The proof of damages in case of a premature termination of a distribution agreement: new guidelines by the Swiss Supreme Court


On 3 January 2018, the Swiss Supreme Court rendered a new judgment related to the termination of an exclusive distribution agreement (judgment 4A_27/2018). The decision primarily deals with the proof of damages in connection with a premature termination of a distribution relationship. Moreover, it discusses the proof of the net annual earnings in connection with a claim for goodwill compensation in terms of article 418u of the Swiss Code of Obligations (“CO”). The new decision is of considerable interest, in particular since decisions of the Swiss Supreme Court in distribution related matters are quite rare.
 

The facts

In 1996, a Spanish supplier concluded an exclusive distribution agreement (the “Agreement”) with a Polish distributor. The Agreement related to the distribution of lollipops and mint dragees. The distributor was obliged not to distribute any lollipops other than the contract products. The distributor was however free to distribute products from other manufacturers as well, and it actually did so.

Either party had the right to terminate the Agreement if, at the end of a calendar year, the parties could not agree on the marketing strategy, sales targets and pricing structure for the subsequent year. Since no such agreement was reached with regard to mint dragees by the end of 1999, the supplier informed the distributor in writing in March 2000 that the exclusive distribution of the contract products will be transferred to another company. The distributor protested and refused to consider the supplier’s letter as a termination of the distribution relationship. In April 2000, the supplier delivered contract products for the last time to the distributor.

In November 2000 (sic!), the distributor filed an action for damages due to a breach of contract (articles 97 et seqq. CO) and for payment of a goodwill compensation in terms of article 418u CO against the supplier with the District Court of Zurich. In the proceedings before the Supreme Court, the total claims amounted to approximately 16.4 million Polish zlotys, corresponding to approximately EUR 3.8 million.

After an initial default judgment against the supplier had been quashed in 2003, the District Court dismissed the action in its entirety in November 2014. According to the District Court, the termination of the distribution relationship did not amount to a breach of the Agreement. In January 2016, the Court of Appeal of the Canton of Zurich overturned the District Court’s ruling. The Court of Appeal found that the Agreement had neither automatically expired nor been terminated in accordance with its terms and remitted the case in order for the District Court to examine claims for damages based on breach of contract.

In November 2016, the District Court dismissed the action in its entirety again, a decision which was this time confirmed by the Court of Appeal of the Canton of Zurich in November 2017. With regard to the damage claims, the Court of Appeal argued that the information provided by the distributor was insufficient for an estimate of damages by the judge. Furthermore, the Court of Appeal was of the opinion that the requirements for an analogous application of Article 418u CO (i.e., the legal basis for a goodwill compensation under Swiss agency) to the exclusive distribution relationship at hand were not met.

In its new decision, the Supreme Court dismissed the appeal filed against the judgement of the Court of Appeal and brought the dispute between the distributor and the supplier, which lasts almost two decades, to an end.
 

Estimate of damages in case of a premature termination of a distribution relationship

With regard to the estimate of damages, the distributor argued that, between 1997 and 1999, 86.72% of the annual budget agreed with the supplier was achieved. The distributor concluded that it would have continued to obtain the proceeds of the budgeted gross turnover, calculated on the basis of that percentage, if the Agreement had not been prematurely terminated. The distributor further argued that saved procurement and distribution costs amounted to in average 78% of the gross proceeds. These savings were calculated in respect of the entire business of the distributor, i.e., also including products other than the contract products from the Supplier. Consequently, the distributor argued that its earnings amounted to 22% in average. For accounting purposes, the distributor divided these earnings into a fixed cost share of 16.5% and a net profit of 5.5%. However, according to the distributor, the fixed costs remained stable despite the premature termination of the Agreement, so that the supplier should have been obliged the replace the entire lost earnings from the transactions with the supplier.

The Supreme Court acknowledged that the distributor provided an estimate of damages based on concrete information. Yet, the Supreme Court noted that such information may only be used as the basis for an estimate of damages if the circumstances put forward are sufficient to draw reliable conclusions as to the existence and magnitude of the damages. Therefore, it would have been up to the distributor to show that the estimate proposed by the distributor meets these requirements, both with regard to the question as to, first, which information is required and, second, the calculation method applied.

