This article is written by Bushra Asif who is pursuing a LawSikho Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.
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Why do we need a Distribution agreement?
When a company makes a product it needs to sell it to customers. Now, if the company is well established it may directly sell and reach its customers, however, sometimes the company does not have the expertise to sell and market its product at retail or wholesale level. In such a case it will engage a distributor, who will have the experience and foothold in the target market. For this purpose, it will need to get into a legal agreement with the distributor, which governs their relationship and clearly defines the terms of their arrangement and allows distributor to sell and market the products.
In simple terms a distribution agreement is a legally binding agreement between an entity that supplies goods and one that distributes goods.
The supplier or the manufacturer and the distributor can also have an informal distribution arrangement. In fact, many do, but these verbal agreements more often than not result in misunderstandings that can lead to disputes and end up in courts.
A proper distribution agreement, with specifically stated terms of the deal, ensures clarity for both parties so they know exactly what they need to do. When one party fails to live up to the agreement terms, the same agreement will save the non-defaulting party by protecting it legally and providing legal remedies.
Key Terms Of a Distribution agreement
Therefore, it is paramount for both parties to understand the key terms of a distribution agreement. These terms may vary, depending on the specific arrangement between parties. A well-written agreement becomes the basis of establishing and maintaining a good working relationship in a channel partnership.
Purpose of the Distribution agreement
Businesses may use distribution agreements for a variety of purposes. Some may appoint a distributor as a means of getting their products to the market while others may want to benefit from their expertise, or to share customer lists and market contacts. The intent and scope has to be made clear in the agreement. It might sound simple but it can pose problems if the exactness of the purpose and products are not clearly mentioned – few questions to address are:
- Does the manufacturer want the distributor to sell its entire line or specific products?
- Will the distributor have the right to later expand or restrict the range of the products?
- Will the manufacturer have the right to either expand or restrict the range of products that it will offer?
- What will happen if the manufacturer introduces a new product that the distributor could sell along with the products it already is selling of the manufacturer?
- Will the distributor be given the right of first refusal on the new products?
- What happens if another company acquires the manufacturer or the distributor?
In one case, for example, a distributor had an agreement to sell a line of farm products from a manufacturer. The farm product manufacturer was bought by a large multinational company, which also produced tractors. The acquiring company wanted the distributor to handle the “full line”, including the tractors. Circumstances can change and it can get difficult at times to deal with them in advance, however this case depicts how a change can become a cause of dispute if it is not addressed in the main agreement. In the end the manufacturer terminated the distributor for not handling a “full line”. The distributor sued on various points and lost on all of them. (See Smith Machinery Company, Inc. v. Hesston Corporation, 878 F.2d 1290 (10th Cir. 1989) and Continental TV v. GTE Sylvania, Inc., 433 U.S. 36 (1977).)
Depending upon for how long you want the arrangement to last you state the Term of the agreement. Distribution agreements may:
- be for a limited period of time;
- be an ongoing arrangement; or
- be renewable for a further period after the initial term ends (which may also be subject to certain criteria).
Experts suggest that you create shorter term agreements (maybe one year) which can be renewed by mutual agreement.
Exclusive or Non-Exclusive Appointment
Other issues may arise by using the term “exclusive” as it may have different connotations. The first meaning of “exclusive” is that the manufacturer will not appoint another distributor for a specific locality and the distributor shall be solely responsible to sell products in that exclusive territory. A second possible interpretation is that the manufacturer will not sell the product directly into that exclusive territory. Therefore, exclusivity may pertain to product and locality.
The supplier or the manufacturer will need to demarcate the geographical territory (such as a state, country or region) in which the distributor shall be allowed to sell and market the goods. An exclusive arrangement often means that a distributor is the sole distributor of the product. Usually a manufacturer will choose a distributor who has market presence and familiarity with that market to sell products easily. It will enable the distributor to respond to all enquiries and satisfy all orders in that area.
A non-exclusive appointment is opposite to an exclusive appointment. It allows the manufacturer to have multiple distributors for the same product. The territory is always spelled out and the distributor must know where he is allowed to sell and market the product. However, a non-exclusive appointment for a distributor may lead to competition within the distribution network.
Minimum Standards of Performance
The manufacturer should have certain benchmarks and performance criteria that it would want the distributor to maintain. The performance will need to be monitored, either through revenue targets or minimum purchase orders. This will ensure justification of exclusive arrangements. A minimum standard of performance by the distributor can be tied to a clause that if such a standard is not met then the manufacturer may appoint additional distributors. This minimum standard should, ideally, be determined before both parties enter the distribution agreement so the distributor can make an informed choice whether to get into the arrangement or not. Having clear standards set out assists the parties to be aware of the obligations and requirements they must fulfil.
Marketing and Promotion
This is another area in which both parties need to be clear on who shall be responsible for marketing and promotion, sometimes both parties do it. If it will be the distributor’s duty then it will need to be made clear how and what specific assets will be used to market or sell the products for distribution. They may require the distributor to follow particular guidelines relating to branding.
Another question to consider is whether the distributor should be required to maintain a sales force. If so, what type of salespeople should be employed? Will they be required to have any specific technical skill, knowledge or background? Will they be undergoing specific training?
I have seen people using the term “best efforts” for the distributor to sell the manufacturer’s product. The distributor should object to such a provision, based on the case of Bloor v. Falstaff, 601 F.2d 609 (2d Cir. 1979), where the court held, essentially, that the phrase, “best efforts,” means just about everything short of bankruptcy. Therefore, a distributor should swap “reasonable efforts” in place of “best efforts.”
Some manufacturers tend to maintain long and relatively peaceful relationships with their distributors. One of the reasons behind it is that instead of simply sitting in an office in some distant city dictating “goals” and “quotas” to their distributors, they work closely with the distributors to establish mutually agreeable goals, and to develop methods for attaining these goals. They also work together to determine what extra steps will have to be taken if the goals are not realized. There is no harm in providing this little margin of mutual understanding in the agreement so that the deal can move forward and not get stuck where quotas are not met.
Another issue arises if the manufacturer is not consistent in implementing the procedures set to check the quotas and goals for the distributor. For example, if you are lenient in not following up on the criteria set but later try to terminate a distributorship on the grounds that the distributor did not meet its goals, you will be confronted with the argument that, since you never before enforced your goals, you must be enforcing this particular goal against this particular distributor for some malevolent reason.
Distributors may also have an obligation to undertake additional marketing or promotional activities. For example, other activities may include:
- attending trade shows;
- creating their marketing or promotional materials;
- attending to customer visits or training events.
Whether the distribution agreement is exclusive or non-exclusive plays a huge role in determining the obligations of each party. As in an exclusive arrangement the distributor is likely to carry more obligations regarding marketing and promotion. And of course, much will also depend on the nature of products being sold, and the level of control that the manufacturer would like to retain over its brand and reputation in the market.
Training and Support
Where more technical products are concerned training becomes one of the key terms of such a distribution agreement. The manufacturer will need to outline the level of training and support they will provide to the distributor and whether they will be available to train any end-customers as to the use of the product. It must be made clear what type of technical know-how is required, what type of training they will have to undergo, who shall be paying for this training, etc.?
Distributors should also be looking out for the support they will receive from the manufacturer. For example, distributors should consider whether the manufacturer will be:
- listing the distributor on their website;
- transferring enquiries to the distributor; or
- including the distributor in their promotional materials.
Competition clause is an important one in some distribution agreements. It places restrictions on the distributor from purchasing similar products from another manufacturer. Further, it may impose restriction on the distributor from competing with the manufacturer during the Term of the distribution agreement or/and even after it expires.
If the parties dispute on the point of “competition” and it reaches the court, the court will generally look at:
- the durationof the restriction;
- the geographical territory of the restriction;
- the specific activity that is being prohibited;
- the amount of hardship created for the distributor; and
- any public interest issues that may be involved.
However, competition restrictions may not apply to all products. They typically apply where the product is unique or if the distributor has stronger bargaining power.
A typical Non-compete clause will look like this:
“During the Term of this agreement and one year after the expiry thereof, the Distributor shall not, (a) engage in development efforts or marketing or bidding (whether or not with a Manufacturer’s competitor) to develop or market similar Products as that of the Manufacturer’s, or (b) build substantial capability around the Manufacturer’s competitors’ products using information or Intellectual Property shared with him under this agreement (including sponsoring or investing in training, marketing and solution development of products similar to that of the Manufacturer’s that include Manufacturer’s competitor products and/or that undermine the Manufacturer’s market strategy).”
Just as the distributor is expected to meet minimum sales requirements, the manufacturer may also be required to meet minimum supply requirements of the products. Sometimes, the distributor will also be required to purchase a minimum order of product. These minimum requirements will be based on forecasts that will be put out periodically throughout the Term of the agreement at specific intervals and manners.
It is important for the manufacturer to clearly state the rights of the distributor regarding the use of its intellectual property, including brand names and trademarks. For example, can he:
- merely put a sign in his window displaying the trademark?
- use the trademark on his letterhead or other written documents?
- use the trademark in his name?
Otherwise as expressly granted by the trademark owner, the distributor cannot use the trademark without incurring liability. The manufacturer has to be careful in granting this right and in what manner as he will not want to lose its exclusive ownership rights in the trademark by granting the distributor those rights.
This clause can be worded as follows:
“During the Term of this agreement, Distributor shall have the right to publicly show that it is an authorized Distributor of the Manufacturer’s Products. It is authorized by the Manufacturer to advertise the Products within the Territory under the Manufacturer’s trademarks, service marks, and trade names that it may adopt from time to time (“Manufacturer’s Trademarks”). Nothing herein shall grant Distributor any right, title, or interest in Manufacturer’s Trademarks. At no time during the Term of this agreement or at any time thereafter shall the Distributor challenge or assist others in challenging Manufacturer’s Trademarks or the registration thereof or attempt to register any trademarks, service marks, or trade name confusingly similar to those of the Manufacturer’s. Manufacturer indemnifies Distributor for all use of Manufacturer’s Trademarks.”
Duties and Obligations
It is by far the most important clause in the agreement as it spells out for both the parties what they are required to do under the agreement.
For the Manufacturer some of the duties will be:
- Supply the agreed products.
- Provide all the required information, education and technical support regarding the product.
- Adhere to the delivery timelines/schedules.
- Provide advertising or promotional allowance.
- Provide other data and information required by the distributor.
- Timely payments
For the Distributor some of the duties will be:
- Maintain an adequate inventory.
- Minimum purchasing expectation.
- Set sales, accountability and customer service expectations.
- Other distributor’s duties relating to sales quotas, sales promotions, documentation and after-sales customer support.
Dispute Resolution and Contract Termination Clauses
A lengthy and arduous lawsuit can be avoided by incorporating a proper mechanism when things fall out. You could keep the dispute resolution in steps, first through negotiation, then mediation and finally arbitration. Arbitration is much faster, cheaper and efficient than a lawsuit. It is also private.
Identify the state having jurisdiction over the agreement. You will need to write how and in what circumstances will you resort to dispute resolution. The seat and venue of arbitration.
For termination, the manufacturer might insert that agreement can be terminated at any time with very short notice. Another possibility is that the manufacturer might stipulate a time period, such as one year, and then decide to either end the agreement or renew it. Finally, if there is a material breach by the distributor the manufacturer will retain the right to terminate the agreement along with having resort to other legal remedies.
The distributor usually will not have an easy way out and the only right to terminate will be if the manufacturer delays payment for a long time or at the expiration of the Term.
The termination clause is crucial and should specify the events and the method for termination.
What must not be ignored is what will happen to unresolved business after termination, for example – payment due, merchandise with the distributor.
This crucial clause may be devised as under:
“The Parties agree to negotiate in good faith to resolve any dispute between them regarding this agreement through negotiation. If the negotiations do not resolve the dispute to the reasonable satisfaction of Parties, the Parties shall try to resolve it through mediation. If that also fails to resolve the issue then the Parties shall conduct arbitration in Chennai, India in English language, in accordance with the rules of the Arbitration and Conciliation Act, 1996 (the “Rules”).
- The Parties agree that the dispute shall be settled by a sole arbitrator appointed in accordance with the said Rules, and the sole arbitrator so appointed shall be referred to herein as an “Arbitrator”.
- Following the appointment of the Arbitrator, the Arbitrator shall set forth the schedule and timing of the arbitration proceedings in accordance with the applicable provisions of the Rules.
- Upon rendering an award or a decision, the Arbitrator shall set forth in writing findings of fact, conclusions of law and a reasoned opinion explaining the basis of such award or decision and shall make a determination of which Party shall be considered the prevailing Party, which determination shall be consistent with such reasoned opinion.
- The Arbitrator shall be empowered to issue injunctive or other equitable relief.
- The Arbitration award shall be final and binding on the Parties.
- Judgment on the award or any other final or interim decision rendered by the Arbitrator may be entered, registered or filed for enforcement purposes in any court having jurisdiction thereof.”
Orders, Delivery and Payment
The ordering, delivery and payment process is dictated by the manufacturer. For example, there may be a requirement to make orders via:
- an online software platform; or
- sending an order form to the manufacturer
It must be specified how both parties will accept and pay for an order.
Further, it should be mentioned exactly when the legal ownership and risk in the product will pass on to the other party. For example, the distribution agreement should state which party is liable if something happens to the product during delivery. Depending on when the risk passes, the relevant party should ensure that they have relevant insurance in place to be able to cover their possible liability.
Main highlights of a distributor’s agreement have been laid out. It is not a complete check list since a distributors agreement can range all the way from a very briefly stated agreement, which merely allows a company to sell the products, to a multi-page, complex agreement covering international arrangements. Long term agreements must include flexibility to adjust change in market taste, product, management- just to name a few in a commercial setting, so that the parties do not have to constantly amend the agreement.
To ensure that a distribution agreement is in line with your best interests, it is important to be aware of and understand its key terms. For this purpose, you need to consult a lawyer who can work with you and draft the best possible agreement for you.
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