By  on July 8, 2008

The courts are helping push what might be called fashion's uncomfortable truth — chargebacks — back into the spotlight.

A pair of lawsuits recently filed against Kohl's Corp. and another against Saks Inc. that is set to go to trial on Monday show that the debate over how retailers prod their vendors to share in the pain when sales flop is alive and well.

It's a game of financial hardball that tends to get especially rough when the economy goes south and might be getting even tougher now that there aren't as many big chains to sell to.

"The retailers have consolidated so much you have fewer and fewer people that you can do business with and a lot of vendors have no ability to try to negotiate with these retailers," said attorney Jed Schlacter of Schlacter & Associates.

Schlacter is representing Fu Da International, an athletic apparel producer that sued Kohl's Corp. in Manhattan federal court June 5 for, among other things, breach of contract and unjust enrichment related to chargebacks. Fu Da is seeking compensation of more than $4.8 million. Kohl's is scheduled to respond to the complaint Monday and a spokeswoman for the store declined to comment on pending litigation.

The suit alleges that Kohl's failed to pay the agreed upon price of $306,873 for an April delivery of women's apparel and another $521,336 for a May shipment.

Fu Da also claims that Kohl's, in May, cancelled a $217,338 order of women's track pants and hooded jackets that was set for delivery the following month, and also pulled the plug on several other orders.

Fu Da shipped Kohl's about $7.5 million worth of women's activewear in 2006 and another $10.4 million in 2007 and signed a vendor support agreement that allowed for "profitability assistance," promising minimum assistance of 2.5 percent of gross receipts.

The vendor said it was in fact required to pay a "significantly higher margin assistance in order for Kohl's to obtain as much as a 43 percent gross margin on its own sales."

Fu Da said Kohl's chargebacks, deductions and returns of merchandise in 2007 and so far this year exceeded $3 million. The vendor also claimed that while Kohl's was seeking margin support it was also planning to cut back its orders due to an exclusive licensing agreement with branded athletic producer Fila.In correspondence from Kohl's to Fu Da cited in the lawsuit, the retailer apparently asked for fall 2007 margin support of $1 million and said: "We are, as I'm sure you are aware, in a very difficult situation ourselves and really need you to be able to come to us with the full need. We definitely value your partnership and everything you have done for us this year. Our situation is one of great need across the board, and we are asking all of our partners to come to the table in full, as pressure is definitely upon us to hit our margin plans."

For the three months ended Nov. 3, Kohl's earnings dropped 13.6 percent from a year earlier to $194 million and Larry Montgomery, chief executive officer, said, "We continued our improvement in gross margin while reducing expenses where possible without hurting the customer's in-store experience."

It is the quarterly churn of profit reports to Wall Street that the suit, at least partially, blames for the chargeback dynamic.

"Kohl's...seeks to report to Wall Street, and to the public, that its sales are increasing, and that (by virtue of it coercing vendors to provide the requested margin assistance), Kohl's is also meeting its gross margin projections," said the suit. "The truth, however, is that Kohl's is artificially increasing its sales, and artificially reaching its gross margin numbers, through fraudulent and improper demands."

In a separate case, filed March 19 in Milwaukee federal court, London Fog Group sued Kohl's for breach of contract and unjust enrichment for what it described as fraudulent and unauthorized chargebacks related to the Pacific Trail brand.

London Fog sold Pacific Trail to Columbia Sportswear Co. in March 2006 as part of its bankruptcy proceedings.

The company had paid Kohl's markdown support for Pacific Trail products, but stopped once the brand was set to be sold. According to the suit, Kohl's requested profitability assistance to support a planned margin of 38 percent after the Pacific Trail assets were sold.

"On May 2, 2006, without authorization from London Fog, Kohl's fraudulently took a deduction of $270,000 from invoices payable to London Fog for Pacific Trail products," alleged the suit. "Kohl's called this deduction a ‘markdown allowance.'"According to the suit, Kohl's has refused to pay the money and London Fog is seeking compensation of at least $270,000. It would turn over any money it gains from the action to London Fog's and Pacific Trail's creditors.

In court papers, Kohl's has denied the charges and said that London Fog is not entitled to the $270,000.

Vendors have long helped retailers make their numbers when times were tough and at the same time complained about the practice. However, as long as orders keep coming in, producers usually grin and bear the payments to hold on to the business.

"Chargebacks are still a profit center," said Andrew Jassin, managing director of the Jassin-O'Rourke Group LLC fashion consultancy. "Clearly, [retailers] are relying on their supply chain to take care of any potential ill." Jassin said retailers are increasingly hitting vendors with chargeback penalties, not because goods didn't sell, but because of some other issue, such as improper shipping. "It's really up to vendors to be much more up on the movement of product," he said.

Chargebacks and vendor allowances also make for one for the larger dark spots in retailers financial statements.

"It's sort of a murky area," said Jason Asaeda, an equity analyst at Standard & Poor's. "It's really something that companies don't talk about and they don't publicly disclose. It's hard to tell on a quarterly or an annual basis how much the chargeback or the vendor allowances are contributing."

The tough selling climate means chains will be stepping up the pressure on their suppliers.

"Anytime you're stuck with a lot of inventory and people just stop buying, obviously you're going to work with your vendor partners to maximize profitability," Asaeda said.

However, chains are more likely to be on their best behavior after the Saks blowup of a few years ago, he said.

In March 2005, an internal investigation at Saks found "improper collections of vendor markdown allowances." The fallout included probes by the Securities and Exchange Commission and the U.S. Attorney's Office in Manhattan. Saks settled with the SEC in September. There was also a lawsuit by International Design Concepts Inc., a licensee of Oscar de la Renta, that alleged it was forced out of business by Saks.Given the time lapses common in the legal realm, chargeback disputes can remain up in the air for years.

Such is the case with Indowear Corp. and Saks.

Indowear, which produces dresses as Anopia Collezioni, sued Saks in New York Supreme Court in October 2005 and will finally get to trial Monday.

Indowear alleges that Saks made only partial payments for goods delivered during 2002 and 2003, withholding more than $190,000.

"The deductions by Saks, which were characterized at different times as allowances or chargebacks, were taken unilaterally, and were unlawful and improper," said the suit. "At no time did Anopia authorize or agree to any of the deductions taken by Saks, nor did Saks ever provide Anopia with prior notice of its intent to pay less than the full amount."

Indowear is seeking more than $5 million for loss of revenues and prospective business opportunities. A Saks spokeswoman said it was against company policy to comment on legal matters.

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