Regarding the information required for an estimate of damages, the Supreme Court drew particular attention to the fact that damages may be awarded only if it is proven that the lost earnings were caused by conduct in breach of the Agreement or, more specifically, the non-delivery of the contract products by the supplier. In that regard, product-specific information may be necessary. Such product-specific information would have been of particular importance in the case at hand, since the distributor also marketed many products from other manufacturers at the same time as it distributed supplier’s lollipops and mint dragees. The products from other manufacturers were not affected by the premature termination of the Agreement.

The distributor argued that it was impossible or unreasonable to provide product-specific information. Yet, the Supreme Court disagreed and argued that the circumstances which rendered the provision of product-specific information impossible or unreasonable were not established. It would have been up to the distributor to show that the latter made corresponding assertions and offered evidence already in the proceedings before the lower instances and in accordance with the applicable rules on civil procedure. The Supreme Court emphasized that it was not sufficient to solely assert that it is impossible or unreasonable to provide certain information. In particular, the Supreme Court noted that the fact that certain information has never been collected on a product-specific basis did not necessarily render the subsequent provision of product-specific information impossible or unreasonable. It might have been possible to subsequently obtain such information without any unreasonable efforts from available documents. Therefore, the distributor should have explained in detail why, due to its internal organization and procedures, it was impossible or unreasonably burdensome to provide product-specific information.

The distributor further argued that it had provided product-specific information, in the sense that supplier’s lollipops and mint dragees were representative products for distributor’s entire business. According to the distributor, this made it possible to base the estimate of damages on average figures relating to the entire business. However, this line of reasoning failed for several reasons. First, the Supreme Court found that the assertion was irrelevant, as it was made too late and was therefore procedurally inadmissible. Second, the mere assertions by distributor that it was simultaneously selling other well-known branded products (notably ketchup, coffee, tea and cereals) and that there are only insignificant differences in profit margins for such traditional consumer goods in the foodstuffs sector was not sufficient. More precisely, the Supreme Court rejected distributor’s argument that these circumstances are notoriously known to the court, so that they do not have to be asserted in the proceedings. According to the Supreme Court, non-industry experts are not in the position to easily assess whether there are differences in profit margins for individual foodstuff products. Moreover, the Supreme Court added that relevant differences between different foodstuff products are also conceivable with regard to storage costs.

In respect of the fixed costs, the Supreme Court stated that the distributor should have explained why the cessation of the distribution of lollipops and mint dragees did not lead to a cost reduction, in light of the specific internal organization and procedures. According to the Supreme Court, it is conceivable that this assertion applied to a limited part of the fixed costs only, so that the distributor had failed to provide sufficient information in that regard. It was therefore not possible to decide whether the proposed estimation method leads to supportable results.

In addition to the comments regarding the insufficient, non-product specific information for an estimate of damages, the Supreme Court also discussed the calculation method proposed by the distributor.

The distributor used as the basis of its calculation the three-year average value of the achievement of the annual budget agreed with the supplier. Nonetheless, the Supreme Court was not satisfied with that method for the following reasons: First, the distributor should also have shown that the average value did not simply represent the arithmetic average of considerably fluctuating amounts but essentially corresponded to the average value over the years and permitted reliable conclusions regarding the damages incurred by distributor. Second, the Supreme Court argued that it would have been more reliable to base the estimate of damages on concrete figures. Such concrete figures could have been, e.g., the number of products actually sold. In contrast, the budget figures used by the distributor constituted mere estimates of both parties and were thus uncertain.

In summary, the distributor failed to prove its damage incurred in connection with the premature termination of the distribution relationship or, at least, to provide sufficient information for the judge to be able to perform an estimate of damages. Therefore, the action for damages was dismissed in its entirety, regardless the fact that the Court of Appeal earlier found that the distribution relationship had been terminated by the supplier in breach of contract.
 

Calculation of the net annual earnings for a goodwill compensation in terms of Article 418u CO

In addition to the action for damages, the distributor also brought an action against the supplier for payment of goodwill compensation in terms of Article 418u CO. This provision states:

“1) Where the agent’s activities have resulted in a substantial expansion of the principal’s clientele and considerable benefits accrue even after the end of the agency relationship to the principal […] from his business relations with clients acquired by the agent, the agent [… has] an inalienable claim for adequate compensation, provided this is not inequitable.

