Distribution agreements govern the relationship between a manufacturer or supplier with its distributor, who purchases specified products and then sells them on to its own customers, such as a retailer or even the end user. Although legally, there is no distinction between distribution agreements and reseller agreements, commercially some parties still refer to them as separate arrangements. Here we seek to explain the differences and the main commercial considerations when entering into either one.
- What is a distributor?
- What is a reseller?
- What is the difference between distributors and resellers?
- Types of distribution
- What is a distribution agreement?
- What should a distribution agreement include?
- Internet selling
- Are distribution agreements legal under competition law?
- How will Brexit affect competition law?
- How Harper James Solicitors could support you when drafting an agreement
What is a distributor?
A distributor purchases goods or products from a manufacturer or supplier and then sells them onto its own customers. These could be retailers or end users, for example. Ownership of the products (and consequently any risk) passes at each stage, from the manufacturer or supplier to the distributor and then from the distributor to its customer. The distributor will sell the products on at a higher price to cover its own costs and provide it with a profit.
What is a reseller?
From a commercial perspective, a reseller purchases goods from one party, perhaps a distributor and then sells them onto another party, often the end user. Ownership of the products (and consequently any risk) passes at each stage. The reseller will sell the products on at a higher price to cover its own costs and provide it with a profit.
What is the difference between distributors and resellers?
From a legal perspective, there is no distinction between a distributor and a reseller. Any differences between the two are purely commercial in nature and are reflected in the drafting of the relevant agreement. For example:
- It can be argued that distributors are perceived as being closer to the manufacturing stage than a reseller but from a legal point of view, this is just a matter of semantics.
- International organisations may refer to ‘distributors’ and ‘resellers’ to differentiate between a party who distributes the products in a specific country through resellers.
- Distributors may have a greater number of, or more arduous obligations than resellers, but on the other hand may have greater flexibility, for example in the use of intellectual property (IP) rights relating to the products.
- ‘Value added resellers’ are specific to the IT sector.
This guide therefore covers distribution agreements, which can be tweaked as required if a ‘reseller agreement’ is required.
Types of distribution
There are four main types of distribution relationship, each requiring their own specific considerations and negotiation points:
- Exclusive distribution where there is only one distributor in a certain territory who has the exclusive right to sell the products in that territory.
- Sole distribution where there is only one distributor in a certain territory but where the supplier itself can also sell the products to final customers in that territory.
- Non-exclusive distribution where there are multiple distributors in a certain territory and where the supplier itself can also sell the products in that territory.
- Selective distribution where distributors are appointed if they meet specific criteria.
The terms of the distribution agreement will depend on the type of relationship that the parties have agreed, which will often affect the risk and obligations that each party is willing to take on.
What is a distribution agreement?
A distribution agreement is the written contract that sets out the terms and conditions and relationship between the manufacturer or supplier and the distributor. Usually, the distribution agreement specifically governs the relationship between the supplier and the distributor. The supplier’s standard terms and conditions will govern the terms by which the products are sold and purchased between the two parties. The two documents therefore need to interact, and it is crucial that the distributor fully reviews and understands the specific terms and conditions. Because of this, commercial legal advice should always be taken.
What should a distribution agreement include?
It is imperative that the terms of a distribution agreement are clearly set out and cover all the pertinent issues to avoid potential confusion and litigation in the future, and to ensure that the terms agreed comply with competition law and other regulations. So, it’s sensible to obtain legal advice on the drafting and negotiation of a distribution agreement.
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If the arrangement is a reseller agreement in the commercial context, the supplier (the distributor) will need to ensure that the terms reflect those in its own distribution agreement with the supplier or manufacturer higher up the chain. For example, if the manufacturer is able to increase the product price, then the distributor will also need the flexibility to do this in the reseller agreement. As a result, a reseller may find that it does not have the bargaining power to negotiate the terms of the arrangement.
The products to be covered by the agreement must be clearly set out. This can be done in various ways, for example, by description, identification number, trademark number and so on, and will depend on the type of product in question. The supplier is likely to want flexibility to change the product either because of innovation or because it is withdrawing a product from the market. But the distributor will want to ensure that any exclusivity rights that it has will continue in respect of new products.
The number of products to be provided to the distributor and the timing of these also need agreement. This is often based on forecasted figures provided by the distributor.
Territory or customer type
The agreement must be certain as to the territory or customers covered by the arrangement. If the agreement provides for exclusive distribution, the position regarding any territories not currently covered by the distribution arrangements should also be set out. Can the distributor sell into those territories? Will it have an option to acquire exclusivity in those territories in the future? Who else can sell there? Not only do these questions need to reflect the agreement between the parties but they also need to comply with competition law.
The term of the agreement is a commercial consideration for the parties but there are various alternatives. It may be for a fixed term or an initial probation period could apply. If the agreement rolls on for successive fixed term periods, the parties will need to ensure that no amendments to the agreement are required before the new period commences.
Details of payments and timing of payments
The specific payment terms must be included in any agreement otherwise the contract may be void for uncertainty. So, the currency, method and timing of payment must all be clearly set out. A supplier may also require some form of security, such as a letter of credit, or even insist on retention of title to the products until payment has been made. Parties should bear in mind that retention of title clause can be unenforceable if drafted incorrectly.
A supplier will want the ability to increase its prices, but this is likely to be resisted by the distributor. Usually, a minimum notice period for a price increase is the best that the distributor can achieve.
Suppliers need to be careful with regard to price restrictions. Most of these will be anti-competitive, although setting a maximum resale price for ongoing sales by the distributor to its customers is permitted.
