This article has been written by Muskan Kalra, pursuing the Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho.This article has been edited by Ruchika Mohapatra (Associate, LawSikho) and Dipshi Swara (Senior Associate, LawSikho).
We often come across headlines such as HFCL signs nationwide distribution agreement with Beetel, Kramer electronics signs distribution agreement with cyber-security manufacturer High Secs Labs, but what is the importance of drafting such agreements?
Distribution agreements help the supplier or the manufacturer of the products in the distribution of their products in markets. It helps in reducing their burden and whenever a supplier wants to sell his products overseas such as in China, where the market is huge, such types of agreements aid in protecting the rights and properties of the suppliers and in case of any disputes further well-drafted agreement always acts as a saviour.
In this article, the author discusses how distribution agreements are drafted, important clauses in these agreements and if one wants to enter into such contracts with Chinese distributors what pointers do they need to keep in mind while drafting such agreements.
What are distribution agreements?
Any business enters into various agreements during its business cycle. Distribution agreements are one of them. Distribution agreements are those agreements whereby the manufacturer or the supplier of the goods appoints certain individual entities known as distributors. This arrangement helps the manufacturer to sell the products to the public or to wholesalers further down the line of distribution. For example, Samsung enters into various distribution agreements with different entities in different geographical locations, another example can be of beverages companies such as Coca-Cola, PepsiCo. etc.
Types of distribution agreements
Before we talk about the drafting of Distribution Agreements, we need to understand the different types of distribution agreements.
1. Exclusive distribution agreements
In simple words, exclusive means entire or absolute so, exclusive distribution agreements are those agreements where the distributor has the sole authority or the absolute rights of selling or marketing the products of the manufacturer within the territory. For example, a book supplier company provides the exclusive rights to Flipkart and now no other online distributor can be involved.
2. Non-exclusive distribution agreements
In non-exclusive agreements, there can be more than one distributor; there will be no obligation on the seller to provide exclusive rights to the distributor. The supplier can enter into various distribution agreements with different distributors.
3. Wholesale distribution agreements
Numerous times, we see that farm products companies have entered into an agreement with farmers and they sell the product in their name or any boutique company buying clothes in bulk from some weaver and selling them under their name. Such agreements are examples of wholesale distribution agreements.
4. Developer distribution agreements
In the case of any apps, games, websites, or any other intellectual property, the developer enters into an agreement with the distributing entity, and such agreements are known as developer distribution agreements.
How to draft such agreements?
For drafting these agreements following clauses will be included:
Parties and recital clause
Firstly, we need to identify the parties that are involved, that is the supplier and the distributor and it needs to include all their details after that the execution and effective date need to be included.
In recitals, it should be stated why the supplier and distributor are getting into this agreement. In simple words, the recitals should summarise all the important facts that led both parties to enter into this distribution agreement.
Scope of distributorship/rights granted
This clause is one of the most important clauses in this agreement. It needs to be defined whether the distributor will have exclusive rights to sell the product within the territory or not and whether the supplier will also sell the products directly to the customers or not.
Product and territory
This clause shall define all the details regarding the product or the product line and it can also be decided whether the new brands produced by the supplier will be included in this agreement or not or what are the products that will be excluded from this agreement.
The clause shall clearly define the area under which the distributor will be allowed to sell and promote the product. It can be stated that the distributor upon consultation with the supplier can expand or reduce the territory.
While determining the distributor’s obligations, exclusivity will play a major role. If the parties are entering into an exclusive distribution agreement, then the supplier can set the specific targets for the sale so that he doesn’t suffer losses and can include in the clause that if such target is not completed within the specified time, then the agreement can be terminated or if not terminated then the supplier can enter into non-exclusive distribution agreements.
Term of the agreement
In this clause, we need to address for how much time this agreement will be valid when it will come into force, when it will end and whether it will be renewable or not.
All the rights related to the intellectual property of the supplier shall remain protected. The clause shall provide the instructions for the usage of intellectual property by the distributor. It should also restrict the distributor to disclose trade secrets.
Governing law and dispute resolution clause
In governing law, we need to specify which system of law will be applicable to the contract as parties may be residing at different places and if this is not specified it can create confusion and chaos. While deciding the governing law, there should be some nexus between the residence of the parties or where the performance of the contract is taking place and the governing law.
In the dispute resolution clause, it can be added that in case of any disputes parties can try to solve the disputes amicably, and then they can appoint either a sole arbitrator or multiple arbitrators as per their convenience. For this clause seat and venue needs to be decided, the language of the arbitration proceedings should be specified.
Distribution contracts in China
Entering into distribution contracts is the most common way by which foreign suppliers can enter the markets of China but while entering into such agreements with Chinese distributors following pointers shall be taken into consideration:
While entering into a distribution contract with a distributor from China, the supplier will have to determine whether the distributor will have exclusive rights for the products or not. In case the distributor has been granted exclusivity, it is always a good idea to include minimum sales targets as it will help to achieve minimum business goals. It can be added that in case the minimum targets are not achieved, then the supplier will have the right to appoint more distributors or he can terminate the contract.
China anti- monopoly law
While entering into a distribution agreement in China, we need to keep in mind China’s anti-monopoly law. The aim of this law is to create an open and competitive market; in other words, it prohibits those agreements which exclude or restrict competition. This means that in the distribution agreement suppliers cannot have a certain price or a minimum resale price though there are certain exceptions to it such as improvement in the product quality, increase efficiency.
Protection of intellectual property rights
While entering into the distribution agreement, the supplier needs the protection of his intellectual property, be it for trademarks or designs. In the agreement, proper guidelines can be stated for the use of intellectual properties by the distributor. Apart from that, suppliers should make sure to register all the trademarks or patents or any other intellectual property in China before entering into a distribution agreement as this ensures an extra layer of security.
Often suppliers use confidentiality agreements to protect their trade secrets and it also restricts the distributor from disclosing any confidential information to any third party. But what if the distributor himself uses all the trade secrets to make a better product with low cost as these types of situations are quite common in China. To avoid this, the manufacturers are often advised to enter into an NNN agreement with their distributor. It refers to a non-distribution, non-use and non-circumvention agreement and with the use of this agreement the supplier can ensure that the distributor will not take your market opportunities.
Termination and licenses clause
In this clause, various grounds for termination shall be stated. Apart from that, the supplier can ensure to have a long term notice period before termination such as 90 days as it will help in buying back existing stock present with the distributor.
While entering into distribution agreements in China, it is preferable that the distributor obtains all the licenses as he will be more aware of the domestic licenses that need to be obtained for selling the product. This will help the suppliers in reducing their burden and ensuring proper compliance.
Governing law and dispute resolution
In China, Civil Law parties are free to choose their governing law and in the absence of this clause, the Chinese law will prevail. But while choosing litigation as the option of resolving disputes, it is better to choose Chinese courts as sometimes the judgements of other countries’ courts might not be enforceable in China and if we look from another angle that is the implementation of the agreement was in China so it is better to choose Chinese law.
While choosing arbitration as a method of dispute resolution, it is important to specify the body. Mostly the Hong Kong International Arbitration or Singapore International Arbitration Centre are chosen as their processes are also convenient for foreign parties.
Also, the agreement should be drafted in both the languages i.e. English and Chinese and the reasoning behind this is sometimes in the case when there is a dispute and the agreement was only drafted in English, then it might become one of the grounds because of which the distributor didn’t understand the agreement properly. For the avoidance of any confusion due to linguistic issues, the agreement should be drafted in both languages.
These were some of the items which should be kept in mind regarding distribution contracts in China but suppliers should never forget the power of negotiation. It is very important to have a clear scope of work and make the best out of the negotiation process.
Sample of this agreement
This Distribution Agreement (“Agreement”) is made and entered on____day of_____at_____
BY AND BETWEEN
______, a company registered under the provisions of Companies Act, 2013 bearing CIN no.___and having its registered office at New Delhi, India
(Hereinafter referred to as “Supplier” which expression unless repugnant to the context or the meaning thereof shall include its assignees and nominees)
______, a company incorporated under the laws of____and having its head office at_______
(Hereinafter referred to as “Distributor” which expression unless repugnant to the context or the meaning thereof shall include its assignees and nominees)
The Supplier and the Distributor will be individually referred to as “Party” and collectively as “Parties”
- The Supplier is the manufacturer of the product and is willing to increase the sales of the product in the territory.
