Progressive Distributor - Preventing mistakes in distributor agreements

Preventing mistakes in distributor agreements

by Glen Balzer

Many factors go into the creation of a great distributor agreement. Mistakes in an agreement are almost invisible during the courtship between a distributor and a manufacturer. Unfortunately, those same mistakes grow into glaring errors at the end of a distribution partnership. In order to avoid problems at the time of termination, the distributor agreement must not contain poor clauses or exclude particular phrases. Here is a list of common mistakes to avoid when drafting your next distributor agreement with a supplier.

Termination and renewal
Inexperienced parties sometimes use clever wording to minimize the opportunity for termination. Calling for annual termination and semiautomatic renewal is a routine procedure among experienced players. In these cases, there is a provision in the agreement calling for termination of the agreement at the end of the first full calendar year of service, and each year thereafter. Terms and conditions allow either party to submit a Notice of Intention to Not Renew 30 days prior to the end of the calendar year.

When a distributor agreement calls for annual termination and semiautomatic renewal, both parties have the opportunity to withdraw from the agreement without proving cause. Using this methodology, performance — not a collection of words in the agreement — holds the partnership together. Seasoned partners always prefer to have performance as the binding force in the partnership.

All distributors and manufacturers understand the agreement must spell out the responsibilities of the parties during the life of the agreement. Fewer understand the agreement must spell out responsibilities for the period after termination. Distributors and manufacturers must be specific about which products are eligible for return and credit and the timetable for such returns. A reliable agreement must clearly state the responsibilities and obligations of both parties during the life of the agreement, upon notice of termination, and after the effective date of termination.

Termination for cause and convenience
Most distributor agreements involving seasoned distributors and manufacturers allow for termination for cause and termination for convenience. Less experienced partners sometimes allow for termination only for a limited set of specific causes. Termination for cause is sometimes straightforward and without controversy, as when one partner declares bankruptcy. Partners frequently disagree over the presence of cause and often disagree over responsibility for cause.

The best distributor agreements allow for termination for cause and for termination for convenience. When an agreement allows termination for convenience, a partner wishing to disengage from the agreement serves Notice of Termination to the other partner with 30 days notice. Parties may choose to insert wording that allows for a longer period between notice and effective termination, proportional to the length of service. When a party invokes a termination for convenience clause, there is no need to argue about cause and responsibility. More important, the distributor agreement does not end in a legal skirmish. Without a legal confrontation, the distributor and manufacturer can focus on their respective customers and businesses without consuming management time, corporate focus, and financial resources on attorneys and courts.

Too much too soon
Every new partnership between a distributor and a manufacturer is born in a period of grand enthusiasm. Like marriage, there is a limit on the number of partnerships in which a supplier or distributor may engage. By signing with a new distributor, a supplier cannot collaborate with yet a newer, additional distributor right away. By teaming up with a new supplier, a distributor cannot immediately sign an additional supplier.

When building a partnership, it is important to assign a territory that is not too large initially. If a distributor has a record of accomplishment in only a small territory, it is not prudent to assign a large territory and hope for the best. A better policy would be to open a new distribution relationship in that distributor’s proven territory and expand the territory gradually, after results in the smaller territory suggest that an expanded geography is wise.

Exclusivity
Distributor franchises may be either exclusive, where there will be no other distributor franchised in the territory; or nonexclusive, where the new distributor might be one of several distributors franchised in the territory. Distributors sometimes make an appeal for an exclusive territory, arguing that without an exclusive territory, the distributor has no incentive to allocate adequate resources toward development of sales. Once a supplier agrees to an exclusive territory, it forfeits the opportunity to franchise an additional distributor. Assignment of an exclusive distributor in a territory represents an unnecessary leap of faith on the part of the supplier. An alternative to assigning an exclusive territory is to draft the distribution agreement in such a way that the distributor is nonexclusive, but to franchise only one distributor. A verbal understanding would suggest that if the new distributor met mutual objectives, the supplier would add no additional distributor to the nonexclusive territory. Such an arrangement provides encouragement for the distributor to perform without restricting options of the supplier.

Comparison with proven industry agreements
Lack of experience creating and negotiating agreements is the greatest cause of mistakes in distribution agreements. Most large companies with years of experience with agreements rarely write mistakes into new agreements. Many mistakes are the result of one partner attempting to gain advantage over the other partner by inserting a bias into the agreement favoring the party with greater experience. How does an inexperienced party to a distribution agreement level the playing field during negotiation? There are several methods: First, use a network of friends in the industry. Although it is unlikely that a direct competitor would lend a copy of its distribution agreement, friends at indirect competitors usually have no fear of sharing an agreement that has proven over time to be free of problems.

Second, solicit a model agreement from an industry or distributor trade association. Many distribution associations provide a model agreement free or at modest cost to their membership, (National Building Material Distribution Association, Specialty Tools and Fasteners Distributors Association, etc.). The model is a good baseline from which to compare agreements.

Third, if attempting to sign a distributor agreement in a foreign land, use the foreign network. There are American chambers of commerce in most countries around the world, (American Chamber of Commerce in Thailand, American Chamber of Commerce in Germany, etc.). If your foreign subsidiary does not yet have a connection with the local chamber of commerce, initiate one immediately. The cost of membership in these organizations is trivial and the benefits extend far beyond learning how to negotiate a distribution agreement.

Fourth, ask the distributor or supplier for a blind copy of two or three agreements that are currently in effect. Knowing the name of the parties in the agreement is not necessary. All that is wanted is a feel for what is customary.

Distribution agreements are an integral tool in the construction of a relationship between a distributor and supplier. A well-written agreement can assist in developing that relationship. The agreement cannot extend the life of a relationship once the relationship expires. A poorly written agreement often leads to a legal quarrel that in turn consumes management time, financial resources, attorneys and courts. A well-written agreement can eliminate expenditure of resources on these unproductive activities and encourage the distributor and manufacturer to go about their respective businesses when the relationship expires.

Glen Balzer, president of New Era Consulting, advises parties involved with contracts between suppliers, industrial distributors, worldwide customers and manufacturers’ representatives. He promotes conflict resolution between parties involved in distribution and representative agreements as an expert witness. Contact him at www.neweraconsulting.com.