International Distribution Agreements
Five key issues every non-lawyer needs to consider when negotiating distribution agreements overseas
Locating “the right distributor” should be the hard part, right? In many cases it is, but a successful distributorship also requires a clear understanding of the relationship from the perspective of both parties. A written contract is essential in formalizing this understanding, but even during preliminary talks, you should keep in mind some fundamental issues in the manufacturer/distributor relationship:
1) Have I found an agent or a distributor?
A critical first question (and one confused enough that it’s frequently litigated) is whether you are working with a true distributor - a party that purchases products and then re-sells them to customers - or with an agent or manufacturer’s representative, who never purchases the products outright, but instead markets them on your behalf. If the relationship being pursued isn’t a true distributor situation, the nature of the relationship is fundamentally different; so too should be the contract.
The distinction may also be important in terms of local law and there are important pros and cons of working with a distributor vs. an agent. For example, the European Agency Directive (EC/86/653) says agents (but not distributors) are entitled to some form of compensation upon the termination of their contract by the principal. The compensation is essentially considered severance if the agent brought you new customers or significantly increased your business with existing customers. Before even beginning to discuss other key terms of your relationship, clarify the exact nature of the relationship and go from there.
2) Should I just use a template distribution agreement?
You might be tempted to go on-line and type in “International distribution agreement template.” That's actually not a bad way to start thinking about the important issues that should be decided in advance of establishing a formal manufacturer/distributor relationship.
The International Chamber of Commerce store at http://store.iccwbo.org/icc-model-contract-on-distributorship sells the ICC Model Contract on Distributorship which includes generally applicable provisions relating to confidentiality, products and territory, advertising, etc. The ICC store also includes free downloads of some standard contract clauses like anti-corruption clauses, force majeure and hardship clauses and sells other handy, low-cost resources for “going global” businesses, like “Drafting and Negotiating International Commercial Contracts.”
But (and it’s a big but!), relying strictly on a template agreement is a really bad idea for memorializing an international distributorship. Using a “standard form” is particularly problematic because local law varies widely and in ways that are hard to imagine.
Take, for example, Puerto Rico where “Law 21” protects an exclusive sales representative from being terminated by a manufacturer without “just cause.” It sounds pretty similar to the EU law, above, right? But Puerto Rico goes a step further with Law 75, which also protects a distributor from being terminated by a manufacturer without “just cause.” Think you can get out of this onerous statute by stating in your agreement that the law of your US state will govern the contract? Nope. Think you can bypass it by expressly saying in the agreement that the distributorship can be terminated without cause or that these two laws aren’t applicable? It won’t work. And the penalties are extraordinary – damages including 5 year profits and goodwill. Ouch.
The bottom line – hire a seasoned international business attorney to advise you on the broad strokes of global expansion, and find a local attorney to help you navigate local laws. If your domestic attorney doesn’t have a good referral, consider starting at the Chambers & Partners website. Naturally, you can always contact us for a local referral as well.
The point is create a document that is comprehensive in scope; it needn’t be overly lawyerly, but should include these absolutely essential, non-commercial terms (and much more): Intellectual Property, Term, Termination, Liability/Warranties, Confidentiality, Choice of Law, and (last but not least) a Process for Handling Disputes.
Poorly worded documents drafted by non-lawyers may save you money in the short-term but could ultimately cost much much more in terms of time fighting about overlooked issues, or worse yet, potential mediation or litigation on a global scale.
3) Should the distributorship be exclusive?
Another threshold question. With an exclusive distribution agreement, a manufacturer gives one distributor the sole rights to sell its products in a defined territory. The manufacturer looks for the increased product demand created by a motivated, aggressive seller of its products, while the distributor is free from potential price and other competition from channel competition in “their” territory.
Almost every distributor will ask for exclusivity, but the decision hinges on many factors. At a minimum, consider the following:
- Will local law permit exclusivity? In the European Union, for example, there are restrictions on exclusivity.
