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Distributor Contracts: Review and Refresh

By: Greg Seminara
Topics: Contracts

Suppliers review their Distributor contracts for two reasons: At the start of a new distributor relationship or when the current distributor has resigned or failed. Most exporters simply revise their standard distributor contract with a new name and make a few minor adjustments when entering a new partnership. Export Solutions frequently reviews distributor contracts as part of our distributor identification process.. We do not pretend to be lawyers but our broad conclusion is that most current distributor contracts were written to reflect business practices of the 1990’s versus the business reality of 2015. Listed below are points for consideration as you seek to refresh or renew your distributor contracts.

Contract vs. Letter of Understanding
A Basic question: Do you really need a contract with all distributors in all countries? Formal contracts make sense when the manufacturer plans a strategic launch, supported by investments in trade and consumer activities. A contract is mandatory in transferring an established business from a direct organization to a third party or from one distributor to another. A Letter of Understanding may suffice in cases dealing with an opportunistic sale or testing a new product concept.  The Letter of Understanding simply outlines the roles and responsibilities of each partner, expected outcome and plan of action, and ability for each party to exit the relationship without much complexity. In some situations, a "Handshake Deal" is acceptable particularly if the volumes are low and the orders are pre-paid. This may function in some countries, but in certain markets such as Puerto Rico (Law 75) a relationship with responsibilities is created with or without a formal written agreement.

Termination Clauses
Most distributor contacts are rarely revisited until the possibility (or probability) of termination becomes likely. Long term contracts lasting 5 years, with one year notification periods do not make business sense for the distributor or supplier. More realistic is a three year contract, with escape clauses for either the manufacturer or distributor to resign if minimum sales levels are not attained. Termination notification periods of 6 months to one year can be harmful for a brand.  A better option is a 3 month notification period, with succession plans formalized at point of notification.

Global Retailer Impact
Retailers such as Walmart,Carrefour,Costco, and Metro maintain a presence in many adjacent countries. Their cross border sourcing activities create challenges for distributors, as retailers buying practices may interfere with protected territories.New contracts should address the role of Global Retailers and responsibilities for each partner to maintain the integrity of the territory.    

Distributor Price Increases
Pricing is a sensitive topic, as some countries maintain strict laws to discourage price manipulation. On the other hand, contracts should include clauses that prevent distributors from taking "unauthorized" price increases without agreement from the brand owner. I have witnessed brands being damaged by a distributor price increase that was independent of any pricing action by the manufacturer.

Key Issue: Distributor Loss of a Major Principal
There have been several high profile distributor bankruptcies. These occur quickly andresult in the loss of receivables by the manufacturer. It's wise to insert a clause stating that Distributor should  notify you in writing within 7 days of notification of any loss of principal that represents 10 percent of their business or more. Another clause, is the right for you to terminate contract within 30 days upon distributor loss of principal of 20 percent of their business or more.

Promotion Payment Handling
Trade discounts and promotional incentives are a standard component of our marketing plans. However, it is surprising that many distributor agreements do not mention promotion payment handling. We suggest adding clauses mentioning documentation required, budgeting, over spends, and right to audit paperwork.

Information Technology Requirements
Most industry participants would be utterly and completely lost without our computers. Yet most contracts do not specify any Information Technology requirements for our distributors. New contracts often specify that a distributor must handle designated EDI transaction sets, Electronic Funds Transfer, and online portal to share shipment and financial information. Data security and back-up requirements also warrant inclusion.

Warehouse Audit
Warehouse inventory is central to many of our business practices: Achieving sales objectives,minimum stock levels, product returns, new products, sales promotions etc.
Manufacturers should maintain the right to inspect distributor warehouses with 72 hour notice. This is particularly important during distributor change or suspected diverting.

Minimum Volumes
It is difficult to forecast volume for a new brand launch due to many variables.
However, it is fair to establish minimum volume thresholds, particularly for year two. If the business is not succeeding, there must be "escapes" for both manufacturer and distributor to exit gracefully.

Next Steps
Respectfully, most suppliers and distributors desire to avoid frequent contact with their lawyers. The new business realities of 2015  reveal that many distributors and manufacturers are not adequately protected. A review of existing contract templates to measure relevance for today’s business practices is warranted. Export Solutions advocates a balanced approach favoring commercial sensibilities.