California Apparel News

The Hatfields and the McCoys. The Montagues and the Capulets. The Skywalkers. To this list of famed familial feuds we add perhaps the most rancorous of them all: retailers and suppliers (also referred to as manufacturers or vendors).

Sam Walton, the founder of Bentonville, Ark.–based discount retailer Wal-Mart and one of Time magazine’s “100 Most Important People of the Century,” is known in some circles as the godfather of retailer chargebacks. He realized that he could further lower inventory costs and speed the flow of merchandise by receiving the right supplies in the right condition. If manufacturers dropped the ball, so to speak, Walton concluded they would be fined. Other retailers agreed and the practice soon became prevalent, initiating an ongoing schism between retailers and manufacturers.

Chargebacks, also known as retailer expense offsets, are defined as fines applied by a retailer to a manufacturer who does not meet vendor compliance guidelines. Since there is no national standard for vendor compliance, retailers set their own rules. This has become a particularly abusive practice in the apparel industry, where $20 off for a short lot or a self-imposed $10 discount for a torn shipping label can be considered conservative deductions. In fact, it is not unusual for a vendor to face fines as high as $3,000 for a mistaken bar code, or $10,000 and refusal of shipment for minor damage incurred by a pallet displaced during transport. As these fees compile, a vendor can actually owe more to the retailer than the retail value of the merchandise.

The argument is basic: Retailers maintain that their deductions are valid and must be utilized to drive efficiency in the supply chain; manufacturers claim illegal abuse. The fact is that whilst Canada and Europe enforce economic dependency laws to prevent such issues, the United States has no such safeguards. Article Two of the Uniform Commercial Code—a standardized set of business laws adopted by every state in the union save Louisiana, which in some form governs the relationship between vendors and retailers—implies that the assessment of retailer penalties is illegal. Still, vendors are nonetheless compelled to pay them under fear that retailers could look elsewhere for their inventory. They consider it the cost of doing business.

Many analysts believe that there is, if not a direct cease-fire, hope on the horizon. As allegations of questionable chargebacks continue to rise, suppliers are beginning to take initiative. First, many vendors now use constructive retailer feedback in an effort to improve their supply practices. Furthermore, the filing of a lawsuit against a retailer— in a worst-case scenario—is no longer considered as taboo as it once was. In the past, though the vast majority of related suits that have been filed have been settled out of court in the favor of the vendor, in most instances said vendor had already been forced to close his business as a result of excessive chargeback practices. Up to 15 percent of all current invoices regardless of industry are regularly affected by chargeback deductions, totaling from 4 percent to 10 percent of all open accounts receivable, according to Columbia, Md.–based Credit Research Foundation (www.crfonline.org), which espouses education and application of credit support solutions. If unchecked, this is not only an expensive proposition, but frequently a fatal one for a supplier.

In March 2001, Seattle-based apparel manufacturer SDG LLC filed a lawsuit against May Department Stores Company (now a part of Cincinnati-based Federated Department Stores). The suit claimed $440,000 in damages for what it said were unjustified chargebacks. SDG LLC attorney Rod Harmon argued that May Department Stores Company had proven neither the legitimacy of their chargebacks, nor any effort to give SDG LLC an opportunity to fix the problems. The defendant paid an undisclosed amount in settlement before the case went to trial.

According to Article Two of the Uniform Commercial Code, when a department store has accepted a vendor’s goods and then alleges that the goods do not conform to the contract, the department store is barred from deducting a chargeback for the non-conformity unless: a) the store notifies the vendor within a reasonable time, and b) the store provides the vendor with an opportunity to inspect the allegedly non-conforming goods. In these instances, the department store has the burden of proving not only that the goods did not conform to the contract terms, but also the amount of the loss it suffered as a result of the non-conformity. The Uniform Commercial Code states that a store may only deduct liquidated damages provided they are not so unreasonably large as to constitute a penalty. (Damages are considered liquid when a contract specifies their amount in advance.) However, the very definition of penalty frequently becomes the stickling point in most chargeback-related disputes.

As a result of vendor pressure, many retailers are attempting to ease compliance issues with their suppliers. On their part, retailers have been reviewing their own vendor- compliance manuals and documentation methods as assurances against undue negative exposure.

In as much as possible or practical, suppliers must negotiate disputed compliance issues in advance, before they become problems. The Credit Research Foundation encourages suppliers to actively form their own compliance teams. The teams would examine routing guides and other compliance manuals, determine which requirements cannot be met, and then ask retailers for a waiver or compromise. The Credit Research Foundation further suggests that suppliers obtain the waivers or modified agreements in writing and include them in their vendor agreements.

Mark Brutzkus is a partner in Encino, Calif.–based Ezra Brutzkus Gubner LLP. He can be reached at (818) 464-3107 or at mbrutzkus@ebg-law.com.