Editorial

Pricing Restraints in Vertical Relationship: New Ways of Attacking Old Problems for Franchisees and Dealers

Since at least the 1960’s (when I first got involved with this topic), and most likely since franchisor/franchisee and manufacturer/dealer relationships first began, a predominant cause of unrest among franchisees and dealers has been the pricing practices of their franchisors and suppliers. Two categories of such pricing practices that have caused significant unrest are (1) efforts by the franchisors and suppliers to control the maximum price at which franchisees and dealers may resell their goods or services, and (2) discriminatory pricing practices favoring one competing franchisee or dealer over another competing franchisee or dealer.

In representing franchisees and dealers who have been victimized by the pricing restraints of their franchisors and suppliers, we apply a six-step analysis.

STEP ONE : DETERMINE ALL ACTUAL AND ARGUABLE REASONS FOR THE CONDUCT IN QUESTION

We look at the announced reason for the pricing practice in question -- e.g., “to benefit the consumer,” and also consider and evaluate other potential reasons -- e.g., to increase the franchisor’s profits at the expense of the franchisee. If we can find a bad or unfair reason for the conduct in question, we are more likely to prevail on our legal theories.

STEP TWO : ANALYZE THE WRITTEN AGREEMENT

We are always interested in what the written agreement has to say, first of all, with respect to substantive issues related to the pricing practices in question -- e.g., a commitment to not discriminate among franchisees; a most favored franchisee clause; an express covenant of good faith and fair dealing; a recitation that the franchisee is free to price as it sees fit; language related to protection against same-brand competition; language that incorporates written policies related to pricing (and, if applicable, an examination of the policies themselves).

In addition, we are interested in the procedural provisions in the written agreement, particularly those that might affect the ultimate outcome -- e.g., limitations on damages; waiver of jury trial; arbitration clauses; choice-of-law and venue provisions; other alternative dispute resolution provisions; and other language incorporating by reference inapplicable statutes.

STEP THREE : DO AN ANTITRUST ANALYSIS

Our experience has been that attorneys for franchisors and suppliers typically do a rather sophisticated, and conservative, analysis of the antitrust laws before invoking pricing policies that adversely affect franchisees and dealers. To say that a specific pricing policy is not an antitrust violation, however, does not eliminate the possibility that this pricing practice will violate other statutory or common-law principles.

STEP FOUR : DO AN ANALYSIS OF OTHER POTENTIALLY APPLICABLE STATUTES

Approximately 19 states have generic statutes that govern the relationships between franchisors and franchisees. These relationship statutes prohibit things like substantial changes in competitive circumstances, discriminatory treatment, and termination or nonrenewal of the relationship without good cause. See Minn. R. 2860.4400(G) (prohibiting franchisor from imposing on a franchisee by contract or rule any standard of conduct that is unreasonable). Likewise, many industries have industry-specific relationship statutes that prohibit the same type of conduct in, for example, the agricultural equipment industry, the construction equipment industry, the beer industry, the wine and spirits industry, and the automobile and truck industries. Minn. Stat. §§ 325E.068 - 325E.0684 (Minnesota Heavy Utility Equipment Manufacturers and Dealers Act prohibits manufacturers from discriminating in prices charged to similarly situated equipment dealers).

One theory that we have successfully utilized is the theory of de facto termination without good cause -- i.e., that particular pricing conduct by a franchisor or supplier is so burdensome to the franchisee or dealer that it will have the effect of putting that franchisee or dealer out of business without good cause. Our argument is that this type of conduct is the same as sending a termination notice to our clients.

Furthermore, there are state statutes which prohibit a franchisor from overcharging the franchisee or requiring the franchisee to purchase goods exclusively from the franchisor where such goods are available from other sources. See Ind. Code § 23-2-2.7-1(1) & (6). In addition, certain states forbid franchisors from taking secret rebates or kickbacks. See Ind. Code § 23-2-2.7-1(4); Haw. Rev. Stat. § 482E-6(2)(D); Wash. Rev. Code § 19.100.180(2)(e).

STEP FIVE : DO A COMMON LAW ANALYSIS

We review the contract to determine if any legal duties found in the contract have been breached. We then argue that the written contract includes the very real likelihood that it has been modified by what has been said between the parties since the written agreement was signed, and by the parties’ course of conduct. The law in many states is that such amendments may be found to exist even if the writing provides that the written agreement may be amended only by a writing signed by the party sought to be bound. See, e.g., Mankato Implement, Inc. v. J. I. Case Co., Bus. Franchise Guide ( CCH ) 9,947 (D. Minn. 1991) (holding that even if the agreement expressly forbids oral modification, evidence of pre-signing oral commitment may be used to establish an estoppel claim).

Furthermore, we argue that the duties found in the contract are expanded by duties which attach to the relationship between the parties as a matter of law. Such “implied duties” include what is now typically referred to as the covenant of good faith and fair dealing, which commonly provides that parties may not act in a way that is unfair, dishonest, unreasonable, or that would deprive the parties of the essential fruits or reasonable expectations of the relationship.

These implied duties have been found to include the prohibition against unreasonable pricing practices. Venta, Inc. v. Frontier Oil & Refining, 827 F. Supp. 1526 (D. Colo. 1993) (recognizing the claim for breach of the covenant of good faith and fair dealing arising out of the discriminatory practices of a motor fuel supplier’s favoritism of certain distributors over others).

STEP SIX : DO A DAMAGES/INJUNCTION ANALYSIS

Finally, we need to establish that the basic conduct of the franchisors and suppliers in question has in fact caused, or will in fact cause, significant damage. We typically argue that the franchisee’s damages should be calculated by subtracting from lost gross profits only such incremental costs as would be directly attributable to the lost sales. This analysis typically results in the damages being substantially greater than conceded by franchisors, suppliers and their counsel, who argue that a pro-rata allocation of expenses should be utilized.

In addition to evaluating the potential damages caused, we also look at the likelihood of obtaining injunctive relief to stop the nature of the conduct. We have had some significant success in arguing that if something is found to be a breach, the breach should not be allowed to continue, but rather should and must be stopped. Additionally, we have argued that pricing practices (e.g., pricing that discriminates against our client), dilute the value of the franchise mark in our clients’ protected territories.

CONCLUSION

Thinking “outside the box” in attacking pricing restraints and vertical relationships can produce a road map to success that is shorter, more direct, and smoother in getting to the desired result for franchisees and dealers than has been the case with traditional antitrust routes.