You Get What You Pay For: Distributor Dispute Resolution Gone Awry

Fred Mendelsohn discusses two recent court cases in which a pair of distribution companies could have avoided substantial litigation expenses if they only had proper written agreements in place before a breakdown in their business relationship.

In two recent cases, two distribution companies could have avoided substantial litigation expenses (and more to come) if only they had proper written agreements in place before there was a breakdown in their business relationship. Both cases ended up in court; and both have cost the companies significantly — not only in legal and other costs to resolve the underlying disputes but also in terms of the lost opportunity costs of having to deploy human capital to support the companies’ litigation activities. One key issue as to these cases is that the parties could have controlled where their disputes would be resolved, and under what rules — for example, in court or arbitration, but the parties failed to do so properly. This tactical mistake increased risk, exposure and costs across the board in both cases.

In the first case, the parties — both sophisticated business entities — simply failed at the beginning of the relationship to execute an integrated, comprehensive written agreement. As such, the battle ground as to contract terms applied to the parties’ relationship involved two diametrically opposed platforms: conflicting purchase order terms and conditions versus course of performance documents, oral testimony and thousands of e-mail communications. Had the parties simply spelled out (presumably with the help of counsel) their OEM relationship, they could have likely avoided years of grief and hundreds of thousands of dollars in expenses — even if there was a legitimate dispute to address in court.

In the second case, the parties began their relationship on a handshake and a very sketchy agreement relative to the sharing of proprietary information between the two business entities. It was not until more than a decade into the relationship that the parties executed a written distribution agreement, but they signed a document that almost no lawyer would allow either party to sign due to its poor wording. The second case is much more complicated due to the fact that the contract as signed contains an equally as poorly written arbitration provision. Arbitration is a creature of contract. As such, its contours are left in large part up to the parties to detail in their business contract.

For example, the parties can enter into a broad arbitration provision, using the template suggested by the American Arbitration Association (AAA), which in most jurisdictions “covers” almost any dispute having any relationship to the parties’ business relationship. But, the law applicable to the scope of arbitration provisions is, to say the least, in a state of flux, particularly when parties involved in the dispute did not sign the contract containing the arbitration provision, which is the fact pattern in the second case. Given allegations of conspiracy to commit and aiding and abetting various other illegal conduct, wrongs — including employees, former employees, subsidiary companies and third-parties — it becomes even more challenging, legally, and hence expensive, to sort out where the case should be heard or if it must be heard in different forums. 

Arbitration agreements, if done correctly, can adequately address dispute resolution, including a number of “procedural” issues applicable in arbitration. A significant deficiency in the second case is the failure to name the arbitration tribunal that will administer the arbitration, like the AAA. Subject to a number of legal variances, when the AAA is designated as the tribunal responsible for overseeing and implementing the arbitration of disputes, its various rules apply, but even those rules have holes, depending on what the arbitration provision of the subject contract says and when the parties entered into their contract containing an arbitration provision.

For example, the issue of expedited relief (in the nature of an injunction) has been raised by one of the parties. The AAA rules allow for expedited relief, but only as to contracts executed after October 2013 (which precludes that relief in the second case). Similar issues exist across the board as to the relief entitled when not spelled out in a comprehensive arbitration provision, so any such provision should be crafted carefully with the aid of counsel. While there is a plethora of common law (federal and state) that can overlay and unwind intended dispute resolution procedures, distributors and all businesses should be aware of these issues, as they can affect how disputes are handled if the parties elect to incorporate an arbitration provision in their supplier/distributor contract. Importantly:

  • The parties should specify a tribunal to administer the arbitration, and delineate what rules of that tribunal apply to any dispute (e.g., those in place at the time of the dispute or at the time of contracting, etc.).
  • To the extent that the tribunal rules do not cover certain aspects of dispute resolution, they should be addressed in the arbitration provision:
    • How many arbitrators will hear the dispute and their qualifications (e.g., a party might want one (or more) arbitrator(s) to have certain experience in various areas of the law or various industry experience).
    • To the extent arbitrators are selected, how the selection process will be effected, and whether a written decision must be issued by the arbitrators. Without the requirement of a “reasoned award,” many arbitrators (or arbitration panels) issue “black box” awards, finding in favor or against a party without explanation.
    • While any arbitration award is difficult to appeal (if not next to impossible), under applicable arbitration statutes — federal or state — the parties are likely better served trying to attack any award if there is gross error. Not having a reasoned award can lead to the inevitable enforcement of the arbitrators (or arbitration panel’s) award, with little recourse to the losing party.
    • The nature and extent of available injunctive and other interim relief, which involves several different issues and, importantly, the scope of the type of disputes to be resolved in arbitration.
    • Finally, (a) the types of pre-hearing discovery available to the parties (e.g., depositions, requests for documents, etc.), (b) whether the arbitrator can award punitive damages and/or attorney’s fees, (c) what substantive law applies to the claims (a complicated issue to sort out after the fact), and (d) the extent to which any award can be challenged (whether interim and/or final) in court or on appeal.

The key lesson in the two case examples presented is for distributors to ensure that there is a clear set of contract terms applicable to parties’ relationship and comprehensive method in place to resolve disputes, whether in arbitration and/or in court. As to arbitration provisions, distributors should not fall prey to the idealistic notion that an arbitration provision provides a more efficient, less expensive and better alternative to the right to proceed in court. While clearly an option, arbitration provisions, if not crafted correctly, can create many issues that the business parties did not even contemplate when entering into an agreement with an arbitration provision. Some practitioners do not like arbitrations, for several reasons, such as:

  • Arbitrations can be expensive. Not only does a party have to pay a hefty fee to the arbitration tribunal to assert the claim, but they have to pay one or more arbitrators by the hour, or day, for work on the case, including serving as the “judge” or “judges” at the hearing of the dispute. With a three (3) member arbitration panel, the costs for such an arbitration panel, with preparation, hearing time, and issuing an award (whether reasoned or not) can exceed six-figures.
  • In federal (and most state’s) court, the availability of discovery is a powerful tool that can often be outcome determinative of a case. The ability to compel the production of documents, obtain interrogatories and requests to admit (answers under oath to written questions or assertions) and/or secure depositions, including of third-parties to the case (e.g., witnesses that have relevant evidence but who are not named in the underlying dispute) is a key issue that should not be overlooked because parties believe arbitration is cheaper or more expedient. As noted, the absence of such rights may preclude a successful offense or defense.
  • In arbitration, no jury rights exist. That right is waived. Some cases warrant and should be heard by a jury. To the extent that the contracting party believes that a jury is not a good option for it in resolving a dispute (e.g., they are foreign to the jury and may not be well received, etc.), then there are options to keep the case in court, but without a jury (e.g., a waiver of any right to a jury trial).

Two propositions are clear from these two case examples. First, there is no case of the nature discussed herein that would not be better and more efficiently resolved if the parties made sure that the agreements that control their business relationship are secure, and air-tight, before doing business. Second, arbitration is not always the speedy and inexpensive forum that many believe. Any such provisions should not be considered “boilerplate” — instead, they may well be the most important provisions in an agreement, and such should not be entered without a full vetting by the parties and presumably counsel.

Fred Mendelsohn is Partner at Burke, Warren, MacKay & Serritella, P.C. in Chicago. For those interested in this or related topics, contact Mendelsohn at [email protected] or 312/840-7004.

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