Beware How You Scare – How a “Scare Tactic” Became an Inadvertent Termination of a Distribution Agreement

By Jerry Meek (June 26, 2015)

In Luv N Care, Ltd. v. Angel Juvenile Products, 3:11-1878 (W.D. La. June 8, 2015), Plaintiff Luv N Care, Ltd. entered into two five-year distribution agreements with the Defendants, giving the Defendants exclusive rights to distribute the Luv N Care’s line of infant care products in China and Taiwan. The agreements required the Defendants to make minimum purchases of the Luv N Care’s products and to pay a 6% royalty to Luv N Care on all sales.

More than a year into the agreement, the Defendants had failed to make any of the required minimum purchases or to pay any royalties, prompting Luv N Care to demand payment. “If full payment is not received within 14 days of today,” it wrote in an October 14, 2003 letter, “then Luv n’ care Ltd. considers both contracts voided as of that date. As of that date, Luv n’ care demands payment for the full term of the contracts, as it considers both contracts to be accelerated in nature.”

No payment followed and in December of 2004 Luv N Care later entered into a new agreement, giving exclusive rights for one of the two territories to a new distributor.

In the resulting litigation, Luv N Care contended it was entitled to recover royalties on the promised minimum sales for the full five year duration of the agreements. The Defendants countered that Luv N Care’s October 2003 letter effectively terminated the agreements, thus ending any obligation pay royalties and sharply limiting the amount of royalties recoverable.

According to Luv N Care, the October 2003 letter was just a “scare tactic” that did not act to terminate the agreements. The distribution agreements, they pointed out, provided that the agreements could be terminated by mailing written notice of termination, by registered mail, at least 180 days prior to the effective date of the termination. This, all parties concede, they did not do. Besides, the terms negotiated with the new distributors were less favorable to Luv N Care than those in Luv N Care’s agreements with the Defendants, given that competitors were aware of the existing agreements between Luv N Care and the Defendants.

In granting the Defendants’ Motion for Partial Summary Judgment, the Court concluded that the October 2013 letter was effective to terminate the agreements effective 14 days thereafter. Thus, the Plaintiff was not entitled to recover royalties during the full five year term of the agreements.

The decision offers two lessons.

First, imprecise drafting of the distribution agreements undermined Luv N Care’s position. Twice the Court noted that the agreements lacked an acceleration clause, pursuant to which future royalty obligations would come due immediately upon breach or upon termination for breach. Inclusion of such a clause could have changed the Court’s decision. The agreements also apparently lacked any procedure by which Luv N Care could declare the Defendants in breach and terminate the agreements, while preserving the Defendants obligation to pay minimum royalties over the full five year term.

Second, Luv N Care’s “scare tactic” clearly backfired. Its October 2003 letter could have stated that, if payment were not received, Luv N Care would consider the Defendants to be in breach and take steps to mitigate its damages by entering into agreements with new distributors. This would have preserved Luv N Care’s ability to recover its damages for the full five year term. Alternatively, Luv N Care could have threatened to invoke the agreements’ 180-day notice of termination provisions, in the event of continued non-payment. This would have given Luv N Care more time to find new distributors, while also lengthening the period during which the Defendants were obligated to pay royalties. Instead, Luv N Care overplayed its hand.