Important Points for Distributorship and Dealership Contract
By Aaron N. Wise, Attorney at Law © 2009
This list of important points is not meant to be complete nor are the points presented in any particular order.
1. Contract Products: These should be clearly defined. If, during the course of the agreement, you develop other products, should they automatically fall under the contract?
2. Sales Territory; Exclusive or Non-Exclusive Rights: These points must be clearly articulated in the contract. The contract should clearly define what is meant by a sale by the distributor or dealer within its specified territory. Where the territory is large (e.g., all of USA, Canada and Mexico, or even all of the Western Hemisphere), you may wish to grant exclusive rights for part of it and non-exclusive rights for other parts. You may wish to reserve certain customers in the agreed territory for direct sales by you, the foreign supplier.
3. Sales To Only Specified Type of Customers: You might wish to confine the distributor’s or dealer’s sale of your products to a particular type of customer (industry segment) or to customers who will use your products only in a particular way.
4. Can the Distributor or Dealer Appoint “Subs” and Sales Agents? Should the distributor or dealer have the right to appoint sub-distributors or sub-dealers, and/or sales agents or sales reps? If yes, can that be done only with your (supplier’s) prior written consent? Should you attach to the distributorship contract a model of such agreements that the distributor or dealer must use?
5. Sales Outside of Territory or Outside of Permitted Scope: Those points should normally be dealt with in the contract. There is, for example, American case law holding that if the contract does not clearly prohibit it, a distributor or dealer can lawfully sell outside of its assigned territory.
6. Duration: Will the contract be for a fixed term (with or without an option to renew) or of indefinite duration? Either way, there should be termination clauses. See point 19 below regarding “termination”.
7. Delivery Terms: These should be clearly set forth, and you should know exactly what the delivery terms mean and what rights/obligations flow from them. Specific delivery terms (e.g., FOB, CIF, C&F) carry with them certain consequences, unless the parties agree by contract to vary them. If there will be variations (e.g., when title or risk of loss passes to the buyer), they should be set forth in the contract.
8. Payment Terms: The method and time for payment, including provisions for interest on late payments, should be set forth. If payment (in whole or in part) will be by letter of credit, the l/c terms must be carefully drafted.
9. Security for Payment: If you will be selling on credit terms, what security for payment will you receive? One very frequently used U.S. mechanism is the “security interest” which operates basically the way a real estate mortgage does and can give you a “secured creditor” position in the agreed “collateral” of the distributor or dealer. The “collateral” under a “security interest” can be any present or future non-real property assets of your buyer. More information about the “security interest” is available in the publications, “A Foreign. Business Person’s Guide to American Law…” and “General Terms of Sale….”---see the list of the author’s other cost-free publications in the Annex.
10. Minimums Quotas: If you are granting the U.S. side exclusive or quasi-exclusive rights for all or part of the USA (or North America), you will normally want the U.S. distributor or dealer to agree to “minimum quotas” which, if not met, will entitle you to terminate the agreement. From your standpoint, minimum purchase quotas (the distributor’s or dealer’s purchases from you) are better than minimum sales quotas (the distributor’s or dealer’s sales to its customers). Sometimes, even when the distributor or dealer has only non-exclusive rights for its territory, minimums may be desired. Minimum quotas are only effective if properly drafted, there being many points to cover to reach that goal.
11. Promotional Moneys: Will there be an agreed minimum budget for promoting your products in the distributor’s territory? As between the distributor or dealer and you, the supplier, which will contribute what portion? Of course, the permitted types of promotion should usually also be specified in the contract.
12. Sales/Promotion Under What Mark or Name? As a general rule, the supplier’s trademark, brand and/or other distinguishing characteristics (for short, “trademark”), rather than the distributor’s or none, should appear prominently on the products and/or their packaging and be used to promote them in the contract territory. Otherwise, the supplier will not build up brand recognition in the marketplace and may lose the customers once the distributorship contract ends. When the supplier’s trademark(s) will be so used, the contract should so state and should contain special clauses designed to protect them.
13. Adequate Stock: Will the distributor or dealer be required to maintain a stock of the supplier’s goods, and if so, at what level?
14. Sales on Consignment: Yes, under U.S. law, you can sell on consignment, but experience has shown that it is a risky practice in terms of getting paid, recovering your goods and for tax reasons. You should consult competent U.S. counsel in advance if you are thinking about consignment sales. You might also read the author’s guide “Placing Your Goods ‘On Consignment’ with Your American Business Partner….” ---see the list of the author’s other cost-free publications in the Annex.
15. “Acceptance”: Sometimes, distributorship arrangements involve machinery or equipment that the U.S. distributor will resell to customers, who will use them in their plants or factories. In arrangements of this type, the distributor’s customer will normally want to have a start up and initial trial test and then condition final acceptance of the goods on a final acceptance test. Provisions dealing with those points, including defining parameters for acceptance, should normally be built into the contract.
