Vol. 82, No. 11, November 2009
Tough economic times may prompt businesses that sell goods or services through third parties to rethink the structure of their distribution systems. For example, manufacturers may look to consolidate their dealer networks or eliminate exclusivity.
Wisconsin lawyers should thus be aware of the reach and restrictions of the Wisconsin Fair Dealership Law1 (WFDL). The WFDL greatly circumscribes the ability of a grantor (as the WFDL terms it2) to alter its relationship with a dealer, even in difficult economic times.3 A grantor must have good cause to make any substantial change in the competitive circumstances of the relationship, and the change must be essential, reasonable, and nondiscriminatory.4 Moreover, the WFDL may apply when least expected; the Seventh Circuit recently held that the WFDL protected a local Girl Scout council from the national organization’s reorganization efforts.5
This article addresses three aspects of the WFDL that businesses contemplating (or affected by) changes to a distribution system in the current economy should consider: 1) whether the distributors are WFDL-protected dealers; 2) whether the proposed change is substantial enough to invoke WFDL protections; and 3) whether the grantor’s economic circumstances provide good cause for the grantor to implement the change.
Determining When a Business Relationship Becomes a Dealership
Although the WFDL is to be liberally construed, it does not protect every person or business that sells another company’s goods or services.6 A business relationship is a dealership under the WFDL if there is “(1) a contract or agreement; (2) which grants the right to sell or distribute goods or services, or which grants the right to use a trade name, logo, advertising or other commercial symbol; and (3) a community of interest in the business of offering, selling or distributing goods or services.”7
The Right to Sell – Dealers Versus Independent Sales Agents. Independent sales agents and manufacturer’s representatives usually are not protected by the WFDL because they usually do not meet the second element of a dealership, that is, the right to commit the grantor to the sale of the product. Even if a distributor markets and services a product and otherwise resembles a dealer, if it does not have the power to consummate the sale, it is not a dealer under the WFDL.8
Community of Interest – Dealers Versus Vendors. Nor does the WFDL protect “the typical vendor-vendee relationship.” Whether a distributor is a vendor or a dealer turns on the third statutory element, community of interest.9 A distributor is a dealer rather than a mere vendor if the distributor and grantor share a community of interest, which the WFDL further defines as “a continuing financial interest between the grantor and grantee in either the operation of the dealership business or the marketing of such goods or services.”10
Determining whether parties share a community of interest sometimes is easier said than done. Lawyers and judges alike have found the abstract community-of-interest concept to be “the most vexing phrase” in Wisconsin’s dealership law.11 State and federal courts have developed competing tests and frameworks for community-of-interest analysis that are difficult to reconcile. While the Wisconsin courts have articulated a 10-factor test, courts in the Seventh Circuit have historically emphasized two factors – the alleged dealer’s sunk investment in the dealership and the percentage of profits and revenues attributable to the grantor – above all others. As a consequence, the twin issues of whether a dealership exists and whether the question should be decided by the judge or by the jury often hinge on the vagaries of the case and the court.
In Ziegler Co. v. Rexnord Inc. (Ziegler I), the Wisconsin Supreme Court set two guideposts to aid community-of-interest analysis.12 The first is a continuing financial interest, which “contemplates a shared financial interest in the operation of the dealership or the marketing of a good or service.” The second guidepost is “‘interdependence,’ the degree to which the dealer and grantor cooperate, coordinate their activities and share common goals in their business relationship.”13
After setting the guideposts, the court cautioned that a “court must not restrict its inquiry to any one facet of the business relationship….”14 The court listed 10 facets that courts should consider when determining whether a business relationship is a dealership, with each facet touching on one or both of the guideposts:
- how long the parties have dealt with each other;
- the extent and nature of the obligations imposed on the parties in the contract or agreement between them;
- what percentage of time or revenue the alleged dealer devotes to the alleged grantor’s products or services;
- what percentage of the alleged dealer’s gross proceeds or profits derives from the alleged grantor’s products or services;
- the extent and nature of the alleged grantor’s grant of territory to the alleged dealer;
- the extent and nature of the alleged dealer’s uses of the alleged grantor’s proprietary marks (such as trademarks or logos);
- the extent and nature of the alleged dealer’s financial investment in inventory, facilities, and goodwill of the alleged dealership;
- the personnel that the alleged dealer devotes to the alleged dealership;
- how much the alleged dealer spends on advertising or promotional expenditures for the alleged grantor’s products or services; and
- the extent and nature of any supplementary services provided by the alleged dealer to consumers of the alleged grantor’s products or services.15
After examining the various facets of the relationship, the Ziegler I court ultimately concluded that “because material issues of fact remain in dispute, [it could not] resolve, as a matter of law, the question [of] whether the community of interest requirement has been met.”16 The supreme court thus remanded the case to the circuit court.
Despite the all-inclusive approach announced by Ziegler I, the Seventh Circuit subsequently focused on one facet, the extent and nature of the distributor’s sunk investment into the alleged dealership.17 The Seventh Circuit reasoned that those distributors who make substantial investments in illiquid or unsalable assets (such as warehouses or product-specific promotional material) are most at the grantor’s mercy and most need the WFDL’s protection. The court further justified its narrowed focus by observing that “[m]ulti-factor tests could imply jury trials in all cases, but no one wants (or can believe the state legislature created) a vapid law, uncertain in every application.”18 As a result of its emphasis on the distributor’s sunk investment, the Seventh Circuit had been less likely to hold that the parties shared a community of interest and thus less likely to hold that the relationship was a protected dealership.19
Joseph P. Wright, U.W. 1988, is a partner with Stafford Rosenbaum LLP, Madison. His practice emphasizes business litigation, including dealership and franchise law.
Thomas B. Aquino, Boston College 2002, is a senior associate with the firm, focusing on business litigation.
The Wisconsin Supreme Court, albeit in dicta, at one point seemed to endorse the Seventh Circuit’s narrowing of Ziegler I.20 However, the court subsequently reaffirmed Ziegler I’s two-guidepost, 10-facet approach in Central Corp. v. Research Products Corp.21 The putative dealer in Central derived only a small amount of its revenue from the grantor, but the parties’ relationship otherwise had the hallmarks of a dealership. The court concluded that because there were “genuine issues of material fact and reasonable alternative inferences to be drawn from undisputed material facts that bear on the question of whether there is a community of interest,” summary judgment was not appropriate.22
Central has not been handled consistently within the Seventh Circuit. In Home Protective Services Inc. v. ADT Security Services Inc., the Seventh Circuit cited Wisconsin Supreme Court pre-Central dicta to conclude that the 10 Ziegler I facets “may be distilled into two highly important questions in establishing a community of interest: (1) the percentage of revenues and profits the alleged dealer derives from the grantor; and (2) the amount of time and money an alleged dealer has sunk into the relationship.”23 The Seventh Circuit then boiled the test down even further, stating that “[t]he ultimate question is whether the grantor has the alleged dealer ‘over a barrel’ – that is, whether it has such great economic power over the dealer that the dealer will be unable to negotiate with the grantor or comparison-shop with other grantors.”24
The Seventh Circuit concluded that the would-be dealer was not “over the barrel,” because the dealer was able to find a replacement grantor. The court thus held that, as a matter of law, the parties did not create a dealership, even though the dealer 1) derived 95 percent of its revenue from and devoted 95 percent of its time to its arrangement with the grantor and 2) incurred $63,000 in one-time losses while searching for a new partner and more than $14,000 in recurring monthly losses once it began a less profitable relationship with the replacement grantor.25 The court did not address the principle at the heart of Central – that the community-of-interest question is subject to a multi-factored test that should be undertaken by the factfinder when reasonable competing inferences may be drawn.
