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Toysrus.Com, L.L.C. v. Amazon.Com Kids

March 24, 2009


On appeal from the Superior Court of New Jersey, Chancery Division, Passaic County, Docket No. C-96-04.

The opinion of the court was delivered by: Parrillo, J.A.D.


Argued December 17, 2008

Before Judges Parrillo, Lihotz and Messano.

This action involves a long-term contract between plaintiffs,, LLC,, Inc. and Geoffrey, Inc. (collectively, TRU), and defendants, Kids, Inc., f/k/a Rock-Bound, Inc. and, Inc. (collectively, ACT). TRU filed a complaint alleging breach and seeking damages and declaratory and injunctive relief. Following a bench trial, the General Equity Part judge terminated the parties' agreement, ordered them to cooperate during a ninety-day wind-down period, but denied their respective requests for damages and injunctive and declaratory relief. That opinion was memorialized in a March 31, 2006 final judgment and April 3, 2006 amended final judgment, followed by post-judgment orders of June 22, 2006, September 14, 2006 and October 20, 2006, all of which were incorporated in the court's February 27, 2007 final order, from which this appeal by defendants and cross-appeal by plaintiffs are taken.

The facts are rather complicated and somewhat in dispute. In August 2000, ACT and TRU executed a ten-year "Strategic Alliance Agreement" (SAA) providing that the parties "cooperate to launch certain co-branded portions of the [Amazon website] dedicated to the sale of certain toy, game and video game [, including baby,] products selected and provided by [TRU]"; that ACT provide support for TRU's sales through services ranging from website development to product distribution; and that, in addition to a set-up fee, TRU pay a significant annual fee, $50,000,000, additional fees based on its use of specified services, and commissions.*fn1

The term "co-branded stores" referred to a sub page of the Amazon website featuring products the parties offered for sale pursuant to the agreement. To reach the sub page, ACT was to create a co-branded toy and video game store navigation tab to be consistent with and "generally as prominent as the Major Tabs on the Amazon home page." Pursuant to the agreement, ACT also had control of the "functionality" of the co-branded stores, including "site navigation, site look and feel," subject to certain restrictions of reasonableness and non-discrimination respecting the way TRU's selected products were "position[ed] in search results." The parties would consult periodically regarding functionality issues.

Section 5 of the SAA addressed selection of the products to be offered on the website. Under Section 5.1.1, TRU was given broad discretion in the selection of its products for sale through the co-branded stores; however, Section 5.1.3 required TRU to provide a comprehensive selection of its products, including, subject to availability, "at least the then-current Top Toy and Video Game Product SKUs,"*fn2 at least 8000 "different Selected Product SKUs," and other specific numbers of baby products and children's sporting goods.

At least from TRU's perspective, the cornerstone of the agreement was its right to sell certain products exclusively, and Section 5 expressly addressed TRU's "exclusivity" rights. Thus, if TRU did not select the product for sale in the "co-branded" virtual stores under Section 5.1.1, then Section 5.1.4 permitted ACT and its affiliates, but not third parties, to sell the unselected product. TRU, however, was afforded the right of recapture, namely to resume or initiate sale of products ACT might then be selling pursuant to Section 5.1.4, provided TRU gave notice to ACT and agreed to purchase ACT's then existing inventory of the applicable product.

In other words, under the SAA, TRU's right to sell toys, games and baby products is "exclusive" only to the extent the agreement restricts sales by others. In addition to Section 5, and with specific reference to third parties, Section 12.1.1 limits ACT's right to sell or permit others to sell; and Section 12.1.2 exempts specified sales from those that ACT may not make or allow others to make.

Specifically, Section 12.1.1 prohibits ACT and its affiliates from selling or permitting a third party to sell any "Exclusive Products" and "Selected Exclusive Products" through the Amazon website. "Exclusive Products" are "toys and games" and "exclusive baby products" (both defined terms). "Selected Exclusive Products" are those "exclusive products" that TRU selects for sale in one of the two co-branded virtual stores. Section 12.1.1 also prohibits ACT and its affiliates from selling or permitting a third party to sell any "Selected Non-Exclusive Products," which are products, other than "Exclusive Products," that TRU selects to sell through either co-branded store.

