The art of reaching true agreement with a foreign distributor is a delicate dance. At the beginning, the relationship is full of possibilities and enthusiasm. Both companies want to reach agreement and get down to the business of selling things as soon as possible.
But, when it comes to negotiating international distribution agreements there is a lot of room for error, which can lead to some major hiccups and ultimately cost your business time, money and customers.
Here are the top ten misconceptions floating around out there, and the solutions to protect your bottom line in distribution agreements.
Myth #1: We don’t have time for a contract – we need to get busy selling!
Many companies will only do a legal agreement if their legal department insists on it, and if they don’t have a legal department, it probably won’t happen.
Even companies with written agreements may think of the contract as something to be done at the end of the negotiations—a necessary evil to tidy up the little details, but that delays getting on with the business at hand.
But they’re missing a great opportunity: the contract negotiation process ensures the parties truly have clarity and consensus, and as an added benefit, builds the all-important relationship between supplier and distributor.
Through the contract negotiation process, a good international lawyer helps reveal gaps in understanding that are never an issue in domestic negotiations, and coaches and guides the parties to a better partnership. Working through small conflicts as part of the negotiation builds trust as they gain confidence they can successfully work through inevitable disagreements.
Myth # 2: How we found our distributor is totally separate from our contract
Many may ask: what does that have to do with the distribution contract?
It matters because the best foreign distribution agreements start long before sitting down with a written document.
A supplier with a distributor recruitment process has thought pretty carefully about its objectives for its distribution business. These objectives can be clearly articulated, which leads to discussions with distributors that are more productive for both companies. They see mutual interest right from the outset of the relationship (or the lack of real interest becomes clear very quickly).
The contract negotiation process is consistently smoother when suppliers do a lot of the contract pre-work by thinking carefully about what they want in their distributors, envision what a great distributor looks like, and then go find those distributors.
Due diligence also helps create better agreements because it weeds out distributors that are bad fits long before wasting time finding that out through a painful contract negotiation process.
Myth # 3: Contract templates are great, because that way we can skip the legal review costs.
Templates are a great place to start. But they are only the START, and should not replace competent legal review.
These days, it’s easy to find templates on the internet. You can purchase them online, or obtain them from colleagues, trade associations, or government agencies. Even most lawyers will admit they start with a document repurposed from somewhere. Make sure the one you use fits your situation.
Some questions to ask to ensure you’re starting with a good template:
Do I have an agent or a distributor? The legal agreements for the two types of arrangement are totally different. If you pull a “distribution agreement” off the internet, but you have an agent, you’re not even starting with the right kind of agreement.
Does the template cover all the key points? Make sure your template is comprehensive.
Does it adequately address services or software? Distribution templates are typically product-focused, and may not address related service and software issues. Today, there is often a service component to many product sales. For example, is installation required for your products? What about trouble-shooting, maintenance, upgrades, and warranty repairs?
Second, templates are NOT a substitute for competent legal review
Used wisely, a good template can facilitate the negotiation process. Unless you’re very experienced with legal agreements, however, you’ll benefit immensely from having a qualified lawyer review the document with you.
Agreements without legal review often omit important provisions. Many are worded poorly and the interpretation is subject to dispute.
Myth #4: We Can Just Have Our Local Contracts Lawyer Review Our Agreements
Just because a signed contract says something doesn’t make it so.
When you have a contract with a foreign distributor, you now have two completely different legal systems—yours, and that of your distributor. The contract interpretation becomes much more complicated and much less predictable. Expert legal advice is needed to sort out the rules that will apply, and how they will apply.
Balancing all this is complicated, and depending on the amount at stake, requires not only an experienced international attorney in your home country, but selective consultation with their counterpart in the distributor’s country. And the lawyer in the distributor’s country cannot be just any local commercial lawyer, but a lawyer who also is experienced with cross-border transactions.
For these reasons, you should NOT have your international distribution agreement reviewed by the local lawyer who helps your company with other business, even other contracts—unless they also happen to be an experienced international lawyer, which is unlikely.
Myth #5: We hope our foreign distributors don’t hand out bribes, but if they do, it’s really not our problem.
Most companies today know that foreign bribery is bad and illegal. They may have heard of the U.S. Foreign Corrupt Practices Act (FCPA), or the UK Bribery Act, and other similar laws.
