Sally Beauty Co. v. Nexxus Products Co.

United States Court of Appeals, Seventh Circuit
801 F.2d 1001 (1986)

ELI5:

Rule of Law:

Under the Uniform Commercial Code, the duty of performance under an exclusive distributorship contract may not be delegated to a wholly-owned subsidiary of a direct competitor without the obligee's consent.

Facts:

Nexxus Products Company (Nexxus), a manufacturer of hair care products, entered into an agreement with Best Barber & Beauty Supply Company (Best) for Best to be the exclusive distributor of Nexxus products throughout most of Texas.
The agreement required Best to promote and sell Nexxus products to barbers and beauty salons.
Approximately two years into the agreement, Best was acquired by and merged into Sally Beauty Company, Inc. (Sally Beauty).
Sally Beauty is a wholly-owned subsidiary of Alberto-Culver Company, a major manufacturer of hair care products and a direct competitor of Nexxus.
After the merger, Nexxus informed Sally Beauty that it would not allow a subsidiary of a direct competitor to distribute its products and subsequently terminated the distributorship agreement.

Procedural Posture:

Sally Beauty sued Nexxus in the U.S. District Court for the Northern District of Illinois for breach of contract.
Nexxus filed a motion for summary judgment on the breach of contract claim.
The district court (trial court) granted summary judgment in favor of Nexxus, ruling that the contract was for personal services and therefore not assignable.
Sally Beauty, as the appellant, appealed the summary judgment ruling to the U.S. Court of Appeals for the Seventh Circuit.
Nexxus is the appellee in the Court of Appeals.

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Issue:

Under the Uniform Commercial Code, may a party delegate its duties under an exclusive distributorship contract to a wholly-owned subsidiary of a direct competitor of the other party to the contract?

Opinions:

Majority - Cudahy, Circuit Judge

No. The duty of performance under an exclusive distributorship contract may not be delegated to a wholly-owned subsidiary of a direct competitor without the obligee's consent. The court determined that the exclusive distributorship agreement was a contract for the sale of goods governed by the Uniform Commercial Code (UCC). Under UCC § 2-210, a party may not delegate performance if the other party has a 'substantial interest' in having the original promisor perform. An exclusive distributorship contract implies a duty for the distributor to use its 'best efforts' to promote the product under UCC § 2-306. The court found that Nexxus had a substantial interest in not having its 'best efforts' distribution performed by Sally Beauty, a company wholly owned and controlled by its direct competitor, Alberto-Culver. The court concluded that such a substituted performance would be a different thing than what Nexxus had bargained for, and the law cannot force Nexxus to accept the risk that its competitor's subsidiary would not faithfully perform the 'best efforts' obligation.

Dissenting - Posner, Circuit Judge

Yes, unless a factual inquiry proves impairment of performance. The majority's per se rule that delegation to a competitor is prohibited is based on judicial intuition rather than legal precedent or business reality. It is common for businesses, like Sally Beauty, to distribute products from multiple competing manufacturers, and it would be against Sally Beauty's own commercial interest to sabotage the Nexxus line and damage its reputation with other suppliers. The fact of the acquisition does not, by itself, prove that Sally Beauty cannot or will not use its best efforts. At most, the acquisition may have given Nexxus grounds for 'insecurity,' for which the proper UCC remedy was to demand assurances of due performance under § 2-609, not to unilaterally repudiate the contract. The case should be remanded for a trial to determine as a matter of fact whether the merger was likely to impair performance of the contract.

Analysis:

This decision establishes a significant common law interpretation of the UCC's rules on delegation, creating a nearly per se rule against the assignability of an exclusive distributorship to a competitor. It solidifies the idea that the 'substantial interest' in performance under UCC § 2-210 includes the right not to have one's 'best efforts' promotion handled by a direct business rival. This holding provides manufacturers with a powerful tool to control their distribution channels when a distributor is acquired by a competitor. However, it also curtails the free alienability of contracts, a principle generally favored by commercial law, by prioritizing the obligee's interest in the identity of the performing party over the assignee's ability to demonstrate adequate performance.

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