The restrictions on sales included in Section 12.1.1 are "[s]ubject to Section 12.1.2," which permits certain sales and provides: "[TRU] acknowledges and agrees that nothing in this Agreement will prevent or otherwise restrict: (a) any sales of products . . . occurring in connection with Programmatic Selling Initiatives . . . ." "Programmatic Selling Initiatives" are defined as: any area, feature or service of the ACT Site through which Third Parties may sell products or services on terms available to the general public (or, in the case of "," to a defined class of dealers (including without limitation, the existing "Auctions," "zShops," "," and " Advantage" areas and services of the ACT Site). [(parentheses appear above as in the original)].

Thus, this so-called "garage sale" provision permits third parties to sell any products in connection with programs that qualify as "Programmatic Selling Initiatives," which, generally speaking, are available to all of ACT's users under terms available to the general public.

Section 12.1.2 also provides that the SAA does not restrict:

(c) ACT and his Affiliates from selling, and permitting Third Parties to sell, Exclusive Products through the ACT site (other than through the Co-Branded Stores), provided that such sales by ACT and its Affiliates, or any such Third Party . . . do not constitute more than three and one-half percent (3.5%) of the Exclusive Product Revenues for any Year (or, for the fourth Quarter of 2000, for such Quarter) . . . . [(emphasis added).]

Thus, subsection (c) of Section 12.1.2 permits third-party sales of "Exclusive Products" up to a specified percentage of total sales, namely the three-and-one-half percent ceiling.

To recap, TRU was given the right to select products to be offered for sale in the "co-branded" virtual stores. Any exclusive product "selected" by TRU for sale pursuant to Section 5.1.1 became by definition a "selected exclusive product." While ACT or its affiliates were allowed to offer for sale exclusive products which TRU elected not to sell on the website, the SAA included no such right for third parties, other than under the limited exception of Section 12.1.2(c), which capped such sales at a 3.5% ceiling. In any event, third parties were not permitted to sell "selected exclusive products" other than through "programmatic" selling initiatives under Section 12.1.2(a).

On the other hand, TRU was required, under Section 8.2, to maintain a certain inventory of the items offered on the website to meet the anticipated demand. Specifically, TRU was obligated to use "commercially reasonable efforts" to ensure a 90% minimum level "in stock" availability on all selected products at all times "at one or more ACT distribution centers." In order to ensure compliance, TRU tracked the distribution center inventory through "feeds" with ACT, supplemented by its own "forecasts," its "catalog[,] and the web site." ACT assigned a so-called Amazon Standard Identification Number, or ASIN, to each item based on product information provided by TRU.

The SAA was to run until December 31, 2010, unless terminated earlier. Section 13 gave ACT the right to terminate in the event that it did not realize a minimum return under the parties' fee structure as provided in the agreement. Section 15.2 permitted "termination for cause" in the event of insolvency, or material breach and failure to cure after due notice. The parties also retained the right to terminate in the event one experienced a "competitive change of control" with respect to the other. In the event of termination, Section 15.4 identified provisions of the agreement that would survive. Under Section 15.6, the parties recognized a "post-termination transition period."

Pursuant to Sections 18.1 and 18.2, the parties agreed on a limitation of consequential damages and that neither would be liable purely as a result of termination. Section 22 addressed resolution of disputes, including mandatory but non-binding mediation. Delaware law was to govern the agreement, which included an integration clause.

By all accounts, the relationship forged between the two and memorialized in the SAA was unique and unlike any other arrangement either had entered into before. Clearly, the parties were venturing into pioneer territory, the frontiers of which were both dynamic and not fully realized at the outset. Yet the prospect of their complimentary contributions that would render the whole much more profitable than its individual parts made the merger inviting and attractive. To truly understand then why such a promising relationship collapsed less than midway through its expected lifespan, it is necessary to examine events both before and antecedent to execution of the contract.

