18 December, 2022
When a supplier or manufacturer is interested in selling products in a foreign country, one of the first points to consider is the sale method – whether to distribute the goods through an agent, through a distributer or by direct sales. This matter involves marketing and logistical aspects as well as legal aspects. In this article, we will briefly review important points to note when entering a distribution agreement.
A distribution agreement is signed between a supplier and a distributer. The distributer buys the products from the supplier, stores them as part of its stock and sells them to its clients. A distributer’s profit is based on the difference between its purchase price from the supplier and its sale price to clients.
Please note that points below are a brief review and do not constitute legal advice, nor are they a comprehensive list of all the matters that must be considered when entering a distribution agreement.
A. Exclusivity – is the supplier granting the distributer an exclusive right to distribute the products?
If exclusivity is granted (there is no obligation to grant it), it includes several components that should be considered:
B. Purchase goals
Granting distribution rights (whether exclusive or not) is not a simple matter. It is usually granted on the condition of meeting a certain annual sales goal. Failure to meet these goals may allow the supplier to terminate the agreement, turn to an additional distributer or employ other repercussions.
C. Defining the distributer’s obligations
While it is trivial that the distributer purchases the products and sells them in the destination country, the distributer may have other commercial obligations as well, such as marketing, advertisement campaigns, establishing a logistics / support system, providing warranty etc.
D. Sale and payment conditions
A distribution agreement is also a product purchase agreement, and sale terms (incoterms) such as payment method, exceptions, retention of title (ROT) clause and others should be part of the distribution agreement.
E. Defects, deficiencies etc.
Clear rules for the method of reporting defects upon arrival of the products (such as sending photos, obtaining the services of a professional assessor etc.) should be defined, as well as a clear return/replace/repair policy.
F. Product liability and warranty
These two terms should not be confused – product liability applies to the manufacturer (and other entities in the supply chain) for bodily damages from use of the product, and in some countries to other damages as well. As a general rule, clauses that exempt from liability will not be valid, but an indemnification mechanism may be established. For example, if the distributer will be forced to compensate due to damages, the supplier will commit to indemnify the distributer (and perhaps demand that an insurance policy for such cases be provided). Warranty is a commitment by the warranty provider to provide services such as repair or replacement for the product. In many cases, particularly if the product is not a consumer product (intended for a private end user as opposed to a business end user), there is no legal obligation to provide warranty, and it is granted due to commercial considerations. The end user may still rely on various options for cancelling the transaction set in the law, even with no warranty.
G. Limiting warranty and compensation
A breach of the distribution agreement by one of the parties may result in severe damages to the other party, including indirect and consequential damages. Therefore, in many cases limited warranty and compensation clauses are included in distribution agreements. Even so, there are cases in which these clauses are void – such as in the case of product liability.
H. Product intellectual property rights
The supplier usually keeps all the product’s intellectual property rights (trademark, design, copyright etc.). accordingly, under Israeli law an exclusive importer cannot prevent parallel import of authentic products (not fake copies), even if they are included in the exclusivity agreement (there are nuances and exemptions to this rule that will be clarified in a separate article).
I. Termination of contract
Termination of contract can occur in several methods:
J. Dispute resolution mechanism
It is common (and recommended) to set a dispute resolution mechanism. This may be through a choice of law clause, a governing law clause or an arbitration clause, which may designate a specific court or arbitrator or simply refer to a legal system or jurisdiction.
K. Compensation and indemnification in case of contract termination
In general, breach of contract grants the damaged party the right to compensation due to the violation, but if the contract was legally terminated (whether due to the end of the period or due to the violation), there are no grounds for compensation. Even so, if the agreement simply ended and was not extended, a distributer may argue that it invested heavily in introducing the product to the market and gaining a market share, and with the termination of the agreement – the distributer is left with nothing. Therefore, distributers sometimes demand indemnification in case of contract termination due to their investment in promoting the products. The sum demanded is usually derived from the length of the contractual period and the profit made by the distributer. The default in most countries is that this is not a legal right, and if the distributer is interested in an indemnification clause, it must insist on its explicit inclusion in the agreement. It should be noted that in Israel and the EU such a legal right does exist for agents, not distributers.
With regard to an agreement with no set end date, Israeli case law determined that a distribution agreement with no set end date may be ended by issuing a reasonably early notice, as the right of distribution is a contractual right. If the agreement was ended without proper prior notice, the terminating party will have to compensate for failure to provide proper notice.
L. Do you even need a contract?
If you reached this far, the need for a contract should be obvious. Even so, it is important to note two issues in this respect:
The content in this communication is provided for informational purposes only and is not intended to be comprehensive. It does not serve to replace professional legal advice required on a case by case basis. The firm does not undertake to update the information in this communication or its recipients about any normative, legal or other changes that may impact the subject matter of this communication.
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