- The Supplier has approached the Distributor who has a wide and extensive network to undertake the distribution of the product in the territory.
- The Distributor agreed to enter into this Agreement whereby the Distributor will undertake the distribution of the product subject to the terms and conditions contained herein.
THEREFORE, In consideration of the mutual promises contained herein, the Parties hereby agree as follows
(a) “Products” shall mean the Supplier’s products to be sold by the Distributor
All the products as referred to in Schedule 1 will be incorporated herein by reference
(b) “Territory” shall mean the geographical area as described in Schedule-2
The Supplier hereby appoints the Distributor as its exclusive distributor for the Products in the Territory. The Distributor shall not have any authority to make any commitments whatsoever on the behalf of the Supplier.
3. Distributor’s Obligations
(a) Distributor shall try to do the best efforts to promote and maximise the Products sale in the Territory.
(b) Distributor shall monthly report all the sales of the Products and marketing activities of the previous month by the 15th of every month.
(c) Distributor shall neither advertise the Products outside the Territory nor solicit sales from purchasers located outside the Territory without the prior written consent of the Company.
(d) Distributor shall not in any way alter the quality of the Products and shall not represent any false or misleading facts on behalf of the Supplier.
Distributor shall pay all the charges due hereunder within 45 days after the date of Supplier’s invoice. All the payments of the undisputed invoices shall be made on time. Suppliers may impose a late payment charge of 0.5% per month on any overdue unpaid balances.
5. Nature of Relationship
(a) The relationship between the Distributor and Supplier is sole of Independent Contractor
(b) In no circumstances the Distributor or its assignees shall be deemed as employees or the representatives of the Supplier.
This Agreement shall be effective from____day of September 2021 and shall continue up to a period of 2 years unless terminated earlier herein. The Agreement can be terminated by giving a prior notice of 90 days.
(A) If any of the Party fails to perform his obligations then the other Party may provide the notice and if the default is not cured within 30 days then the Agreement shall stand terminated.
(B) Either Party can terminate the Agreement without any notice in case of insolvency and bankruptcy.
© In case of a failure in meeting minimum sales targets then the Supplier will have the right to terminate the exclusive rights and may continue the Agreement with non-exclusive rights.
Distributor acknowledges and agrees that in the term of this Agreement the Distributor will be exposed to various trade secrets and confidential information of the Supplier thereby the Distributor agrees not to disclose any of such information to any third party. In the event of termination of this Agreement, there shall be no use or disclosure by Distributor of any confidential information of Company, and Distributor shall not manufacture or have manufactured any devices, components or assemblies utilizing Company’s patents, inventions, copyrights, know-how or trade secrets.
9. Governing Law and Dispute Resolution
- This Agreement shall be construed and enforced according to the laws of India.
- In the event of any claim or controversy or dispute between the parties(“Parties”) hereto relating to this agreement, the aggrieved party will send the notice to the disputing party to solve the issue within 60 days of the notice issued.
- In case of any dispute(es) or claims including any breach or termination or interpretation which is not solved within the cure period then the Parties will try to solve the issue amicably through discussion on any convenient place with good faith.
- In case, the dispute is not solved within the 30 days period of time then the dispute shall be referred to the arbitral tribunal consisting of three arbitrators, with one arbitrator appointed by each party and then the third will be appointed by the two arbitrators appointed. An arbitral tribunal shall be formed within 20 days from the appointment of the first arbitrator.
- The seat and venue of the Arbitration will be New Delhi and the proceedings will take place in accordance with the Arbitration and Conciliation Act,1996.
- The proceedings and arbitral award shall be in the English Language.
- The fees and any other expenses will be borne equally by the parties.
- The jurisdiction over this agreement shall lie with the competent courts of New Delhi.
- The arbitral award shall be binding to both the Parties.
Distribution Contracts play an important role in governing the relationship between the supplier and the distributor. The success of the business depends on how well the products are distributed as that plays a major part in generating profits and there comes the importance of a well-drafted distribution agreement. Apart from the profits the distribution agreement helps to manage the risks and will also help in establishing the product market overseas. After the completion of drafting, the agreement should be properly reviewed and analysed so that both the parties are well aware of their rights and obligations and it will also help in reducing further risk of disputes. Thus, reduce the risks and maximise the profits as it will serve as the way to flourish.
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