Court of Appeal clarifies legal doctrines applicable in distributorship agreements in upholding USD 14 million claim for breach of contract

In 2013, Heineken East Africa (Heineken EA) a Kenyan subsidiary of Heineken International B.V. (Heineken BV), signed a distributorship agreement with Maxam Limited (Maxam) (the Agreement).

Maxam became the exclusive distributor of Heineken beer in Kenya. Maxam invested heavily and rented warehouses, bought trucks, and hired staff to build a distribution network specifically for Heineken. This investment was based on the expectation of a long-term partnership.

Three years later, Heineken EA, through Heineken BV, sent Maxam a termination notice, abruptly ending their distributorship agreement.

Litigation at the High Court

Maxam sued Heineken EA and Heineken BV (collectively Heineken) for KES 1.8 billion (USD 14 million) in damages including for loss of business and loss of profits arising from an alleged termination of the Agreement. Maxam’s suit challenged the validity of the termination and claimed that the termination notice issued on a ‘without prejudice' basis was illegal and of no effect, and that there was no privity of contract between Maxam and Heineken BV, which had issued the termination notice. The High Court initially granted interlocutory orders preventing Heineken EA and Heineken BV from terminating the Agreement or appointing other distributors, but the interim orders were lifted by the High Court in 2017. Thereafter, Heineken proceeded to appoint third-party distributors before the determination of the dispute contrary to the provisions of the Agreement, which Maxam argued was a breach of the Agreement.

The High Court found that the automatic extensions under the Agreement motivated Maxam to invest heavily in infrastructure to continue performing the Agreement, thus creating a legitimate expectation that the Agreement would be renewed. On the validity of the termination notice, the High Court held that the notice was invalid as it was not issued in accordance with the Agreement which required that reasons for termination be provided to Maxam. Additionally, the notice was sent on a ‘without prejudice’ basis and created no legal obligation on Maxam. Therefore, Heineken’s actions in appointing other distributors without issuance of a legally binding termination notice amounted to constructive termination of the Agreement. The High Court found in favour of Maxam and awarded special damages in the sum of KES 1,799,978,868 for loss of business and KES 16,612,188 as special damages for loss on decreased volumes and loss of profit. The High Court also issued declaratory orders and injunctive reliefs in favour of Maxam.

Litigation at the Court of Appeal

Heineken filed an appeal at the Court of Appeal which set down various issues for determination including:

• a) Whether the appointment of third-party distributors by Heineken EA and Heineken BV was valid.
• b) Whether the award of special damages was excessive and unwarranted.

i. Whether the notice of termination issued by Heineken BV to Maxam was valid 

The Court of Appeal held that the legitimate expectation doctrine as determined by the High Court was inapplicable as the parties to the dispute were all private parties. It found that the doctrine of legitimate expectation is applicable in public law and not applicable where parties to a dispute are private parties who are not seeking any relief from a public body. The Court found that the trial judge mistakenly combined the doctrine of legitimate expectation with the principle of reasonable expectation, the latter of which typically solidifies within a contractual context rather than in relationships outside of a contract. 

The Court however held that the termination notice was invalid as it was labelled ‘without prejudice’ which the Court found rendered the letter inadmissible as evidence. The Court therefore concluded that the ‘without prejudice’ letter was not a valid notice of termination under the Agreement, which remained in effect as of the letter's date.

ii. Whether the appointment of third-party distributors by Heineken EA and Heineken BV was valid

The Court found that Heineken’s appointment of third-party distributors meant that Maxam was unable to continue with the performance of its obligations under the Agreement because of the clause which obligated the parties to continue performing their obligations until the final resolution of any registered dispute. This appointment, it found, amounted to a repudiatory breach of the Agreement by Heineken, giving Maxam the option to affirm the contract or accept the repudiation. The Court held that the breach released the parties from the Agreement, leaving only the issue of compensation.

iii. Whether the award of special damages was excessive and unwarranted.

The Court affirmed and upheld the award by the High Court to the Respondent of special damages for loss of business of KES 1.8 million (Approx. USD 14 million). The Court held that, while Heineken argued Maxam's evidence in support of its claim for specific damages it had suffered after Heineken ended their distributorship contract was flimsy, there was merit in Maxam's expert valuation report which it used prove and justify the award on special damages sought on account of loss of business. In upholding the High Court decision, the Court referred to the unique nature of exclusive distributorship agreements which it held often require distributors to make significant investments that may result in a costly termination for them. The Court found that Maxam's investment in building distribution infrastructure left it vulnerable upon termination of the agreement, and the lack of counterevidence from Heineken challenging Maxam’s evidence of loss ultimately tipped the scales in Maxam's favour.

Why this is important for you?

This case clarifies the legal principles applicable to termination of distributorship agreements in Kenya, particularly in beer distributorship. Some of the key learnings from the decision are:

• Exclusive distributors, like Maxam, often make significant investments based on the expectation of a long-term partnership. These investments are specific to the brand they distribute and can be difficult to recoup if the distributorship agreement is terminated unexpectedly.
• Traditionally, distributorship agreements might include clauses stating the distributor is an ‘independent contractor’ and assumes business risks. However, the court may consider these clauses irrelevant if the agreement itself requires specific investments in infrastructure for the supplier's benefit.
• In entering exclusive distributorship agreements, suppliers should consider the capital deployed by the distributor and the period of the contract to establish whether there may be a reasonable expectation that the contract will be extended for a period necessary for the distributor to recover this investment.
• This case establishes that a Court will interrogate what constitutes a fair termination in an exclusive distribution agreement. In doing this, the court will likely consider factors such as:
  • Reasonableness of termination - does a supplier have a legitimate reason to terminate, or was it done arbitrarily in consideration of the reasonable expectation by the distributor?
  • Notice period - is the termination notice period sufficient for the distributor to find alternative business opportunities and recoup its investment?
  • Compensation for investment - should the distributor be compensated for the specific investments they made based on the agreement's requirements?
• The Court of Appeal distinguishes between legitimate expectation in public contracts and reasonable expectation in private contracts, setting a clear precedent for future cases.
• The ruling also reinforces the inadmissibility of "without prejudice" correspondence in legal proceedings and the importance of issuing clear and unambiguous correspondence during commercial transactions.
• Additionally, the case highlights the potential for distributors in exclusive arrangements to recover significant damages for losses incurred due to improper termination, as evidenced by Maxam's successful claim for financial losses.

For more information please contact the authors George Ndung’u, Eugene Owiti and Anjella Musumba.