FTC Staff Comment to the Hon. C.T. Cub Houck Concerning Oregon S.B. 34 to Prohibit Suppliers of Heavy Equipment From Discontinuing Supply Relationships With Dealers, With Certain Exceptions

UNITED STATES OF AMERICA
FEDERAL TRADE COMMISSION
WASHINGTON. D.C. 2OSSO
V890061
COMMISSION AUTHORIZED
BUREAU OF COMPETITION
May 	2, 	1989
The 	Honorable 	C.T. 	"Cub" 	Houck
Oregon State 	Senate
State Capitol
Salem, 	Oregon 	97310-1347
Dear Mr. 	Houck:
The 	staff 	of 	the 	Federal 	Trade 	Commission 	is 	pleased 	to
provide 	these 	comments 	on 	Senate 	Bill 	34, 	"A Bill 	for 	An Act
Relating 	to 	Equipment 	Dealers." 	~/ 	The 	bill, 	if 	enacted, 	would
prohibit 	suppliers 	of 	"heavy equipment" 	from 	discontinuing 	supply
relationships 	with 	any Oregon 	dealer 	unless 	the 	supplier 	is
withdrawing 	from 	the 	state or 	the 	dealer breaches 	a 	"reasonable
and material" 	provision of 	its 	cOntract with 	the 	supplier. 	We
believe 	that 	the 	proposed 	legislation 	is 	likely 	to 	harm Oregon
consumers 	by 	increasing the 	costs 	of 	distributing 	heavy equip-
ment.
I. 	Interest 	and 	Experience 	of 	the 	Federal 	Trade 	Commission
The 	Federal 	Trade 	Commission 	is 	charged by 	statute with
preventing 	unfair methods 	of 	competition and unfair 	or 	deceptive
practices 	in or 	affecting commerce. 	15 	U.S.C. 	S 	45. 	Under 	this
statutory mandate, 	the 	Commission seeks 	to 	identify and comment
upon 	restrictions 	that 	impede 	competition or 	increase 	costs
without 	offering countervailing benefits 	to 	consumers. 	The
Commission and 	its 	staff, 	upon 	request, 	have 	provided comments 	to
federal, 	state, 	and 	local 	legislatures 	and 	administrative
agencies 	on matters 	that 	raise 	issues 	of 	competition 	or 	consumer
protection policy. 	The 	Commission's 	staff 	has 	commented 	on
several 	bills 	limiting 	suppliers' 	ability 	to 	terminate 	dealers.
Earlier 	this 	year, 	for 	example, 	the 	Commission's 	staff 	commented
on 	an Alabama 	bill 	to 	curtail 	the 	ability of 	construction equip-
ment 	distributors 	to 	terminate 	dealers 	in 	that 	state. 	In 	1988,
the 	staff 	submitted comments 	to 	the 	Wisconsin 	legislature 	regard-
ing 	a 	bill 	restricting 	the 	ability 	of 	suppliers 	to 	terminate
dealers 	within 	that 	state. 	In 	1986, 	Commission 	staff 	commented
on 	a 	District 	of 	Columbia 	bill 	that 	restricted 	the 	ability 	of
suppliers 	of 	alcoholic 	beverages 	to 	terminate 	wholesalers. 	In
~/ 	These 	comments 	are 	the 	views 	of 	the 	staff 	of 	the 	Bureau 	of
Competition 	of 	the 	Federal 	Trade 	Commission. 	They 	are 	not
necessarily 	the 	views 	of 	the 	Federal 	Trade 	Commission or 	of 	any
individual 	Commissioner.

