VIA COURIER Carlos E. Peña, Esq. Senior Counsel Pepperidge Farm, Inc. 595 Westport Avenue Norwalk, CN 06851 Re: Pepperidge Farm Distribution Issues Dear Mr. Peña: I want to thank you again for your June 22, 2004 response to the concerns raised by our clients, including the Pepperidge Farm Owners Association. Our clients have finalized their work in gathering data needed for making this response to your letter. It is our hope that, once you have had a chance to review this letter, you and Pepperidge Farm, Inc. ( Pepperidge Farm ) will consider convening a meeting with J. Michael Dady, me, and our clients to further review these important issues. For your ease of reference, this letter is formatted consistent with the Talking Points structure set forth in our initial letter of May 26, 2004. (1) Pepperidge Farm s Imposition of Certain Fees In our earlier letter, we voiced a concern on behalf of our clients involving the imposition of certain fees 1 by Pepperidge Farm -- a practice which is diminishing the return earned by our clients on the operation of their routes. 1 Among the fees discussed in the May 26, 2004 letter were: processing fees, computer maintenance fees, greater-than-cost prices for computer software and hardware, and pallet fees.
Page 2 While we can likely agree that these fees are not... designed to reduce the commission income of my clients, as you assert in your letter response, these fees do cut into the commission income that the distributors receive from sales of Pepperidge Farm products. More importantly, the fees are nowhere authorized by either the Green or Blue Agreements (the Agreements ). (See, respectively, Exhibits A and B hereto.) Paragraph 5 of these Agreements, which you point to as authorizing Pepperidge Farm s imposition of fees, does not authorize the imposition of the fees. Paragraph 5 simply requires that the distributor to maintain adequate equipment and facilities for the handling of Pepperidge Farm product. Perhaps your point is that, because the distributors are required to maintain adequate facilities and equipment for the handling of Pepperidge Farm product, the distributors should reasonably anticipate a certain level of costs associated with doing that work (e.g., the sort of hand-held and personal computers commonly used in the distribution business). The problem with that suggestion, however, is that our clients have not been free to choose who will service their computer systems or from whom our clients must purchase their hardware and software; our clients tell us, unequivocally, that Pepperidge Farm has never allowed them to procure such services and equipment from anyone other than Pepperidge Farm and its designated vendors. As a result, our clients believe they are paying greater-than-bona-fide cost for such services and equipment. Our clients are not obliged to pay these excess charges. 2 To the extent that Pepperidge Farm has announced to its distributors that they are free to purchase services and equipment from unaffiliated third party sources (as you contend), we would appreciate your forwarding us copies of such policies so that we may, in turn, pass them along to our clients. 2 Computer maintenance and equipment fees aside, Paragraph 5 cannot be interpreted as authorizing the imposition of either: (a) the processing fees that our distributor clients pay to Pepperidge Farm upon a distributor s communicating a change in his/her order (a charge which our clients, again, indicate that Pepperidge Farm does impose contrary to your sense for the issue as outlined in your letter response); or (b) pallet fees. Perhaps Pepperidge Farm has imposed such charges because of the existence of some transactional costs associated with changed orders or pallet deliveries. The problem, again, is that these costs are borne by the distributor, not Pepperidge Farm (and, further, that Pepperidge Farm has unilaterally sought to defray its costs without seeking to appropriately update its Agreements with its distributors).
Page 3 (2) Execution of Less Favorable Written Agreements Required at Sale With our initial letter we had hoped to highlight for you our position that neither the Green nor Blue Agreement allows Pepperidge Farm to requires a purchaser of a distributorship to execute a newer and less favorable written agreement (as opposed to allowing the acquiring distributor to continue operating under the selling distributor s more favorable agreement). See Green Agreement, 16; Blue Agreement, 18 (requiring that the acquiring distributor be allowed to operate under an agreement of substantially the same form). In your letter response, you assert that the agreements signed by an acquiring distributor do not materially differ from that of the selling distributor. Your response indicates that while Pepperidge Farm may acknowledge the legal obligation to allow an acquiring distributor to operate under an agreement of substantially similar form, Pepperidge Farm believes that it has complied with that obligation. An analysis of the voluminous changes to the various agreement forms proffered by Pepperidge Farm over the years seriously calls your conclusion into question. I have attached for your review a comparative analysis of the changes made to the various agreements (i.e., Yellow, Green, and Blue) prepared in 1996 by the Boston law firm of Witmer, Karp, Warner & Thuotte (noting, among other changes: the changed terms on which credit will be offered to a distributor by Pepperidge Farm; the increased frequency of service requirements; the imposition of a non-competition clause prohibiting sales of like products; the imposition of sales quotas; the imposition of requirement that distributor finance the purchase of accounting, inventory, billing, and computer systems; the elimination of compensation to distributor by Pepperidge Farm if and when Pepperidge Farm eliminates a store from the distributor s Territory for failure to comply with increased service requirements; the imposition of a right of first refusal in Pepperidge Farm if and when the distributor wishes to sell; and the imposition of a right in Pepperidge Farm to purchase the distributor s route(s) at any time). These changes are numerous and substantial enough to safely conclude that Pepperidge Farm has not allowed its acquiring distributors to operate under an agreement which is substantially similar to that enjoyed by his/her predecessor. For these reasons, we request that Pepperidge Farm commit to honoring its selling distributors right to sell the opportunity to operate under the same agreement as he/she has been operating.