TRU, a Delaware LLC, is a domestic and international retailer of toys, games and baby products. It considers itself "one of the fabulous brands of the . . . world," and prides itself on providing the toy consumer "the high probability of finding" a wanted item in its store stock over any of its competitors. "The real proof of the strength of the brand is in the last three or four weeks before Christmas," when TRU continued to carry popular items after competitors had sold out of product.

TRU was valued at $2.2 billion in 2000 and $6.6 billion in July 2005, its "brand" being worth about one-sixth of the company's overall value, according to its expert. As of 2000, TRU had approximately 1500 stores worldwide. Seeking to expand its ever-increasing market share, TRU introduced online shopping in 1999, but its "fledgling website" simply did not have the logistical capacity to respond to online consumer demand, and as a result, the company was left with "a big black eye."

Meanwhile, ACT was launched in 1995 as an online book seller, but consistent with its vision for an internet superstore, gradually sold other products, including online music, videos, DVDs, and toys. In fact, ACT had developed its own line of specialty toys, employing its own "buyers and planners who were responsible for identifying and purchasing toy products and creating relationships with toy manufacturers and vendors." By 2000, however, ACT had also launched three programs through which third parties could sell their products on zShops, Auctions, and Advantage. The zShops program was successful by allowing merchants to list products for sale on the Amazon platform at a fixed price, while Advantage was a "consignment selling model" whereby " receives inventory . . . from the Advantage seller, and then when a customer comes to and buys that product, we pay the seller on . . . a consignment basis." Eventually, the Amazon website evolved into a virtual "marketplace," which allowed anyone to list items on the Amazon platform.

Considering its first foray into online shopping proved problematic, and concerned about fulfilling online orders for the upcoming holiday season, TRU approached ACT in January 2000 about a possible business alliance. From TRU's perspective, ACT could provide "web-hosting, order fulfillment, customer service and other functions." From ACT's standpoint, TRU would help "merchandise" and market its site and add to its assortment of selections. Thus, in initial draft agreements, it was envisioned that TRU would be responsible for inventory and marketing while ACT would address "the site, fulfillment, and customer service." As the idea took shape, TRU would own the inventory. [TRU] would ship it. [TRU] would source it and ship it into the Amazon fulfillment facilities. And [ACT] would operate the site, connect customer demand to inventory through the ordering process, pick it, pack it, ship it, and at the time that it was shipped in and billed, they took ownership of the inventory . . . .

In giving up the right to sell its products on any "domain name" or website of its own or a third party's, TRU focused instead on "[m]aking sure the exclusivity of [its] ability to sell toys, games and baby products was maintained." TRU also wanted its shoppers to "be easily linked across" its product sites, as, for example, if one of its online toy customers wanted a Babies "R" Us product. There were a variety of reasons why exclusivity was important to TRU. According to John Eyler, TRU's Chief Executive Officer (CEO):

First of all, we had to ensure that we could get quality fulfillment [of an order], flawless fulfillment, as close as we could get. That's why it was our opinion that unless . . . [we] had a partnership arrangement to make sure it was successful, that the risk would increase that they simply would not focus enough time, attention, and effort to make sure that fulfillment was done correctly.

Secondly . . . [s]ince all this was all about brand, it was very important that this be done in a way that was perfectly clear to the consumer that they were dealing with Toys "R" Us. When we saw the way the site was presented as a co-branded site . . ., it was really the legitimizing of one source, a partner called Amazon, to be the best in the space of fulfilling our consumers' needs.

Thirdly, exclusivity was important to us because . . . we needed exclusivity to make sure that unconsciously our brand wasn't eroded by people who don't do this business as well as we do and make different choices than we do. We didn't want customer dissatisfaction from other sellers to taint our brand.

Finally, we needed a partner if we were going to go outside our own, where we could sell this assortment similarly to how we source. . . . So one set of eyes was buying it, pulling some to Amazon and some to [our] stores. If we had to do two assortment strategies, we couldn't do that.