..
The 	Honorable 	C.T. 	"Cub" 	Houck
Page 	2
1984, 	the 	Commission presented 	testimony concerning proposed
federal 	legislation 	that 	would 	have 	restricted the 	ability 	of
suppliers 	of 	office machines 	and equipment 	to 	terminate 	dealers.
II. 	Restrictions 	on 	Terminations 	of 	Supply Relationships
S.B. 	34, 	if 	enacted, 	would 	restrict 	the 	ability of 	suppliers
of 	heavy equipment 	to 	discontinue 	supply 	relationships 	with
Oregon dealers. 	Under 	section 	2 of 	the 	bill, 	heavy equipment
suppliers 	would 	be 	prohibited 	from 	terminating or, 	upon 	expira-
tion 	of 	a 	supply contract, 	failing 	to 	renew 	the 	supply 	relation-
ship with 	any Oregon dealer without 	"good 	cause," 	as 	that 	term 	is
defined 	in 	the 	legislation. 	The 	bill 	defines 	good cause 	as 	the
supplier's 	withdrawal 	from 	the 	sale 	of 	products 	in Oregon, 	the
dealer's 	bankruptcy or 	the 	assignment 	of 	its 	assets 	for 	the
benefit 	of 	creditors, 	or 	the 	dealer's 	failure 	substantially to
comply with 	any 	"reasonable 	and material" 	requirement 	imposed
upon 	it 	in writing by 	the 	supplier. 	2/ 	The 	bill would 	also
require 	suppliers 	to 	give 	a 	dealer 	notice 	of 	the 	intention to
discontinue 	the 	supply 	relationship, 	whether 	through 	termination
or contract 	nonrenewal, 	at 	least 	120 	days 	prior to 	such discon-
tinuation 	and 	state 	the 	reasons 	for 	the 	proposed discontinua-
tion. 	~/ 	Where 	the 	reasons 	for 	the 	proposed 	discontinuation
"relate 	to 	a 	condition which may be 	rectified by 	action 	of 	the
dealer," 	the 	dealer may 	take 	corrective 	action within 	75 	days 	of
receipt 	of 	the 	notice. 	if 	During 	the 	pendency 	of 	the 	notice,
the 	dealer 	also 	has 	the 	right 	to 	transfer 	the 	dealership 	to 	new
owners. 	sf
S.B. 	34 	would override 	the 	private 	agreements 	of 	suppliers
and 	dealers 	in 	two 	principal 	ways. 	First, 	the 	bill 	would 	require
suppliers 	to 	continue 	supply 	relationships 	with dealers 	beyond
the 	duration 	specified 	in private 	contracts. 	Second, 	the 	bill
would 	override 	private 	contractual 	provisions 	governing 	good
2/ 	S.B. 	34, 	§ 	2(1).
~/ 	~., 	s 	3(2). 	A dealer may 	be 	terminated 	without 	notice 	if 	it
is 	bankrupt 	or 	has 	had 	its 	assets 	assigned 	for 	the 	benefit 	of
creditors, 	attempted 	to 	defraud 	the 	supplier, 	or 	has 	failed 	to
operate 	during 	its 	normal 	business 	hours 	for 	seven 	business 	days
for 	reasons 	other 	than 	acts 	of 	God, 	strikes, 	or other 	similar
circumstances. 	~., 	S 	3(4).
if 	~., 	§ 	3(2).
~/ 	~., 	§ 	3(3). 	Although 	the 	bill 	does 	not 	explicitly 	state
so, 	it 	appears 	that 	the 	transfer 	extinguishes 	the 	supplier'S
right 	to 	terminate 	the 	dealership.

The Honorable 	C.T. 	"Cub" 	Houck
Page 	3
cause 	for 	termination, 	including the 	duration 	for 	which 	a 	breach
of 	contract must 	continue 	to 	support 	a 	termination 	and 	the 	cir-
cumstances 	under which a 	breach may be 	cured. 	We 	believe 	that
both of 	these 	effects 	of 	the 	bill 	are 	likely 	to 	harm Oregon
consumers.
By 	requiring 	suppliers 	to 	continue 	to 	supply 	dealers 	even
after 	the 	expiration of 	a 	contract, 	the 	bill 	would 	freeze 	supply
relationships 	without 	regard 	to 	changes 	in market 	or other
economic 	conditions. 	As 	a 	general 	matter, 	private 	negotiations
between 	suppliers 	and 	dealers 	can be 	expected 	to 	result 	in 	con-
tracts 	that 	provide 	for 	efficient 	terms 	governing 	duration 	and
termination 	rights. 	Dealers 	who 	value 	the 	stability offered by
long-term 	supply 	relationships 	seek 	long-term 	contracts 	that
protect 	their 	businesses 	from 	termination except 	upon 	specified
terms. 	Suppliers 	who 	expect 	their 	distribution methods 	to 	remain
unchanged 	for 	long periods 	similarly may choose 	to 	enter 	into
such 	long-term contracts 	and offer dealers 	protection 	from
termination. 	Of 	course, 	any 	dealer who 	is 	terminated 	in con-
travention of 	contractual 	terms 	can 	seek 	relief 	for 	breach 	of
contract. 	Consequently, 	regulations 	that 	override 	private
contract 	terms 	should be 	unnecessary 	to 	protect 	dealers 	from
wrongful 	termination or 	to 	secure 	long-term 	supply where 	such
arrangements 	would be 	efficient. 	Such regulations, 	however, 	may
prevent 	parties 	for 	whom 	long-term 	supply 	relationships 	are
inefficient 	from 	negotiating distribution 	contracts 	for 	shorter
terms 	and 	retaining 	the 	flexibility 	to modify 	their 	distribution
systems.
By requiring 	that 	a 	supplier affirmatively 	show 	some 	mis-
conduct 	on 	the 	part 	of 	the 	dealer before 	it 	may 	refuse 	to 	renew
an 	expired 	distribution agreement, 	S.B. 	34 	would prevent 	sup-
pliers 	from 	modifying 	their 	distribution 	networks 	in 	response 	to
business 	or 	technological 	changes. 	For example, 	a 	supplier may
wish 	to 	withdraw 	from 	a 	particular 	geographic 	market 	within 	the
state 	of 	Oregon 	because 	it 	cannot 	operate 	in 	that 	market 	profit-
ably. 	In 	other 	cases, 	a 	firm 	may 	seek 	to 	reorganize 	its 	national
distribution 	system to 	operate more 	efficiently and 	in 	the 	pro-
cess 	realign 	its 	dealership 	network. 	~/ 	Similarly, 	suppliers 	may
need 	to 	alter 	their 	distribution methods 	to 	take 	advantage 	of 	new
cost-saving 	technologies. 	In 	all 	of 	these 	cases, 	the 	realignment
of 	distribution 	systems 	to 	operate more 	efficiently 	is 	likely 	to
produce 	cost 	savings 	that 	will 	ultimately 	be 	passed 	on 	to 	con-
sumers. 	By 	prohibiting 	such 	realignments 	from 	taking 	place, 	S.B.
~/ 	For 	example, 	in American Mart 	Corp. 	y. 	Joseph 	E. 	Seagram 	&
Sons. 	Inc., 	824 	F.2d 	733, 	734 	(9th Cir. 	1987), 	the 	defendant
"change[d] 	from 	a 	system 	under 	which 	it 	authorized 	several
distributors 	to 	do 	business 	within 	a 	particular 	geographic 	area
to 	a 	system 	of 	exclusive 	distributorships."