In contrast, a Seventh Circuit panel recently applied Ziegler I’s 10-facet test and concluded that a local Girl Scout council was a dealer with respect to the national Girl Scout organization.26 When the national organization (the GSUSA) announced its plans to merge the Girl Scouts of Manitou Council Inc. (Manitou) into a larger, regional council, Manitou filed suit and sought a preliminary injunction preventing the merger. The Seventh Circuit held that Manitou met all three elements of a dealer and thus was protected by the WFDL.27
In deciding that the GSUSA and Manitou shared a community of interest, the court recited the full two-guidepost and 10-facet test of Ziegler I and Central, rather than the distilled two-factor test of Home Protective Services. The court observed that Manitou devoted 100 percent of its time and resources to Girl Scouts, derived virtually 100 percent of its profits from Girl Scout products and services, had a broad and exclusive territory that included seven counties and more than 7,000 members, made extensive use of GSUSA trademarks, had substantial investments in real property (such as campgrounds) and goodwill within the community, and had marketed Girl Scouting exclusively.28
The fact that Manitou was a nonprofit corporation was irrelevant. Manitou was still a business that owned property, sold products, had employees, and made profits. The only difference between a for-profit and a nonprofit corporation is that a nonprofit corporation cannot distribute profits to equity owners. The court concluded that this attribute of a nonprofit corporation is irrelevant to the question of whether Manitou was a dealer.29 Indeed, the WFDL makes no distinction between for-profit and nonprofit entities.30
By this point it should be clear that there are few certainties in community-of-interest analyses. One certainty is that courts should at least address all of the Ziegler I factors in their analyses. Also, practically speaking, both judges and jurors are likely to find the revenue and investment facets most persuasive.31 The bottom line is that, tough economic times or not, attorneys cannot lose sight of the first hurdle in WFDL cases: is this a dealership covered by the statute?
Successor Liability. Successor liability issues (the complete scope of which are beyond the reach of this article) may become more prevalent in today’s economy. Consolidation at all levels of distribution is ever more common. A grantor that disappears through merger may leave a dealer empty-handed. Dealers who acquire a competitive line from a defunct local competitor may destroy their community of interest with their original grantor. Because the first element of a dealership is a contract or agreement between the parties, a successor company may not be considered the grantor of a dealership under the WFDL.32
Successor liability under the WFDL, one court has held, is no different than under any contract. When one corporation purchases the assets of another, the purchaser generally does not succeed to the seller’s liabilities, unless 1) the purchaser expressly or impliedly agreed to assume the seller’s liability; 2) the purchase amounts to a consolidation or merger; 3) the purchaser is a mere continuation of the seller; or 4) the transaction is a fraudulent attempt to avoid liability.33
Attorneys should at a minimum keep in mind that a former dealer who cannot establish that one of these exceptions applies may not be without a remedy.34
Exclusions. Even if a business meets the definition of a dealer, it may be specifically excluded by the WFDL. Wis. Stat. section 135.07 makes explicit that the WFDL does not apply to auto dealerships, the insurance industry, and door-to-door sales. Indeed, because automobile dealerships are regulated separately, by Wis. Stat. chapter 218, the WFDL did not apply to what was probably the most radical dealership restructuring in U.S. history, the plans of General Motors (G.M.) and Chrysler to eliminate thousands of dealerships.35
The G.M. and Chrysler cases highlight another limitation on the WFDL: federal bankruptcy law. Federal bankruptcy law supersedes Wisconsin’s dealership laws (that is, the WFDL and the auto dealer statute). Indeed, one of the primary motivations for G.M. and Chrysler to enter bankruptcy protection was the opportunity to restructure their dealer networks.36
In addition, the WFDL only applies to Wisconsin dealers.37 An out-of-state dealer cannot use the WFDL against a Wisconsin manufacturer.38
The community-of-interest analysis sometimes confounds both attorneys and courts, but it is an obvious prerequisite to consideration of the other questions that arise in WFDL litigation. Sometimes the most important question is never asked – is this a dealership? If the WFDL applies, grantors and dealers must consider how the statute affects their relationship.