- What does exclusivity mean – can the manufacturer itself sell directly in the exclusive territory (e.g., direct to an OEM), or are other distributors the only parties banned from selling?
- Is exclusivity defined by territory, vertical, channel, product or some combination of these (and potentially other) factors?
- What about sales to a customer in one territory resulting in a drop shipment to the customer’s branch office in another distributor’s exclusive territory?
- Should any of the manufacturer’s existing accounts be excluded?
- Is the distributor allowed to sell to sub-agents or sub-distributors?
- Is the exclusivity mutual (is the distributor allowed to sell your competitor’s product within the territory)?
- What is required for the distributor to maintain exclusivity – is it a “good faith” effort to sell the product or (more frequently) are there minimum purchase provisions? Are those minimum purchase provisions enforceable?
- Do you understand the antitrust and non-competition rules relating to the grant of exclusivity? What implications are there for price? Here again, consultation with a local attorney is essential.
- If exclusivity is terminated, is the whole agreement considered terminated?
- What about “new products” --- will those be excluded from exclusivity but an “updated product” remains subject to it? How are those terms defined adequately to minimize misunderstanding?
- What are the consequences of terminating the exclusivity (see below)?
Keep in mind there are alternatives to granting a distributor exclusive rights to sell your product in a designated geography. These alternatives may satisfy everyone’s key objectives without triggering the extra risks – legal and otherwise – associated with exclusivity. A few alternatives to exclusivity:
Assigning Areas of Primary Responsibility (“APRs”): An APR clause requires a distributor to use its “best efforts” or “reasonable efforts” to sell a manufacturer’s product in a particular area, but doesn’t preclude the distributor from selling outside of the APR. Performance goals can be set to clarify the goal within the APR. Keep in mind that APRs of different distributors can overlap, either in the initial contract or later if one distributor fails to meet its performance targets.
Drop-Shipments: for a specified fee, a manufacturer may elect to ship products directly to the distributor's customer, saving the distributor the cost of storage, handling and reshipment. A common structure is to have a manufacturer agree to drop-ship only to customers located within a distributor's APR.
Location Clauses: A location clause specifies that a distributor can only receive product shipments at designated warehouses or facilities. This may encourage distributors to sell within a specific area.
Pass-Over Clauses: Pass-over clauses say that if a distributor sells outside of its APR, it must pay the distributor located within that APR a portion of the purchase price.
4. Do We Have to Talk About Termination?
Many parties don’t want to even consider the possibility that a newly established relationship won’t be successful, or that it will likely run its course after a fixed period of time. But failing to plan for termination can have serious implications for your business down the road.
Things to think about when negotiating termination rights:
- Should termination be allowed (with notice) for any reason or only for “cause”? How is cause defined? Keep in mind that some jurisdictions have specific statutes providing additional legal protection for certain types of businesses upon termination, and others, like Brazil, may require a court order to terminate.
- Is the termination right mutual?
- Once terminated, what happens to inventory? Accounts receivable? IP? Product registrations/compliance programs the distributor might have previously handled? Customer lists?
- What are the financial consequences of terminating – remember that in some countries, “goodwill payments” are required upon termination, regardless of what the contract actually says and what “choice of law” you’ve decided will govern the agreement. Puerto Rico’s Rule 75 was mentioned above, but other jurisdictions have similar legislation, such as Spain and Germany.
- Is a terminated distributor required to cooperate with an on-boarding distributor?
Finally, be sure to specify which clauses of the agreement “survive” termination. For example, consider the scenario where a distributor holds trade secrets of the manufacturer. Without a continuing confidentiality provision, the distributor may be able to exploit those trade secrets post-termination.
5. What are the common nuts and bolts/commercial terms in an international distribution agreement?
Here, the devil’s in the details. Rather than being viewed as a legal necessity, the distribution agreement should be viewed as a critical document outlining key commercial terms. Laying out the fundamental business terms that define your relationship – which can and should be done in plain language -- will get the relationship off on the right foot and likely save you an extraordinary amount of time and headache down the road. Many otherwise healthy seller-buyer relationships inadvertently went south because the parties simply didn’t anticipate and contract for key issues.
