November 2007

Your distribution agreement - is it worth the paper it's written on?

You have a good relationship with your biggest reseller customer. You sign a 1 page Distribution Agreement which seems to cover all the major issues. But have you considered the impact of the Trade Practices Act (TPA)? Severe penalties can be imposed for breaching the Act. And what if the relationship becomes rocky and you can't "work through" an issue which wasn't dealt with properly - or at all - in the 1 page agreement?

Unfortunately this happens often. Having a thorough and well written distribution agreement is important. It can protect your good relationship and avoid costly misunderstandings and disputes. It can keep you out of court.

Principal or Agency?

The threshold question should be whether the arrangement will be structured as a transaction between principals or whether the distributor will be an agent of the supplier. This is often overlooked. A true "agency" occurs where the distributor never actually buys the goods from the supplier, but is paid a commission for finding buyers - the contract of sale is between the supplier and the end user. The agent is merely a conduit. Commission agencies were much more common 30 years ago than they are now, and for good reason, defining the scope of agency is difficult and a principal is liable (vicariously) for the actions and defaults of its agents. The message here is don't use the words "agency" or "agent" unless that is exactly what you mean!

In this article we consider only arrangements between principals - where the distributor actually purchases, then resells, the goods.

Is it a Franchise?

Another question is whether the distribution arrangement is in fact a franchise agreement. The Franchising Code in the TPA contains an extremely wide definition of "franchise agreement". It catches a range of transactions that may not traditionally have been considered to be franchises. If your distribution agreement contains a marketing plan or system of business and gives the distributor a right to operate its business using the supplier's trade mark,on its face it is a franchise agreement. Failure to comply with the requirements of the Franchising Code is a breach of the TPA and will make the agreement unenforceable.

Exclusive dealings

If you are considering exclusivity of any kind - territory, customer type or product range - you should get legal advice. These types of "exclusive dealings" are illegal under the TPA if they cause a substantial lessening of competition in the relevant market and severe penalties can be imposed.

Performance targets

A long term, exclusive Distribution Agreement may sound good but what if the distributor doesn't achieve the expected results? Without performance targets, a supplier may be "stuck" with an under-performing distributor and unable to appoint a replacement or alternative.

Clearly defining the performance targets is essential. There are many options. What is required of the distributor - a minimum dollar value of sales or a minimum number of units sold - or is it a minimum dollar value of product purchased from the supplier? And what are the consequences if the distributor fails to make its targets? This is equally important. If a right of termination sounds too harsh, there are alternatives. For example, termination might only apply if targets are not met in, say, 3 consecutive periods or there may be various target levels, only the lowest of which triggers termination if not reached. Alternatively exclusivity itself could lapse.

Adjustment of the targets is also important, especially over a long term agreement. Distributors might be fairly entitled to reduced targets early in the term (or even a target 'holiday' while it gets established), but as time goes on, arguably targets should be increased.

Sales and marketing plans

These plans are often incorporated into distribution agreements in which case the distributor may be obliged to comply with them. But don't forget that marketing plans need to be fluid and responsive to changing market conditions - so appropriate mechanisms for collaboration and variation of the plan are needed.

Care is also needed if the distributor is given the right to use the supplier's trade mark in promotional material (which is often the case). The Distributor's use of your valuable trade marks should be subject to compliance with guidelines and appropriate approvals by you.

Post-termination procedures

Addressing post-termination procedures can help you in the transition to a new distributor with minimal disruption to sales or customer relations. The distribution agreement should at least address issues including:

  • whether the distributor is able to sell down stock on hand or must cease to sell the product immediately?
  • whether the supplier has the option ? or is it required ? to buy back stock held by the distributor? And in either case, at what price?
  • who is responsible and liable for sales commitments (if any) made by the distributor for the period after termination?

Is there a standard agreement?

The next time you start negotiating a distribution agreement, there will be many other issues, but at least consider the foregoing. Think carefully about the threshold issues of agency and franchise, and about exclusivity, term and termination rights. Above all, don't simply copy someone else's distribution agreement. There really is no such thing as a "standard" document and every trader's products, markets and, consequently, needs are different!

Authors: Matt Crouch & Jennifer Brown