Designer Skin LLC v. S & L Vitamins, Inc., et al.
Toys R Us.com, LLC v. Amazon.com
Docket No. C-96-04 (Superior Ct. N.J., March 1, 2006)
After a lengthy trial, the Court found that defendant Amazon.com had breached an agreement it had entered into with plaintiff ToysRUs.com LLC ("Toys R Us"), by permitting third parties to sell toys on Amazon's web site. Finding that this breach went to the substance of the parties' agreement - which as interpreted by the Court provided that Toys R Us was to be the sole third party toy retailer on Amazon's web site - the Court granted Toys R Us's request that the agreement be terminated. Notwithstanding its finding that such a breach had occurred, the Court did not award Toys R Us damages. The Court also rejected counterclaims asserted by Amazon, arising out of Toys R Us's alleged failure to maintain levels of inventory sufficient to meet customer demand.
The Court's 132 page decision provides a window into the negotiation of a highly complex transaction, in which the parties have competing visions of the structure of the transaction, and settle on contractual language that does not fully express those visions, or resolve the parties' conflict. In resolving this dispute, the Court elected not to base its determination on the literal meaning of the words ultimately accepted by each side. Instead, it strove to find their intentions in entering into this Agreement, and to give effect to those intentions. In so doing, the Court found that it was the parties' intention, under their agreement, to make Toys R Us the exclusive toy retailer allowed to market on Amazon.com. While it found that none of the wrongs Amazon allegedly committed, standing alone, constituted a technical breach of the parties' agreement, the Court concluded that taken together, they constituted a breach of this central provision, and mandated termination of the agreement.
Plaintiff Toys R Us and its affiliates specialize in the sale of toys and baby products to the public. Throughout its history, Toys R Us has sold its products in "brick and mortar" retail stores.
Defendant Amazon.com ("Amazon") is a retailer that sells a vast array of products, including books, to the public, at its web site Amazon.com.
Prior to 2000, Toys R Us operated web sites at toysrus.com and babiesrus.com. By its own account, Toys R Us' online performance in 1999 was highly unsatisfactory. During 1999, Toys R Us did not have adequate inventory and fulfillment capabilities to meet the online demand for its products.
Amazon's performance in the toy arena in 1999 was similarly flawed. While it sold $65 million in toy products during that year, it purchased an additional $35 million in toy inventory it did not sell. This was a significant negative, given Amazon's inability to return this inventory to the vendors from whom it had been purchased.
The parties respective performances in 1999 created the opportunity for the transaction at the heart of this litigation. In early 2000, Toys R Us approached Amazon about the possibility of a partnership, which would marry Toys R Us's expertise in the toy arena, and its relationships with vendors, with Amazon's online prowess, and both its fulfillment and customer service capabilities.
The parties had differing visions as to how to best achieve their joint goal of a highly successful, online toy store. Toys R Us believed the road to success called for a focus on the top, best selling toys, which accounted for most of the toy sales in any given year. The key was to identify these toys, and have them in stock in supplies necessary to meet the high demand of the Thanksgiving to Christmas selling season, when the bulk of the product was sold. Here, Toy's experience was crucial, particularly given the fact that toy orders must be placed six to eight months before the Christmas season, and thus reflected an investment in inventory that may or may not sell, depending on public taste. Toys R Us did not want to offer the complete universe of toys, because of the inventory risk attendant thereto, arising out of the potential failure of portions of this inventory to sell.
Amazon had a different view. Consistent with its general operational philosophy of offering the customer the largest product selection available, Amazon wanted to offer as many toys as possible on its website. Amazon did not want to limit toy selection only to the best selling toys.
The parties ultimately entered into a Strategic Alliance Agreement in August 2000. The parties faced significant time constraints in the negotiation of this Agreement, as their joint desire was to have a site operational for the Christmas 2000 selling season.
Under this ten year Agreement, Toys R Us agreed to abandon its own operational websites, and migrate its online presence to Amazon's site. At that site the parties would create co-branded toy and baby product stores, jointly bearing the Amazon and Toys R Us marks. These stores would sell products selected and purchased by Toys R Us, which would own the inventory it determined to offer for sale on the site. Fulfillment and customer service would be supplied by Amazon. Amazon would also be responsible for site development and maintenance, including the site's 'look and feel.'
Toys R Us agreed to pay Amazon an annual fee, ultimately agreed to be $50 million a year, for the first four years of the agreement. Additional participation in the revenues generated by the store's online sales was also provided for in the Strategic Alliance Agreement.
As originally created, the parties' toy store was assigned a navigational "tab" that appeared prominently at the top of Amazon's home page. Clicking on this "tab" took a consumer to the co-branded online toy store. Other navigational links were also provided, including a link on the site's home page - again labeled "toys" -- in a navigational guide appearing on the left-hand side of the site's home page.
Between August 2000 and 2003, the parties jointly operated the toy store. Thereafter, Amazon pursued a number of initiatives that permitted third parties to sell toys on its site - both toys Toys R Us had elected not to sell, and toys then being sold by Toys R Us. These ventures took various forms. Third parties were permitted to post 'sponsored links' on Amazon's website, via Google advertisements. Clicking on these links took consumers off Amazon's site to those of third parties, at which toy purchases could be made. Amazon derived revenue from a consumer's click on such links that it did not share with Toys R Us.
Amazon also permitted third parties to sell toys on its site via use of its 1x1 GUI technology, and via various merchant@ agreements. These agreements permitted third parties, including toy sellers, to sell toys on Amazon's website. Some of those toys were listed on the very same web pages that displayed Toys R Us offerings. These included both toys Toys R Us had elected not to sell, as well as a smaller amount of toys it had in fact elected to sell. Access to such third party selling sites could also be obtained via searches for toys performed from the co-branded Toys R Us-Amazon toy store itself. Amazon also modified its site. During this modification, the prominent "tab" to the co-branded toy store that appeared at the top of the Amazon.com home page (along with tabs pointing to other stores) was eliminated.
These selling initiatives created disputes between the parties. When they could not be resolved, Toys R Us commenced this suit, charging that they constituted a breach of the parties' agreement. Toys R Us sought to terminate the agreement. It also sought to recover damages for its breach. Amazon counterclaimed, asserting Toys R Us had breached the agreement by failing either to maintain the appropriate number of toys for sale on the site, or keep sufficient inventory of such goods on hand to meet customer demand.
The heart of the parties' dispute centered on exclusivity. Toys R Us claimed that the parties' agreement called for it to be the sole third party toy seller on Amazon.com. Under the agreement, as seen by Toys R Us, Toys R Us had the exclusive right to sell toys on the site. If, however, Toys R Us elected not to sell a particular toy on the site, Amazon could offer that toy itself, subject to Toys R Us's right to subsequently "recapture" that toy, and market it. Amazon had a different view. It claimed it had the right either to sell these "rejected" toys itself, or to allow third parties to offer them for sale. Toys R Us vigorously contested Amazon's claim that such sales could be made by third party toy sellers. It believed that only incidental toy sales that did not exceed 3.5% of Exclusive Product Sales could be made by third parties on the site, under the agreement's "safe harbor" provisions.
Significantly, the Strategic Alliance did not contain language that directly stated that Toys R Us was to be the sole third party toy retailer permitted to market toys on Amazon.com throughout the life of the agreement. Conversely, however, outside of the agreement's safe harbor provision, the Agreement did not expressly permit third party toy retailers to sell toys at Amazon.com. either.
In determining whether the Agreement provided for exclusivity, the Court focused its attention on several of its passages. The agreement defined "selected exclusive product" as an "exclusive product" that Toys R Us elected to sell on Amazon's website. As stated above, the parties agreed that Toys R Us had the exclusive right to sell such "selected exclusive products" on the site, provided it complied with the Agreement.
