Important Issues in Distribution Agreements | Practical Law

Important Issues in Distribution Agreements | Practical Law

Whether in-house or outside counsel, commercial attorneys often deal with the what, when, and how that accompany drafting and negotiating distribution agreements for the resale of goods. This article looks at some important issues counsel should address when drafting and negotiating an exclusive or non-exclusive distribution agreement, including minimum purchase requirements, purchase order requirements, product warranties, and termination rights.

Important Issues in Distribution Agreements

Practical Law Legal Update w-004-7296 (Approx. 8 pages)

Important Issues in Distribution Agreements

by Practical Law Commercial Transactions
Law stated as of 14 Dec 2016 • USA (National/Federal)
Whether in-house or outside counsel, commercial attorneys often deal with the what, when, and how that accompany drafting and negotiating distribution agreements for the resale of goods. This article looks at some important issues counsel should address when drafting and negotiating an exclusive or non-exclusive distribution agreement, including minimum purchase requirements, purchase order requirements, product warranties, and termination rights.
A distribution agreement usually involves a distributor who buys products from a manufacturer or other seller, takes title to those goods, and resells them to its customers. This article looks at some important issues that counsel on both sides should address when they are drafting and negotiating a distribution agreement.
The distributor has separate contractual agreements with the product seller and the distributor's customers. No contractual relationship is created between the upstream seller and the downstream customer. These agreements are often part of complex supply chains with manufacturers, resellers, distributors, and customers all playing different roles. For more information, see:

Is It a Franchise Agreement or Business Opportunity Agreement?

Sellers and distributors should analyze their arrangement with each other before entering into a distribution agreement to see whether it may be subject to:
The parties should try to define the remedies available if the agreement is subject to the Franchise Rule or business opportunity laws, including whether the seller should have the right to terminate the agreement if it is deemed to have created a franchising agreement or business opportunity agreement.

Is it an Exclusive or Non-Exclusive Agreement?

The parties should determine if the agreement is exclusive or non-exclusive and how exclusivity is defined. Exclusive arrangements can be structured in two ways:
  • Exclusive Distribution Arrangement. An exclusive distribution arrangement typically:
    • grants a distributor the right to be the sole seller of the supplier's products in the specified geographic territory.
    • restricts the upstream supplier from selling these goods in the specified geographic territory by any person other than the exclusive distributor, either directly or using third-party distributors.
  • Exclusive Dealing Arrangement. An exclusive dealing arrangement, by contrast, is a restriction on the distributor that requires the distributor to buy products or services only from the upstream supplier for the duration of the exclusive relationship.
The parties should carefully consider the anti-competitive impact and, therefore, the antitrust law implications, of entering into any exclusive arrangement (for more information see Standard Clauses, General Contract Clauses, Exclusive Distribution Rights: Section 1). For a discussion of exclusive dealing under antitrust law, see Practice Note, Distributors and Dealers: Exclusive Dealing and Minimum Purchase Obligations.
The parties should also determine if there are any territorial or product related exceptions to an otherwise exclusive agreement. For example, where the distributor has an exclusive right to sell within a territory, the seller may retain the right to sell to certain accounts (often called house accounts) within the same territory (see Standard Clauses, General Contract Clauses, Exclusive Distribution Rights: Section 2). For more information on drafting and negotiating exclusive distribution agreements, see Drafting and Negotiating a Distribution Agreement Checklist.

Territory

Whether or not the parties agree to an exclusive or non-exclusive arrangement, the parties must define the territory for the distributor's sales activities. The territory where the distributor will sell the goods to its customers can be defined by:
  • Geographic Area.
  • Jurisdiction.
  • Industry.
  • Customer channel.
  • Customer.
The parties should also:
  • Consider how the territory should be defined if the distributor plans to resell over the internet.
  • Determine the seller's remedies for the distributor's breach of the territorial restrictions.
  • Address the parties' rights to change the territory in the future.

Purchase Orders

The seller and distributor should include terms in the distribution agreement that outline acceptance and rejection of purchase orders.
The distribution agreement should specify:
  • How the seller accepts a purchase order, for example by:
  • Whether the seller must accept the purchase order within a stated period of time.
  • Whether the seller has the discretion to reject purchase orders issued by the distributor.
  • If the seller has the discretion to reject the purchase order, whether it is absolute or limited to specific instances, for example, where the distributor has:
    • breached the agreement; or
    • become less creditworthy.
  • Consider whether the seller may:
    • discontinue its supply of goods during the term; or
    • allocate its inventory of goods to other distributors (and under what conditions).
Alternatively, consider whether the seller must maintain necessary capacity and levels of finished goods and raw materials inventory to meet the distributor's purchasing needs (for example, see Standard Document, Distribution Agreement (Pro-Distributor): Section 6.04).

Cancellation of Purchase Orders

The parties should include terms that specify the circumstances under which either party may cancel accepted purchase orders. The terms should describe the procedure for cancellation and whether it must be made within a stated period of time (for example, see Standard Document, Distribution Agreement (Pro-Supplier): Section 8.05).

Minimum Purchase Commitments

The parties should determine if the distributor will have a minimum purchase or order commitment. If so, the distribution agreement should include terms that specify:

Warranties

The parties should consider the allocation of risk arising from product defects among the upstream seller, the distributor, and downstream customers. For more information about product warranties, see:

Important Standard Contract Provisions

The parties should also ensure that the distribution agreement contains other deal-appropriate contract provisions, such as:
For sample distribution agreements, see Standard Documents, Distribution Agreement (Pro-Supplier) and Distribution Agreement (Pro-Distributor).