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Is A Wholesale-Distributor Protected From Termination As A “Franchisee”?

Most material handling manufacturers would be surprised to learn that a typical independent wholesaler-distributor, who buys and resells the manufacturer’s products, may be protected from termination under state law as a franchisee.

For example, a federal appeals court in Chicago recently affirmed an award of $1.5 million in damages to a forklift distributor, who was a franchisee under Illinois law, and was terminated without “good cause” as defined in the statute, (To-Am Equipment Co. vs. Mitsubishi Caterpillar Forklift America, Inc. No. 97-1895). The manufacturer, seeking to consolidate distribution, terminated the distributor‘s written contract in strict compliance with the contract terms. For over 13 years, To-Am had served as Mitsubishi’s exclusive distributor, selling and servicing new forklifts in defined Illinois and Indiana counties. To-Am also agreed to represent Mitsubishi exclusively. At trial, Mitsubishi conceded that its termination of To-Am was without good cause.

The appeals court held that To-Am was a franchisee under the Illinois franchise act because:

  • To-Am paid an indirect franchise fee when, over an eight-year period, To-Am purchased parts and service manuals from Mitsubishi for a total cost of $1,600.
  • Mitsubishi’s suggestions to the distributor on signage, advertising, product demonstrations and trade show exhibits constituted a franchise marketing plan under the statute even though To-Am was not required to follow this advice.
  • The operation of To-Am’s business was substantially associated with Mitsubishi’s trademark.

The court noted that terminations of wholesaler-distributor franchisees are not impossible. However, the termination decision should be the subject of negotiation unless the manufacturer can prove that good cause exists.

State Franchise Laws
Like Illinois, a number of other states have enacted franchise laws which protect the franchisee from termination or non-renewal by the franchisor except for “good cause.” Generally, advance notice is required and the franchisee must be given a chance to remedy cited deficiencies. As the To-Am case illustrates, failure to follow the law may result in a lawsuit and a significant damage award in favor of the terminated party, plus attorneys’ fees and court costs.

State Franchise Laws
District of Columbia
New Jersey
North Dakota
Puerto Rico
Virgin Islands
Source: Legal Aspects of Selling and Buying (1997). In addition to the states listed above, some states have industry specific laws dealing with termination. Legislation may be pending in other states. Always check state statutes for the current status.

Generally, a franchise is defined as an agreement, express or implied, written or oral, whereby one is granted the right to engage in the business of selling or distributing goods or services under a marketing plan or system prescribed or suggested in substantial part by the franchisor; the franchisee is required to pay, directly or indirectly, a franchise fee of a stated amount; and the operation of the franchisee’s business is substantially associated with the franchisor’s trademark, logotype, advertising or other commercial symbol designating the franchisor.

What Constitutes a Franchise Fee?
Most states require payment of a franchise fee before a relationship can be categorized as a franchise. Typically, the fee is based on a percentage of the franchisee’s gross sales and involves a direct payment to the franchisor. The courts have also ruled favorably on creative arguments that other forms of payment may qualify as an indirect franchisee fee. For example, a distributor’s purchase of excessive inventory has qualified as a franchise fee. In some states the purchase of materials, equipment or services as required by the franchisor will meet the test. One common exclusion, however, is the purchase of goods at reasonable levels at bona fide wholesale/retail prices for resale or use. A franchise fee may be present regardless of the designation given to it, the form of the fee, whether payable in a lump sum or installments, definite or indefinite in amount, or contingent on future sales, profits or purchases by the franchise business.

Whether or not the parties denote the relationship as a franchise is immaterial. Additionally, a contract that expressly attempts to void or waive rights under state franchise laws generally is ineffective.

There are differences in the various laws and regulations defining “franchise” so that a relationship may be a franchise under the laws of one state but not under that of another. In addition, several different state laws may apply to a wholesaler-distributor with multi-state operations. Therefore, it is necessary to determine which laws are applicable and review those statutes and court cases.

A list of states that have enacted franchise laws is in the sidebar. Before changing or ending a business relationship, the parties would be well advised to review all legal implications, including exposure under federal antitrust law and applicable state laws. The cost savings could well be substantial.

Similar Result in NJ Franchise Case
The To-Am decision is not unique. Cooper Distributing, an independent refrigeration distributor located in New Jersey, was suddenly terminated by Amana Refrigeration as part of the manufacturer’s nationwide plan to consolidate distribution. The distributorship had been a long-term 30-year relationship and was exclusive in a four-state area.
The distributor’s economic dependence on Amana products, which accounted for 85 percent of the distributor’s revenue, was a key factor. Cooper’s close relationship with Amana and its extensive use of the Amana trademark in its business (signs, uniforms, repair vehicles and advertising) were also significant.
Cooper filed suit for damages and claimed the termination violated the New Jersey franchise law since “good cause” was not present. The U.S. Court of Appeals in Philadelphia agreed and ruled in favor of Cooper, even though the written agreement permitted either party to terminate upon ten days’ notice and it specified that Iowa law would govern the parties’ relationship (Cooper Distributing Co. vs. Amana Refrigeration, Inc., No. 94-5569).

Parts of this article originally appeared in the December 1998 NAW Report. Reprinted with permission.

George Keeley Meet the Author

George W. Keeley, Esq., MHEDA legal counsel, is partner at Keeley, Kuenn & Reid in Chicago, Illinois.

Material Handling Equipment Distributors Association

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