Distribution Damage: 5 Common Distribution Agreement Mistakes that Could Harm Your Business
Regardless of whether you are a supplier or a distributor, your business could benefit from a distribution agreement. A distribution agreement is a legally binding contract between a seller of goods and a distributor that outlines the details involved in the sale and transfer of goods. By having a distribution agreement, businesses save time and money by avoiding misunderstandings that affects the profitability of each party and preventing future litigation over disputes.
Typically, a distribution agreement designates what goods are being sold, how many goods are being sold, how the goods will be transferred, and what steps each party can take if something goes wrong. Common provisions include a detailed item description, delivery terms (Incoterms), transfer of title (when ownership of the product is transferred, risk of loss or damage until transfer of title), inspection protocol, auditing terms and return and exchange policies. While having a distribution agreement in place is advantageous, it is important to avoid the following 5 common mistakes businesses make in drafting distribution agreements.
1) Not using a distribution agreement
Distribution agreements are extremely helpful for businesses because they allow each party to clearly state the terms of the sale as well as protect themselves in the event that something goes wrong with the transaction, such as the goods being damaged or inferior products being delivered, or payment not being received. By not using a distribution agreement, parties have deprived themselves of a legally enforceable framework under which each side agrees to do business. Without this framework, parties are often forced to resort to expensive and time-consuming litigation for resolution which can even include fighting over which state or country’s laws apply and which state or country has jurisdiction over the transaction before the underlying issues are even discussed.
2) Attempting to distribute too much, too fast
When a new distribution agreement is created, the seller and distributor agree to a certain quantity of goods to be sold and distributed. Problems arise, however, when either party overestimates or underestimates distribution projections. Overly optimistic quantities can often sour a business relationship and lead to a surplus in product or services which can be dangerous to a business’s cash flow. An underestimation leads to unhappy end customers and loss in revenue potential and possibly good will of your product or sales. Initially, both the seller and distributor should set small goals and only after proven success, expand the quantity of goods and use forecasting models to assistance with future orders.
3) Failing to specify whether the agreement is exclusive or nonexclusive
Distribution agreements can either be exclusive or nonexclusive. An exclusive agreement typically involves a seller awarding a distributor a certain territory or outlet for distribution with the understanding that it will not award the same area to another distributor. Failing to specify whether the agreement is exclusive or nonexclusive can create confusion and potentially conflict with fair competition laws. In addition, when used properly the term of exclusivity can be a powerful sales tool to incentivize the right distributor. However, the opposite is also true, granting a distributor exclusivity when there is little value to you can limit your options to expand the distribution channels to that area. Finally, any term for exclusivity, should at minimum include a floor amount as to the amount of sales that is required by that distributor in any given defined period of time (i.e. one year, six months, etc.) in order to maintain its exclusivity status.
4) Lack of termination clauses
An effective distribution agreement should include language outlining conditions where termination of the contract is possible and the applicable termination procedures. Termination clauses should protect both parties equally, include termination for cause and without cause, as well as provide the terms under which notice of termination should be given. In addition, any termination clause should outline what happens to the parties’ rights upon termination, both with and without cause. For example, upon termination with or without cause, a distributor may be obligated to cease all sales and marketing efforts and any inventory still remaining in distributor’s possession shall be shipped back to the manufacturer within seven (7) days of termination and distributor shall be credited at the original price sold to the distributor for the product returned to manufacturer within thirty (30) days of receipt by manufacturer.
5) Lack of renewal language
Parties should also include renewal language in their distribution agreements. Some agreements specify that renewal is automatic, while others stipulate that certain performance goals must be met before the relationship qualifies for renewal. While the parties have flexibility in crafting renewal language to fit their needs, an absence of this language can disrupt continuity of sales and supply, leading to potential lost profits on both sides.
Distribution agreements tailor-made for your business
Because distribution agreements are such an important part of business, both suppliers and distributors should seek qualified business lawyers to ensure that their agreement complies with applicable laws and protects their business interests. If you are a business owner who would benefit from a distribution agreement, contact the experienced business lawyers at the Campbell Law Group.