Thus, Eyler envisioned a true partnership wherein Amazon and Toys "R" Us would, in effect, become "anchor" or dominant stores in the "virtual mall," with Babies "R" Us only slightly less prominent. According to Ray Arthur, TRU's Chief Financial Officer, Amazon was "primarily known for books, music and video," and TRU would "become attached to that space, the mall, and become another anchor tenant to sell toys and children's products," with TRU's "baby store" an additional "smaller store" at the online virtual mall. Eyler believed "[t]here certainly would be other stores [within the rest of the Amazon 'mall'], but there certainly would not be other toy stores or other baby stores."

TRU's vision was directly conveyed to Jeff Bezos, CEO and Chairman of ACT, who nonetheless "had a strong view that more assortment is better." From ACT's perspective, "the really founding basis of was to have selection[,]" and the "only way I know of to [have a huge inventory necessary for a large selection] . . . is with third parties, and that was understood at the time of these negotiations." In particular, Bezos wanted to be free to use other merchants or third parties to sell "the stuff Toys 'R' Us did not want to sell." ACT, already a "[l]eading online retailer," sought to be "the world's most customer-centric company, where customers can find and discover anything they might want to buy online."

Nevertheless, Mark Britto, ACT's senior vice-president of worldwide sales who participated in the negotiations, acknowledged that exclusivity was a critical feature of the transaction and that TRU's vision "was to have Amazon exit the toy business in [TRU's] favor and yet provide the fulfillment and customer service that is the hallmark of [ACT's] identification." Indeed, while the compromise ultimately reached provided only for limited "carve-outs" detailed in Section 12.1.2, every other section of the draft agreements that had made reference to third parties' ability to sell on the Amazon site had been removed from the final SAA. According to Harrison Miller, ACT's vice-president and general manager of toys who helped negotiate the SAA, ACT continued to convey the impression during the negotiations that TRU was the exclusive seller of toys on the Amazon website. Indeed, Miller further acknowledged that the SAA does not provide that third parties could sell products marketed by TRU on the Amazon website.

To be sure, the parties, as noted, agreed to certain limitations on TRU's otherwise broad exclusivity rights. Eyler recalled that the only exceptions discussed during negotiations were the inventory ACT already had on hand, ACT's right to "acquire and sell through our site any items that we did not choose to buy and to execute," and the so-called "zShops," or a "sort of flea market, people who had things to sell and sell in these environments they were creating." Such zShops, including "Auctions" and " Advantage," were acknowledged by Arthur, TRU's CFO, as the Programmatic Selling Initiatives (sometimes PSIs) carved out as an exception in the SAA. The second exception acknowledged by Arthur was what was referred to as "overlapping products," meaning that vendors who were not in direct competition with TRU could sell "certain products that could be on the fringes overlapping with other areas." Arthur cited the example of a pet store that sold dog gates that were essentially the same as TRU's baby gates. He also noted how TRU negotiated the cap on the sale of such "overlapping products" down from fifteen to three-and-a-half percent.

Arthur expressed his understanding of TRU's exclusivity rights thusly: "[I]f I said it once I said it a thousand times during negotiations, we would never see Wal-Mart, never see Target, never see eToys. We would never see our competitors on the market" with ACT. According to Arthur, therefore, "we had to get over that philosophical disagreement and we thought we did, because we never would have entered into an agreement that we weren't solely and exclusively in charge of."

At least for some time after execution of the SAA, ACT abided by TRU's understanding of its exclusivity rights. Thus, for example, agreements ACT signed with third-party merchants prior to September 2004 for sale of products on the Amazon website typically excluded the sale of toys, games and baby products. Most notably, on August 21, 2001, ACT and Target, a competitor of TRU, entered into their own SAA which, among other things, restricted Target from selling "toys, games, or baby products" through its "store" on the Amazon website. According to Target's president, Dale Ritschke, Target had a "desire to sell all of those types of products on the Amazon site, and we spent some energy around defining exactly what a toy product was or a baby product was so we . . . would not break [ACT's] previous agreement" with TRU.

