August 2001: Volume 43, Number 8
Two Sides of Culligan, Part 2: The Dealers & Northbrook
by Carlos David Mogollón, WC&P Executive Editor
The following is from a late-April conversation with Peter Singler, a principal attorney with Carter & Singler, Sebastopol, Calif., which specializes in franchise law. Singler -- who also is a board member of the American Franchisee Association -- is representing the Culligan Dealer Association of North America in its franchise contract negotiations with Culligan International:
WC&P: There've been some tough issues under debate the past several months, with the highest level of rhetoric in February when CDANA invited Alamo, IWW Inc., Trusco and R&M Manufacturing to its dealer convention in Austin, Texas, to exhibit core product, i.e., softeners and ROs, etc. Now, it's going to be buying commodities on behalf of dealers through Allied Purchasing Co., an industry consortium or cooperative. What's the dealers' legal standing to do that? Does Culligan have any legal remedy? Under the original franchise agreement?
Singler: Both under the 1957 and the 1991 version -- even moreso under the 1957 one -- Culligan dealers have the right to purchase and distribute supplies. And that would even include core products from any vendor of their choosing. Under the 1991 version, Culligan then has the contractual ability to reasonably disapprove of products sold from the dealership. So, yes the dealers do have the right to explore alternative sources of supply, particularly if they can get a like or in many cases the exact same product but get it at a considerably lower price because of their collective purchasing power.
WC&P: It sounded though as if Culligan has veto power on some of those particular products?
Singler: They do and they don’t. It has to be exercised reasonably. If for example, you have a brand of pencil that you can purchase for a penny and you can buy it from a Culligan supplier -- the same exact pencil -- for two cents, there would be nothing they would legally be able to do to stop you from buying that pencil from the other vendor for a penny and save yourself 50 percent. You can extrapolate that anywhere from there to core product. The only thing Culligan has the absolute right to do is to control what has the Culligan name affixed to it.
WC&P: They didn’t have any legal standing to protest the outside vendors coming into the Culligan dealer convention?
Singler: No. That was more of an emotional or philosophical disagreement. Everybody that I’m representing and dealing with…
WC&P: Who are some of those?
Singler: If you mean franchisee associations, we represent the National Coalition of 7-11 Franchisees, the Roundtable Owners Association, Straw Hat Cooperative Corporation, Marie Callender’s Franchisee Association, Independent Hardee’s Franchisee Association -- lots. I could go on for a long time. But, getting back to the purchasing issue is, Culligan dealers don't want to take down their signs. Most of these guys have been in this for two, three and sometimes four generations. These are the original Culligan men and women. Current management has been here for three years, their predecessors a couple of year, and before that management seemed to rollover every 18 months. The dealers are the one consistent and unifying force in the Culligan system, and they're very loyal and very proud of the Culligan name. They don’t want to lose it.
WC&P: What’s their standing in that? If you think about it, the typical Culligan dealer will argue that, in reality, they effectively own the name because they’ve been the ones who put all these coop ad dollars into it. Legally, however, it sounds like they should have some say, but…
Singler: They own the good will in their businesses. They own their customer lists. What’s often overlooked in these issues is although Culligan International -- and, by way of attribution, USFilter and Vivendi -- owns the Culligan name. But it doesn’t own the Culligan system. You might own the Culligan name, but if you go into Sioux Falls, S.D., or Sioux Falls, Iowa, and you’re sitting there at a Rotary Club meeting with all your customers and you’ve been in the community for 20 or more years -- you’re the person they call the Culligan man. If you take the name Culligan out of that, you’re still going to have the contacts. Whereas, Vivendi, USFilter or Culligan International is not. So, what they don’t -- and by they I mean franchisors -- often appreciate is the interaction and involvement in the local communities that has established that name. If you just take the name off it, it’s like Shakespeare -- you call a rose by any other name and it still smells as sweet. The qualities that made that name are still in those individuals and those communities…
WC&P: Yes, but Culligan dealers recognize that there’s still value in that name?
Singler: Yes. There’s an emotional tie much more than a legal or a financial tie to the name. They grew up with the Culligan name and they don’t want to lose it. And hopefully, they won’t have to. They won’t be put in a position of having to decide between a franchise agreement they can’t live with and taking down their sign.
WC&P: Is there any time schedule on this?
Singler: It’s really up to Northbrook. CDANA -- and when I say CDANA, I’m basically saying all the independent dealers who are really active in their businesses -- has one of the largest percentages of dealer members of any association we represent. They have a very high turnout and participation rate. These guys have done everything they can to work through some of these issues and hope that Culligan will come back to the table. But, in the meantime, it would not be very sensible from a business perspective to not start lining up alternatives. So, if a dealer is forced to make a decision and they can’t live with an agreement that Northbrook is putting in front of them, they do have a viable alternative to sourcing alternative product if they do choose not to sign that agreement. And certainly, neither CDANA nor any of its leadership are advocating anybody take down their signs. That’s the last thing we want to see happen. But we have to be realistic. It takes two people to dance and we’ll need the Northbrook people to sit down with us and try to work through some of these issues.
WC&P: I’ve kind of likened these negotiations to those between a GM or Ford and the UAW in the sense that all those other suppliers to Ford and GM that may also have UAW unions are likely to be affected by how those negotiations go with the big company. There are a lot of people on the sidelines of this industry looking at what’s going on here. Some look at it a bit lustily, others a little nervously. None of them want to necessarily put their foot out because they don’t want to appear to be too opportunistic or create an enemy. What are some of these things that are going on as far as lining product up? I’ve spoken to some of the outside core vendors at the show and some others as well. How do you go about doing a line-up to make sure you’ve got core product covered? Is it all strictly related to water treatment or is it as you mentioned before where you’ve got basic products and services like tires?
Singler: No, it’s everything. We’re talking first to Allied Purchasing Group, which is a mutual benefit, non-profit purchasing cooperative. They just get people together and they charge a 1 percent administrative fee and you become a shareholder in the corporation. They then go out with leverage and bulk purchasing power. They originally started out serving dairy bottlers. So, we’ll have milk bottlers and beer bottlers and things like that where we’re all in buying from certain vendors on a group basis. We’re looking at a group purchasing program that’s really independent of this whole franchise issue. It will possibly serve as a mechanism for that and the capacity is there to bring in core products or whatever the dealer may need should the need arise. But the program is really more coincidental than anything that it’s coming about at this time. This is something every other franchisee association has and, for CDANA, it’s one of those services that it had not undertaken to provide to its members up until this time. If it can save people two or three percent on their sales, then great.
WC&P: Regardless of what happens with the franchise agreement, it’s something that’s smart for the dealers?
Singler: Yes. It makes for a stronger system. And it makes for a stronger association. It allows CDANA to put on and fund more educational programs and seminars, nicer conventions and things like that.
WC&P: I’ve got a couple questions I want to ask you and one of them is how does what’s going on currently with this franchise negotiation with CDANA -- since you are a board member for the American Franchisee Association -- reflect or mirror what’s going on in other dealer associations?
Singler: It’s very similar. It's estimated that over 50 cents of every retail dollar spent in this country was channeled through a franchise system or franchise outlet. So, it is by far the dominant method of sale in this country. And if you think about as you drive down the street, anything from travel agents to donuts to hotels to tanning salons -- anything you can think of is basically susceptible to franchising. Most are. They’re franchise outlets. The same types of issues have to be rehashed over and over again. What happens is, franchisors -- and if you go back 50 years, say within Culligan to the 1957 agreement, that’s not a bad agreement. It’s some guys who said here’s a reasonable business relationship and there are things to consider on both sides of the equation. That’s how franchise agreements were drafted a long time ago. Franchisors though have a luxury and that is they’re in the business of franchising and they have in-house lawyers so if they get a poor performing franchisee or someone doing something he or she wasn’t supposed to do and if it slipped through the contractual crack the first time, they go to their legal department or outside law firm and say, "Fix that. Don’t let that happen again." After 20 or 30 years, basically every scenario comes up and the lawyers doing their job to fix all those cracks and fill all those holes. But what happens is you then have a document that’s completely one-sided. It takes into account every one of the franchisors issues without regard to the impact that it may have on the franchisees. They’re the ones that are trying to run their businesses every day and they usually don’t have the resources individually to go out and, every time something comes down, take it to their lawyer and have it evaluated. Nor do they on an individual basis have the ability to negotiate those out. The response they get is "Well our legal department says we can’t change it for you, because we have all of these other franchisees. That’s the form. Take it or leave it." The issues that arise are not necessarily inherent to franchising or the mode of doing business. They’re inherent into very one-sided agreement.
