Some Strategic and Legal Key Considerations
A. Background
There are various ways on how to enter a new market, expand your business within a region or increase your overall market share, one common option is to appoint a distributor for the sale of your products and solutions.
Depending on the relevant applicable jurisdiction, the legal definitions of a distributorship might vary. However, in many legal systems distributorships are considered as an arrangement under which the distributor buys goods from a manufacturer and resells them on its own behalf.
Distribution arrangements are not only opening avenues to tap into new consumer markets and strategic overseas territories, but they are also relatively less risky and less capital intensive in comparison to other market entry strategies such as incorporated joint ventures and establishment of subsidiaries and PE’s.
B. Strategic and Legal Key Considerations
So, what are the key elements, potential pitfalls and strategic considerations when developing a fair, sustainable, and successful distributorship arrangement with a local partner located in the target market? Depending on the nature of the respective envisaged business relationship with the local distributor, the industry, type of products and specific regulatory or legal jurisdictional requirements the key elements and considerations may differentiate. Below a summary of some aspects, we find useful to consider when structuring distributorship agreements.
- Exclusive vs. Non-Exclusive Appointment of Distributor: This is often based on strategic business considerations such as pre-existing business relationship between distributor and principal/manufacturer, both parties’ expectations, significance, distribution power and market share of distributor, and expected sales performance from distributor. If exclusivity is wanted by the parties, it is often recommended to limit the exclusivity of the distributor in terms of term, geographical reach and range of products in the beginning in order to exercise control over the appointment and contractual arrangement, if and when necessary.
- Scope of Agreement / Range of Products: Important to define for which product segment or specific portfolio the distributor should be appointed. Can be tactically only for a limited range of products /solutions. This can be extended if the performance is up to principal’s expectations. Especially when the distributor is appointed exclusively to maintain some control and check and balances regarding distributor’s performance.
- Term and Renewal of the Agreement: Initial distributorship arrangements are often limited to terms ranging from 3 to 5 years. Any periods below that might be unproductive or not realistic for the appointed distributor to demonstrate reasonable results and sales figures in a new market or territory due to long ramp-up times. Contract renewal options are in many incidents are subject to achievements of pre-agreed sales targets, KPIs or increase of market share, etc.
- Direct Sales: Well established manufactures have often global business relationships and supply arrangements with OEMs or major resellers, etc., in various jurisdictions. This might overlap territory-wise with later appointed distributors for the same geographical area. To take into consideration distributors substantial marketing an capex investments (safe storage and after sales structure, etc.) required for manufacturers products or solutions, often principals grant distributors pre-agreed commissions for direct sales to OEM’s which are mostly of strategic nature.
- Territory: The assigned territory of the distributor can be a strategic factor for the manufacturer and associated expectations on increase of market share. It is recommended to assign key markets only if and when the distributor has been proven successfully in growing manufactures products market share for extend periods. Otherwise, it might be more efficient to divide territories among several distributors or several distributors for the same geographical region to control and monitor their performance.
- Distributor’s and Principals Obligations/Limitations: Important to define in detail each parties’ expectations and contractual obligations and limitations (e.g. acting in its own name and for its own account, no authority to alter any of the products or their appearance, nor affix any additional material thereto, to advise on business trends and sales forecast within the territory, principal shall pass to distributor all enquiries related to the territory, principal grants distributor a non-exclusive, non-transferable, free license to use the trademarks during the term of the agreement for the sale of the products, etc.). If both parties’ expectations are not clearly listed and stipulated it might often lead to ambiguities and event frustration and trigger termination by respective disappointed party.
- Manufacturer’s IP-Rights: Tradenames, trademarks, formulations, patents and copyrights owned mostly by the manufacturer/ principal might play a significant role for the success of the sale of the products and hence need to be properly protected and regulated in the distributorship agreement often by license arrangements addressing development and enhancement of those licensed IP-rights during the term of the agreement to mitigate potential later IP related disputed in terms of ownership and usage.
- Product registration with Governmental Authorities and Regulatory bodies: Depending on the type of product or solution to be sold in the assigned territory, they might require pre-approval, assessment and testing by the relevant regulatory body of the market before being sold to potential customers. Necessary costs and expenses might be significant in some cases. Often the appointed distributor carries the expenses for obtaining required regulatory approvals. But also costs splitting is common.
- Termination: Besides events of breach of contract by either party, termination rights are often subject to not meeting pre-agreed sales targets and predefined KPIs and violation of rigid compliance obligations by the local distributor. This is a form of delegation of risk from manufacturer to the distributor for especially high-risk markets in terms of money laundering and terrorist financing (AML/CFT) and corruption, among others.
- Applicable Law & Dispute Resolution: Often the laws and dispute resolution mechanism of the local jurisdiction e.g. mediation, regular courts or arbitration in which the distributor is domiciled applies to ensure enforcement of judgments or awards. In some cases, arbitration in another country such as UAE, UK, Switzerland, and Singapore might be more appropriate in case of risk of corruption or structural deficiencies in the judiciary of the relevant target market.
C. Conclusion
Appointing a capable and well-established distributor with an efficient sales channels and deep market knowledge can often be vital for the success to enter into a new market or geographical region, among other critical factors. Before appointment its essential to conduct a proper due diligence on the future distributor and analyze its sales performance track record in general for the specific market and if passible comparison data for same or similar products.
Besides the appointment of a potent distributor, it is significant to incorporate efficacious contractual tools and provisions enabling to monitor, manage and control the performance and contractual execution of the distribution agreement to manage expectations and to exit the contractual relationship in case of e.g. compliance violations.
D. How Can We help?
At Pannike+Partners, we have well versed lawyers experienced in developing, drafting, and negotiating complex, protective and comprehensive distributorship agreements either domestically or with cross-border nexus. We are representing manufactures as well as local distributors in their contractual drafting process. We would be delighted to guide you through the draft agreement clauses and to highlight potential pitfalls and/or suggest amendments promoting to strengthen your contractual rights and position.
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