Whether the WFDL Prohibits the Proposed Change
The WFDL does not protect a dealer from all changes sought by the grantor. Under Wis. Stat. section 135.03, the WFDL applies only if the grantor seeks to “terminate, cancel, [non-]renew or substantially change the competitive circumstances of a dealership agreement without good cause” (emphasis added). Generally speaking, if the dealership agreement contemplates the action, then it is not prohibited by the WFDL. For example, if a dealership agreement does not grant the dealer an exclusive territory, the WFDL will not prevent the grantor from appointing a second dealer within the territory.39
A grantor may have to give notice of a proposed change even if the change is not prohibited. Under Wis. Stat. section 135.04, the WFDL’s notice requirements apply to any “substantial change in competitive circumstances,” not just to changes to the dealership agreement. Thus, a grantor had to give a dealer 90-days’ notice of its intent to appoint a second dealer to the territory, even though the dealership agreement was nonexclusive and did not prohibit the appointment.40
Whether the Grantor’s Economic Circumstances Constitutes ‘Good Cause’ for the Proposed Change
If the WFDL applies to a proposed change in the dealership relationship (up to and including termination or nonrenewal), the grantor must have good cause for the change.41 The statute makes clear that dealer behavior may provide the requisite good cause. For example, a grantor may have good cause when the dealer has failed to perform as expected (such as by missing sales targets),42 has violated some other aspect of the dealership agreement (such as by entering into an agreement with a competitor),43 has otherwise acted in bad faith,44 or has fallen into bankruptcy, insolvency, or another type of financial difficulty.45
The Wisconsin Supreme Court first addressed whether the grantor’s circumstances alone could create good cause in Ziegler II.46 Rexnord sought to change Ziegler, which sold Rexnord’s rock-crushing equipment, from a dealer to an agent. As a dealer, Ziegler purchased Rexnord products at a discount and sold them at any price it could, keeping the difference as profit. As an agent, Ziegler would receive only a fixed commission from each sale, would not provide startup or warranty service, and would not have to keep an inventory of spare parts. Consequently, Ziegler would not have to maintain a place of business or service personnel. There was no question that the new arrangement would have lowered Ziegler’s profits – Rexnord admitted that the whole point was to lower its sales costs – but the record did not provide an estimate of the amount of lowered profits.47
The parties agreed that Rexnord was losing a substantial amount of money (more than $8 million in the prior year) in the rock-crushing-equipment market. Rexnord claimed that the losses were a result of its relationships with dealers, Ziegler included. Ziegler argued that the losses were simply the result of the poor economy. Also, while Rexnord claimed that the agency arrangement was the only possible way to stanch its substantial losses, Ziegler claimed that Rexnord simply chose the only alternative it considered.48
The court first considered whether a grantor’s economic circumstances could ever be the good cause necessary to redefine a dealership. The court rejected the notion that the WFDL requires grantors to always subordinate their own economic problems to the wishes of the dealer. “[T]he Wisconsin legislature could not have intended to impose an eternal and unqualified duty of self-sacrifice upon every grantor….”49 Instead, the court said, the WFDL’s purpose was to balance the relationship between grantors and dealers. “The WFDL’s primary and underlying purpose and policy is ‘[t]o promote the compelling interest of the public in fair business relations between dealers and grantors, and in the continuation of dealerships on a fair basis.’”50
The court then closely examined the following statutory definition of good cause:
“Failure by a dealer to comply substantially with essential and reasonable requirements imposed upon the dealer by the grantor, or sought to be imposed by the grantor, which requirements are not discriminatory as compared with requirements imposed on other similarly situated dealers either by their terms or in the manner of their enforcement.”51
The court parsed the definition into meaning that if the grantor seeks to impose requirements that are “essential, reasonable and not discriminatory between similarly situated dealers[,]” and the dealer refuses to accept those requirements, then the grantor has good cause to change the relationship.52