Page 4 (3) Termination for Alleged Failure to Honor Service Frequency Requirements at Certain Chain Stores We were surprised by your response to the contention in our May 26, 2004 letter that Pepperidge Farm had abused its discretion to issue 5-day termination notices (i.e., that type of notice typically issued in situations where Pepperidge Farm alleges that a distributor has not serviced an account with sufficient frequency) to effect a chain-wide terminations (e.g., for 7-11, Circle-K, Toys R Us, Trader Joe s, Staples, Costco, Walgreens, Sam s Club, and Wal-Mart stores) in certain geographic regions. Your response to this serious allegation was that:... some customers, such as 7-Eleven, Circle-K and Toys R Us, have instructed Pepperidge Farm that their stores are to be serviced exclusively via their centralized warehouse distribution system. These customers will not accept store-door deliveries from our distributors. We have requested all such customers to notify us in the event they wish to institute store-door delivery of our products... Such procedures comply with the requirements of Paragraph 9 of the Consignment Agreement. Your response suggests that, to the extent that these three chains requested that Pepperidge Farm begin making direct deliveries (as opposed to via service through our distributor clients), it appears Pepperidge Farm made little effort to talk these chains out of that decision (let alone advising distributors in writing that these customers had taken such a position or inviting a distributor representative to be party to the discussion with these customers). Instead, Pepperidge Farm issued 5-day notices to distributors suggesting that their service frequency had been inadequate an entirely different issue altogether! This appears to have been neither an open nor honest way of conducting business and has our clients wondering whether Pepperidge Farm has accepted some benefit from these chains in return for having arranged for direct service. The contention that these chains, in fact, demanded warehouse delivery by Pepperidge Farm appears dubious given that numerous blue-chip manufacturers (Archway, Frito-Lay, Budweiser, Coke, Pepsi, Coors, etc.) continue to utilize their independent distributors for distribution at these chains. Whatever the case, Pepperidge Farm s conduct in issuing these unfounded 5- day notices has given rise to a serious number of prospective wrongful termination claims (i.e., claims that the affected distributors were not, in fact, terminated for inadequate service frequency).
Page 5 We hope to discuss further with you and Pepperidge Farm: (a) how we might achieve a resolution to this issue, and (b) how Pepperidge Farm proposes to deal with similar requests by chain stores in the future (e.g., by involving Pepperidge Farm s distributors in the discussion). (4) Pepperidge Farm s Imposition of Thrift Caps We would like to request copies of the thrift policies, as amended from time to time which you mention in your letter response. To the extent that such policies vary by geographic region, we would appreciate being provided with copies of these varying policies. While our clients are troubled by Pepperidge Farm s unilateral changes to the announced thrift policies, receiving copies of such policies might go some distance in helping us to further evaluate this important issue. Resolution of the thrift cap issue is particularly important to our clients (who are beginning to feel as though they are unable to effectively plan their inventory due to a variety of factors, e.g., increasing forced shipments of products into their depots and pallets over which they have no control, all of which is subject to an unspecified cap). (5) Pepperidge Farm s Movement Towards Use of a Scan Based Trading System With respect to the scan-based trading ( SBT ) issue, you have indicated that Pepperidge Farm is currently testing a pilot program at six Target store locations but that, [i]f SBT becomes a condition for continued business imposed by our customers, it will be appropriate to adjust the payment of commissions to the time of scan. We hope that you will also acknowledge that if, for whatever reason, Pepperidge Farm decides to further pursue SBT, that it will be appropriate to engage in a negotiation with its distributors regarding an agreed-upon resolution of this issue as implementation of SBT would represent a fundamental change in Pepperidge Farm s business (and legal) relationship with its distributors. (6) Recognition of the Pepperidge Farm Owners Association Finally, I am hopeful that we can resolve the issue of whether Pepperidge Farm is willing to recognize the Pepperidge Farm Owners Association for purposes of these discussions. While you may be correct in observing that the Pepperidge Farm Owners Association does not represent all Pepperidge Farm distributors, we thought it important
Page 6 to draw your attention to the fact the membership of the Pepperidge Farm Owners Association, comprised of over 200 members, accounts for a significant chunk of Pepperidge Farm s product sales. In fact, my clients estimate that the Pepperidge Farm Owners Association s membership generates over $2 million dollars in sales of Pepperidge Farm products per week. In any event, your response does not explicitly address whether Pepperidge Farm is willing to communicate with Dady & Garner, P.A. with respect to the legal issues being raised by all of our clients including, but not limited to, the Pepperidge Farm Owners Association (whether or not the Association s collective view is representative of... Pepperidge Farm distributors at large ). To the extent that Pepperidge Farm is unwilling to address the concerns being raised by the Pepperidge Farm Owners Association with the assistance of its selected representatives and Dady & Garner, P.A., I would appreciate your letting us know that. As mentioned above, we would like to have your feedback on the foregoing and would be pleased to convene a meeting with Pepperidge Farm so as to be able to discuss these issues if you are willing. I look forward to hearing from you in the near future. Sincerely, DADY & GARNER, P.A. J. Michael Dady John D. Holland JDH:jmv Enclosures cc: Clients