We’re all stuck for time. In a long and complex distribution agreement between supplier and distributor, what is the single most important clause that a supplier of goods needs to enforce? Read on and I’ll tell you.
Hello all! Simon here from The Contract Company. Contracts, that’s what we do all day every day. Sometimes overnight, but that’s ok because we love contracts and everything about them.
So. You are a supplier and you supply goods to a distributor. The distributor might want exclusivity in a particular region. What clause do you look out for? Easy – Volume.
If you have no idea what the significance of a volume clause is, allow me to explain. The distributor wants exclusivity in the given area so that they are safe. As the only distributor in that region, they are going to spend considerable effort in marketing and sales. They need exclusivity to do this. It can be tricky to grow in a normal market, but far more difficult when there are multiple competitors trying to undercut the distributor on many different business vectors with an identical product. So, simply put, the distributor wants the reassurance of Exclusivity.
On the other hand, the supplier has a different set of concerns. They sign up to a contract for 1, 2,3,4,5 years or more with given rates and expectations but have no reassurance that the distributor will buy a significant amount. Which is why a volume clause needs to be inserted in order to provide some assurance to the supplier that they are making a certain amount on the contract.
It does not cover all areas. The price of labour, materials, electricity, transports, etc, can go up and thus the profit margins may go out of whack. Yet, all things remaining equal, the volume clause will provide a financial safety net for the supplier who can rest easy knowing that a minimum volume is forthcoming from the distributor. Provided you put the volume clause in place.
So it can be a good bargain to ‘trade’ exclusivity for volume between supplier and distributor. For instance, let’s say the minimum volume is 500 products in a given quarter. Obviously, they will be hoping to do better, but at least 500 product sales are guaranteed in those 3 months. Because of this comfort, it is a good trade to give exclusivity to the distributor and the supplier is assured of a given financial income stream, regardless of whatever else happens.
This is why I believe that mandating a minimum volume of orders is the most important clause to insert into a Distribution Agreement. You will make the money that you need in order to grant the exclusivity to the distributor. The agreement is also going to stipulate that the contract can be terminated by the supplier if the minimum volume requirements are not met (most likely). This is a reasonable stipulation given that the distributor is not upholding his/her part of the bargain. The supplier will have the option to terminate.
After drafting and analyzing thousands upon thousands upon thousands of contracts, this is my assessment of the most critical clause for a supplier to insert in a distributor agreement. But it’s just my opinion and I’m happy to chat with you about your unique circumstances. After all, no two contracts are the same.
Hope this helps.
What is a distribution agreement?
A distribution agreement is made between a distributor and a supplier. The distributor can be a store or group of stores. The supplier is often the manufacturer, but can also be the wholesaler or importer. The agreement is quite simple – the supplier agrees to supply a set amount of goods to the distributor at a given rate.
Sounds easy – why can’t I draft one up myself?
Well, it might sound simple – selling a certain amount of items for a given price. But the inner workings are incredibly risky and complex. Experienced business people will take advantage of those who don’t know what they’re doing. A distributor agreement should cover:
- The specific area of product distribution.
- Whether the distributor has exclusive rights in the region.
- Whether the distributor can sell to sub-distributors.
- Whether the distributor can sell competing products.
- Any clauses regarding acceptable marketing methods.
- Payment terms and conditions.
- Clauses to do with IP and confidential information.
- Termination for cause or convenience.
- Party responsibilities post contract termination.
- Renewal terms.
- Frequency of price changes adjustments.
There are a thousand ways to get taken advantage of a party and many moving parts to account for. The contract needs to be very clear and well written so you know exactly where you stand. Otherwise, best of luck enforcing something that isn’t in the initial distribution agreement.
What are the benefits of distribution agreements?
The distribution agreements allow mutual benefits for both suppliers and distributors. The distributor is assured of the purchase of a set amount of goods from the supplier at a given rate, and that the goods are of a certain quality and standard. And the supplier is assured of sales to the distributor. As mentioned above, the supplier might benefit from a minimum volume clause while the distributor might benefit from an exclusivity clause.
What is the difference between a distributorship and an agency?
In a ‘distributorship’ (i.e a distribution agreement resulting in a distributorship), the distributor has legal title to the goods. They cannot sell the goods in the name of the supplier. In contrast, with an agency agreement, there is an agent that is selling the goods in the name of the distributor. The agent never takes legal possession of the goods. They merely sell them in return for a commission.
What are the standard terms found in distribution agreements?
Distribution agreements can get quite complex and there are many permutations. However, all should contain the following information:
- The supplier name.
- The distributor name.
- The product/service.
- The location of sale.
- The payment terms.
- The duration of the agreement.
- Conditions for termination.
- Duties of each party and remedies for breach of duty.
- Whether the supplier may appoint other distributors in the area (i.e exclusivity).
- Terms of renewal.
What are the most common mistakes found in distributor agreements?
Mistakes can be made by either party. Many fail to specify what happens after termination with regard to product returns and customer service. Another mistake is that a supplier should not really grant exclusivity to an unproven distributorship in a large area, as they limit their options. Many new parties are eager to ‘lock in’ rates and terms and do not allow for easy termination or frequent alteration of contract. It is probably better to allow for termination for convenience, which can avoid a legal skirmish but allow for flexibility. It is also best to allow for contract termination after a year.
While long term contracts might sound like a great deal, understanding that economic conditions can easily change. A flexible partnership built on performance instead of words is going to thrive and expand. In contrast, long term rigid contracts are often a recipe for one side to get hammered.
But there are ways to make the agreement amenable to both parties, with a little expertise.