The court elaborated that “what is essential and reasonable must be determined on a case-by-case basis” and requires a balancing test that considers the effect of the proposed change on the dealer. For example, the test may be satisfied if the grantor shows that the status quo would have resulted in continuing heavy losses for the grantor, but that the grantor has compensated the dealer for its investment in the dealership relationship. Importantly, “[t]he need for change sought by a grantor must be objectively ascertainable,” and “[t]he means used by a grantor may not be disproportionate to its economic problem.”53 The court also observed that the nondiscrimination requirement protected dealers in three ways. First, the dealer’s competitive position relative to other dealers would be protected. Second, it effectively protected the dealer from being targeted by a grantor with improper motives. Third, because the nondiscrimination requirement “presumptively requires systemic changes, it tends to reinforce the requirement that the change be essential.”54
Applying its rationale to the record before it, the court concluded that it could not make a determination on the good cause issue as a matter of law. There was a genuine issue as to whether Rexnord’s proposed change in the dealership structure was essential, because the parties disputed whether Rexnord’s losses were the result of the economy or the nature of its distribution agreements. There was also a genuine issue as to whether the change was nondiscriminatory. While the agency agreement offered to Ziegler contained some benefits that other dealers were not receiving, other dealers received proposed agency agreements containing benefits not found in Ziegler’s.55
The Seventh Circuit applied Ziegler II in Morley-Murphy Co. v. Zenith Electronics Corp.56 Morley-Murphy is instructive for several reasons. First, it illustrates the economic realities prompting many manufacturers to jettison their distributor networks. The “domestic consumer electronics industry had been in a state of decline for more than 30 years,” and Zenith itself had reported $320 million in losses over the prior five years. At the same time, large discount consumer electronics retailers such as Best Buy began dominating the retail market, often demanding that manufacturers such as Zenith deal directly with them rather than through the manufacturer’s distribution network. By the mid-1990s, Morley-Murphy was one of only 15 independent Zenith dealers remaining. A Zenith task force recommended converting completely to a one-step distribution system, and to that end Zenith sent Morley-Murphy a 90-day notice of termination.57 Zenith had offered to allow Morley-Murphy to keep the “premium business,” that is, to sell Zenith televisions to businesses that would use them as gifts to employees and customers, but Morley-Murphy rejected the offer and instead brought suit.58
Second, Morley-Murphy built on Ziegler II by holding that economic circumstances justify may not only a change in the relationship (such as from a dealership to an agency) but also an outright termination. While the district court refused to extend Ziegler II to a complete termination of the relationship, the Seventh Circuit noted that the statutory interpretation made by Ziegler II applied to any change in the dealer relationship, including termination.59
Third, although the Seventh Circuit did not apply the good-cause balancing test to the record – it simply held that Zenith should have “an opportunity to prove that its particular circumstances qualified as ‘good cause’ under the statute for the steps it took” – its recitation of the facts suggest Zenith might have difficulty passing the test.60
“Zenith never bothered to determine whether Morley-Murphy, standing alone, was a profitable dealer, or if independent distribution in the upper Midwest might have been preferable to one-step distribution. Nor does the record show how successful Zenith’s change in business strategy has been, or how its current financial health relates to this particular move. Upon termination of Morley-Murphy’s dealership, Zenith took over sales to retail accounts in Morley-Murphy’s former territory and has aggressively promoted its products there.”61
Finally, the court somewhat rewrote the essential, reasonable, and nondiscriminatory test, stating that good cause requires a showing of “(1) an objectively ascertainable need for change, (2) a proportionate response to that need, and (3) a nondiscriminatory action.”62
The Morley-Murphy court’s formulation of the Ziegler II test has been applied by two district courts considering applications for preliminary injunctions.63 Both cases illustrate the importance of gathering hard evidence to justify the proposed change.
In Builder’s World, a window manufacturer, Marvin, began selling dealer-direct in Builder’s World Inc.’s (BWI’s) territory. The district court granted BWI a preliminary injunction after concluding “that the evidence [was] unlikely to show that Marvin had good cause to make such a substantial change in the parties’ relationship.
