Top 5 Issues That Every Business Needs To Know About When Negotiating Distribution Agreements

Posted October 27, 2014
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Distribution Agreement

A DISTRIBUTOR AGREEMENT (a/k/a DISTRIBUTION AGREEMENT) is a contract between a  manufacturer and a  distributor that stipulates the responsibilities of both parties.  Because a  distributor takes a more active  role than that of a mere wholesaler, a great distributor agreement is  critical to ensuring success when  growing into new or expanding markets.

Here is a checklist of five key issues to consider when drafting your next  distributor agreement.

 1. Exclusive or Nonexclusive.  Distributor franchises may be either exclusive (where there will be  no other distributor franchised in the territory) or nonexclusive (where the new distributor might be one of several distributors franchised in the territory).  Distributors often appeal for an exclusive territory, arguing that without exclusivity, the distributor has no incentive to allocate adequate resources toward development of sales for the manufacturer.  Once a manufacturer agrees to an exclusive territory, it forfeits the opportunity, for a period, to franchise an additional distributor.  Assignment of an exclusive distributor in a territory often represents an unnecessary leap of faith on the part of the manufacturer.  One alternative to granting an exclusive territory is to draft the distribution agreement in such a way that the distributor is nonexclusive, but to franchise only one distributor.  If a manufacturer’s objectives were met, no additional distributor would be added to the nonexclusive territory. Such an arrangement provides encouragement for the distributor to perform without restricting options of the manufacturer.

2. How Fast, and How Much. Every new partnership between a distributor and a manufacturer is born in a period of bright optimism.  But like marriage, there is a limit on the number of partnerships in which a manufacturer or distributor may engage. By aligning with a new distributor, a manufacturer is prohibited from singing an alternative distributor.  By aligning with a new manufacturer, a distributor is prevented from immediately signing an additional manufacturer. When aligning with a new distributor, it is important to assign a territory that is not too large initially. If a distributor is proven in only small territory, it is generally not a good idea to assign a large territory and hope for the best.  A better approach would be to open a new distributor relationship in that distributor’s proven territory and expand the territory gradually, after results in the smaller territory suggest that an expanded geography makes sense.

3. Termination for Cause and Convenience.  Less experienced partners sometimes attempt to allow for termination for a limited set of specific causes.  However, partners sometimes disagree over the presence of cause, or responsibility for cause.  Many distributor agreements allow for termination for cause and for termination for convenience.  When an agreement allows termination for convenience, a partner wishing to disengage from the agreement serves Notice of Termination to the other partner with 30 days notice.  When the convenience clause is invoked, cause and responsibility for cause need not be argued.  Legal confrontation is avoided.  The parties are able to focus on their customers and businesses without consuming management time, corporate focus and financial resources on attorneys, courts and arbitration.

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 4. Annual Termination and Semiautomatic Renewal.  Annual termination and semiautomatic renewal  are best practices when it comes to distribution agreements.   In these cases, there is a provision in the agreement  calling for termination of the agreement at the end of the first year after the agreement is placed in effect, and  each year thereafter. Terms and conditions allow either party to submit a Notice of Intention to Not Renew 30  days prior to the end of the calendar year.  When annual termination and semiautomatic renewal is written into the agreement, both parties have the opportunity to exit the agreement, without proving cause, once per year. The partnership is held together by performance and not just words in an agreement.

5. Frequency of Price Changes and Amendments. Distributors sometimes believe that they would have a competitive advantage if their manufacturers are allowed to adjust prices only once per year. This may serve the distributor well, but at the expense of the manufacturer.  This arbitrary advantage can torpedo many a partnership.  During periods of inflation or other rising costs, the manufacturer must have the opportunity to pass along increases in cost. The marketplace will control against aggressive price increases. Allowing the manufacturer to increase prices upon 30-day notice eliminates one opportunity for conflict and reinforces the principle of fairness.   With respect to amendments, it is important to remember that external factors periodically apply pressure to the distributor and manufacturer. Those pressures sometimes call for a change in the distributor agreement. If the agreement allows changes to be made throughout the year, there is little problem. However, if the agreement allows for changes only once per year, one or both partners must survive undue pressure until the agreement can accommodate such an annual change. The best distributor agreements allow changes to be made throughout the year.

Conclusion.  DISTRIBUTION AGREEMENTS are key to constructing an effective relationship between a distributor and a manufacturer. A well-written agreement can assist in developing that relationship. The agreement cannot extend the life of a relationship once the relationship expires. A poorly written agreement often leads to a legal disputes that consume management time and financial resources and can lead to legal disputes.  A well-written distribution agreement can eliminate expenditure of resources on these unproductive activities and encourage productive, healthy relationships between the distributor and manufacturer.