All About the Distribution Agreement

INHALTSVERZEICHNIS

In the following article you will learn more about a popular yet complicated contract: the distribution agreement.

We will explain the most important points to consider when entering into this agreement. Approovd provides legally compliant templates according to Swiss law in German and English.

1. Distribution Agreement: Definition

1.1. Distribution Agreement: What is it?

The distribution agreement (or “wholesale distribution agreement”) concerns the distribution of products manufactured by a manufacturer (often referred to as the supplier) and sold by a distributor. The distribution agreement has two main aspects.

On the one hand, the supplier undertakes to deliver and sell its products to the distributor under certain conditions, as in the case of an ordinary sales agreement. The special feature here is that the supplier delivers its products periodically during the term of the agreement (sales agreement with successive deliveries), and the distributor undertakes to purchase and take delivery of them at regular intervals, respectively.

On the other hand, the economic purpose of the parties is to market the supplier’s products in a given territory. This means that the distributor undertakes to promote and market the supplier’s products. In this context, the supplier often grants the distributor exclusivity for its products in the territory covered by the agreement (see below ‘Exclusivity’).

It is in the nature of things that the distribution agreement is entered into for a long term. The drafting of the agreement is therefore of particular importance, as conflicts can arise long after the agreement has been entered into.

1.2. Distribution Agreement: Difference With Other Commercial Agreements

There are a variety of contracts for the distribution of products, for example, the licensing agreement (where the licensor transfers part of its intellectual property to the licensee), the franchise agreement, the concession agreement, the agency agreement, and so on. 

In an agency agreement or a brokerage agreement, the agent or broker does not buy the seller’s products, but acts as an intermediary and receives a commission on the sales price. The distributor, on the other hand, receives on its own account the income from the sales made in the designated territory. 

In the case of a licence agreement, the licensor remains the owner of the rights; it merely transfers the use of the rights to the licensee. In contrast, as in a normal sales agreement, the distributor becomes the owner of the products to be distributed and bears the commercial risk alone.

1.3. Distribution Agreement: Examples

The supplier’s interest is to benefit from the distributor’s distribution network, customer base, commercial and logistical capabilities and knowledge of the domestic market. The distributor’s interest is to increase its turnover by benefiting from the demand for the supplier’s products.

The distribution agreement can thus cover a wide range of products, services and use cases, such as:

  • the distribution of software (this usually requires a licence)
  • the distribution of luxury watches (in the case of luxury products, the distribution agreement often includes specific requirements concerning presentation, shop fittings, etc.)

  • the sale of local food products to a wholesaler (distributor) whose customers are retailers, restaurants, etc. in its territory
  • etc.
Der Vertriebsvertrag ist einer der populärsten Verträgen, enthält jedoch eine Vielzahl an kniffligen Punkten, die zu beachten ist.

The distribution agreement: although popular, it may be very complex. Numerous points are tricky and have to be dealt with.

2. Distribution Agreement: Contents

The distribution agreement can cover a variety of aspects, depending on the economic interests of the parties, the nature of the products (for example, luxury goods or software), the duration, and so on. We focus here on aspects that are common to the vast majority of distribution agreements.

2.1. Distribution Agreement: Exclusivity

The marketing of a new product often requires significant investment on the part of the distributor (and, to a lesser extent, on the part of the supplier), for example the preparation of contractual documents, the rental of sales premises, a marketing campaign, the training of specialised personnel, etc. In order to make these investments profitable, the supplier often allocates the sales territory to the distributor on an exclusive basis.

Exclusivity means that the distributor has the exclusive right to sell the supplier’s products in that territory. Thus neither the supplier nor any other intermediary has the right to sell the products in the sales territory during the term of the agreement. The consideration for the exclusivity granted to the distributor is the latter’s obligation to promote the supplier’s products, in particular through marketing and advertising. Such exclusivity may be problematic from an antitrust point of view, in particular if the supplier and/or the distributor have a large market share (see below “Antitrust”).

In order to strengthen the protection of the distributor, the parties sometimes agree that the supplier will oblige its distributors established outside the sales territory not to sell its products there. Conversely, the parties may agree that the distributor is not entitled to solicit customers outside its reserved territory. The latter two types of agreements may also be problematic from an antitrust point of view as they generally lead to a (further) reduction of competition in the sales territory (see below “Antitrust”).

