Saks Chargebacks May Cause Changes

Some Hope to Rebalance Vendor/Retailer Relationship

Don Hogsett, May 23, 2005

New York — The growing Saks Inc. chargebacks case and surrounding investigations have the potential to forge "a defining moment in the history of American retailing," according to an attorney with the law firm of Phillips Nizer, which filed the suit.

The second of what could become many lawsuits was filed against the retailer last week, claiming that an apparel company that sold Oscar de la Renta sportswear was put out of business after Saks Fifth Avenue deducted nearly 35 percent, or $31.4 million of the more than $90 million the company billed Saks.

The fallout from an earlier chargebacks suit has already claimed the jobs of three top Saks executives, including the brother of CEO R. Brad Martin.

Also last week, a second plaintiff joined an existing chargebacks suit against Federated Department Stores, asking the Supreme Court for the State of New York to grant the case class action status. And in what may be a related development, Nordstom released an annual report that for the first time broke out vendor allowances — which amounted to $206.4 million in 2004. The retailer’s pre-tax profit was $647.3 million.

"An opportunity now exists, which had not existed before, for a rebalancing of the vendor/retailer relationship, helping to create a genuinely level playing field," said Donald Kreindler, an attorney with Phillips Nizer.

The suit was filed in the U.S. District Court for the Southern District of New York by International Design Concepts, which bought the assets of Apparel Group International (AGI). Before it went out of business, AGI for years produced sportswear under license from Oscar de la Renta. Saks Fifth Avenue accounted for about 60 percent of the company’s total annual sales, the complaint states.

The Saks case is already being investigated by the Securities and Exchange Commission and the U.S. Attorney’s Office, and could also come in for scrutiny by public watchdogs like New York State Attorney General Eliot Spitzer. "I do know that a number of conversations have taken place with Spitzer’s office," said Kreindler. "I certainly hope the attorney general becomes interested in this case."

Spitzer’s office last week told HTT it is not currently investigating the case.

The suit filed by Kreindler’s firm charges that Apparel Group International was "forced out of business" by the actions of Saks, and charges "contract fraud, deceptive acts and practices, unjust enrichment and interference with prospective economic advantage." At least some of the chargebacks and deductions Saks took were improper, the complaint alleges, and "Saks failed to provide any itemization or documentation."

Kreindler said, "We don’t know exactly how much was involved in improper deductions. Saks has refused to discuss that with us. We believe it’s in the many, many millions. We won’t really know until we examine the books and records in discovery."

Kreindler said International Design Concept is "seeking whatever was improperly deducted, plus additional damages for what they did to Apparel Group International, driving them out of business."

Kreindler said, "Remember, Oscar de la Renta was 60 percent of Apparel Group International’s business. And as a result of what Saks did, AGI was unable to pay Oscar de la Renta the royalties it owed them. So Oscar de la Renta withdrew the license. After that happened, AGI couldn’t afford to pay its lenders, and they foreclosed."

The suit charges that the chargebacks scandal has broad implications that go far beyond just one retailer and just one vendor. The suit charges that "because of the extreme disparity in economic and bargaining power" between Saks and other major retailers on the one hand, and between most vendors on the other, Saks "has been able to coerce many, if not all, of their vendors into not challenging the chargebacks practice whether or not the chargebacks were justified."

The suit claims Saks has admitted it "improperly collected vendor markdowns totaling $21.5 million between 1999 and 2003."

Focusing tightly on the men who run Saks and other major retailers, Kreindler said senior executives "have a vested interest in running up chargebacks and allowances." Because chargebacks swelled the corporate profits at Saks on which executives’ bonuses are based, "senior executives had a personal financial incentive" to encourage the company to "issue improper and excessive chargebacks to their vendors."

Kreindler said, "There’s no question the Saks executives had a vested interest. But the situation may hinge with the investigations going on now at the SEC and the U.S. Attorney’s office. There’s no question this will change the landscape."

The attorney said the Saks scandal has the potential to attract the interest of public and consumer watchdogs. "There is a strong possibility since this does affect the public. Vendors have to take into account the money they know that retailers will deduct in the form of vendor allowances, and they build that into the price they charge. In the case of our client, legitimate and agreed upon markdown allowances totaled 35 percent of the price of the product. And that doesn’t include the ‘back door’ chargebacks for short shipments, late shipments, labels pasted on improperly, etc.

"When the vendor is forced to increase his price, consumers are going to pay more than they should because of these chargebacks."

And it’s not just consumers who are affected, said Kreindler. "This hurts the small specialty retailers, the moms and pops, as well. Specialty retailers get hurt because they pay the same higher price for the product, without getting the benefit of the chargebacks. There are multiple constituencies which get hurt."

Meanwhile, no court date has been set on determining whether the suit against Federated will be granted class action status. Neither of the suits against Federated — one by CLC/California Fashion Industries Liquidating Trust and the other by the former chief executive of Royal Apparel — has specified the amount of damages they are seeking, according to Nancy Pacharzina, an attorney at Tousley Brain Stephens, one of the law firms representing the plaintiffs.

The plaintiffs are still seeking information from Federated to complete their damage calculations, she said. However, the plaintiffs will be seeking a refund of the chargebacks as well as a refund of the 8 percent discount Federated allegedly took for making on-time payments even when it didn’t.

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