But there are plenty of companies that export using distributors still don’t understand that they can be held accountable for bribes their distributors make. Maybe it’s because it seems far-fetched that a completely independent company like your distributor can put you at risk for their actions. Maybe it’s because it seems unlikely your distributor or you will get caught.
Whatever the reason, the truth is: more and more companies are finding themselves subject to FCPA enforcement because of their distributor’s bribes.
Whatever the reason, the truth is: more and more companies are finding themselves subject to FCPA enforcement because of their distributor’s bribes.
According to the U.S. government, here’s what every U.S. company needs to do with their foreign distributors to avoid liability:
- Conduct thorough due diligence, which may include regular background checks and investigations on distributors.
- Include anti-bribery language in all distributor agreements (which presumes you must have written contracts) that clearly allows you to terminate if you discover bad behavior.
- Train your distributors (as well as your employees who interact with them) regularly on anti-bribery compliance.
- Clearly understand how your products are reaching the end customers and confirm if there are any other intermediaries.
- Prohibit use of sub-distributors, agents, or other intermediaries by your distributor unless you have investigated appropriately and provided written approval.
- Make sure your distributors’ customer margins, and any other compensation you pay them, are reasonable and customary.
- Have controls in place to make sure any red flags are raised and addressed.
- Have your internal audit or finance function monitor this program regularly.
- Document everything that you verified, as well as how any issues or problems were investigated and resolved.
By the way, bribes are still pretty common in many countries. So make sure you get good legal advice when exporting so that you can assess bribery risks and create an anti-corruption program that works for your company.
Myth #6: Two extremes: We never give exclusivity unless forced to, or, we give exclusivity freely.
Virtually every international distributor will ask for (or insist on) exclusivity. A frequent question in contract negotiations is whether you can or should give it to them. It’s an issue worth weighing carefully.
There is no single rule about granting exclusivity. It depends on the geography, local laws, what is customary in your industry, and practical business considerations.
The best we can do is set out some of the most common factors to consider.
Does local law permit the type and extent of exclusivity you are considering?
When granting exclusivity, it is expected to have minimum purchase requirements. You will still want to understand which these will be enforceable under local law, especially regarding “take or pay” minimum purchase provisions.
If a distributor insists on exclusivity, but is unwilling to agree to enforceable minimums, think long and hard before moving forward with this partner.
You will also need to weigh the practical and business considerations. In some cases, you may have no real choice on exclusivity. If there are only two qualified distributors in a market and your competitor already works with one, you have limited negotiating leverage.
Are you are willing to invest in the distributor, and vice versa?
Ensure that you contract allows you to terminate exclusivity without terminating the entire agreement.
Understand clearly the local law requirements for terminating exclusivity, including the grounds for termination and whether any payments will be due.
Myth #7: If We Set Aggressive Deadlines to Finalize Our International Contracts, We’ll All Stay Focused and Get it Done More Quickly!
Negotiating a cross-border agreement flat out takes a lot more time to negotiate than the same agreement within your country, or between a U.S. and a Canadian company. Expecting negotiations to move at the pace of a typical domestic agreement is almost guaranteed to result in disappointment and frustration.
This concept is simple on its face, but in reality is often very difficult for some to accept. The reasons these agreements take so much longer varies. Time zone differences and language issues definitely play a role. Differing cultural expectations, though, usually have a larger impact. To effectively negotiate great distributor relationships in the international arena, you need to get a bit zen. Negotiating styles vary widely from country to country, and you must accept that your distributor is not going to change their culture suddenly to meet your arbitrary timelines.
It helps a lot to relax, and just enjoy the process of seeing the many different styles of negotiation. Getting frustrated will not force your foreign partner to be more like you!
In the end, continuing to build a good relationship with the distributor is most important – if you have that, you are much more likely to have a productive business partner and a better agreement than by simply rushing to meet artificial deadlines. And you may also need to help educate your own bosses to help manage their expectations.
Myth #8: We don’t need to spell out operational details in the contract—that’s business stuff, not legal!
Operational issues generally make or break client-distributor relationships. And the time to think through and discuss them is during contract negotiations. If the parties have detailed discussion and put their agreement in writing, there tends to be fewer issues later.
Here are some of the most common sources of disputes, and some questions to consider:
Investments: How many people will the distributor dedicate to selling and supporting your products? What kind of skill sets do they need? Do you want the right to interview, veto, or replace these people? When there is turnover of personnel, how quickly should these positions be filled, and what recourse should you, the manufacturer have, if the positions aren’t replaced? Which of you will pay for product training, congresses to promote your products, or the creation of localized marketing materials?
Forecasting & Demand Planning: There is nothing worse than having your distributor provide you an aggressive sales forecast, and you purchase or make products based on this forecast, only to find the orders never come. The reverse is equally bad: the distributor suddenly wants lots of unforecasted products shipped immediately, and you don’t have them available.
Logistics and Supply Chain: When are rush or air freight shipments appropriate? How long are manufacturing lead times? How are product shortages rationalized? Will the distributor incur penalties in their customer contracts if delivery is delayed? What shipping metrics will you use?
Reporting and Business Reviews: Will there be an agreed business plan? Will there be quarterly business reviews? Will there be minimum purchases, and how and under what circumstances will they be adjusted? What metrics, besides minimums, are you expecting your distributor to meet? Do you expect sales tracings reports? If so, how often, and in what format?
After-Sales Support: How will returns and repairs be handled? What tasks are the distributor able to handle? Should they receive special training to do certain after-sales support activities? Will the manufacturer or a third party handle? How quickly can repairs be done? When is replacement appropriate?
Take the time to discuss these and any other relevant operational detail with your new distributor. Memorialize these in your contract. Think of your distribution contract less as a document you pull out of the dusty files when things have gone wrong, and more like a blueprint for governing your distributor relationship.
Myth #9: We don’t spend much time negotiating termination, because it will spoil the enthusiasm.
No one (except, of course, the lawyers) want to think about how to end a relationship when it is only just beginning and full of promise. However, most agreements eventually end, and that’s why it’s worth spending time thinking about termination—especially while the relationship is amicable.
You should always plan for termination in the context of how you would transition to a different distributor or your own stand-alone sales office. (It’s always easier to torch and run from the market, but the reality is that you should think hard about entering a market if you think that’s how it will end.)
Goodwill payments: Make sure you clearly understand any goodwill payments that may be due on termination. Think about how long-term customer contracts and government tenders should be managed to avoid disruption to the customer.
Inventory: Think through how the distributor’s existing inventory should be handled. Consider buying back some or all the inventory (other than maybe excess no-move inventory) to essentially buy their goodwill so that your brand isn’t ruined.
Product registrations and other key files: If you’re in a highly-regulated industry, think through how all the registration documents and files should be handed over. This can significantly shorten your new partner’s time to market, and may be worth a generous payment to your old distributor.
Customers: Ultimately, protecting your brand is about making sure the end customers are happy or at least accommodated. Agreeing that your distributor will provide a list of customers and key contract terms will allow a much smoother termination.
Myth #10: We’ve Invested So Much Time in This Relationship – We Can’t Give Up Now!
Whether in contract negotiations or in a long-term business relationship, human psychology is definitely at work.
Companies often feel like they’ve invested so much already that they need to slog through and finish the negotiation or continue the relationship.
All too often, suppliers keep distributors around whose poor results suggest they should be replaced. If you are clear about your exit strategy (even if that strategy evolves over time), it will guide you to a decision about whether it’s time to put in place a direct sales force, find a new distributor, or leave a market altogether if certain results aren’t met over a specific time.
Similarly, having a backup plan (again, it’s OK if that plan morphs over time) helps you keep you’re your walk-away point clearly in focus. If you don’t have Plan B, human psychology again will come into play, and you’re likely to settle for sub-par results because making change is hard and requires focus.
Having a Plan B is especially important in emerging markets. Huge currency fluctuations, political unrest, and sudden regulatory changes can happen, and the market that was once attractive no longer is. But it’s also important almost everywhere in today’s business environment, where technology changes, mergers and acquisitions, and factors have accelerated the pace of change. Being flexible and adaptable is one of the most important attributes for success in global markets.
Your distribution business will be more successful if you always keep your walkaway point in mind, and know when it’s time to pull the plug, regardless of the investment made already—that’s a sunk cost that can’t be recovered. Know when you want to exit, and how you want to exit by being prepared with a backup plan.
This article series originally appeared in Global Trade Magazine. You can view the series here.