2) The amount of such claim must not exceed the agent’s net annual earnings from the agency relationship calculated as the average for the last five years or, where shorter, the average over the entire duration of the contract.

3) No claim exists where the agency relationship has been dissolved for a reason attributable to the agent.”

In its November 2017 decision, the Court of Appeal of the Canton of Zurich agreed with the District Court of Zurich and found that the conditions set out by the Swiss Supreme Court in May 2008 in its leading BGE 134 III 497 for an analogous application of Article 418u CO were not met.

In accordance with the leading case BGE 134 III 497, an analogous application of Article 418u CO to exclusive distribution agreements requires that the distributor is integrated to a large extent into the supplier’s distribution organisation, so that the distributor finds itself in an agent-like position and disposes of only limited economic autonomy. Such an agent-like position may be given, in particular, in case of

  1. minimum purchase quantities by the distributor;
  2. a supplier’s right to unilaterally change prices and delivery terms;
  3. a supplier’s right to unilaterally terminate the manufacturing and distribution of contract products;
  4. minimum marketing expenditure obligations on the part of distributor;
  5. obligations to maintain minimum stocks of contract products by the distributor;
  6. periodical reporting obligations (e.g., regarding achieved sales and activities of competitors) by the distributor to the supplier;
  7. a supplier’s right to inspect distributor’s books and to conduct audits;
  8. the distributor being prohibited from continuing distributing the contract products following the end of the distribution relationship.

Under these circumstances, a distributor may be entitled to a goodwill compensation, provided that: 1) the distributor’s activities have considerably expanded the customer base; 2) the supplier benefits from the acquired customer base even after the termination of the distribution relationship and; 3) if such goodwill compensation is not inequitable.

In its November 2017 decision, the Court of Appeal of the Canton of Zurich emphasized that a claim to goodwill compensation is mandatory in case the above-described requirements are met and cannot be contractually excluded in advance. According to the Court of Appeal, these rules shall also be applicable to existing exclusive distribution agreements. The latter statement made by the Court of Appeal of the Canton of Zurich is of general interest, since suppliers regularly attempt to exclude claims for goodwill compensation in their distribution agreements. Nevertheless, if an analogous application of Article 418u CO to distribution agreements is justified, provisions according to which no compensation whatsoever shall be owed will be null and void.

In the present case, the Supreme Court left open the question of whether Article 418u CO could be applied analogously to Agreement. According to the Supreme Court, the action for payment of goodwill compensation was doomed to fail anyway, since the distributor failed to proof the net annual earnings achieved under Agreement. The distributor calculated the average net annual earnings for the purpose of quantifying the goodwill compensation solely on the basis of the business as a whole, but not on a product-specific basis. Moreover, just as with regard to the estimate of damages, the distributor had failed to assert in due course that lollipops and mint dragees were representative foodstuff products for its entire business. This ultimately led to the dismissal of action for payment of goodwill compensation.
 

Summary

The new verdict of the Swiss Supreme Court recalls that the proof of a breach of contract by a supplier is not sufficient to provide financial compensation to the damaged distributor. For this purpose, the existence and magnitude of damages must be asserted and proven by the distributor, in conformity with the applicable rules on civil procedure. The same requirements also apply with regard to the proof of net annual earnings if a distributor tries to enforce claims for payment of goodwill compensation.

The proof of damages might be relatively straightforward if a distributor markets products of one single supplier exclusively, and does not conduct any other business. In such cases, it might be possible to prove the damages on the basis of distributor’s books.

In most cases, however, distributors market products from several suppliers. In such cases, the proof of damages becomes more complicated, and distributors are well advised to assert and prove damages and/or net annual earnings on a product-specific basis. If this should not be possible, the reasons thereof (e.g., the distributor internal organisation) must also be asserted and proven to the judge in detail.

As a general take-home, distributors should not rely on an estimate of damages by the judge; otherwise they risk forfeiting their existing claims and having to say: Huge expense, no recompense…

 

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