For Japan Inc., A Kentucky Whipping

Kentucky executive Eugene E. Freeman Jr. likes a lot of things about the Japanese. He enjoys driving his Acura. And he likes what Toyota Motor Corp. has done for his region's economy, building a giant auto-assembly plant in nearby Georgetown and bringing in a lot of Japanese investment. So when Tomen America Inc., the subsidiary of Japan's $50 billion Tomen Corp., asked to be his company's exclusive sales agent in the Far East, he had no qualms. The Japanese trader seemed "the ideal company to be our representative in this new market," Freeman says.

That was in 1989. Now, instead of winning new customers in the Far East, the 64-year-old Freeman has just concluded a bitter breach-of-contract suit against Tomen--one that convinced a jury of the Japanese giant's disregard for its tiny partner.

Tomen denies any misconduct. Yet for many American trade negotiators and critics of Japan, Freeman's travails seem to confirm a long-harbored suspicion: That many Japanese companies use such dodges as claims of poor quality to undo overseas deals they no longer like and to protect Japanese partners over foreign ones. "This is a classic, a typical case with the veil pulled away," says Leon Hollerman, a U.S.-Japan expert at Claremont McKenna College.

Here's how this cautionary tale unfolded. In 1989, Freeman Corp., a privately held maker of hardwood products, teamed up with Tomen's U.S. subsidiary. Although it had not yet cracked the Far East, the Winchester (Ky.)-based company was no export neophyte: In its 40 years in business, it had already tapped Middle Eastern and European markets. By 1992, they accounted for 30% of its $10 million in sales.

IN THE LURCH. In its role as Freeman's agent, Tomen America asked the company to develop a special, extra-thick sheet of hardwood floor veneer, the material contractors glue onto inexpensive composite-wood floors to give them a classy look and feel. Such a veneer had big sales potential in the Far East. Tomen agreed to buy all the new wood veneer Freeman could produce for six months and use its "best efforts" to sell additional amounts for five years.

But according to Freeman's lawsuit, Tomen America never told Freeman that instead of selling the veneer to various Asian wholesalers, the trader had formed an exclusive alliance with just one customer--Kyodo Veneer Corp., a Japanese wood-products and flooring company. Kyodo wanted Freeman's extra-thick veneer because it was developing a new technology capable of splicing the veneer into finished floor paneling. Tomen had another reason for giving Kyodo exclusivity: It had a 30-year trading relationship with Kyodo.

Gene Freeman, meanwhile, thought Kyodo was just the first of several customers Tomen planned to line up. To pay for new equipment, he borrowed $2 million, while Tomen America chipped in an additional $1.1 million. Then, in October 1990, a month before Freeman's upgrading was completed, Kyodo ran into snags perfecting its new technique. The Japanese company decreased by more than 60% its orders of Freeman veneer. It changed its senior management and delayed the project. That left Tomen America with virtually no outlet for the veneer, according to internal Tomen America memos obtained by Duane Cook, Freeman's lawyer, who has filed them in the local court.

Gene Freeman says he was kept in the dark about these critical developments, a point supported by internal Tomen memos written in Japanese and submitted in English translations as plaintiff's evidence. "We won't tell Gene Freeman this when we visit," says an Oct. 15, 1990 memo about Kyodo's technical difficulties. Tomen America sent its memo to the parent company's headquarters in Osaka. And instead of exerting its "best efforts" to find more customers, Tomen stuck with Kyodo. On Oct. 22, 1990, Yukio "Lucky" Morita, Tomen's general merchandising manager, explained why to Tomen America representatives. "We want Kyodo to develop this machine and be able to splice automatically," he wrote. "They need more time to develop this machine."

"HARD WORK." Then Freeman ran into the complaints of poor quality. While Tomen and Kyodo representatives O.K.'d seven shipments of veneer to Japan, each individual sheet was inspected on arrival. Every one was rejected by company inspectors for quality reasons.

Tomen executives, and Tomen's U.S. lawyer, insist the quality was poor and justified refusing to pay for the goods. At trial, Danny C. Reeves, Tomen America's counsel, charged that initial problems with Freeman's new equipment produced a "bunch of garbage."

Freeman concedes there were startup problems. But even Tomen America representatives questioned the purpose and results of the quality inspections. At one point, Kyodo requested that the veneer be dried to a moisture content guaranteed to crack the wood--which would make rejection a certainty, according to internal Tomen memos. Mitsushige "Mick" Morita, Tomen America's representative to Freeman and no relation to Lucky Morita, wrote headquarters on Jan. 24, 1991: "I cannot do that to them now after all their hard work."

No matter. On Jan. 28, 1991, Tomen told Tomen America: Don't buy any more veneer. On Jan. 29, Mick Morita fired back a memo saying Tomen was "not doing business with Freeman in good faith." It was threatening Freeman, he said, like "the Yakuza," the Japanese mafia.

When Tomen canceled the orders, Freeman had to act fast. To stabilize his increasingly fragile finances, he sold his company's lumber business and laid off half of its workers. Then, he sued Tomen America for $10.9 million in damages, charging breach of contract.

At the trial last July and in depositions, Mick Morita acknowledged writing the anguished memos but testified that he was "upset and confused." He added that he later found he had "totally misunderstood the problem."

Despite Morita's testimony, it took the jury only four hours to return a verdict finding that Tomen had committed breach of contract. In July, the jury imposed on Tomen America a $6.5 million damage award--about what Freeman claimed was his operating loss as a result of Tomen's actions. That amount was reduced to $4.8 million in September, when Tomen America agreed not to appeal in return for a lower damage award, although it did not admit any wrongdoing.

But what about those revealing memos? Tomen America's general counsel, Robert B. Cohen, calls them part of the frank discussions that take place inside any company--not evidence of a deliberate attempt to chisel Freeman.

REBUILDING. As for Kyodo Veneer, it changed its name to Tostem Woodwork Co. in April, 1992. Reached in Japan, Managing Director Shigehiro Shii rebuts a number of Freeman's claims. He says the company doesn't care about the thickness of the wood, for example, and says Tostem Woodwork is now purchasing better-quality wood from Japanese-owned companies in the U.S. He denies that the company had problems perfecting its technique. Moreover, in making its product, "it's perfectly normal to evaporate moisture from the wood," Shii says. "The fact is, other wood that we import from the U.S. has passed the same tests."

Today, Gene Freeman plans to use proceeds from the settlement to rebuild the company his grandfather founded. He still hopes to break into the Far East market. The Tomen America episode, he says, "was a nasty mess we'd all like to forget about."

Freeman may manage to forget this episode. But companies that want to follow President Clinton's exhortations to crack the Japanese market may want to remember Freeman's case. It shows the pitfalls can be greater than they ever imagined.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE