PUERTO RICO: An Introduction to Dispute Resolution

Arbitration provisions in Puerto Rico dealership contracts

By Sylmarie Arizmendi, Esq.

Reichard & Escalera LLC

I. Introduction:

Businesses seeking to distribute services or products in Puerto Rico should understand the impact that the Puerto Rico Dealer’s Act of 1964 (“Act 75”), will have on the relationship with their distributor. Act 75 implements one of the most comprehensive dealer protection schemes in the United States. It limits the principal’s ability to modify the terms of business with the dealer and imposes severe penalties on principals who end such contracts without just cause. The often subjective standards of conduct of Act 75 provide fertile ground for litigation, where a dealer may obtain an injunction to preserve the status quo. The United States Federal Arbitration Act (“FAA”), however, has forced inroads into Act 75, by requiring courts to recognize the validity of arbitration covenants in dealership contracts. An arbitration clause with a choice of law provision, therefore, is a principal’s best recourse to avoid Act 75’s pitfalls.

II. Dealer Protections:

A. Protection for termination without just cause

A principal may be surprised to learn that, under Art. 2 of Act 75, it may neither terminate nor refuse to renew a dealership upon its expiration, except for “just cause”. Failure to have just cause entitles the dealer to recover significant damages and penalties from the principal.

“Just cause” includes i) a breach of an essential obligation, ii) conduct that “adversely and substantially” affects the interest of the principal in promoting sales of its services or products, or iii) complete market withdrawal after failed negotiations with the dealer over essential contract terms.

“Just cause” excludes changes in capital structure, changes in control, or transfers of corporate interests. Most significantly, it excludes non-performance of contractual provisions that may not adjust to the realities of the Puerto Rico market. The principal must show such provisions are “reasonable”.

B. Protection from unreasonable impairment

A principal may not “impair” the dealership contract without incurring in Act 75 liability. Impairment includes setting up direct distribution or services previously in charge of the dealer or appointing additional dealers despite an exclusivity provision. Significantly, varying shipping methods or payment terms, as well as refusing to fill an order for merchandise, could also be deemed an impairment, if the principal acts “unreasonably”.

C. Quantifying Damages

Principals who terminate a dealership without just cause or who impair the relationship as described above, incur in a tort and face liability under Art. 3. The following factors weigh into the damages a court may award: the actual value invested in facilities and supplies that the dealer cannot reasonably use in other activities; the cost of goods in stock that the dealer is unable to sell; the good-will of the business; and the last five years of profits.

III. Dispute resolution considerations

A. Injunctive relief pending litigation

The greatest source of leverage for a dealer is the right to petition for an injunction enjoining termination or the alleged impairment of the dealership while litigation is pending. Litigation in local courts can take years, so this “provisional” remedy may end up being quite onerous. This remedy is available even if the principal admits liability and all that remains is assessing damages.

B. Arbitration covenants

In 1978, Act 75 was amended to declare null and void any stipulation that compelled dealers to arbitrate any controversy outside of Puerto Rico or under foreign law, Art. 3B of Act 75. The Puerto Rico Supreme Court (“PRSC”) interpreted Art. 3B to mean that, despite the FAA, arbitration provisions were null and void as against the public policy behind Act 75.

Fifteen years later, recognizing subsequent developments in FAA case law, the PRSC retracted, finally upholding the validity of arbitration provisions in dealership contracts. For example World Films, Inc. v. Paramount Pict. Corp., 125 D.P.R. 352 (1990). In response, Act 75 was amended to curve arbitration clauses. Arbitration covenants in a dealership agreement are deemed contracts of adhesion, so ambiguities must be resolved against the principal. Further, before any such provision may be invoked, a court with jurisdiction in Puerto Rico must determine that it was entered into freely and voluntarily by both parties, Art. 3C of Act 75.

C. Choice of law and forum

Significantly, the arbitration clause at issue in World Films contained choice of forum and choice of law provisions, so that arbitration would take place in California, under Californian law. The PRSC did not separately address the validity of these provisions, nonetheless, it ordered arbitration to proceed as stipulated, which can be read as tacit approval. The ambiguity has opened some ground for controversy.

At least one decision by the intermediate Puerto Rico Court of Appeals has found that World Films does not preclude an inquiry into the validity of choice of forum provisions. Relying on local case law regarding the validity of choice of forum provisions in general, the court held one such clause null and void, as contrary to the express prohibition of Act 75. At least one other panel of this same court has suggested a different result: “when the parties have stipulated an arbitration clause in a distribution agreement, per Sec. 2 of the [FAA], the process will be undertaken as agreed, which includes the choice of forum and the choice of law governing interpretation of the agreement”.

Decisions by the United States District Court for Puerto Rico and the First Circuit Court of Appeals, in contrast, have found that the FAA displaces Art. 3B’s prohibition against choice of law and choice of forum provisions. Nonetheless, they still leave the door open to examine the validity of the forum selection clause under the forum selection case law that otherwise applies to any contract, which in Puerto Rico, follows federal law.

The forum selection analysis involves examining three factors (the Bremen factors), which include fraud and overreach, reasonableness and fairness, and public policy. In applying the Bremen factors to reject a public policy challenge to a forum selection clause in a dealership contract, the Court of Appeals remarked that the challenge “rests on a false assumption that the public policy of Puerto Rico is dispositive” and noted that “[federal] courts have frequently upheld forum selection clauses pertaining to claims arising pursuant to Puerto Rico Law 75.”

Should litigation over the choice of law or choice of forum provisions be required, principals should consider that federal courts have been more receptive to the validity of these clauses than local courts. If there are grounds for jurisdiction in that forum, such as to enforce an arbitration provision under the FAA, it may provide a better avenue to enforce the arbitration provision as drafted, including its choice of law and forum provisions.

IV. Conclusion

Act 75 significantly constrains the relationship between a principal and its dealer by turning into a tort the unjustified termination, non-renewal, or impairment of a dealership contract. By operation of the FAA, however, Courts have recognized the validity of arbitration agreements in dealership contracts and enforced them along with their choice of law and choice of forum provisions, even if they refer to the law of another jurisdiction. Essentially, therefore, an arbitration clause provides the means to displace Act 75’s restrictions on the commercial relationship.