WC&P: Well, so far, while that’s illuminating, it’s also very esoteric. Let me sort of layout how I saw this particular scenario developing and which I’ve run by a few people who’ve said it sort of hits the nail on the head with respect to Culligan here. One is that we had Culligan and USFilter battling it out in the ‘90s, cutting margins on each other, buying up franchises, etc. USFilter buys Culligan at a premium by floating stock. It’s already basically floated stock -- in other words, loans or debt to investors -- to buy all these other companies as it grew as well. Wall Street is breathing down its neck saying OK integrate this stuff and start cutting costs to make it more efficient and profitable. Vivendi comes in, buys in cash -- which takes away that big debt bear on its shoulder. Suddenly, they’re in a position where the sky’s the limit. We don’t have to worry about this issue. We have more time to build in these efficiencies within the company, etc. Then, Jean-Marie Messier sets his eye on Universal Studios and buys Seagrams. But in order to do that, the stock analysts and financiers press him to spin off all the debt they’ve got which settles on Vivendi Environnement or Vivendi Water. Now, that big bear -- the debt -- is back on their shoulder. Everybody starts crunching down from the top saying we’ve got to fix these numbers, we’ve got to move more units, we’ve got to make more sales. I draw that analogy to bring us to this point where we see the basic pressures that are on the people at Culligan in Northbrook to move product, which is why I think this issue has come to a head. How on track is that analogy? And how does it reflect on things they’re looking at -- from the perspective of CR Hall and Henry Strait -- about whether they have a say in how Northbrook uses the Culligan name in the future, i.e., whether it goes to Big Box or whether it goes online to find new ways to move additional units faster than it can through its traditional dealer network?
Singler: In terms of your scenario, you have about as much information as we do. I don’t know anything more about Vivendi than what I read in the Wall Street Journal. And I’ve gone through some of their disclosure statements when they converted the stock and put it out on the exchange, so I’ve got a little more there. But to put things into perspective, we believe the independent dealers comprise 70 percent of Northbrook’s revenues. This, though, is as little as one-half of one percent of Vivendi's annual revenues.
WC&P: Of those, how many are CDANA members?
Singler: Sixty-nine percent -- I mean quite a few. The dealers that are not CDANA members are the guys who have the Culligan name and are associated with a hardware store in very rural America where they may sell one or two units a year. All the guys who sell the bulk of the product are CDANA members. And they’re generally in the leadership ranks, either DAC or CDANA or both. So, the guys who are really into this and moving most of the product are very involved in the association and dedicated to the system.
WC&P: DAC being?
Singler: The Dealer Advisory Council. Again, trying to put things into perspective, we believe -- and we’ve never really had this confirmed, but based upon sitting around the room with dealers and looking at the revenues in how much they buy -- we’re guessing that 70 percent of the product that is coming out of Northbrook is sold through the independent dealer network. We are their No. 1 customer. Now, put that in perspective. That 70 percent of Northbrook’s revenues comprises about one-half of 1 percent of Vivendi’s revenues. You’re dealing with one of the largest conglomerates in the world. They control the cellular Vodaphone. They control the music industry and film industry in Europe. They’re coming over here and getting Universal and Seagrams over here. Although they started in water treatment, that’s become somewhat a sideline to the more glamorous stuff on the entertainment side. And so, from a strategic standpoint, doing transactional stuff, it’s not a bad move. They’re going into a volatile area, into the U.S. market and so what you want to be is as debt-free as possible. You have a main source of revenues. If you can spin your debt off to that, it makes the entry into the entertainment segment an easier transition. If you’ve got historical numbers on the water treatment side, you know how much it can bear and you’ll be OK -- there still will be a source of revenue and allow you to free up and move forward on the entertainment side. That’s all well and good. But do Culligan dealers even have Paris’ attention? I mean this is really a thorn in their side. What there are are egos involved and pride. And Vivendi, regardless of how much money you make, paid a lot for USFilter and USFilter paid a lot for Culligan. Each one of those guys wants to make a return on that investment. So, even though we’re a very small part of the overall puzzle, everybody wants to make a return and make it work. Back to where we are, is Jean-Marie Messier going to be sitting down with me and Henry Strait, the president of CDANA, to work this out? I seriously doubt it. But there are guys who are beholden to making certain calls and certain quotas whose bonuses and jobs may be in jeopardy if they don’t make those numbers. Those are the guys who will hopefully have the authority and wisdom and sit down to take care of your No. 1 customer, the independent dealer. Can we control how they use the name? No. But if they roll out and just try and deal with mass retailers and, in the short term, forsake the independent dealers, bottom line is they still comprise 70 percent of the revenues. So, you can’t replace the independent dealers overnight and it would be folly to think that you could. What hopefully we can do -- and this is the other thing I can say and if you’ve talked to dealers, you’ve probably heard the concern over Big Box, meaning the mass retailer -- there’s very little intrinsic resistance to the Big Box. The concern is where does the independent dealer fit into this niche? How do we fit into the overall business model?
