealer warnings about his or her lack of performance (and document those warnings); (2) give the dealer reasonable opportunity to cure the default, and (3) build a record of quantifiable nonperformance by the dealer

Other Claims
Even if your dealer contract clearly states that you can terminate for no cause or any cause and at-will; and, even if you are not subject to any state franchise laws requiring you to terminate or nonrenew only for good cause, you are risk free.

The contract that is actually enforced by a court may be far different than the written dealer agreement you have had in place for many years. Typically, there are continuing oral communications between your people and the dealer about the duration of the dealership or the circumstances under which the dealership could be terminated. A number of common law legal theories may prevent termination, even if the contract provides otherwise. Here are some ways this can happen:

1. Evidence is admissible to explain or clarify ambiguous writings. Therefore, if your contract is ambiguous in any way, evidence may be admitted to clarify the ambiguity; and ambiguities are strictly resolved against the drafter. When you are reviewing the contract, look for possible ambiguity on language concerning the hot issues like inventory buy-back and length of termination notice.

2. Custom and practice in the industry and the course of dealing and course of performance between you and the dealer are regularly admitted as evidence to clarify what the real meaning of the written contract was.

3. Every contract carries an implied covenant of good faith and fair dealing. These standards are increasingly applied by the courts to curb abuse of broad or limitless discretion by a manufacturer, even when the dealer contract expressly grants unfettered discretion. What effect this may have may be affected by how big the dealer is and whether the dealer is regularly represented by counsel and whether counsel participated in the negotiation of the dealer agreement.

4. The law can supersede the written provisions of a dealer contract where you, by your conduct, led the dealer to believe that you would not enforce a particular clause against the dealer.

5. Recoupment is a theory that implies a minimum term on at-will termination dealer agreements. This minimum term is the length of time in which the dealer can reasonably be expected to recoup his or her investment. What is a reasonable time for the dealer to recover his or her capital investment varies by industry, market, and company; but generally, notice of termination should give the dealer a reasonable chance to find an alternative supply source. Calculate how many total years the dealer has been with you and quantify the investment the dealer has made in reliance on carrying, and being trained on, your product line.

6. Fraudulent inducement is a theory in which the dealer is required to show that: (1) you made a material misrepresentation of fact; (2) knowing it was false (3) intending that the dealer rely on the misrepresentation, and (4) that the dealer actually and detrimentally relied on that misrepresentation.

7. Another tort that comes up in dealer termination lawsuits is tortious interference with contract and prospective contractual relationships. Under these theories, you can be liable for (1) interfering with the dealer's contractual relationships with its customers and prospective customers (2) interfering with contractual relationships existing between individual owners or operators and the corporate entity and (3) refusing to provide customary and reasonable assistance to the dealer during the time between the notice of termination and the termination date.

Implementing The Decision
Once you have thoroughly analyzed the proposed dealer termination or nonrenewal and have come to an unequivocable decision to terminate or nonrenew a dealer, you should implement the decision in a good faith manner, not arbitrarily, and without malice. These guidelines will help you minimize the risks arising from a dealer termination:

8. After the decision is announced, the dealer will try to contact people within your organization searching for sympathy and ammunition for litigation. To avoid this, centralize all communications in one individual who should be responsible for a prompt and thorough response to all dealer communications, including requests to negotiate an alternative termination arrangement.

9. Give as long a notice of termination as possible.

10. Do not mention any other dealers in any context in connection with the termination.

11. Give the dealer a reasonable chance to mitigate any financial losses created by the termination.

12. Give the dealer a reasonable chance to complete any short-term deals and retain any profit from them.

13. Instruct your sales staff to send the decision maker all papers regarding the termination, and to give that person the whole truth. Remind your people that any actions they may have undertaken with the dealer they were not authorized to take, or that were beyond the course and scope of their employment could lead to disciplinary action.

14. Remember that your dealer termination and nonrenewal policy should be uniformly enforced. Do not put yourself in a position where you do something in this termination that you would not be willing to do in others unless there are documented unique circumstances.

15. Continue the pricing, service, training and promotional opportunities available to the dealer between the period of notice of termination or nonrenewal and the effective termination date.

16. Be careful about any communication with the marketplace as to the dealer's termination, and especially the announcement of a new dealer.

17. Consider supplying goods to the terminated dealer for a temporary period stating in writing exactly what you will do and for how long you will do it, and remind the dealer that this is not a contract extension.

18. Consider the possibility of arranging for other means for the dealer to get products for a short period of time like purchasing from another dealer or distributor.

19. Do not rely on the contract for any short notice of termination or nonrenewal allowed. Do not wait until the last minute to give notice.

20. Do not send heavy-handed termination or nonrenewal letters.

21. Do not send letters that include anticompetitive language.

22. Do not leave unanswered letters from dealers in the file.

Of course, nothing can guarantee that you will not be sued or that you will win a lawsuit if it is brought. These guidelines should, however, put you in a better position.