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Distribution agreements are typically used as a low risk means of expanding business into new markets or territories. It is important for a supplier or manufacturer, when considering how best to market, sell or distribute its products, to be aware of the difference, in legal and practical terms, between appointing an agent and a distributor. Some of the key differences are set out below.
Distributors versus agents
A distribution arrangement exists where one party, the distributor, buys goods on its own account from a manufacturer or reseller, the supplier, and resells them to customers.
In contrast to an agent, a distributor usually has no authority to create a contract between the supplier and customer.
- The supplier has no contract with the customer of the distributor, although it may have liability under general legal principles or under product liability legislation, for example, the Consumer Protection Act 1987.
- A distributor takes more financial risk than an agent, but this should be reflected in the margins on resale of the product(s). These will generally be greater than commission payable to an agent.
- The purpose of a distribution agreement is to determine the rights and obligations of the parties and, in particular, the restrictions on competition that can be properly accepted by each party.
- The term “distributorship” is sometimes preferred to “distribution”, as “distribution” may relate to a mere contract for the carriage of goods.
Agency exists where one party, the agent, has authority from another party, the supplier, to introduce orders from a third party, the customer, or to create a legal relationship between the supplier and the customer.
- An agent usually benefits from the relationship by receiving a commission from the supplier.
- An agent does not contract with customers in its own right, and therefore generally has no liability to them.
- The purpose of a written agency agreement is to define the actual authority and duties of the agent as well as specifying the agent’s rights.
There are both advantages and disadvantages of using a distributor rather than an agent.
The advantages of using a distributor rather than an agent include:
- In selling to a distributor, the supplier may be able to pass on a large degree of the risk associated with the products.
- A distributor should be more motivated to sell the stock it purchases from the supplier, since it takes on greater risk of failing to sell.
- A supplier will not generally be liable for any liability incurred as a result of the distributor’s activities, whereas the principal is liable for the acts of its agent.
- The appointment of a distributor will avoid the need for a supplier to have an established place of business within the distributor’s territory, which will reduce the supplier’s administrative costs, and may also be beneficial for tax reasons.
- The supplier will not need to monitor accounts with a number of customers, but only with the distributor.
- In the UK, no compensation or indemnity is payable to a distributor on termination of the distribution agreement.
The disadvantages include:
A supplier has less control over the activities of a distributor than it would over its own agent. Therefore a distribution arrangement may not be suitable for products where the supplier or manufacturer requires contact with the ultimate customer (for example, tailor-made products), or where the supplier wishes to maintain tight control over the marketing and pricing of the products.
Where the supplier appoints an exclusive distributor for a territory, its entire credit risk in respect of sales into that territory is concentrated on the distributor, rather than with each customer, as would be the case with an agency arrangement.
A distribution agreement is far more likely to be at risk from competition law problems than an agency agreement.
Types of distribution agreement
Once you have decided to go down the distribution route there are a number of different distribution models to choose from. The most common types are described below.
An exclusive distribution arrangement is one where a supplier agrees to sell the contract products only to the distributor within a certain defined territory, and agrees not to appoint other distributors or sell the products directly to other customers within the territory.
Such an arrangement is frequently used to exploit a product within a new territory. The supplier appoints a distributor with local knowledge and usually an established business within the territory. The distributor in turn agrees to take on the high risk and costs associated with promoting a new product in return for the knowledge that, as exclusive distributor, it alone will benefit from its sales and promotion efforts. The supplier has the advantage of knowing that the distributor will be motivated to sell its products, particularly if a restriction is placed on the distributor prohibiting it from selling competing products. The supplier can use the threat of withdrawing the exclusivity if target sales are not met by the distributor within a specified period.
A “sole distribution agreement” is one whereby a supplier appoints a distributor as its only or sole distributor within a territory, but the supplier reserves the right to supply the products directly to end users. The meaning of the term should always be clarified within the agreement.
Such an arrangement combines the advantages of exclusive distribution for the distributor, with the advantage for the supplier that it is free to promote the products itself within the territory and to continue to deal with any customers it may have had in the territory before the appointment of the distributor. Such an agreement would contain similar provisions and restrictions to those in an exclusive arrangement, but it would afford more control by the supplier over the territory, should the distributor fail to meet the required minimum purchase targets.
The Vertical Restraints Guidelines (which relate to competition legislation) also refer to “dual distribution”, where a supplier of goods or services also acts as a distributor of those goods or services in competition with its independent distributors (who may or may not be sole distributors). Sole distribution is therefore a form of dual distribution.
A non-exclusive appointment gives the supplier complete freedom both to sell directly and to appoint other distributors within the territory. The terms of the appointment will be far less onerous on the distributor than those within an exclusive or sole appointment, as it will need to compete with the supplier and other distributors in terms of both pricing and promotion of the product.
A supplier, in appointing a distributor as part of a selective distribution system, agrees to appoint additional distributors only if they meet certain criteria. This effectively limits the number of additional distributors who will be appointed within the territory. Selective distribution arrangements are perceived as particularly suitable where the nature of the product requires an enhanced level of service or advice at the point of sale to the customer and where the supplier or manufacturer will be required to provide after-sales support. Owing to their potentially exclusionary nature, such arrangements can cause competition law problems. However, examples of products for which a selective distribution system has been held to be justified include high value cosmetics, pharmaceutical products and electrical goods.
Usually, as part of the arrangement, distributors must also agree only to sell on the products to end users or to other approved distributors. In this manner, the supplier retains tight control over the manner in which its products are marketed and it will generally have greater influence over the marketing of the product.
A number of other issues arise in the context of distribution. Here is a brief outline of some of the key issues:
Given the comparatively large degree of autonomy granted to a distributor to promote and sell the supplier’s products, it is critical to ensure that the selected distributor is financially and commercially sound. The supplier should:
- Carry out research into the proposed territory to identify potential distributors with a good knowledge of the product type and, preferably, a proven track record.
- Ensure the distributor has the necessary financial standing and resources to fulfil the contract properly, which will include the purchase and maintenance of adequate stocks of the product, meeting promotional and advertising costs, and sometimes providing an after-sales service.
- Check the creditworthiness of the distributor, particularly as the contract products are supplied on credit and the supplier may be wholly dependent on the distributor for payment in respect of sales into the relevant territory.
- Scrutinise the distributor’s other commitments to ensure they will not conflict with or hamper effective promotion and sales of the contract products. In this context, the distributor’s existing product range and the presence of any competing products will be an important factor.
Laws governing the appointment and operation of a distributorship vary from country to country, and the supplier should always seek advice from a local lawyer on any particular local requirements.
Under the EU and UK competition rules, there is a specific framework for assessment of vertical agreements. A vertical agreement is one that is entered into between businesses operating at different levels of the economic supply chain, and includes, for example, agency and franchising arrangements as well as distribution agreements.
Most distribution agreements will benefit from the automatic (block) exemption afforded to vertical agreements and therefore fall outside the scope of the EU and UK prohibitions anti-competitive agreements, provided that criteria for the block exemption are met.
Alinea Law documents relating to distribution
The following documents relating to distribution are available for download by Alinea Law Members: