Undercutting a Sales Rep Puts Manufacturer in Hot Water

Independent sales rep X-Cel Sales, LLC represented A.O. Smith Corporation, the well-known water heater manufacturer, for 15 years in Arizona and Nevada.  Soon after terminating X-Cel in June 2010, A.O. Smith discovered that scorned sales reps have replaced women as the subject like which hell hath no fury.

The Brewing Controversy

            Although the parties had a written sales representative agreement, the termination did not violate that agreement, and thus X-Cel did not rely on it in attacking A.O. Smith’s conduct. X-Cel instead sued A.O. Smith for breach of an implied contract, and as long as it was going to the trouble of filing suit, added claims for promissory estoppel, fraud, fraudulent concealment, negligence, and negligent misrepresentation. 

            The suit, filed in the Phoenix federal court, alleges that despite a policy requiring pricing parity for all three of its water heater brands, A.O. Smith allowed a competing sales rep to market water heaters at lower prices.  When X-Cel confronted A.O. Smith about its suspicions, it received repeated assurances that all water heaters were sold in conformity with the pricing policy.

            X-Cel’s Complaint also alleges that in 2006 A.O. Smith convinced it to expand into the Colorado market.  X-Cel orally agreed to do, but was reluctant due to the major investment required, and only after A.O. Smith promised that by taking Colorado, X-Cel would “be untouchable for five years.”  Based on this oral promise, X-Cel entered into a Denver warehouse lease with a five-year term, and incurred other significant costs.

            Two months after signing a new rep agreement in 2010, A.O. Smith first confirmed to X-Cel that its elastic pricing practices were both widespread and longstanding.  X-Cel was terminated soon after receiving this notice. In court, X-Cel asserted it would never have entered into this new contract had A.O. Smith revealed the unevenness of its pricing in advance.

A.O. Smith Raises the Temperature

            Asserting various defenses to X-Cel’s legal theories, A.O. Smith moved for summary judgment, essentially arguing that the only reasonable view of the facts points in its favor, and urging the court to short-circuit the proceedings.  The court looked carefully at each of the manufacturer’s arguments.

            A.O. Smith noted that many of X-Cel’s claims were premised on the notion that it had deviated from its own pricing policy.  This policy is not a statute or a contract that X-Cel could enforce, reasoned A.O. Smith, it was just an internal policy which it had no legal duty to maintain. 

            The court, however, ruled that A.O. Smith’s argument “misses the point.”   X-Cel did not contend that A.O. Smith had a duty to follow its own policies, but that A.O. Smith represented it was following its internal policies when it was not.  This was the central allegation behind X-Cel’s claims for negligence, fraud and breach of an implied contractual duty.

            Further, the court found that a duty of good faith and fair dealing is implied in every contract, and X-Cel’s allegations that A.O. Smith misrepresented facts to it relating to its contract performance fairly invoked this duty.  When A.O. Smith failed to produce evidence that it did not make the misrepresentations claimed, its motion for summary judgment was denied.

Oral Promises Don’t Evaporate

            Fighting the “promissory estoppel” theory, a legal principle that holds the promisor to its promise when relied upon by the other party, A.O. Smith also tried to escape liability for allegedly promising X-Cel that if it took Colorado, it would “be untouchable for five years.” It turned to another established legal doctrine requiring certain promises to perform over a period of more than one year to be in writing to be enforceable.  The parties here accepted that A.O. Smith’s promise was oral, not written. 

           While that agreed point might seem to render the five-year promise unenforceable, most legal doctrines, to the constant frustration of many non-lawyers (and more than a few lawyers), have exceptions.  The exception at work in this case involved X-Cel’s partial performance of its duties based on the asserted five-year promise. 

           By overcoming its reluctance to move into Colorado, and beginning operations there at considerable expense, including incurring the Denver warehouse lease, all based on A.O. Smith’s five-year promise, the court applied a recognized exception to the doctrinal writing requirement in order to enforce the oral promise.  Where X-Cel had already partially performed based on the oral promise, the court recognized it would be inequitable not to enforce that promise for lack of a writing when A.O. Smith pulled the plug short of the five-year mark.

X-Cel Splashes Evidence of Fraud All Around

            On summary judgment, unlike at trial, a plaintiff is not required to fully prove its claim, and must only produce some evidence to show that a reasonable jury could (not would) return a verdict in its favor.  A.O. Smith argued that X-Cel failed to meet even this low standard by producing no evidence to support its fraud claim.

            In response to A.O. Smith’s summary judgment motion, X-Cel identified evidence in the record of various misrepresentations made by A.O. Smith, including its assurances that it was enforcing the company’s uniform pricing policy, while it systematically aided a competing rep to sell at lower prices.  X-Cel was even able to show that A.O. Smith’s disparate pricing dated back to 2007. 

            The court also considered how X-Cel was terminated within two months of entering into a new sales rep agreement, and just one week after extracting from A.O. Smith the admission that its uneven pricing was widespread.  This evidence was deemed sufficient by the court for a jury to find that A.O. Smith knowingly made false statements to induce X-Cel to renew its rep contract.  X-Cel’s 15-year history with A.O. Smith suggested that it could reasonably rely on A.O. Smith’s assurances, and X-Cel had evidence that it would not have signed the new rep agreement without receiving the assurances of pricing parity.  Thus, the court determined that a jury could find X-Cel was fraudulently induced to enter into the 2010 rep agreement.

Cold Water Gets Poured on A.O. Smith’s Other Arguments

            Other summary judgment arguments attempted by A.O. Smith were quickly extinguished.  The assertion that X-Cel lacked the legal “standing” to assert a claim because it never actually purchased an A.O. Smith water heater was rejected by the court for the intuitive reason that the law does not require X-Cel to purchase an A.O. Smith product to raise contract and tort claims against it.

            The only A.O. Smith summary judgment argument not defeated was deferred.  Correctly asserting that X-Cel must show that the allegedly wrongful conduct caused it to suffer damages, A.O. Smith argued X-Cel had failed to do so, and its claims were “impermissibly speculative.”  X-Cel responded that it needed to gather more evidence in the discovery phase of the case to respond to this argument, and the court accepted this.

            Specifically, X-Cel suggested it would take depositions of distributors who could testify to getting undercut by other distributors serviced by the competing rep who receives better pricing from A.O. Smith, causing X-Cel to lose sales.  In the face of such potentially relevant and compelling evidence, the court deferred summary judgment to enable X-Cel to take the identified further discovery.

The Pot Doesn’t Boil Over

            A.O. Smith considered both the tone and the language of the court’s denial of its motion for summary judgment, and settled the case with X-Cel just weeks later, avoiding any distributor depositions or other potentially disruptive discovery efforts.  While A.O. Smith may have felt it ultimately had valid defenses to X-Cel’s claims, it made the strategic decision to contain the risk that arose from its inconsistent pricing policies, and belatedly compensate the sales rep who had been competing on its behalf in an unfair market.  The decision puts other manufacturers employing similar, uneven pricing among its sales reps on fair notice of the heat such a practice can generate.