Distribution agreements are used between distributors and manufacturers to provide certainty and clarity within the commercial relationship.
In this guide, we explain what an effective distribution agreement should include and consider the key areas of risk to be mitigated when drafting and relying on a distribution agreement.
What is a distribution agreement?
A distribution agreement is a contract between the supplier of goods or an interim distributor and an independent organisation that will purchase those goods and re-sell them, usually to the end customer.
Suppliers appoint distributors because they wish to expand the market for their product, or do not have the capability to distribute their product themselves.
The supplier of the goods usually requires the distributor to follow its own standards in terms of delivery and branding. From the distributor’s point of view, they will want to know what rights they have to use the supplier’s IP, if any, and if they or the supplier will be responsible for customer after-sales care, for example, if the product needs to be repaired.
It’s in the interests of both parties to ensure that a distribution agreement is as clear as to each other’s rights and responsibilities in relation to the commercial relationship and any transactions. The principal reason for this is that the distributor will take legal ownership of the products before selling them on.
The distributor will also take over all risk relating to loss or damage to the products once the supplier has delivered the products to them.
Therefore, if the supplies wishes to retain any rights over the products, or how they are marketed or sold, this will have to be written into the distribution agreement.
What should a distribution agreement include?
The distribution agreement should cover the terms and conditions under which the transaction will take place, for example, the price the distributor will pay for the goods, the number of goods they will purchase, the geographical area in which the distributor can operate and whether or not the distributor is the sole distributor and or can operate exclusively.
The agreement should include:
- The products the distributor will buy and distribute. The distributor may wish to include provisions relating to the quality of the products here.
- The quantity of the products the distributor will purchase (usually there is a minimum purchase), and the price the distributor will pay for these. Often there is a pricing structure document included as an annex to the agreement.
- How the contract can be terminated. The agreement can simply end with the effluxion of time. However, either party may need to give notice to terminate the agreement before that. Usually, both parties will be tied in for a period of time, after which they will have the right to give notice. The supplier may also require the right to terminate the agreement if the distributor does not meet a minimum level of sales.
- The geographical area covered by the agreement and in which the distributor will operate.
- Exclusivity – whether or not the supplier can appoint other distributors to distribute its goods in a particular area and whether or not the supplier itself is going to do so. This is covered in more detail below.
- Pricing – suppliers should exercise caution if they are tempted to set a minimum price that the distributor must adhere to when selling its products. See below for more information on this point.
- Promotion of the products – the supplier will expect the distributor to exercise due care and diligence in selling the products. It may also require certain levels of conduct and adherence to uniform brand standards.
- Intellectual property – to what extent, if any, can the distributor be allowed to have access to the supplier’s know-how in order to sell the products.
- An obligation on the distributor to maintain adequate insurance, both in terms of looking after the products, but also public liability insurance.
- Confidentiality – a clause that requires the distributor to keep confidential for the duration of the agreement and afterwards, all information that the distributor has about the products.
- A non-compete clause – this prevents the distributor from selling products that compete with the supplier’s products for the duration of the distribution agreement and a period of time after the agreement has ended.
- After-sales obligations – if the distributor is to be given the right to market maintenance and repair contracts with the customer, then this should be stated and basic terms outlined where necessary.
- The laws and regulations that govern the agreement. This is of course extremely important if the distributor is selling the products in a different jurisdiction to the supplier.
Legal risks of distribution agreements
Both suppliers and distributors should be aware that it is not uncommon for certain contractual terms to be unenforceable, particularly in light of competition laws. These could include:
- exclusive and / or sole distribution rights in a particular market;
- non-compete clauses;
- minimum pricing; and
- minimum purchase obligations.
Both the UK and the EU have laws in place to protect competition. Broadly, these cover anti-competitive agreements and abuse of a dominant market position.
Anti competitive agreements
These are defined as agreements between businesses that distort or prevent or restrict competition, or are intended to do so, and which affect trade in the UK and / or the EU. For example, an agreement to fix the price to be charged for a product would count as an anti-competitive agreement and be unlawful. Similarly, an agreement that discriminated between customers as to the price of a product that remained the same in each case would also be deemed anti-competitive.
Abuse of a dominant market position
This refers to a business that is so powerful that it can behave independently of competitive pressures in the market. Accordingly, such an organisation would be in breach of the law if it charged excessively high prices as a result of its dominant position.
Although on the face of it, the provisions of a distribution agreement may appear to be anti-competitive, the law does contain an important exemption that enables the majority of distribution agreements to exist without breaching competition law.
The exemption is known as the ‘vertical agreements block exemption’. It creates a legal presumption that an agreement is legal if it is made between businesses operating at different levels of the supply chain, the supplier does not have more than a 30% market share, and the agreement does not contain any ‘hardcore’ restrictions.