WC&P: It’s also about which products are being sold through that channel?
Singler: What product's being sent there, what’s our role in servicing it, do we do the warranty work, does that become part of our revenue base, are we basically joint venturing in our area? What are we basically doing? Or is it just at our risk and sales cut into our share -- we just want to know where we fit in and we want to make it work for both sides. There’s two terms used in franchising and depending upon who you talk to the two terms are used to describe the same situation. One is an "additional channel of distribution" -- franchisors use that one. Franchisees use "alternate channel of distribution." If it’s an additional channel of distribution and both sides benefit from the brand exposure and fully saturate the market with the brand to the detriment of the competition -- great. Everybody wins from that.
WC&P: i.e., a sum-sum gain for all parties…
Singler: Right, it’s a win-win situation. If it’s an alternate mode of distribution -- whereas if you sell one through a Home Depot or a Sears, that’s one less that the independent dealer sells and the independent dealer has to do the warranty work at basically no profit or very little margin -- now, we have a problem.
WC&P: That’s where you’re basically cannibalizing the sales of your dealer network…
Singler: Right. If the franchisor or factory is gaining additional revenues at the expense of the independent dealer, obviously we have a concern. And the independent dealers obviously aren’t looking for a windfall and are not looking to stop adaptation to competitive pressures…
WC&P: Yes, but how realistically can they effectively be able to have -- and effectively is the operative word here -- a voice in the corporate structure? Do you know what I mean?
Singler: Well, there are two things happening here. One is, hopefully, we appeal to prudent business people who understand the importance of your strengths. And the strength of the Culligan system is -- and has been since its inception -- the independent dealer. If it’s 70 percent of your revenues, wouldn’t you like to keep that 70 percent intact or even enhance it and also explore and exploit additional channels. If it can be done, and I really think it can -- in the negotiations, I don’t really want to go into it; but we have proposed ways and mechanisms, not the individual details of each plan because we don’t know what the technology will bring us a year down the road, but a means of evaluating and exploring each additional channel and how the dealer will fit into that situation so the scenario will be win-win. That’s all we’re looking for is a process that they’re beholden to. Beside that, if the independent dealer is always at the mercy of… if there’s something in the contract that says "reserves the absolute right, at the sole discretion of the franchisor to do whatever they want"… and that’s how most franchise agreements are written these days, then what is the dealer’s incentive to reinvest into that business? There’s no long-term security. You gotta remember that you’re dealing -- particularly with the Culligan system -- with guys who’ve been in this for two, three and four generations.
WC&P: Can I add a question? Also, what is the role of the Big Box retailers or others in supporting the name? Why should the dealers be forced to pay for the name exclusively through that co-op advertising program, etc.? What investment is being made by say a Home Depot or whatever in supporting the brand?
Singler: That’s a very good question and that’s one of the questions we would ask if we have this process. As long as there are safeguards in the process that allows the dealer security and peace of mind let’s say, I can promote this because I know I can at least have input according to some schedule or formula or process. I know I’m going to be guaranteed this won’t hurt us or we’ll share in revenues or will get additional advertising revenues. Say all these studies show X, Y and Z and this is how we’re going to participate. As long as the process is in place, it gives the dealer that incentive to move forward and support the program. But those are the same issues we deal with all the time and what happens is if those contractual agreements aren’t there, it’s a lot easier for a franchisor and a Big Box retailer to cut a deal that benefits them. And, it’s not that they deliberately go out to hurt the dealer, they just don’t consider them in the whole process. And ultimately, we end up bearing the risk that way. So, back to your question on how do we hope to influence them, hopefully, we’ll appeal to business prudence. You’ve got somebody who comprises 70 percent of current revenues -- let’s strengthen that. Let’s play to our strengths and then explore together how we can improve that. That’s what we’re looking for. Now, the other thing that we have is in addition to having a very strong basis of power relatively speaking -- not in terms of Vivendi, but in terms of the niche of Culligan and the Culligan name -- we also have some contractual restrictions. That’s why I said the current contract doesn’t really do anything to give dealers peace of mind or security nor does it allow Northbrook to move forward with some of these things. The 1957 agreements, and I won’t go into details of that, but there was litigation over very similar issues that Northbrook and the dealers are working with now. Out of that litigation, there was a consent decree entered with the FTC and there were also some amendments put out by Culligan and some negotiating done 50 years ago. Out of that, what happened is Northbrook can’t contractually authorize another dealership or another dealer to sell or service or sell Culligan products in what’s called a PAR or primary area of responsibility -- or, at that time, an authorized territory -- without going through a process. One step is doing all the market studies, showing a need to explore this additional dealer or additional channel of distribution, bringing it to the DAC and the DAC then renders an opinion. Presumably, it’s got to be consistent with those findings. Now, again, the Uniform Commercial Code applies to all of these contracts, and it imposes certain obligations as to how Culligan must exercise its discretion -- reasonably so as not to deprive dealers of the "fruits" of the contract.
