Minimum purchasing requirements are a useful tool for suppliers in managing distributors’ performance. However, using such requirements in order to terminate a distributor requires a considered and thought-out approach.
What are minimum purchasing requirements
Minimum purchasing requirements are obligations set out in distribution agreements that oblige the distributor to purchase a certain amount of product from its supplier.
- encourage the distributor to actively pursue sales with its customers so as to meet purchasing requirements set out by its supplier; and
- allow performance of the distributor to be monitored.
The distributor is appointed to sell product, often via an exclusive distributorship, in a certain territory or to a certain customer group. If it is not buying product from its supplier, it is not selling product to customers!
A failure by the distributor to sell sufficient quantity or value of product to its customers defeats the object of having appointed the distributor in the first place.
A supplier gains not only a useful tool in managing a distributor by including minimum purchasing requirements, but also a potential way to exit a failing distributorship.
The reliability of minimum purchasing requirements
How reliable minimum purchasing requirements are depends on what the agreement says, or in the case of unwritten agreements, what has been agreed by the parties.
Obviously a more formal agreement that sets out purchasing requirements is going to be more useful to the supplier in this scenario. However, this comes with the warning that an unclear, poorly drafted minimum purchasing requirement can cause more headaches for a supplier than you might expect.
Uncertainty always gives rise to the risk of a dispute. It is therefore important that the obligation to meet minimum purchase requirements and the consequences for a distributor that fails to meet those requirements are clearly set out in the agreement and understood by both parties.
Often formal written contracts are half complete – for example, perhaps minimum purchasing requirements are provided for Years one, two and three, but then the agreement is silent as to what happens next, or the agreement says something like ‘the parties will then meet to agree the following year’s requirements’ which is an unenforceable agreement to agree in law.
Terminating an underperforming distributor
Where minimum purchasing requirements are included in written agreements, or agreed in unwritten agreements between the parties, clear consequences for the distributor in failing to reach the required levels should be included.
Why rely on minimum purchasing requirements? The notice period to terminate in long-term distribution agreements is likely to be substantial – perhaps something between six and 12 months – and . a supplier is unlikely to want to keep an underperforming distributor in its supply chain for such a significant period of time.
What does termination look like?
In the termination clause, the ideal situation for a supplier is to have a particular provision that gives a supplier an immediate right to termination if the distributor fails to achieve minimum purchasing requirements. This is an absolute right and provides for the right to be effective in a binary sense – either the distributor meets the requirements, or it does not.
However, unless the supplier is in a particularly strong position, a “one strike and you’re out” approach is unlikely to be accepted by the distributor.
So what else is relevant?
An immediate right to termination for the supplier where the distributor fails to meet minimum purchasing requirements over a certain period of time could be included.
In that case, a strong supplier will want to provide for minimum purchasing requirements to apply on a shorter period than annually. For example, imposing requirements on the distributor to purchase certain quantum or quantity of products every quarter and if the distributor fails to meet requirements over three consecutive quarters, the supplier’s termination right is triggered.
This may appear a more balanced approach than the “ one strike and you’re out” position, even though the period of time in question might be shorter!
A less favourable option for the supplier is to fall back on claiming that the distributor’s failure to meet the minimum purchasing requirements amounts to a ‘material breach’ of the agreement.
However, whether such requirements amount to a material breach is somewhat uncertain and a supplier keen to walk away from a distributor agreement may be tempted to call material breach when the materiality of the breach is not there, only then to be faced with a claim from said distributor for damages in lieu of a notice period that the distributor argues that it should have been given in order to bring the agreement to an end.
If not termination, what else?
Other than termination, it is also possible for a supplier to provide that the distributor pays to the supplier any shortfall in the purchasing made by the distributor as against the minimum purchasing requirements.
In a way this is a form of liquidated damages – a lump sum that is payable by the distributor to the supplier if it fails to comply with its contractual obligations.
If that is pursued, care is needed that the amount is not completely disproportionate and unreasonable so as to be classified as an unenforceable penalty under English law.
Another option would be for the distributorship grant to be reduced – perhaps a part of the territory is to be taken away or customer group reduced. Where this happens, it can cause a distributor to try to negotiate an exit if the remaining territory or customer group is unappealing or would provide for an unprofitable business for the distributor. A negotiated exit is likely to be acceptable to a supplier where a distributor is failing to perform.
For unwritten agreements, consideration should be given to whether the failure by the distributor in meeting any agreed minimum purchasing requirements amounts to a total failure of performance.
By failing to perform, the supplier would want to argue there is no consideration and no valid contract under which the distributor could be said to be appointed. In other words, the agreement terminates for serious breach by the distributor that the supplier accepts. Again, this would need to be considered carefully before taking action.
Take home points
- Minimum purchasing requirements can be a useful tool in ensuring that a distributor performs – or is exited.
- But termination is a severe step – make sure that before you call on a termination right, you have everything lined up so as to ensure that you can continue to meet the needs of customers in the distributor’s territory.
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