When is a Distributor a Franchisee?

By Jerry Meek (January 16, 2016)

The typical distributor enjoys few statutory protections against termination by a manufacturer. Unless the relationship is for the distribution of one of several traditionally protected products – notably alcohol, motor vehicles, or farm, industrial, construction, or outdoor power equipment – the distributor’s only defense to termination may be the provisions of the distribution agreement itself.

But if the distributor is operating in a state that has enacted a franchise relationship law, the distributor may argue that it was a franchisee rather than a distributor, thus entitling it to statutory protection.

One such attempt was recently rejected by the Court in Rogovsky Enterprise, Inc. v. MasterBrand Cabinets, Inc., 3:15-cv-22 (S.D. Ind. November 30, 2015). Rogovksy Enterprise was the franchisor of kitchen and bath design and remodeling businesses, operating under the tradename KHI. KHI entered into an “Exclusive Distribution Agreement” with MasterBrand Cabinets, pursuant to which KHI agreed to require its franchisees to purchase their cabinets exclusively from MasterBrand in exchange for a 15% rebate from MasterBrand to KHI.

As alleged by KHI, MasterBrand terminated the agreement after MasterBrand’s pre-existing network of dealers complained about the added competition. KHI sued, arguing in part that it enjoyed the protections of franchise relationship statutes adopted by nine States.

The Court noted that – generally – a distribution relationship is properly characterized as a franchise where: (1) the franchisee makes a required payment to the franchisor or its affiliate; (2) the franchisor grants the right to use a trademark associated with the business; and (3) the franchisor has the right to exert significant control over, or promises to provide significant assistance in, the franchisee’s business. The Court dismissed KHI’s claims under prongs 1 and 2, without discussing prong 3.

As to the first prong, KHI argued that the requirements under the distribution agreement that it remodel its showroom, sell only MasterBrand products, and pay for training provided by MasterBrand to KHI employees constituted monetary and non-monetary fees required by the agreement. The Court rejected the argument. While the “remodel arguably provided some indirect benefit to MasterBrand, it primarily benefited” KHI and thus did “not constitute a direct or indirect fee paid to MasterBrand.” In addition, although the agreement permitted MasterBrand to invoice KHI for any training it provided, there was no allegation that MasterBrand ever sent such an invoice or that any such payment was ever made. Finally, the Court ruled that non-monetary consideration such as the promise to sell exclusively MasterBrand cabinets does not constitute a franchise fee under the governing statutes.

Turning to the second prong, the Court rejected the argument that KHI’s business was substantially associated with MasterBrand’s trademark. While the agreement did grant KHI the right to use MasterBrand’s mark “to advertise and promote the sale of” MasterBrand cabinets, it did not grant KHI the right to use the MasterBrand trademark to sell KHI franchises. In fact, in KHI’s Franchise Disclosure Document (required under federal law in order to sell franchises), there’s no reference to the MasterBrand mark. Presumably the Court finds this distinction relevant because KHI is in the business of franchising, rather than selling MasterBrand cabinets.

Having failed in its attempt to characterize itself as a franchisee, KHI now moves forward on its contention that MasterBrand breached the distribution agreement between the parties. Although other distributors have enjoyed more success invoking the protections of franchise relationship laws, the distribution agreement itself is always the distributor’s first line of defense.