Hey dude, the law protects independent sales reps from “moral obliquity”

By Adam Glazer, Esq. and Adam Maxwell, Esq., from SFBBG

Sales rep-principal relationships follow certain inviolate standards, including that reps only get paid when their principals get paid, and if orders procured by reps do not ship, no payment is due. “Inviolate”? Not so fast, dude.

The facts

Footwear industry sales rep Ronnie Malatesta, owner of Ronnie Malatesta Sales, LLC (“RMS”), contracted with Lucky Top, Inc. to promote the sale of its products. Lucky Top was then acquired by Crocs, Inc., which later merged with Hey Dude, Inc.

RMS was to receive commissions between 1 and 8 percent on net sales, and as was customary, its sales took the form of customer orders, booked several months in advance of the shipping date.

The parties’ Sales Representative Agreement (“SRA”) provided for commissions to be paid “upon payment of an invoice by a customer on or before the 30th day of the month following the receipt of the funds.” It also stated that commissions “shall not be paid in any case where a customer fails to pay within 120 days from an invoice due date.”

The SRA enabled either party to terminate with or without cause on 30 days’ notice. Upon termination, the SRA obligated Hey Dude to fulfill all orders placed at the time of termination.

In March 2022, Hey Dude gave RMS its 30-day notice of termination. According to RMS, as of the termination date, it had prebooked sales orders exceeding $57 million. This translated to Hey Dude owing some $3.7 million in commissions, of which approximately $1.9 million went unpaid.

The dispute

To recover this significant sum, RMS sued Hey Dude in federal court in Oxford, Mississippi (where RMS maintained an office). RMS’ claims included breach of the SRA and breach of the implied duty of good faith. Seeking to avoid a trial, Hey Dude moved for summary judgment on these claims following the discovery process, contending no reasonable jury could rule in RMS’ favor based on the evidence presented.

Central to RMS’ case was the cancellation by Hey Dude of a large percentage of its 2022 orders booked prior to termination. Because Hey Dude did not fulfill these orders and no customer payment was received, it took the position that no commission was due.

Hey Dude largely blamed cancellations on supply chain issues arising from the COVID- 19 pandemic. The parties’ SRA was silent on order cancellations and did not expressly set out when a commission was earned. This meant the litigation was largely focused on whether shipment and customer payment were prerequisites to RMS earning its commissions.

The evidence

In her deposition, the former sales operation manager for Hey Dude admitted that following the acquisition, when the company would encounter a backlog of orders, its customer service representatives reached out to customers to offer the opportunity to cancel their orders.

RMS’ customers were primarily smaller, independent stores. In June 2022, Hey Dude started selling to Academy Sports + Outdoors, a $10 million customer. RMS alleged that Hey Dude wrongfully diverted inventory to noncommissionable accounts, including Academy, rather than fulfill the orders pre-booked by RMS.

This was roundly denied at the depositions of Hey Dude executives. It would serve no purpose for Hey Dude “to rob Peter to pay Paul,” asserted a former vice president of sales. However, she also conceded that she would have to check RMS’ cancellation summary and Academy’s orders “line-by-line” to see “if there’s any correlation in there.”

Additionally, the Court specifically cited to this deposition testimony from the vice president of finance for Crocs:

Q. Do you know of anything in the agreement that gives Hey Dude discretion to cancel an order?

A. There’s nothing addressed on that topic in the agreement.

Q. And correspondingly, there’s nothing in this agreement that says what happens to RMS’ sales commissions in the event that Hey Dude decides to cancel a purchase order?

A. That’s correct.

Q. And so, if Hey Dude decides to cancel an order, it means it doesn’t ship that order, correct?

A. That would be correct.

Q. And if it doesn’t ship that order, the customer doesn’t have an obligation to pay for it, do they?

A. Of course not.

Q. And if they don’t – if they don’t pay for that order, it’s the company’s position that RMS is not entitled to commission?

A. That’s correct.

The former vice president of sales further admitted in her deposition that Academy was treated as a priority account by Hey Dude. In contrast, most of RMS’ customers were smaller, independent stores not deemed “priority” by Hey Dude.

The ruling on RMS’ breach of contract claim

Viewing this evidence in the light most favorable to RMS, which is the governing standard when a party moves for summary judgment, the federal judge in Oxford determined that summary judgment was not appropriate.

Even though Hey Dude argued the evidence showed the orders at issue placed by RMS did not ship and that it was not paid on these orders, the reasons for this were deemed significant enough that they warranted meaningful exploration at a trial. RMS would be afforded the opportunity to prove that Hey Dude was seeking to benefit from its own actions preventing the shipments and attendant commission obligations.

The Court noted the testimony showed Hey Dude contacted at least some of RMS’ customers to give them the option to cancel their orders as the result of its own inventory shortage. “Overall,” the Court ruled: “there exists a jury question of whether Hey Dude diverted the overlapping inventory from RMS’ customers in order to satisfy its new priority customer – Academy.”

The duty of good faith claim

RMS charged Hey Dude with breaching the implied contractual duty of good faith, or stated differently, with acting in bad faith, by failing to pay commissions on the orders on the books at the time of termination.

As in most states, contracts in Mississippi contain an implied duty of good faith and fair dealing in their performance and enforcement. Mississippi courts define “good faith” to mean “the faithfulness of an agreed purpose between two parties, a purpose which is consistent with justified expectations of the other party.”

Relatedly, “bad faith” is not shown by bad judgment or negligence; it requires “some conscious wrongdoing because of dishonest purpose or moral obliquity.”

The Crocs’ vice president of finance testified that shipments to Academy in 2022 “had absolutely no impact on the orders to RMS,” but when called upon to explain, he stated “there is very little overlap in the products that shipped to Academy, if you look at a style level.”

As the Court observed, by claiming the overlap was “very little,” he implicitly conceded “that there was at least some overlap between the inventory shipped to Academy and the inventory that could have been allocated to some of RMS’ orders.”

Viewing this testimony, together with the concession from the former vice president of sales that Academy was a “priority account” for Hey Dude unlike most RMS customers, the court held that a jury could find “it implies some conscious wrongdoing because of dishonest purpose or moral obliquity.”

Reading between the lines of the written decision, it was apparent the judge felt Hey Dude was acting with deceptiveness (or “obliquity”), and was not about to award it summary judgment on these claims. Epilogue Exactly one week after the judge issued her opinion highlighting the principal’s highly questionable moves, and facing the prospect of traveling to the Oxford federal court to say “Hey, Jury,” the decision-makers at Hey Dude fully settled the dispute with RMS.