Puerto Rico's Act 75 of June 24, 1964 was enacted to protect Puerto Rican distributors or dealers from arbitrary terminations to a distribution agreement. It essentially provides that, regardless of any contractual provision to the contrary, a dealer or distribution agreement may not be terminated, impaired or not renewed by the principal, unless there is "just cause" (as defined in Act 75) for such termination.
Moreover, if the distribution agreement is terminated without "just cause," the principal is liable for damages pursuant to a statutory formula that includes five years of profits and the goodwill of the distributor. Act 75 also prohibits the use of choice-of-law provisions to escape its provisions.
As a result, distribution agreements in Puerto Rico are evergreen, regardless of the language in the agreement itself. In addition, the distributor can allege constructive termination (impairment) if it believes the principal is treating it unfairly and seek damages. Terminations for cause will be determined by a judge based on the provisions of Act 75 and applicable case law, and not necessarily on the specified default provisions of the agreement itself.
Although Act 75 does not override all contractually agreed terms, it does override several of the most important ones. Act 75 also applies to verbal or course-of-dealing agreements. It provides Puerto Rican distributors with powerful protections and has been the source of substantial litigation over the years.
For these reasons, prudent principals seek to consult with counsel prior to commencing any sales to distributors in Puerto Rico.
Background to Act 75
Act 75 was enacted as a result of the lobbying efforts of many intermediaries in the distribution chain whose relationship with principals or suppliers was being terminated according to the terms stipulated in their contracts or whose contracts were not being renewed when the contractual term expired, allegedly to unfairly reap the product of their labor once they had successfully created a market for the product. This argument proved successful with the then members of the Puerto Rico legislature.
In fact, the report prepared by the Puerto Rico Senate Industry and Commerce Committee states that the express purpose of Act 75 is to protect local "distributors" of imported and locally manufactured products from the termination, impairment or refusal to renew the distribution relationship without just cause. According to the report, situations had arisen in which the manufacturer, after the distributor had made substantial efforts to develop and maintain a local market, had deemed it economically advantageous to set up its own sales office or branch or find another representative that was willing to distribute the product for lower compensation. This situation was found detrimental to Puerto Rico's economic welfare.
Section 1(a) of Act 75 defines the term "distributor" as a "person with actual interest in a distributor's contract because he effectively handles in Puerto Rico the distribution, agency, concession or representation of a given merchandise or service." This definition is very broad and covers almost any course of conduct in sales and purchases which ends up creating a market for a product or service.
When determining if a "distributorship" is involved, several factors must be taken into consideration, among them:
- if the "distributor" actively promotes the product and/or concludes contracts
- if it keeps an inventory
- if it has a say on the pricing policy
- if it has discretion to fix the sales terms
- if it has delivery and billing responsibilities and authority to extend credit
- if it independently or jointly embarks on advertising campaigns
- if it has assumed the risks and responsibilities for the activities undertaken
- if it buys the product and
- if it has facilities and offers product-related services to his clients.
This list of factors is not exhaustive and no single factor is conclusive by itself or has more weight than others.
Defining "just cause"
The term "just cause" is defined in the Act as "nonperformance of any of the essential obligations of the distributors contract on the part of the distributor, or any action or omission on his part that adversely and substantially affects the interest of the principal or grantor in promoting the marketing or distribution of the merchandise or service." The definition of "just cause" is such that it is essentially limited to acts imputable to the distributor. Only when the distributor fails to comply with any of the essential obligations of the agreement or adversely affects in a substantial manner the interest of the principal, may the latter terminate the contract without payment for damages. Act 75 does not recognize the good faith of principals in the termination of the contract, nor the principals' right to establish their own distribution system or to make adjustments in the system which in good faith they consider necessary to improve the market for their product.
What is an essential obligation? Case law guidance
Given the subjectivity of determining what is an essential obligation or whether a given action substantially affects the interest of the principal, the Supreme Court of Puerto Rico and the US federal district court have provided certain guidance via case law. For example, the withdrawal of a product from the market will be considered just cause for the termination of a distribution relationship provided that the decision is made in good faith and that the distributor is forewarned with sufficient time to make the changes that are necessary for the continuation of its business activities. Likewise, the sale of a global business unit which leads to a chance in distributor may constitute just cause if certain requirements are met
Once it is determined that no just cause exists for terminating the distribution relationship, then it follows that the principal has committed a tortuous act against the distributor and that the distributor is entitled to indemnity.
The amount of indemnity will vary depending on the actual value of the amount spent by the distributor on the distribution activity, the cost of the inventory, the profits of the distributor and the goodwill of the business. The imposition of Act 75 damages entails a facts-and-circumstances analysis, which the courts have chosen to address on a case-by-case basis. Thus, it is extremely difficult to predict with any degree of certainty the measure of damages that would ultimately be applied by a court should a dealer be successful in an Act 75 action
When establishing distribution operations in Puerto Rico, it is essential to carefully consider Act 75 and its ramifications beforehand. Experienced counsel can recommend the inclusion of certain clauses and provisions in the distribution agreement which may mitigate the impact of Act 75 on the principal.
Find out more by contacting either of the authors.