2.2. Distribution Agreement: Licensing

Often, the marketing of products by the distributor requires that the distributor can use the supplier’s trademark or other intellectual property rights (patent, design, etc.). For example, in order to be able to market a clothing collection under the supplier’s brand name and if that brand is duly registered and protected in the specified territory, the distributor must obtain a licence to use that brand name.  The distribution agreement therefore very often includes the granting of a licence to the distributor. In the vast majority of cases, this licence is not remunerated separately; rather, it is a necessary condition for the marketing of products as an end in itself. The distributor, on the other hand, must ensure that the trademark is legally registered and does not infringe the rights of third parties. The distribution agreement then often contains a warranty to that effect and an obligation on the supplier to indemnify the distributor if the warranty is breached. If the supplier has granted territorial exclusivity to the distributor, the licence will also be granted exclusively to the distributor.

2.2. Distribution Agreement: Minimum Purchase

Under a distribution agreement, the supplier does not sell its products to the final consumers in the target market, but to the distributor. 

In principle, the supplier does not control the sales of its products (although it can indirectly influence how the distributor markets its products in its territory). It is therefore in the supplier’s interest that the distributor purchases a large quantity of products from it. For this reason, the distribution agreement sometimes contains a minimum purchase obligation on the part of the distributor

In practice, this will be the case even more often if the sales territory is exclusively allocated to the distributor for a longer period of time. In return, the supplier often grants the distributor a discount on the sales price for large quantities.

2.3. Distribution Agreement: Non-Competition Clause

2.3.1. Distribution Agreement: Non-Competition Clause During the Term of the Agreement

In addition to the obligation to purchase a minimum quantity of products, the distributor often undertakes not to sell products which may compete with those of the supplier. Such a restriction is of course in the interest of the supplier and directly serves the objective of both parties to promote sales in a particular territory. The non-compete obligation also includes an obligation to purchase products only from the supplier (“exclusive purchasing obligation“, see below “Antitrust”). 

From a commercial point of view, the non-compete obligation obviously depends on the particular product. A perfumery, for example, usually offers a wide range of brands to attract customers. The supplier then has little interest in reducing the distributor’s offer and thus the attractiveness of the store through a non-compete obligation.

2.3.2. Distribution Agreement: Non-Competition Clause After the Term of the Agreement

A post-contractual non-compete obligation may make sense if the supplier intends to take over the distribution of the products in the sales territory itself or to entrust another distributor with it. In this case, the non-compete obligation must be limited in time as well as geographically and may in principle only cover products that have been marketed by the distributor.

3. Distribution Agreement: What Needs to be Considered?

3.1. Distribution Agreement: Compensation for Acquired Customers

In the case of an agency agreement, the agent is entitled to compensation for the customer base (‘customer indemnity‘) that it has provided to the supplier if certain conditions are met at the end of the agreement. In particular, the agent’s activity must have resulted in the creation of a customer base for the marketed products and the manufacturer actually benefits from it.

Unlike an agent, the distributor is in principle not entitled to a customer indemnity upon termination of the distribution agreement, although the parties are free to agree on this. In some specific cases, however, the courts consider that the distributor is also entitled to a customer indemnity. This is particularly the case where the distributor has an economic and operational dependency relationship with the supplier and has made significant investments in the marketing of the products. Various indicators may point to a relationship of dependency: the obligation to purchase a minimum quantity of products, the possibility for the supplier to unilaterally change prices or delivery conditions or even to stop distributing the product altogether, the obligation for the distributor to spend a minimum amount on marketing and advertising costs, etc.

3.2. Distribution Agreement: Antitrust Law

The contractual relationship between the supplier and the distributor may contain mechanisms that reduce competition in the sales territory (“vertical agreements”). They can then be problematic from an antitrust perspective. In the following we briefly summarise some agreements or groups of cases that are relevant in practice:

  • the possibility for the supplier to influence the resale prices charged by the distributor. In particular, fixed or minimum price agreements are generally inadmissible. Non-binding price recommendations are in principle unobjectionable and may even make sense from a commercial point of view, unless the supplier puts pressure on the distributor to adopt its recommendations.
 
  • an exclusive purchasing obligation (see above “non-compete obligation”) restricts the sales possibilities of competing suppliers. This can be problematic from an antitrust point of view if this obligation has been agreed for a longer period (usually more than 5 years) and the parties’ market share exceeds a certain percentage. However, the exclusive purchasing obligation may be justified by economic considerations, for instance if the supplier has made high investments in marketing its products through a distributor and would not have made these investments if it did not have the guarantee that the distributor would only purchase them from it.
 
  •  the allocation of an exclusive sales territory to the distributor (see above “Exclusivity”) or the prohibition for the distributor to sell the supplier’s products outside this territory necessarily restricts competition. However, under antitrust law the respective agreements are in principle unobjectionable if the market share of the parties does not exceed a certain threshold. Even if the threshold is exceeded, exclusivity may be justified on efficiency grounds. This is, for instance, the case if the distributor has made large investments to develop a new sales territory (or would not have made such investments without the guarantee of being the exclusive distributor for the products). 
 

3.3. Distribution Agreement: Product Liability

If a defective product has been placed on the market and causes damage to property or personal injury, the manufacturer is liable under the law, even if it is not at fault. Defects can lead to very large damages if the product is marketed on a large scale, as in the case of baby milk powder which could cause infant diseases. The regulation of product liability is therefore of particular importance in a distribution agreement.

In a distribution agreement, the supplier is often the manufacturer of the product, while the distributor markets it. The distributor is therefore on the front line of responding to customer complaints. The supplier’s delivery of the products is generally considered a sale, and the parties may determine liability for defects as they see fit, or exclude it altogether. However, statutory product liability does not cover damage (loss of value) to the product itself. In addition, the economic loss or “consequential loss” suffered by the distributor due to claims for damages by its customers, and often due to lost sales, is often excluded from the seller’s liability. The distributor will therefore seek to oblige the supplier to compensate it for the financial consequences (customer complaints, consumer damages, loss of sales, etc.) that it has suffered as a result of the defective products.

For its part, the supplier wishes to ensure that the defects are not caused or aggravated by the way in which the distributor handles the products. The supplier will therefore seek to exclude its liability insofar as the distributor has not transported, stored or handled the products properly. Similarly, the supplier’s liability should in principle be excluded or limited where the distributor has not adequately informed its staff or consumers of the correct use of the product.

3.4. Distribution Agreement: Governing Law

In principle, the parties are free to determine the law applicable to the distribution agreement as well as the place of jurisdiction in the event of disputes. The provisions of the Vienna Convention on the International Sale of Goods are in principle not applicable, but it is advisable to expressly exclude them. If the parties have not determined the applicable law, the law of the distributor’s domicile or registered office shall generally apply.

However, the free choice of law does not apply to the provisions of antitrust law. In this case, the law of the state in which the distribution takes place is applicable.

4. Termination of a Distribution Agreement

The parties are generally free to determine how, when and under what conditions the distribution agreement ends or can be terminated. In practice, the parties often agree on a minimum term (for example, 2 years), if only to amortise the investment in marketing the products. After the expiry of this minimum term, in practice, the agreement is automatically renewed for a new fixed term, unless either party terminates it with a specified period of notice (usually at least 6 months). The termination is often made in writing.

Apart from the normal cases of termination (expiry of the term of the agreement and/or the notice period), the parties often establish cases or circumstances that allow one party to terminate the agreement early. There are cases common to both parties in which either of them can terminate. For example, if one of the parties goes bankrupt and/or ceases operations, the other party can terminate the agreement immediately. In other cases, only the distributor or the supplier can terminate the agreement if the other party breaches provisions that are considered essential. For example, if the supplier itself makes sales in the territory which it has exclusively allocated to the distributor, the latter has the right to terminate the agreement prematurely. Similarly, the supplier may terminate the agreement if the distributor sells competing products even though it has undertaken to purchase exclusively from the supplier.

Finally, the parties may decide to terminate the distribution agreement by mutual consent. In this case, they enter into a termination agreement where they agree on a new end date.

In any case, it is advisable to deal with the consequences of the termination in the agreement. In particular, if the distributor still has stocks of unsold products or, conversely, has undertaken to supply products that are still with the supplier, the parties should find an arrangement that ensures the smooth running of the business. In addition, depending on the circumstances of the termination, certain provisions may bind the parties even after the end of the agreement, such as a non-compete obligation or a confidentiality obligation.

5. Templates for the Distribution Agreement

5.1. Templates for the Distribution Agreement in English

5.2. Templates for the Distribution Agreement in German

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Tobias Güntenspenger - Sales Manager bei Approovd - Schweizer Vertragsmanagement Software

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