WC&P: So, there’s a little bit of teeth to this DAC agreement?
Singler: There is. That’s in the 1957 agreement, but it’s also -- by virtue of everything that’s been done since then -- in the 1991 agreement because that’s been their written policy. It’s called a "capping" policy. It’s how they would determine whether or not another dealer would be authorized to serve products or services in a given area. It basically adopted the same standards that were in the 1957 agreement.
WC&P: What was the 1997 or 1998 document when USFilter bought Culligan or Vivendi bought USFilter? Wasn’t there another document at that point?
Singler: No, that was the 1991 form. What happened was you have a 1957 agreement that’s perpetual. But through doing deals or granting consent to do certain things, they upgraded people or when they sold they said here’s the new agreement. So, there was some switchover and there’s probably about 40 of the 1957 forms still in place in the system throughout the country.
WC&P: Of how many?
Singler: I’m going to guess there’s probably 550 agreements out. But some of these ’57 agreements are for very large territories. They’re not insubstantial. They’re fairly inclusive.
WC&P: Like a John Packard?
Singler: Like a John Packard situation, yes. Then, what happened is you had one in 1974 that came out and it had a 10-year term. Then you had a 1986 version that had a 5-year term. So, by all of those terms they would have expired. And then the 1991 agreement came out that had a 10-year term on it.
WC&P: And now Northbrook is hoping to go back to a 5-year term and also…
Singler: Well, they’ve already recanted on that. They’ve agreed to put a 10-year term on it, primarily because nobody can get financing if they only have a 5-year franchising agreement.
WC&P: When did that happen?
Singler: That happened about a week or two ago.
WC&P: And what about the issue of the ability to terminate the dealership, i.e., there was an issue as I understood it of circumstances under which a dealership could be terminated and the period under which Northbrook had first right of refusal if the dealer chose to sell their business. That period being two-years, regardless of whether the dealer’s departure was voluntary or they were terminated.
Singler: Yes, that’s a new critter that came into existence after USFilter bought Culligan. In one respect, that’s one of the things that enabled them to get Culligan. They bought up a number of dealerships. They had people terminate. And since it’s inception, the dealers always had a unilateral right to terminate their agreement in either 60 or 90 days. The predominant one is 90 days. So, they had a number of dealers terminate, use their 90 days and then it was part of a plan that Filter would buy the dealership directly after that. They acquired a number of dealerships in that fashion. And remember what I said when I told you what franchise lawyers do? They go back and say, "OK, never let that happen again." Well, they exploited an issue in the franchise agreement and then as soon as they got it, they told their lawyers, "Never let that happen to us." Now, the 90-day period is still in effect for those under the 1991 or 1957 agreements. It’s only new contracts that applies to where they’ve stretched it to two years.
WC&P: They don’t want somebody to do to them what they did to Culligan, in other words?
Singler: Most of them at USFilter were right up front with me. I knew that’s why they did it, but they so much as admitted that: "Well, that’s what we did. We can’t let that happen to us." And I will say this is a legitimate reason for the franchisor to have a right of refusal and post-termination too. That is to keep the assets in the system and to keep brand presence up in a particular area. But if you let a sign change over, you pretty much lose that. A 90-day post-termination or post-expiration right of refusal is reasonable because you can still keep that presence going and not have to re-establish or re-take a terrirtory. But if it goes past 90 days, you’ve already lost a significant amount of that exposure. Going out two years, all it does is really devalue the dealership. There is certainly a reasonable and legitimate compromise that can be reached on that issue.
WC&P: I take it that’s still being negotiated?