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Myths and misunderstandings about international distribution agreements

April 1st, 2012 / By: / Uncategorized

We all routinely, and often unconsciously, make assumptions. They allow us to function smoothly as we go about our daily activities, but they can also get us into trouble when it turns out that they’re not well grounded in fact. Incorrect assumptions about the laws of other countries and how they apply to our business activities can be especially expensive, particularly when it comes to using distributors and sales agents. Here’s a chance to test your knowledge about worldwide distributor rules—and check out your scores when you’re finished.

1. True or false. In many countries outside of the U.S., the distribution agreement is a type of commercial agency relationship, governed by commercial agency laws.

True. In many European countries and other regions, there are no laws governing distribution agreements as such; they fall under the category of commercial agency laws, which often contain protections in favor of the distributor requiring compensation upon termination of the contract.

2. True or false. In Europe, a party who is negotiating an exclusive distributorship agreement, and breaks off negotiations without a valid reason before signing the contract, can be liable for damages.

True. Unlike the U.S. common law system, the European civil law system allows a legal claim of “fault in contracting,” based on the implied duty of both parties to act in good faith during contract negotiations. The terminating party can be liable for damages, especially where the terminating party knowingly allows the other party to incur expenses in order to be able to perform their side of the contract, and where there has been clear intent to enter into a contractual relationship.

3. Your sales and marketing director has found a Spanish company that provides a complementary, localized version of the product that your company sells. He’s excited about his discussions with this Spanish company to enter into a joint marketing agreement, under which both companies would cooperate in delivery of complementary products to customers in Europe, all under the trade names of both companies. No formal corporate joint venture is planned. Before proceeding further with negotiations, what is the next prudent step?

  • a) Do a background check on the Spanish company;
  • b) Find out who some of the company’s customers are, and interview them;
  • c) Draw up a sales brochure highlighting the expertise of both companies; or
  • d) Get a Spanish lawyer to research the trademarks the Spanish company has registered.

D. The danger of marketing your products jointly with another company is that the other company may over time acquire some ownership rights in your trademark. You need to protect your company’s trademarks by registering them in every country in which they will be used in connection with your company’s products or services. The U.S. has a ‘First to Use’ rule for ownership rights in trademarks. Most of the rest of the world has a ‘First to File’ rule. The first step would be to know what marks your joint marketing partner has already registered, and to make sure they haven’t already registered some of your marks, under the First to File rule. This issue should be addressed before you start printing joint brochures.

4. In some countries outside the U.S., termination of a distributor agreement for cause by the distributor, or without cause by the principal, entitles the distributor to the following compensation payments:

  • a) A minimum indemnification payment, which may vary depending on whether the agreement is for a fixed term or an indefinite term;
  • b) Marketing expenses invested by the distributor in promotion of the principal’s products;
  • c) Both of the above.

C. Many countries have laws protecting distributors upon termination well in excess of any such protections under U.S. laws.

5. True or false. A U.S. company acquires a French company, which has had a distributor in Belgium for 20 years. The U.S. company does not need the distributor because it has its own sales office in Belgium. In Belgium, it is considered “just cause” to terminate a distributor to replace it with your own sales force.

False. Belgium has one of the toughest distributor termination laws in the world. It is not considered “just cause” in Belgium to terminate a distributor to replace it with your own sales force. In fact, the Belgian law was designed to avoid that eventuality, to forestall situations in which a local company creates a market and goodwill for the principal’s products, and is then terminated.

6. True or false. Germany recognizes a “goodwill indemnity” that is owed to the distributor upon termination of the distribution agreement.

True. Under German case law, some distributors are treated by analogy as sales representatives. The German Commercial Code, in line with a European Directive, sets forth specific causes for termination in addition to compensatory damages (including compensation for goodwill created by a sales representative) in the event of invalid termination of a distribution relationship. A very clear definition of “causes” in a termination provision is recommended to avoid any costly surprises if the business relationship should not work out.

7. True or false A carefully drafted termination clause in the distribution agreement, specifying events of termination, notice period for termination and waiver of termination indemnities by the distributor, is enough to protect the principal from termination claims by the distributor.

False. Not in every country. The parties are usually free to agree to specific termination events under a distribution agreement. For instance, the agreement may be terminated without cause upon prior written notice without further penalties or compensation. In the case of early termination of a fixed term agreement by the principal, a reasonable prior notice should be given to the distributor. However, in many cases, the distributor may still claim compensation for early termination of the agreement if the distributor can show it has suffered actual loss or damages.

For example, in Lebanon, if the principal terminates the agreement without cause or refuses to renew upon expiration of the term, without fault by the distributor, the principal will owe an indemnity (compensation). In the case of termination without cause, the principal will owe an indemnity corresponding to the damage suffered and the profit lost by the distributor. In the case of non-renewal, the principal will be liable for payment of an indemnity when the distributor’s activities resulted in measurable success in promoting the principal’s business, launching the principal’s trademark or increasing the number of its customers.

The right to an indemnity is a matter of public policy, so any agreement to the contrary between the parties is null and void. In evaluating the amount of the indemnity for lost profit, the Lebanese courts, as a general rule, consider the average of the annual net profit realized over the last five years prior to termination or refusal to renew—and multiply by a factor of three.

8. True or false You should never blow your nose in the middle of a meeting with Japanese businesspeople (even with a handkerchief).

True. Blowing your nose in public, even into a tissue or handkerchief, is considered unhygienic and extremely rude in Japan. It should only be done in private. Getting some good cross-cultural information before you start any international negotiation can prevent unpleasantness, misunderstanding and even failure of the deal.

Mary K. McCormick, McCormick International, is an attorney with more than 30 years of experience in international business law. She can be reached at mary@mccormickintl.com.

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