Hardcore restrictions prevent businesses relying on the vertical agreements block exemption outlined above. They completely restrict:
- fixed or minimum pricing, although a maximum price or a ‘recommended’ price is usually allowed;
- the distributor being bound to sell in a particular territory or to particular customers. However, the supplier can prohibit ‘active sales’ into territories which have been reserved exclusively to itself or another buyer. Active sales means actively approaching customers in another distributor’s exclusive area or exclusive customer group;
- within a selective distribution system, the supplier restricting the end-customers to whom the distributors can sell;
- any attempt by a supplier to prevent cross-supplies from distributors within a selective distribution system, i.e. the distributors are allowed to buy from each other, not just the supplier; and
- any requirement that attempts to restrict the ability of consumers and independent repairers to buy spare parts directly from the manufacturer of the spare parts (i.e. the distributor cannot require that the spare parts are purchased only through it).
If the relevant enforcement authorities found that your distribution agreement was in breach of the relevant competition law, the agreement would not be enforceable and your business could be fined up to 10% of its global turnover. According to the jurisdiction you are in, directors of the company could also face being ‘struck-off’ as well as personal fines and / or criminal convictions.
What is the difference between an agency and a distribution agreement?
The key difference between an agency agreement and a distribution agreement is that in a distribution agreement the distributor takes legal ownership of the goods to be sold, and the full risk of whether or not the goods will be re-sold. Of course, the distributor is also able to charge more for the goods in order to cover its costs and make a profit.
The only way in which the original manufacturer or supplier of the goods has a direct contractual relationship with the end-customer is in relation to product liability and the manufacturer’s own guarantee or warranty.
Because of the dire consequences of breaching competition legislation, an agency agreement is often seen as a ‘safer’ option. Competition law can apply to an agent, but in a much more limited set of circumstances.
What is an exclusive distribution agreement?
An exclusive distribution agreement is one where the distributor has the exclusive right to distribute in a particular territory, i.e. the supplier agrees not to appoint anyone else to distribute those products in that territory. It can also refer to the exclusive right to sell a particular product or use a particular sales channel.
The exclusive arrangement can be contrasted with the sole distributor agreement, under which the distributor is the only distributor in a particular territory or of a particular product, but the supplier itself can also sell its own products and / or in the same territory.
If a distribution agreement is non-exclusive, then the supplier can market its own goods and appoint multiple distributors to sell its goods in a particular territory.
The final category of distributor agreement is known as ‘selective distributorship’. This is where the supplier operates a ‘selective distribution system’ under which only distributors which meet certain criteria will be allowed to join and therefore distribute the goods in question. It is particularly popular where the goods to be sold have a high degree of brand recognition and the supplier wishes to maintain tight control in order to ensure consistently high-quality standards.
Distribution agreement FAQs
What should a distribution agreement include?
A distribution agreement should state the geographical area in which the distributor is supposed to operate, and whether or not the distributor is acting exclusively in that area and if the supplier is able to sell directly to customers within the relevant territory, ie whether it is a sole distributor. Other important provisions will include the quantity of goods the distributor is bound to purchase from the supplier, whether it is allowed to offer additional services in relation to the product, for example a repair service, and how the agreement can be terminated.
How does a distribution agreement work?
A distribution agreement works by regulating the arrangement between a supplier or manufacturer of products, and the distributor of those products. The distributor is usually appointed because it has the logistical capability and technical know-how to distribute the products in a particular geographical area. The distributor is usually bound to purchase a minimum amount from the supplier and often has to meet minimum sales figures in relation to its re-sale of the products in the market.
How do I write a distributor agreement?
A distributor agreement is a contract between two parties - the supplier of the goods and the distributor of those goods. The agreement should set out, amongst other matters, the geographical area in which the distributor operates, whether they have exclusive or sole rights to distribute in that area or the agreement is non-exclusive, the pricing structure under which the distributor will purchase the products from the supplier and the supplier’s brand requirements.
What is the difference between agency and distribution?
The key difference between an agency agreement and a distribution agreement is that in a distribution agreement the distributor takes legal ownership of the goods to be sold, and the full risk of whether or not the goods will be re-sold. Of course, the distributor is also able to charge more for the goods in order to cover its costs and make a profit. The only way in which the original manufacturer or supplier of the goods has a direct contractual relationship with the end-customer is in relation to product liability and the manufacturer’s own guarantee or warranty. On the other hand, an agent will negotiate and complete a contract with the customer on behalf of the supplier, the agent will not be a party to the contract themselves. They will simply receive a commission from the supplier for having arranged the sale.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal advice, nor is it a complete or authoritative statement of the law, and should not be treated as such. Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission. Before acting on any of the information contained herein, expert legal advice should be sought.