Franchisor and Designated Supplier Attempt to Justify Payments

The U.S. District Court for Massachusetts reviewed a complaint alleging commercial bribery, unfair trade practices, and violation of the implied covenant of good faith and fair dealing stemming from an alleged kick back scheme between a franchisor and approved supplier for franchisees. In response to motions to dismiss, the court released an memorandum of decision in the case of Substantial Investments, Inc. v. D'Angelo Franchising Corp, No. Civ.A. 03-11202-RWZ, 2004 U.S. Dist. LEXIS 17300, 2004 WL 1932749 (D. Mass. Aug. 30, 2004). The opinion is interesting because of the variety strategies employed by the defense and how the court ultimately dealt with each strategy.

The plaintiffs are a group of New England-area franchisees of D'Angelo Sandwich Shops, the defendants are D'Angelo Franchising Corporation (D'Angelo) and U.S. Foodservice, Inc., and its wholly owned subsidiary J.P. Foodservice Distributors (U.S. Food). The suit stems from the D'Angelo franchise agreement which required franchisees to purchase all perishables, meats, dairy, poultry, seafood, and janitorial and paper products from suppliers designated by D'Angelo. U.S. Food was a designated supplier. U.S. Food made weekly deliveries to the plaintiffs, for which it charged the price of goods delivered as well as a delivery fee.

The delivery fees charged by U.S. Food followed two pricing structures. From April 1999 to March 2001, U.S. Food charged $284 plus tax for each delivery. U.S. Food then changed their delivery fee to 10% of the price of the delivered goods, plus tax. This second structure was in place from April 2001 until mid-January 2002.

The plaintiffs allege that U.S. Food kicked back first $157 of their delivery fee, then 40% of the delivery fee in each period respectively. Plaintiffs claim that the total amounts of the kick backs exceeded $887,000. In their complaint, the plaintiffs contend: Count I, that the commission payments constituted commercial bribery that violated section 2(c) of the Robinson-Patman Act (15 U.S.C. § 13(c)); Counts II – V, the defendants violated unfair trade practice statutes in Massachusetts, Connecticut, Rhode Island, and Maine; Count VI, the defendants violated the Massachusetts antitrust act (Mass. Gen. L. ch 93, §§ 1-14A); and finally, Count VII, the defendants violated the implied covenant of good faith and fair dealing.

The defendants filed motions to dismiss for failure to state a claim for which relief can be granted. The defendants' motions rely on four alternative theories, none of which the court accepted.

The defendants first argued that section 2(c) the Robinson-Patman Act does not apply to commercial bribery. The defendants claimed that because the applicability had not yet been resolved in the First Circuit, the court should dismiss Count I. Nevertheless, the court declined this option, instead choosing to follow the five circuits that have held that section 2(c) does apply to commercial bribery.

Second, the defendants claimed that commercial bribery requires a fiduciary relationship the parties that is lacking in the franchising relationship. The court disagreed, stating that commercial bribery is based on whether a buyer has the option to forgo purchasing. Accordingly, a fiduciary relationship test was held to be immaterial.

Third, the defendants claimed the plaintiffs had constructive notice because D'Angelo's year 2000 Uniform Franchising Offering Circular (UFOC) note that "we and our parent, or persons affiliated with us, may derive revenue as a result of your purchases of approved supplies or from approved suppliers…" The court acknowledged the existence of the language, but stated that the UFOC was provided to prospective and not existing franchisees, and that it was too early in the case to determine whether the plaintiffs knew or should have known about the statement.

Finally, the defendants claimed that the plaintiffs failed to allege an "antitrust injury". The court disagreed here as well, holding that the allegation that the kick back scheme forced the plaintiffs to operate at a competitive disadvantage to the franchisor-run shops as well as other competitors, with an estimated loss in sales and profits to the plaintiffs of over $1.5 million, was sufficient to preserve Count I.

Regarding the other counts, the court found that section 2(c) claims are sufficient to state claims for unfair trade practices under state statutes for Counts II and III, but since the plaintiffs conceded they had no standing in Rhode Island or Maine, Counts IV and V were dismissed.

The court also preserved Count VII, the allegation that the kick back scheme violated the implied covenant of good faith and fair dealing. While it recognized that the plaintiffs alleged no express violation of the franchise agreement, the court held that defendant D'Angelo could have violated the spirit of the agreement by exercising its discretionary right to choose suppliers for the purpose of extracting even more money from the franchisees.