16. Clauses Designed to Reduce the Foreign Supplier’s Product Liability and Late Delivery Risks: These types of clauses, including limitations on the supplier’s express warranty on the contract goods, require careful thought, negotiation and drafting. See the next Chapter regarding “product liability”.
17. Competitive Restrictions on Distributor or Dealer: Certain types of contractual restrictions on distributors or dealers may violate U.S. “antitrust” law. These can include price fixing, minimum price levels, territorial restrictions, non-compete clauses, “tying”, and other restraints. Avoiding antitrust violations or even allegations thereof is essential, because a party allegedly injured by competitive restrictions can sue for and, if successful, recover 3 times the damages sustained, plus attorneys’ fees and costs. With careful drafting, the foreign supplier may be able to achieve its business goals while minimizing the risk of such claims.
18. Avoid Having a “Franchise”: Unless what you really want is a franchisor-franchisee relationship (or to grant a “master franchise”), avoid falling into the trap that your distribution, sales agency, license or other agreements can be characterized as “franchise” arrangements under U.S. law. Franchises are often subject to an entire level of regulation that you might wish to avoid. Competent U.S. counsel will provide guidance in this area.
19. Termination Provisions; Improper Termination Claims: Related Points: There should normally be a number of provisions allowing the supplier, or either party, to terminate the contract on several different grounds, including, in many instances, without cause. These must be carefully negotiated and drafted. Not infrequently, terminated distributors, dealers, sales agents and reps attempt to claim damages for improper termination. With skillful drafting, that risk can usually be reduced, if not eliminated. Similarly, the contract will usually state what happens upon or shortly after the contract’s termination or expiration. Among them, the supplier will often want either the obligation or the right to repurchase the distributor’s or dealer’s remaining stock of goods. The supplier might also want the right to take over some or all of the sub-distributorships and sales agency/sales rep contracts that the distributor has entered into for the supplier’s products.
20. What Tribunal Decides Disputes/Claims and What Law Applies? How you deal with these questions in your contract are vital “business” points, not just legal ones for the lawyers to work out. That statement merits strong emphasis. Consider this writer’s “general rule”: you, the supplier, should be able to attack (bring your claims against the U.S. side) in the USA via arbitration under particular American Arbitration Association (“AAA”) rules in a U.S. city not too close to the U.S. party’s place of business but reasonably convenient for you; and to defend (the U.S. side brings claims against you) via AAA arbitration in the same location as just mentioned or, alternatively, in a city in your home country (or possibly some third country) under acceptable, specified arbitration rules. How these points are resolved will vary from case to case, according to the facts and circumstances and what can be negotiated.
21. Tax Aspects: When arranging your U.S. export sales and contracts, be careful to avoid having, for US income tax purposes, a “permanent establishment” in the USA or a “fixed base” in the USA from which you render services, if there is an income tax treaty between your country and the USA that utilizes these terms. Absent such a treaty, avoid acts and actions that may cause you to be “doing business” in the States for U.S. federal, state or local income tax purposes.
Sales Agency and Sales Rep Contracts for the U.S. Market. A number of the points made above will apply here, but with adaptations here and there. Unlike distributors and dealers that buy and resell goods, sales agents and reps do not buy and resell, but rather obtain customer orders for the supplier’s goods (the sales being between the supplier and the customer).
Here are a few other points applicable to sales agents and sales reps:
- Commission, Rate and Basis: These terms must be carefully negotiated and drafted. On which sales does the agent or rep earn its commission and at what point in time? If you have more than one sales agent or rep for the USA, there is the potential for territorial customer overlaps. Who earns what commissions on which sales are questions that should be resolved in advance by contract.
- Agent or Rep Accepting Orders: Avoid allowing your agents or reps having or exercising the power to accept orders for your goods, and deal with that point specifically by contract. Allowing any of your agents to accept orders can result in tax and legal problems for you. You, the supplier, should be the only one to accept (or decline) orders.
- Advances : If you plan to allow your agent or rep to receive advances against future commissions, the contract should be very clear that these are advances to be repaid within a specified time--even if earned commissions do not equal the advances.
- Rep or Sales Agent as Your Employee: If the sales rep or agent is an individual, take care that he/she is not characterized as your “employee”. Simply writing in the contract that he/she is not your employee will probably not do the trick. A foreign company will not want to have any U.S. employees soliciting orders within the States. If one or more sales reps or agents are, in fact, likely to be viewed as your employees, and if you cannot alter that situation, you should consider forming a U.S. subsidiary and having those individuals be employees of the sub.