“As justification for selling dealer-direct, Marvin states that some of its competitors have eliminated the two-step distribution system and now sell directly to dealers. It also states that several of its larger dealers asked if they could buy directly from it and that if it did not agree, such dealers would likely have turned to one of its competitors. However, Marvin presents no evidence that any Marvin dealers presented such ultimatums or that, if they did, whether their threats were credible and, if so, what financial effect their defections might have had. Marvin presents no evidence that by not selling dealer-direct, it would have been likely to lose money in BWI’s territory. On the contrary, it appears that in recent years, Marvin has experienced record sales and record profits and that it has made money in BWI’s territory. Thus, it is unlikely that the evidence will show that Marvin had an objectively ascertainable need to change its distribution system in BWI’s territory and even if it does, that selling dealer-direct was a proportionate response to it. Moreover, because it appears that Marvin has not gone dealer-direct everywhere but in fact maintains a two-step distribution system in some areas, the evidence may well also show that Marvin’s action was discriminatory.”64
Similarly, in Girl Scouts, the court observed that the grantor lacked any objective evidence that its proposed change was necessary. First, the GSUSA’s “financial circumstances [were] a far cry from the dire economic straits confronted by Rexnord and Zenith. GSUSA’s financial statements indicate that GSUSA’s operating revenues exceeded its operating expenses in Fiscal Years 2005 and 2006, earning operating profits of $886,000 and $2.5 million, respectively.” Moreover, “GSUSA’s [reliance on] intangible concerns such as ‘fading brand image’ and ‘waning program effectiveness’ [does not,] without a tangible effect on the bottom line, present the types of concerns Wisconsin courts have contemplated by the ‘good cause’ provision of the WFDL.”65
The Girl Scouts court also doubted the proportionality of the GSUSA’s proposed move. The GSUSA claimed that the goal of its realignment strategy was to create fewer councils of larger size. However, its proposal for Manitou would have kept the same number of councils, but with one council (Manitou) shrinking considerably. The court did not “believe that this method of implementing GSUSA’s realignment strategy is a proportionate response to its need to address ‘unfavorable trends’ in ‘membership, brand image and program effectiveness.’”66
Several lessons may be drawn from these four cases. First, the worse the grantor’s financial condition, the more likely the proposed change will be found to be essential or necessary.67 A grantor is unlikely to prove that a change is necessary if it is currently profiting despite the arrangement.68
Second, even if the grantor is in a desperate financial situation, it cannot just shoot from the hip. The need to change the relationship must be objectively ascertainable.69 This suggests that a grantor should seek expert advice or at least perform an internal study on whether the grantor’s situation is a result of its dealership system or the grantor’s general economic condition, and if it is the former, what the grantor should do about it. Any expert analysis should refer to evidence of the grantor’s financial situation,70 possible alternative dealership arrangements,71 the distribution system used by competitors,72 and the performance of particular dealers.73 The grantor also should be prepared to show its performance after the change is made; if the company continues to do poorly, that would suggest that it was not necessary to change the dealership arrangements in the first place.74
Third, any change must be reasonable75 or a proportionate response to the problem necessitating the change.76 Ziegler II suggested that in some instances, this means that the change should include financial compensation to the dealer. “The balanc[ing] test may be applied by allowing the grantor to avoid continuing heavy losses by the recovery of damages for reasonably necessary investment by the grantee on termination of the agreement.”77
Fourth, both the essential and the nondiscrimination requirements suggest that a change should be systemic.78 A grantor will likely have to make wholesale changes to its entire distribution system, rather than in isolated areas.79
Finally, good-cause analysis will almost always be a question of fact. Both Ziegler II and Morley-Murphy referred the question to the fact finder, and the Girl Scouts court concluded that “chances are better than negligible that a jury could conclude that GSUSA lacked an objectively ascertainable need for its proposed change, or that it failed to respond proportionately to that need.”80
The paucity of economic good-cause cases may reflect that the good-cause issue is a factual question for a jury. Another possible explanation, though, is the specter of bankruptcy. When a grantor is facing the truly dire economic circumstances that may give it good cause to reorganize its distribution system, it also may qualify for reorganization of all its business relationships through federal bankruptcy law. This reality provides a strong impetus for dealers to come to terms with their grantors, rather than risk being wiped out completely by a bankruptcy judge.
At a time of economic upheaval, reworking distribution systems may seem like a prudent idea. However, care must be taken to determine whether the WFDL applies to the parties and to the proposed change. If the WFDL does apply on both counts, then the change must be essential, reasonable, and nondiscriminatory. The grantor must be prepared to point to specific facts showing that it needed to make the change as a matter of survival, rather than simply to increase profits. Finally, the change should be systemic, that is, made to the entire distribution system rather than to just a few dealers.