"Exclusive products" were toys Toys R Us had elected not to sell. To determine whether third party toy retailers could sell such products on the site, the Court turned its attention to Section 12.1.2 of the Agreement, which provided:
The term "Programmatic Selling Initiative" was defined in the Agreement as:
Amazon argued that these provisions permitted it to allow any third party to sell "exclusive products" on its site. Under its view of the Agreement, a "Programmatic Selling Initiative" covered any sales program through which any "third party may sell products or services" provided the terms for participation in this program were "available to the general public." It also argued that such third party sales were permitted under the "safe harbor" found in Section 12.1.2(c) of the Agreement, so long as they did not exceed the 3.5% of Exclusive Product Sales.
The Court held that the agreement was ambiguous, and that it would accordingly consider extrinsic evidence to ascertain the parties' intentions.
After listening to extensive testimony from those involved in negotiating, drafting and implementing the agreement, the Court determined that Toys R Us always intended to be the sole toy retailer allowed to market toy products on the site. Amazon's desire to expand selection beyond those toys Toys R Us elected to sell was accommodated by permitting Amazon, but not third parties, to make such sales, with Amazon bearing the inventory risk attendant thereto, and subject to Toys R Us's right to "recapture" such products for its own sales. This would permit Amazon to make such toys available for sale to consumers on the co-branded toy store, but not third parties.
The provisions relied upon by Amazon were designed to be safety valves, intended to avoid conflict as to incidental sales occurring on the site. These safety valves would permit third parties such as drug stores to make incidental toy sales, but were not to provide a vehicle for major competition.
The Court found support for its interpretation of the agreement in the testimony of a number of witnesses. It also found support for this interpretation in the parties' conduct. Thus, after the Strategic Alliance had been executed, Amazon entered into a deal with Target that permitted it to sell products on Amazon's site. Target was not permitted, however, to sell toys on the Amazon.com site. Instead, a separate website was created, at which Target could make such sales. The parties' conduct, and communications at this time, supported the Court's view that this was done in recognition of Toys R Us's rights under the Strategic Alliance.
The Court also found support for its conclusion in various drafts of the agreement, in which language granting third parties the right to sell on site was removed. Here, the Court pointed to a draft of paragraph 5.1.4 of the agreement:
It also noted that, with the exception of Section 12.1.2, "every other section of the Agreement that made reference to third parties' ability to sell on the Amazon site had been removed from the Agreement."
Interestingly, the Court did not find that any of the individual actions undertaken to date by Amazon constituted a breach of the parties' agreement. Thus, the Court determined that the challenged selling that occurred by use of the 1x1 GUI technology was a Programmatic Selling Initiative permitted under the parties' agreement. Moreover, though it was critical of the data produced by Amazon of site sales, the Court did not find that onsite sales by third parties of exclusive products, or selected exclusive products, exceeded the 3.5% safe harbor contained in Section 12.1.2. (This accounted for the Court's failure to award Toys R Us damages.) The Court further found that "sponsored links are not a technical violation" of the Agreement, and that Amazon had the right to eliminate and/or modify the "tab" structure that had prominently pointed consumers to the parties' online toy store. Said the Court: "This Court finds as a matter of law [that] [Toys R Us] has failed to establish a material breach of the [Agreement] by the change in the appearance of the tab structure on the Amazon web site."
Nonetheless, the Court held that the totality of Amazon's conduct constituted a breach that went to the substance of the parties' agreement, and mandated its termination. Said the Court:
This decision provides some useful insights as to the consequences of drafting complex agreements that do not clearly address and resolve central conflicts in the parties' business transaction, or inserting therein 'artful' language in the hope that it will permit one of the parties to achieve an unbargained for result.
As the Court noted:
Similarly, the Court noted:
Finally, the Court rejected Amazon's Counterclaim. After noting that Amazon had not claimed Toys R Us was in breach during the parties' relationship, the Court stated: