By Micky Barnea, Managing Partner, Barnea & Co.
Distributors, agents, resellers and OEM partners all share the same commercial function of selling goods to end users. Thus, although there are significant differences between the legal statuses of each of these players, this article below treats all of them collectively as “distributors”.
Appointing a distributor involves significant inherent risks. The drafting of the distribution agreement may help in mitigating these risks and realizing the potential benefit of your relationship.
While formulating distribution agreements you should pay special attention to the following key issues:
- Choose an Effective Distributor: Choosing the right entity as the distributor of your products or services is the most important point. You may appoint a distributor you happened to come across, or that appears impressive. However, you have to remember that you made the appointment so that your products will be distributed and sold. The concern is that the distributor will not act upon the appointment, and the agreement that you signed will remain “on the shelf”. These situations get complicated when the distributor is granted with long term exclusivity over a territory. In such event, the concern is not only that the distributor will do nothing, but that you will not be able to appoint other, better, distributor for the same territory.
- Specify the Distributed Products: a distributor may be excellent for the distribution a certain product, but unsuitable to distribute other products. Therefore, it is advisable that you define the subject matter of the agreement carefully and provide an explicit reference to issues such as upgraded or updated products. For example, when you designate certain software as the products to be sold under the agreement, one could consider newer versions of the software as being covered by the exclusive rights of the distributor and another may consider them as being beyond the scope of the exclusivity (and there is no doubt as to who is the one and who is the other).
- Consider the Territorial Coverage: the territorial scope of your distribution agreement is not just a question of geography. For example, if exclusive rights are given for distribution of a certain product in the East Coast of the USA, it should be made clear that such rights are not infringed if the same product may enter the territory through an OEM partner, embedded in another product. You should specify precisely all the possible channels through which the product may penetrate the market and thus protect yourself from future disputes with your distributor.
- Include the Distributor’s Commitments: suppose that you and your distributor have set sales targets or even established minimum purchase quantities, failing which you are entitled to terminate the exclusivity or the entire agreement. In the real world, you do not get to impose these sanctions so quickly. They are often subject to long grace periods, to further conditions or to both, so that basically, they give you no real guarantee. With that being said, it is very important that you perform a due diligence on your distributor and receive a detailed business plan. Such business plan should include, at least, commitments regarding marketing expenditure and details of the human resources to be assigned to the distribution. If you add to this a proper incentive for meeting sales targets, you will acquire some confidence that you have a suitable, capable and motivated distributor in place.
- Beware of Exclusivity: exclusivity can be unilateral, that is, the distributor is your sole distribution channel in the market, but he may sell competing products. Similarly, you may supply your product to others, but the distributor may not sell competitors’ products. In reality, these one-sided arrangements usually do not work so that it is more advisable to conclude bilateral arrangements. In this regard, it is important to note that in many countries, exclusivity arrangements are considered anti-competitive and thus, in some cases, unlawful. Thus, it is highly advisable that you consult with an anti-trust specialist lawyer to make sure that the arrangement that you are about to enter into is not illegal.
- Set the Term of the Agreement: flexibility regarding termination of the distribution agreement is crucial. Take for example a case where your company is facing an acquisition and the acquirer conditions the purchase on the termination of the distribution agreement. In such event your exit is dependent on your distributor’s consent to release you from the agreement. This issue also arises where “change-of-control” provisions are included, whereby your distributor may terminate the agreement upon a change of control in your entity. Thus, if your buyer’s proposal depends on the continuation of your relationship with the distributor, you are at his mercy. Therefore, set definitive and short initial periods that can be extended repeatedly by mutual consent. In this way, you may not be free to end the relationship whenever you want to, but you will always be able to do so within a specified period of time.
- Deal with the Post-Termination Period: questions of no less importance can arise in relation to the post-termination period. Among the things you must consider are return or buy-back of remaining products, non-competition and confidentiality undertakings, commissions for transactions that are close to being concluded, continued support for the supplied products and more.
- Opt for Home-court Governing Law: in some cases, well defined “choice of law” provisions may impact upon the probability of disputes between the parties leading to actual litigation. In many cases, when you have a local jurisdiction clause in your agreement with a foreign distributor, your distributor will be hesitant to initiate proceedings against you. Another way to avoid proceedings is to set an expensive arbitration arrangement as the sole and exclusive procedure for settlement of disputes. In this way, the party with the greater economic strength sometimes assures for himself a sound and peaceful relationship.
- Remember your Intellectual Property: when you appoint a distributor, you also grant a license to use your intellectual property for purposes of the distribution. You are basically giving him access to your most sensitive assets. He is authorized to use your domain name, your logo and your trademarks. If these issues are not specifically addressed in the agreement, this may lead to situations where your distributor takes possession of your intellectual property and actually blocks you from the territory.
- Limit Liability: in most jurisdictions, the liability for damages caused by the use of the products lies with the manufacturer. Some agreements attempt to shift this liability to the distributor, but when tested by the courts they will probably not hold. Therefore, the correct way to address the risk of liability is to formulate an effective indemnification mechanism that will limit the scope of your liability. Such mechanism should limit your liability both in terms of amount and time and be backed up by adequate insurance coverage.