Thursday, July 31, 2008

Soft Drink Distributors Were Not Minnesota Franchisees

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

Five soft drink distributors were not “franchisees” under the meaning of the Minnesota Franchise Act (MFA) because they neither sold a manufacturer’s drinks in order to start a new business nor paid the manufacturer an indirect “franchise fee,” a federal district court in St. Paul, Minnesota, has decided. Thus, the manufacturer did not violate the MFA by terminating its agreements with the distributors without “good cause” and was granted summary judgment on the distributors’ claim.

The distributors brought suit against the manufacturer after it notified them that their agreements would terminate at the end of 2006. Three of the distributors had only oral agreements with the manufacturer, while the other two had written agreements that permitted termination without cause.

Business Opportunity Provision of the MFA

The distributors argued that they were franchisees under the meaning of the MFA’s business opportunity provision because they entered into their relationships with the manufacturer in order to start new businesses. Under the MFA’s business opportunity provision, payment of a franchise fee was not necessary to establish the existence of a franchise, the court noted. Rather, that portion of the statute defined, in relevant part, a “franchise” as the sale or lease of any products “for the purpose of enabling the purchaser to start a business…” Specifically, the distributors contended that they had been in the business of distributing beer prior to entering their relationships with the manufacturer and that the manufacturer sold them its soft drinks so that they could start the new business of distributing premium soft drinks.

Neither the parties nor the court was able to locate any caselaw interpreting the MFA’s business opportunity provision. However, a review of caselaw from other jurisdictions and consideration of the commonly understood meaning of “start a business” suggested that the phrase did not have the broad meaning claimed by the distributors, according to the court. Whatever the ambiguities inherent in the phrase “start a business,” the court believed that it could not be stretched to cover a situation in which an already-established beer distributorship took on the distribution of a line of soft drinks. Were the court to hold otherwise, the scope of the MFA would be so broad that, anytime a wholesaler or retailer added a new line of products, the wholesaler or retailer could be deemed a “franchisee” and the supplier could be deemed a “franchisor.” Thus, the distributors were not franchisees under the MFA’s business opportunity provision.

Indirect Franchise Fee

The distributors asserted that they were franchisees of the manufacturer under the MFA’s definition of a “franchise” requiring the franchisee to pay, directly or indirectly, a franchise fee. The distributors claimed that they pad indirect franchise fees in the form of co-op advertising and marketing fees, excessive minimum volume and sales requirements, and discount pricing programs.

Minnesota courts long held that ordinary business expenses such as purchased supplies, marketing materials, and participation in advertising and discount programs were not franchise fees unless they were unreasonable and lacked a valid business purpose, the court observed. Further, the record was devoid of evidence that any of the marketing and advertising expenses incurred by the distributors were unreasonable or lacked a valid business purpose.

At most, there was some showing that one of the distributors occasionally lost money when it participated in one of the manufacturer’s marketing programs, but to say that a distributor lost money because of such participation was not to say that the program was unreasonable or lacked a valid business purpose, the court reasoned. The evidence showed that when the distributor agreed to participate in a discount program at a loss, it did so in the hope of promoting brand awareness. Based on the record, no reasonable jury could find that the manufacturer’s discount and other marketing programs were unreasonable or lacked a valid business purpose, the court held. Similarly, there was no evidence that the manufacturer’s minimum purchase requirements and sales goals were unreasonable or lacked a valid business purpose. Thus, because the indirect fees that the distributors were allegedly forced to pay were ordinary, reasonable business expenses with a valid business purpose, they were not franchise fees under the meaning of the MFA, the court ruled.

The July 25, 2008, decision in Day Distributing Co. v. Nantucket Allserve, Inc., Case No. 07-CV-1132 (PJS/RLE), will appear in the CCH Business Franchise Guide.

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