EM Law | Commercial Lawyers in Central London
Distribution agreements are typically used as a low risk means of expanding business into new markets or territories.
Under a distribution agreement, the supplier or manufacturer sells its products to the distributor, who then sells the products on to its customers, adding a margin to cover its own costs and profit. In purchasing and reselling the products, the distributor contracts both with the supplier and with its customer, and title to the products in question will pass to and from the distributor.
Types of distribution agreements
An exclusive distribution arrangement is one whereby a supplier agrees to sell the contract products only to the distributor within a certain defined territory, and agrees not to appoint other distributors or sell the products directly to other customers within the territory.
Such an arrangement is frequently used to exploit a product within a new territory. The supplier appoints a distributor with local knowledge and usually an established business within the territory. The distributor in turn agrees to take on the high risk and costs associated with promoting a new product in return for the knowledge that, as exclusive distributor, it alone will benefit from its sales and promotion efforts.
The supplier has the advantage of knowing that the distributor will be motivated to sell its products, particularly if a restriction is placed on the distributor prohibiting it from selling competing products. The supplier can use the threat of withdrawing the exclusivity if target sales are not met by the distributor within a specified period.
A “sole distribution agreement” is one whereby a supplier appoints a distributor as its only or sole distributor within a territory, but the supplier reserves the right to supply the products directly to end users. The meaning of the term should always be clarified within the agreement.
Such an arrangement combines the advantages of exclusive distribution for the distributor, with the advantage for the supplier that it is free to promote the products itself within the territory and to continue to deal with any customers it may have had in the territory before the appointment of the distributor. Such an agreement would contain similar provisions and restrictions to those in an exclusive arrangement, but it would afford more control by the supplier over the territory, should the distributor fail to meet the required minimum purchase targets.
A non-exclusive appointment gives the supplier complete freedom both to sell directly and to appoint other distributors within the territory. The terms of the appointment will be far less onerous on the distributor than those within an exclusive or sole appointment, as it will need to compete with the supplier and other distributors in terms of both pricing and promotion of the product.
A supplier, in appointing a distributor as part of a selective distribution system, agrees to appoint additional distributors only if they meet certain criteria. This effectively limits the number of additional distributors who will be appointed within the territory. Selective distribution arrangements are perceived as particularly suitable where the nature of the product requires an enhanced level of service or advice at the point of sale to the customer and where the supplier or manufacturer will be required to provide after-sales support. Owing to their potentially exclusionary nature, such arrangements can cause competition law problems. However, examples of products for which a selective distribution system has been held to be justified include high value cosmetics, pharmaceutical products and electrical goods.
Competition law and regulation
Under the EU and UK competition rules, there is a specific framework for assessment of vertical agreements. A vertical agreement is one that is entered into between businesses operating at different levels of the economic supply chain, and includes, for example, agency and franchising arrangements as well as distribution agreements.
Most distribution agreements will benefit from the automatic (block) exemption afforded to vertical agreements and therefore fall outside the scope of the EU and UK prohibitions anti-competitive agreements, provided that criteria for the block exemption are met.
On 29 March 2017, the UK government gave formal notice of the UK’s intention to leave the EU under Article 50(2) of the Treaty on the European Union. The direct legal implications of the UK leaving the EU for distribution agreements are unclear. The current legal framework will not change until the exit negotiations between the UK and the EU are finalised. However, the UK’s exit may affect existing laws on distribution agreements. Areas that may be subject to change include competition rules (and the administration and enforcement of competition law), the definition of “Territory” (particularly references to the “European Union”) and the possible applicability of TUPE.
Fundamental terms of the appointment
Some or all of the following will need to be addressed before the distribution agreement can be prepared:
- Extent of the territory or customer group: this should be defined precisely. State expressly whether territory includes jurisdictions whose constitutional status might otherwise have to be checked, for example, does the United Kingdom include the Channel Islands or the Isle of Man, and does France include the French overseas territories? This could also be important for delivery obligations in the supply terms. Consider also whether the defined “Territory” may change, for example, the defined term “European Union” after Brexit or “the United Kingdom” if Scotland were to leave the UK.
- Basis of the appointment: for example, exclusive, sole or non-exclusive. Spell out what these terms mean in the context of the agreement, for example, by stating that the supplier will not appoint another distributor in the territory, or that the supplier will not itself sell directly into the territory, or whatever happens to be the case.
- Term of the appointment (including a minimum term, notice periods and provision for renewal). Where applicable, consider the implications of Brexit as regards duration of the appointment.
- Establish the products or ranges of products which are to be covered by the agreement. Consider whether the distributor is to have the right to market new products as they become available or to suggest new products for development. Should future rights extend to developments of the existing products using the same technology, or different products which perform the same function as existing products but using different technology, or completely different products but marketed under the same brand name?
- Establish who is to be responsible for complying with local formalities and obtaining any necessary permits (generally the distributor) and arrange for this to be done at an early stage.
For any questions, our distribution agreements solicitor Neil Williamson can hep you.