The Honorable 	C.T. 	"Cub" 	Houck
Page 	4
34 	could be 	expected to 	increase 	the 	cost 	of 	doing business 	and,
hence, 	the 	price paid by consumers 	for 	the 	products 	affected.
The 	proposed 	legislation 	also 	assumes 	that 	"good cause" 	for
a 	termination or nonrenewal 	may 	readily be 	established 	in 	legal
proceedings. 	Yet many performance 	deficiencies 	are 	not 	suscep-
tible 	to 	proof 	in 	a 	legal 	proceeding or may 	not meet 	the 	narrow
"good cause" 	standard 	set 	forth 	in 	the 	proposed 	legislation. 	For
example, 	a 	supplier who 	believes 	that 	a 	dealer 	is 	making 	insuffi-
cient 	efforts 	to 	promote 	its 	products 	may be 	unable 	to 	satisfy
the 	"good cause" 	requirement. 	The market 	solution 	for 	such proof
problems 	is 	a 	privately negotiated agreement 	setting 	forth 	the
duration 	of 	supply 	relationships. 	A supplier or dealer who 	is
unhappy with 	the 	performance 	of 	its 	contract 	partner may 	simply
decline 	to 	renew 	the 	contract 	upon 	its 	expiration. 	2/ 	Under 	the
proposed 	legislation, 	however, 	a 	supplier would 	not 	be 	able 	to
protect 	itself 	from 	inefficient 	supply 	relationships 	by 	con-
tractually 	limiting 	the 	duration bf 	such 	relationships.
5.B. 	34 	would 	also 	displace 	privately 	negotiated 	procedures
for 	discontinuing 	a 	supply 	relationship 	even when 	the 	stringent
good 	cause 	requirement 	is 	satisfied, 	and 	is 	therefore 	likely 	to
increase 	the 	costs 	associated with 	the 	termination or 	nonrenewal
of 	a 	dealer 	"for cause." 	Under 	the 	bill, 	a 	supplier who 	is 	dis-
satisfied with a 	dealer's 	performance 	and wishes 	to 	terminate 	or
refuse 	to 	renew 	the 	supply 	relationship must 	invest 	resources 	in
compiling 	a 	record 	of 	that 	performance 	for 	use 	in 	legal 	proceed-
ings 	and 	secure 	legal 	representation 	in any challenge 	to 	the
discontinuation. 	Moreover, 	it must 	retain 	a 	poorly-performing
dealer 	for 	at 	least 	four 	months 	after discovering 	the 	dealer's
shortcomings. 	The 	supplier 	thus 	must 	incur 	the 	costs 	associated
with delay 	in 	implementing 	an 	efficiency 	enhancing change 	in 	its
distribution 	system while 	the 	legislatively-mandated process 	runs
its 	course. 	These 	additional 	costs 	may 	deter 	suppliers 	in 	some
cases 	from 	terminating 	dealers 	who 	do 	not 	perform 	in 	accordance
with 	their 	contract 	obligations. 	As 	a 	result 	of 	these 	restric-
tions, 	suppliers 	must 	incur 	greater cost 	in maintaining 	their
distribution 	networks 	and pass 	these 	costs 	on 	to 	Oregon 	con-
sumers.
III. 	Conclusion
By 	denying 	firms 	the 	flexibility 	to 	tailor 	their 	supply
contracts 	to 	market 	imperatives, 	S.B. 	34 	would 	tend 	to 	create
excessively 	rigid 	distribution 	systems 	that 	are 	unresponsive 	to
changes 	in market 	conditions. 	Such 	systems 	are 	likely 	to 	be
2/ 	Klein 	& Murphy, 	Vertical 	Restraints 	as 	Contract 	Enforcement
Mechanisms, 	31 	J. 	Law 	& Econ. 	265 	(1988).

.,
The Honorable 	C.T. 	"Cub" 	Houck
Page 	5
costlier 	for 	suppliers 	to 	operate 	and therefore 	to 	lead to
increased prices 	to Oregon consumers.
We 	appreciate 	the 	opportunity 	to comment 	on this 	bill. 	We
would be happy 	to 	provide 	additional 	information 	if we 	can be 	of
further 	assistance •