How to negotiate your distribution agreements to avoid disputes

Are you planning to export more? Appointing a distributor is a hugely popular way for suppliers of goods to expand sales channels into new countries without having to set up a local operation itself. However, distribution agreements are one of the contract types that most frequently gives rise to disputes.

Inability to terminate

Suppliers seek legal advice on how to exit distribution agreements far more frequently than they ask for help to draft a distribution agreement in the first place. The supplier may wish to terminate the agreement because the distributor is performing poorly, or the supplier may wish to restructure its routes to market. Either way, many suppliers find they do not have the right to exit the contract without risking an expensive claim from the distributor.

That doesn’t need to be the case, since the same issues cause problems time after time. By being aware of the common pitfalls, you can ensure your distribution agreement is drafted to give you the best possible position to exit, if and when the time comes.

Common pitfalls

1. Avoid exclusivity – If your distributor is appointed on a non-exclusive basis and is performing poorly, you can appoint another distributor to give you a second route to market and create some competitive tension, or sell directly into the territory yourself. However, if you have an exclusive distributor that isn’t achieving the market potential, your only option is to try to terminate the contract, which you may find difficult and costly.
2. Set the duration carefully – It is common for distributors to be appointed for long terms, for example 5 years, because the distributor wants certainty. However, setting a shorter duration, for example a one-year rolling term, is usually far better for suppliers. To negotiate this position, you can argue that if the arrangement is working well for both parties, then the contract will continue to be renewed. Make sure you also have a right to terminate on notice included in the contract.
3. Draft termination rights broadly – Distribution agreements usually include a right to terminate if the distributor commits a material breach of the agreement, or is insolvent. Problems arise because proving a ‘material breach’ can be very challenging. If you get it wrong, you could be in breach of contract yourself. Often, there isn’t a single material breach by the distributor. It is more common for there to be repeat instances of low-level poor performance which together amount to an unsatisfactory position. Your contract therefore needs to contain a right to terminate for persistent breach too.
4. Use minimum purchase obligations – By specifying the amount of product that the distributor must purchase from you each month/quarter/year, you create an objective benchmark for performance. Your contract should state that a failure to meet those minimum obligations will justify termination for material breach, or at least permit you to remove any exclusive rights of the distributor.
5. Re-issue minimum performance obligations annually – It is critical to ensure that updated minimum purchase obligations are issued to the distributor each year, or that the contract contains a default position if you fail to do so. This is a common source of problems; for example, an arrangement has been in place for a long time, the distributor’s performance declines but there are no current targets in place, so it is difficult for the supplier to justify termination of the contract.
6. Scope of products – Limit the product types covered by the agreement as much as possible. If you introduce a new product line, it will give you better flexibility about whether you offer that new range to your existing distributor or not.
7. Waiving breaches – Often poor performance is ignored by the supplier, so the distributor is able to argue that the supplier has waived any breaches because they were not acted upon. Therefore, you should at least note any breaches in writing to the distributor, and reserve your rights. Your contract should also contain a “no waiver” clause.
8. Ignorance of local laws – Some countries have laws which give statutory protection to distributors, such as minimum notice periods and a right to claim compensation from the supplier on termination of the arrangement. Before appointing a distributor in a new territory, check out whether any such local laws exist.

It sounds obvious to say that getting your agreements right in the first place will avoid problems down the line, but with distribution agreements this is particularly the case. By knowing what normally trips suppliers up, you can get ahead of the game.

If you need advice on drafting or exiting a distribution agreement, please complete this short form to arrange a no-obligation call with Lucy Pringle.