Appointing a distributor

Appointing a distributor

Distribution arrangements 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 his products, to be aware of the difference, in legal and practical terms, between appointing a distributor and an agent.

Under a distribution agreement, the supplier or manufacturer sells his products to the distributor, who then sells the products on to his customers, adding a margin to cover his own costs and profit. In purchasing and reselling the products, the distributor contracts both with the supplier and with his customer, and title to the products in question will pass to and from him.

In the supplier/distributor relationship, the duties owed by the principal and agent to each other are replaced by mutual contractual rights and obligations within the distribution agreement, which is essentially a variation on a sale of goods contract. This has the disadvantage for the supplier that he has less control over the distributor's activities than he would over an agent, particularly with regard to the final pricing of the products to retailers or end-users. However, in selling the products to a distributor, he also passes on a large degree of the risk in the products.

In reselling the products to his customers, the distributor assumes liability for the products and therefore incurs a far larger degree of risk than an agent in the course of his business. This is particularly the case if the distributor is not fully indemnified by the supplier for any claims brought in respect of the products. The higher level of risk assumed by the distributor is reflected by his level of remuneration or margin as compared with the commission earned by an agent. The greater the level of risk that the supplier places on the distributor, the higher the distributor's margin will generally be.

There are various different types of distributorship and it is crucial to ensure the correct contract is used.

Pre-contractual considerations

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. Research should be carried out in the proposed territory to identify potential distributors with a good knowledge of the product area and, preferably, a proven track record. A distributor must also have 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.

The creditworthiness of the distributor will be an important factor, 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. The distributor's other commitments should also be scrutinised to ensure that 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.

Local laws

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 requirement.

Competition law and regulation

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 an automatic (block) exemption afforded to vertical agreements and therefore fall outside the scope of Article 101, which prohibits anti-competitive agreements, provided that criteria for the block exemption are met.

At the UK level, until 1 May 2005, all vertical agreements that did not fix prices fell outside the Chapter I prohibition, regardless of the other clauses within the agreement and the market strengths of the parties. As a result of the modernisation of EU competition law, this exclusion was revoked and currently the EU exemption alone is applied in the UK to exempt vertical agreements from the application of both the EU and the UK competition rules.

Bribery Act 2010

The Bribery Act 2010 (BA 2010) came into force on 1 July 2011. It replaces the existing bribery offences and introduces new offences. In particular, it introduces a strict liability offence which may affect suppliers in distribution arrangements.

Under section 7, a commercial organisation (which includes a company or partnership) commits an offence if a person associated with it bribes another person, intending to obtain or retain business or a business advantage for the organisation. A person (A) is associated with a relevant commercial organisation (C) if A is a person who performs services for or on behalf of C (section 8, BA 2010).

Section 7 is strict liability offence. The only defence available to the commercial organisation is if it can show that it had in place "adequate procedures" to prevent a person associated with it bribing others. The BA 2010 does not set out prescriptive adequate procedures, but the Ministry of Justice has published guidance to assist commercial organisation putting in place procedures to prevent persons associated with it from bribery (Guidance).

In the context of a distribution arrangement, in most cases it is unlikely that the risk of a section 7 offence arises because:

A distributor does not fall within the definition of "associated person", since the distributor does not (as such) supply services to the supplier under the distribution agreement. It simply purchases goods from the manufacturer and resells the goods in its own right. In other words, a distributor performs services for itself, not the manufacturer.

If a distributor bribes, say, an end-user customer in order to procure a large sale, the distributor could not be considered to have the intent necessary for a section 7 offence because its intention would be to obtain or retain business or a business advantage for itself, not for the supplier.

However, in one sense, a distribution arrangement might be viewed as the means by which a supplier expands its own business into new markets or territories. In this analysis, the distributor is effectively performing a general marketing service for the supplier, promoting its brand in the relevant territory. A typical distribution agreement will contain numerous obligations on the distributor to promote the brand image of the supplier in the territory. If this argument is sustainable, then a supplier would fall into the definition of an associated person, as it is providing a (marketing and business expansion) service for the supplier. Increased sales by a distributor in those territories mean increased purchases from the supplier (benefiting supplier’s business). So the supplier enjoys an indirect business advantage from any bribery by the distributor.

But even if a distributor can be considered to be supplying a service to the supplier, it would be difficult to show the requisite intent on the part of the distributor to secure business or a business advantage for the supplier, because the distributor is likely to be seeking business for itself. This has some support in the Guidance, which suggests that the mere fact of an indirect benefit to a commercial organisation is not in itself sufficient, without the required intention of the associated person to benefit that commercial organisation (paragraph 42, Guidance). Thus, even if the supplier is considered to be indirectly benefiting from a bribe offered or made by its distributor (through increased sales), unless the distributor can be shown to have intended to benefit his supplier, it is still unlikely that the supplier would be caught by section 7.

Nevertheless, despite what appears to be a low risk of exposure, it is prudent for a supplier to put in place adequate procedures to protect itself from the risk that its distributors commit bribery and trigger liability under section 7. This is partly because the wording of section 7 is far from clear, and also because some types of distributor agreement incorporate other legal arrangements. For example, a distribution arrangement may include elements which are closer to agency, such as:

The distributor sells low end products as reseller, but in respect of high end products, it procures customers for the manufacturer as an agent;

The distributor sells hardware as a distributor, but in respect of bundled software, it promotes the sale of software licences as an agent (so that the customer is directly licensed by the manufacturer of the software).

In any event, many suppliers will in place anti-bribery policies and include an anti-bribery clause in their distribution agreements for ethical reasons.

Distributorships can be a great way to market and expand a business, however care needs to be taken with the legal documentation.

To discuss distributorships further, contact us at commercial@berrysmith.com or on 029 2034 5511.

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