Any minimum purchase requirements?
A supplier is likely to require the inclusion of minimum purchase obligations or targets. Consideration needs to be given as to whether these will be determined by reference to the number of products purchased by the distributor (likely to be preferred by the distributor) or the number or value of sales by the distributor to its customers (which provides more accurate sales information).
The parties will also need to agree whether these figures are subject to periodic increase or whether they will be reviewed on say, an annual basis. What will happen if agreement between the parties cannot be reached? Would this constitute a termination event?
The agreement also needs to be clear as to the effect of non-compliance with these minimum requirements. The most draconian outcome would be termination of the agreement by the supplier, but an alternative measure may be loss of the distributor’s exclusivity in a territory (if applicable).
That said, suppliers need to carefully consider the effects that this may have on the distributor’s motivation going forward. If loss of exclusivity does apply, the agreement will need to be reviewed to ensure that it still follows competition law.
The IP rights in the products may be significant and a supplier is likely to want to retain control of these. Depending on the product, various IP rights may apply, such as trademarks, design rights and copyright. As such, the IP clauses in a distribution agreement may be extremely important, and from the supplier’s point of view, it is imperative that sufficient protections and comfort are given; possibly less so in a reseller agreement assuming that any IP rights remain in the name of the supplier/manufacturer, although certain protections and comfort will still be needed.
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The parties need to agree when the agreement can be terminated. For example, can either party terminate the agreement on notice (and how long should that notice period be), or must one party be in breach or subject to an insolvency event? If the distributor fails to meet minimum purchase targets, can the supplier terminate the agreement?
The agreement also needs to be clear as to the position of stock, orders and so on if the agreement terminates. Distributors are not entitled to compensation on termination of the agreement and should bear this in mind when discussing termination provisions to ensure that they are adequately protected.
How to prevent a distributor selling products that compete with your own
Non-compete clauses are permitted under competition law, provided that they do not exceed five years in length. Anti-competitive restrictions need careful thought and drafting to be enforceable.
Although the parties will need to comply with all relevant laws anyway, it is normal to include a specific provision in the agreement about these. Suppliers should also bear in mind specific UK legislation. The Bribery Act 2010, for example, states that where an associated person (such as a distributor) engages in bribery, failing to stop such bribery is a corporate offence. Not preventing the facilitation of tax evasion by an associated person is another corporate offence. You should seek legal advice immediately if you have any concerns about compliance.
In some distribution arrangements, there is the potential for the Transfer of Undertakings (Protection of Employment) Regulations 2006 to apply, which means that employees engaged in distribution activities may transfer across to the distributor or to the supplier either at the start of the distribution relationship or following its termination. This will depend, for example, on whether the employees were principally engaged in the activities and how closely the activities mirror those governed by the relevant agreement.
Other provisions will also be included in the distributor agreement. Specific obligations on each of the distributor and the supplier will be set out, for example:
- Their advertising and promotion obligations
- Requirements as to the provision of information
- Maintenance of stock levels, agreement not to alter the products
- The provision of training in respect of the products
- Insurance requirements
One provision which may also be considered is a force majeure clause, which provides what happens if a force majeure event arises, that is an event which no one could foresee. Given the COVID-19 pandemic, both suppliers and distributors should consider ensuring that they have a well-drafted force majeure clause in the agreement.
What about international resellers?
Where distribution agreements cross international boundaries, it is important that legal advice for the relevant jurisdiction(s) is obtained. Local taxes and import and distribution laws may apply, which may affect the relationship or require documentation or filings. Insurance requirements may also differ depending on the jurisdictions involved.
Online selling and marketplace portals are now commonplace and there are specific laws and potential issues which apply in this context. Competition law also differs depending on whether the sales are online or not. Harper James has IT law specialists who are able to advise you in this respect.
Are distribution agreements legal under competition law?
In the main, distribution agreements are legal under competition law, with the majority falling within the EU vertical agreement block exemption. A vertical agreement is an agreement between parties who, for the purposes of the agreement, are operating at different levels of the supply and distribution chain (such as a distribution relationship). If the vertical agreement block exemption does not apply, the agreement will need to be considered in light of the relevant competition regime (UK or EU) to determine whether it is anti-competitive or not.
Notwithstanding the above, certain provisions in a distribution agreement can cause competition law issues (for example, price fixing). This can possibly result in the vertical agreement block exemption no longer applying, and it is important that the written document is reviewed by your legal advisor to ensure that these do not arise. In particular, selective distribution arrangements can cause competition law issues.
Further information regarding competition law and distribution agreements can be found here: Horizontal and Vertical Agreements.
How will Brexit affect competition law?
Brexit should not materially affect competition law in the immediate future. During the transition period, the UK is still being treated as an EU member state and so the status quo will be preserved until the end of 2020. The UK Government has also announced that, after Brexit, there will be no significant changes to the domestic competition law regime.
That said, the EU vertical agreement block exemption, which exempts certain agreements from falling foul of EU and UK competition law will expire in 2022 and it is not clear whether the UK will then adopt any changes made at EU level. However, the general consensus is that vertical agreements are much less likely to have anti-competitive effects than horizontal agreements and so any amendments are likely to be in the detail rather than a fundamental switch.
How Harper James Solicitors could support you when drafting an agreement
At Harper James Solicitors we have experience in all types of distribution agreements, ‘reseller agreements’, contract law and IP law and are more than happy to discuss your distribution and supply plans with you to ensure that you are adequately protected, obtain full advantage of the benefits available under these arrangements and do not fall foul of any competition law issues.