Local distributors and commercial agentsDistribution relationships
What alternative distribution relationships are available to a supplier?
The options for distribution, for the most part, are limited only by the creativity of the business people structuring the relationship. The most common are discussed below.Direct distribution
Distribution by the foreign supplier using its own employees or through a subsidiary.Commercial agents and sales representatives
The agent does not purchase or take title to the goods, but rather sells them on behalf of the foreign supplier and receives a commission. Matters such as who actually delivers the product, who generates the invoice, how risk of non-payment is shared and other logistical matters may be addressed by contract, together with a definition of each party’s duties and how the relationship may be terminated.Independent distributors
The supplier contracts with an independent distributor that buys goods from the supplier, taking title to those goods, and resells them at a profit to its own customers. The details of the relationship, including the responsibilities of each side and the parties’ rights to terminate, are defined by contract.Franchising
Franchising, under the typical definition, amounts to the use of independent distributors who: (i) are licensed to use the supplier’s trademarks, either in the business name or in the products sold; (ii) are required to follow a prescribed marketing plan or method of operation; and (iii) pay a franchise fee to the supplier. (Under New York law, a franchise exists when either of the first two elements is present, and a franchise fee is paid.) The specific definition and the consequences of being deemed a franchise vary from state to state. In many US states, franchises are regulated in one, or both, of two ways. First, many states and the Federal Trade Commission (FTC) require disclosure documents in a prescribed format to be provided to the prospective franchisee and, in some states, to be registered with the state. Second, some states regulate the substance of the relationship between the franchisor and the franchisee in various ways, most notably by restricting the franchisor’s right to terminate or not renew the relationship except for statutorily defined good cause, often requiring a specified period in which the franchisee may cure any default. States that regulate franchising often require franchisors to submit to jurisdiction and appoint an agent for service of process in the franchisee’s state.Joint ventures
A joint venture can be established by a foreign supplier with its distribution partner in the US, whether the partner is an agent, distributor or franchisee, by having the local distribution entity owned in part by the supplier, directly or through a subsidiary, or through another form of sharing of profits and expenses. An ownership interest can provide greater control through ownership rights and representation on a board of directors or management committee.Licensing of manufacturing rights
A foreign supplier may license a US manufacturer to use its intellectual property – patent, copyright, trademark or trade secrets – to make its products locally and sell them. While all the implications of licensing intellectual property are beyond the scope of this chapter, care must be taken by the licensor to maintain quality control over the finished product and the use of the intellectual property. Failure to do so can not only put the brand equity at risk, but it also risks the loss of trademark protection.Private label
Distribution of products under a private label amounts to a reverse licensing arrangement where a US distributor or retailer distributes the foreign supplier’s products under the US business’s own trademark. In essence, the supplier gives up its own brand name in exchange for the distribution strength of its US partner, with the supplier reaping no enhanced brand value. Control over sales, distribution, marketing and advertising are in the hands of the local brand owner, resulting in negligible distribution costs to the supplier and virtually no control, save perhaps for sales and performance benchmarks in the contract, with benefits to the supplier limited to its profits on sales of the product.Legislation and regulators
What laws and government agencies regulate the relationship between a supplier and its distributor, agent or other representative? Are there industry self-regulatory constraints or other restrictions that may govern the distribution relationship?
By and large, the relationship between the supplier and its distribution partner is governed by contract, which the parties are free to structure as they wish. Notable exceptions are: (i) business franchises, which are regulated by federal disclosure requirements and by various state disclosure, registration and relationship laws; and (ii) federal and state laws governing certain industries, which can regulate the right of a supplier to terminate a distribution relationship, among other aspects of the relationship. There are federal laws governing automobile dealers and petroleum products retailers (petrol stations). Many states have similar laws for those industries, and there are state laws governing beer, wine, and spirits, farm equipment and occasionally other industries. (Understanding the laws and regulations governing businesses and individuals in the US is complicated by the fact that there is regulation at the national, federal and state level by each of the 50 US states, Washington, DC, and US territories and possessions, such as Puerto Rico, the US Virgin Islands and Guam.)
Many industries have adopted codes of conduct applicable to companies in the industry, which suppliers often incorporate into their distribution agreements so they become part of the contract. (Some companies incorporate similar codes of conduct that they have adopted individually.) Such codes of conduct that have been incorporated into contracts by reference are enforceable just like any other contract provision.Contract termination
Are there any restrictions on a supplier’s right to terminate a distribution relationship without cause if permitted by contract? Is any specific cause required to terminate a distribution relationship? Do the answers differ for a decision not to renew the distribution relationship when the contract term expires?
The parties’ freedom to contract generally governs the distribution relationship, including the parties’ right to terminate or not to renew the relationship without cause or for specified reasons. However, some states’ laws restrict the ability of franchisors, and of suppliers in certain industries, to end a relationship. Where a statutory restriction exists, it often prohibits termination without good cause, just cause or a similar formulation. This cause is often narrowly defined and typically does not include poor performance, but often does include a material failure to comply with reasonable contractual requirements, which makes clearly drafted and substantively reasonable contractual performance standards important. Moreover, many states require that, before termination occurs, the franchisee or distributor be given a specified period of time – often 60 or 90 days – in which to cure any deficiency or breach. The statutory ‘good cause’ requirements typically, but not universally, apply equally to a failure to renew a contract on expiration.
In the absence of such a statute, however, there is generally no restriction on the parties’ ability to agree on the conditions for termination with or without cause. Where there is no applicable statute and no agreement, or no contractual provision regarding termination, state law may imply requirements for reasonable notice or a reasonable time to recoup investments made by a distributor before permitting a termination without cause.
Is any mandatory compensation or indemnity required to be paid in the event of a termination without cause or otherwise?
When an applicable statute restricts termination without good cause or where a termination violates a contract’s terms, the wrongfully terminated distributor may recover damages and, in some cases, may be able to obtain injunctive relief preventing termination. (The requirements for injunctive relief vary from state to state, but typically require irreparable harm that is not adequately compensable with money damages. This is often interpreted to mean a likely inability for the business to survive in its current form.) Where damages are to be awarded, the amount will vary from state to state and usually is not defined by any specific formula or multiple of profits or sales. Often the damages will be defined as the fair market value of the distributor’s business in the terminated product lines (ie, what a willing buyer and a willing seller, neither under compulsion to deal, would agree on for the price of the business). Damages may also be calculated as the net present value of the profits that would be earned by the distributor in the absence of termination. In the absence of an applicable statute or breach of contract, damages will not be assessed for a proper termination.Transfer of rights or ownership
Will your jurisdiction enforce a distribution contract provision prohibiting or restricting the transfer of the distribution rights to the supplier’s products, all or part of the ownership of the distributor or agent, or the distributor or agent’s business to a third party?
In general, yes. However, there may be specific laws applicable to certain industries that limit a supplier's ability to prevent transfers of ownership, or otherwise affect the enforceability of such provisions.
Law stated dateCorrect as of
Give the date on which the information above is accurate.
7 February 2020