Both parties agree that the first year of operation under the SAA went smoothly. Once the co-branded stores were launched in September 2000, an internet user typing in either "" or "" was taken directly to the website, which featured a "Toys & Games" tab that, when clicked on, would direct a user to the co-branded toy store. Once "inside," if the visitor entered the name of the toy into the search bar and hit "go," search results were returned for products sold only by TRU. As a result of the "admirable performance" of both parties, the first year of operation was highly successful. Indeed, TRU's John Barbour boasted that "[TRU] became the #1 worldwide e-commerce site for kids in terms of traffic for the majority of the year."

Unfortunately, problems surfaced soon afterward. Most notably, ACT's August 21, 2001 deal with Target, one of TRU's biggest competitors, gave TRU pause for concern. Even though TRU was assured that Target was not going to be allowed to sell toys on,*fn3 Target "had a second site off the platform where they did sell toys and where Amazon also provided the technology for the fulfillment." Eyler perceived ACT's deal with Target as a "thinly veiled way of getting around the exclusivity commitment that [ACT] had to [TRU]." For instance, while customers would not be able to "link from the Target store at to, and then buy a toy there," nevertheless on the so-called "subnav" portion of the Amazon website, Target "appears . . . underneath the toys and games tab." Arthur's understanding, however, was that because Target was not supposed to be offering toys and games on the Amazon site, "it would not be in the toys and games tab." Moreover, "[w]hen the Target deal was implemented on the home page of the Amazon platform in the sub-navigation area, there was a branded Target button that you could hit that would bring you to their boutique on Amazon." TRU, however, had "fought very hard to get branding put on the toys and games tab" during its negotiations, but ACT was unwilling to agree, giving TRU only a non-branded tab on product "categories." But to Arthur, "[w]hen that [Target] tab showed up on the home page, quite frankly, I saw it as much as branding on the tab as being right below it."

Furthermore, in an internal memo of September 2001, ACT's Miller pointed out that by the following year's holiday season, TRU could expect to see video games offered by Target on the Amazon site. Miller further asserted that "[i]t was a deal like this that we contemplated when we made flexibility in this category [of selling video games] a major deal point . . . ." Although the SAA between ACT and TRU had not made video games "Exclusive Products," ACT initially had allowed TRU to be the exclusive online seller of video games.

Whether or not meant as an accommodation for the Target deal, on April 17, 2002, the parties executed their first amendment to the SAA, whereby the fee escalator was discontinued and the base fee was capped at $50 million through 2004, with adjustment thereafter for the CPI through 2010. That same day, the parties also signed a consent to amendment and release by which TRU effectively relinquished its claims against ACT with respect to the Amazon/Target relationship.*fn4

In 2002 and 2003, continuing its policy of "fill[ing] out particular categories," ACT followed the Target deal with a series of "merchant@ agreements," or "specifically negotiated agreements where third parties could sell products on the site." According to ACT's Rudy Gadre, corporate counsel and vice president, these individualized agreements initially included the same types of prohibitions against selling selected toys, games and baby products as ACT included in its agreement with Target. At a certain point, however, the agreements were amended to permit the sale of "non-selected" items. When asked why ACT did not provide for the sale of non-selected items in its initial merchants@ contracts, Gadre explained that, originally, ACT lacked the "technical ability to screen out . . . selected [Toys 'R' Us] products," that "there were discussions ongoing all the time with Toys 'R' Us [as to] how they could expand selection and . . . provide the SKUs that we thought we were missing," and that at that point ACT was concentrating on expanding other categories such as apparel, office products and sporting goods.

At around the same time, TRU began noticing "a lot of things that were disturbing to us as [other vendors'] products began showing up on the site, as discussions were being held of other initiatives that were going to be made that we felt would dilute our exclusive rights on the site." For example, running a check at one point Arthur typed in the word "toy" in the search box on Target's "boutique on the Amazon platform" and received 754 results, the very first of which was a toy that TRU did, in fact, carry. There were other instances as well, which according to Arthur, created "incredible confusion" for customers and was not what TRU negotiated for.

When the issue first surfaced, ACT "took the [offending] product down." In fact, ACT's Gadre agreed that, up to a point, when TRU challenged other products on the Amazon site, "we endeavored to take them down whenever possible." Eventually, however, "it became more of an issue." A number of times, ACT approached TRU for permission for third-party sales of "exclusive" toy items on the website in return for some concession on ACT's part. In 2003, for example, ACT's Van der Meulen offered TRU a revenue share for another merchant's sales of skateboards and accessories on the Amazon website. An amended agreement to this effect was drafted, but never signed. Nevertheless, ACT eventually began selling skateboard products that "overlapped" TRU products, with Gadre believing that such sales were permitted in accord with a "safe harbor," "handshake agreement" between Van der Meulen and Arthur. ACT never paid TRU any revenue from the skateboard sales. Moreover, if "exclusive" or "selective exclusive" products were out of stock, ACT would reclassify them as "non-exclusive", and allow third-parties to sell those items.

Simultaneously, paid advertisements began appearing on the Amazon site, including within the co-branded store, that consisted of one or more links to separate, third-party websites.*fn5 When TRU's Arthur "hit on one of them," he found "strollers that were in [TRU's] exclusive category for sale." When Arthur complained about these so-called "sponsored links" or "hot links" that direct customers to third-party websites, in particular the fact that TRU's "primary competitors" such as eToys or Bye-Bye-Baby began "show[ing] up" as links, he was assured the practice would end.

Instead of being discontinued, however, the practice became a "permanent feature of the Amazon web site." That was significant for TRU, because not only was it "very difficult to get a customer, [but] . . . here we are sending a customer to someone else to buy product." TRU feared losing business as a result: "[O]nce someone goes off the site and transacts with someone else, there is a good chance that they will continue to transact with that person." Moreover, ACT did not have information as to which sponsored links were clicked on by customers, or of "what takes place once a user clicks on a sponsored link and goes to a third party web site." ACT got paid "based upon a click" on the sponsored link, although it was generally Google, and not ACT, who controlled "which third party web sites are advertised as Sponsored Links on the ACT site in response to a given set of keywords."

As a result of these growing concerns, Arthur and Eyler met with Van der Meulen and Bezos in New York City in the summer of 2003. ACT remained interested in increasing selection, and suggested compromising TRU's exclusivity rights in exchange for revenue sharing. TRU, however, was reluctant to agree to any exclusivity compromises because of concerns over quality control.

TRU also had concerns over the amount of compensation for its partial surrender of exclusivity rights as well as the workability of exercising its so-called online "recapture rights" when non-selected products sold by third parties became good market sellers. In this regard, Van der Meulen had wanted TRU to agree that it "would not recapture those products and select them and knock the third-party sellers off the site." TRU's position, however, was that "third parties can't sell on the web site."

According to Van der Meulen, as of the New York meeting, ACT did not plan to allow third parties to sell products with the same UPC*fn6 as TRU's products, but acknowledged that it was a difficult problem to resolve. "Similar" but not identical products with UPC codes different from TRU's codes would be permitted, such as an item sold as a "set" but which might include some individual items offered separately by TRU. ACT wanted to add "selection," and Van der Meulen said it was simply more "scalable" to use third parties to add such selection than for ACT to add more products itself. Also as of the New York meeting, ACT did not have the technology to "weed out selected exclusive products," but was working on developing it.

It was at the New York City meeting that TRU was first alerted to what it perceived as perhaps the greatest threat to its exclusivity bargain, namely the impending implementation of ACT's 1X1 GUI technology,*fn7 a dynamic step forward in the Amazon "marketplace" concept. 1X1 GUI was developed as a technology tool to provide "another means by which third party sellers could add items to the catalog" via detail pages with various product information that would appear in search results pages.*fn8 A "detail page" is ultimately a description of the product that a customer can choose to buy. It has many different features associated with it.

The image of the product, the description of the product, editorial reviews about the product, customer reviews about the product, a list of items that are similar based on purchase history for that ...

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