Essential Commercial Terms of an International Distribution Agreement (not exhaustive!):
- What is the initial pricing, when and how will pricing adjustments occur?
- How much notice must be provided for adjustments?
- Does pricing include taxes and customs duties?
- In what currency will pricing be quoted?
- How will currency fluctuations be handled?
- How and when will adjustments be made if a product is heavily dependent on the price of raw materials that fluctuate? i.e., is there a set formula based on a commodity index?
- Will you offer the distributor volume discounts or other special pricing program dependent on meeting certain performance targets?
- On what terms will you sell to the distributor?
- Method of payment – cash in advance, letter of credit, bill of exchange? Open account? Security and guarantees of payment? Currency used?
- How will late payments be handled?
- Territory: For obvious reasons, be as precise as possible in defining the geographic territory associated with the distributorship.
Use Incoterms - shorthand for “Uniform Commercial Terms” published by the International Chamber of Commerce - to define relative logistics obligations between you and your buyer. An incoterm is a universal term that defines a transaction so that both parties fully understand the tasks, costs, risks and responsibilities of logistics and transportation when products are bought and sold across borders. Using Incoterms can be a useful tool in avoiding unnecessary misunderstanding between parties (and are required anyway for many official documents related to exporting from the US). For a more detailed discussion on Incoterms, see our Insight Fun with Incoterms - What Are They and How Can They be Used to Your Advantage.
Product Labeling, Testing, Packaging, Inspection:
- Who is responsible for the above and what approvals are required?
- Will cancellations or returns be accepted and on what basis?
- Is there a restocking fee? And if so, how much?
- What are sales quotas and/or performance targets and what are the consequences of not meeting them?
- Will product mix be considered in performance targets, or only aggregate sales volume?
- When will performance targets be adjusted and under what circumstances?
- Will a “rolling” system be used for purposes of tracking performance targets?
- What methodology will be used for tracking?
- Who will create localized marketing materials? If the distributor is responsible for materials, the manufacturer should maintain a right to review marketing materials (subject to a notice period) or at minimum a veto.
- Who will pay for local programs? Are market development funds available, and if so, based on what criteria?
- How will new product launches be handled?
- Who is responsible for translation of marketing materials?
- What is the initial inventory investment required, and minimum levels ongoing?
- How many salespeople will be dedicated to selling your products? What kind of skill sets do they need? Will the headcount be keyed to the level of sales (i.e. a certain ratio to volume)?
- Forecasting & Demand Planning:
- How frequently will a distributor be required to forecast and for what period of time?
- How will adjustments to forecasts be handled and what are the consequences of not adhering to agreed-upon processes?
- What obligation does the manufacturer have to inform a distributor of supply issues and how are backorders prioritized?
- What warranty is offered? Are there limitations to that warranty (be aware of destination country requirements around minimum warranty coverage!)?
- How will returns/repairs be handled?
- Who provides after-sales support functions?
- What training does the distributor receive (and from whom) regarding after-sales support and what are your expectations regarding after-sales support in terms of headcount and responsiveness to customers?
As business people eager to get a new business relationship up and running, we tend to shy away from the heavy lifting required to negotiate and execute a commercial agreement (especially internationally). We don’t want to slow things down, have “uncomfortable" discussions with new customers, or sit for too long in the same room as an attorney (God forbid!).
But in the end, it’s worth it. Take the time and make the investment to have really good buyer-seller agreements that are localized to the market in which you’re doing business. Not only will you minimize risk and avoid potential legal issues down the road, but from a commercial standpoint, you will set a great foundation for a long term relationship by clearly defining roles and responsibilities, setting expectations (on both sides), and establishing a focal point for future discussions as the partnership develops over time.
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