Distribution agreements are an acceptable and efficient way of expanding and increasing business activities.
As in any commercial agreement, the issue arises of when each party, in emphasize on the manufacturing party, may to unilaterally terminate the agreement, what are the terms it must consider prior to termination, and which circumstances will cause the need to indemnify the distributing party due to terminating the agreement made with it, and the scope of the aforesaid indemnification.
Distribution agreements connect two parties, each holding a relative advantage: the first party, the product manufacturer, has superior capabilities and/or knowledge in the production field, however, due to various reasons, does not wish or is incapable of establishing an integral distribution chain. The other party, i.e. the distributor, holds a relative advantage in the product distribution field – whether this is an administrative advantage of an existing distribution chain, or a geographic advantage of knowledge of a foreign territory for the manufacturer.
The contracting of these two entities creates an efficient mechanism by which the manufacturer markets its products via the distributor, in wholesale or retail distribution.
Exclusive Distribution Agreements
In cases where a territory is new for the manufacturer, and/or the distribution requires investing significant funds in advertising, marketing, professionalizing, trainings, complex installations etc., the common agreements are of an exclusive nature, in which the distributor is granted with exclusivity in distributing the products for a specified period.
The main issue of exclusive distribution agreements relates to the circumstances under which the manufacturer can terminate the exclusive distribution agreement, and the implications of the aforesaid termination of the agreement.
Let us preface and note that under the Israeli contract laws, a principle is applied by which the parties are free to design the details of their contracting as they deem fit (except for extreme cases, such as public regulation etc.). Thus, most distribution agreements include provisions regarding termination of the agreement that tend to three issues: (1) termination of the agreement not as a result of a breach by the distributor (termination for convenience), (2) duration of the prior notice granted to the distributer, and (3) whether there is cause to compensate the distributer, and inasmuch as a cause exists, according to which compensation mechanism.
The answers to the three issues hereinabove are based, first and foremost, on the distributer’s scope of investing in the products’ distribution, and on the amount of damage caused as a result of terminating the agreement. For example: a distributer who practically invested significant monies, and also significant work in inserting the product to the market, while exposing new product to the market , and his businesses dramatically relies on distribution of the specific products, will obviously argue that the agreement cannot be terminated without a significant cause, and even so, he must be granted several cumulative or alternative remedies, depending on the circumstances of the agreement termination, such as: significant period of prior notice; termination of exclusivity will not terminate the agreement, i.e. the distribution agreement will continue to apply but the distributer will not be an exclusive distributer in the territory, and also a monetary compensation compatible with his scope of operation during the period prior to the agreement termination.
It is important to understand that in numerous cases things are not as clear as they should be, as the legal system between the parties is more complex. On many occasions the distribution agreement is not very clear, or alternatively there was a historical agreement signed dozens of years ago, and revised numerous times ever since (either orally or in writing).
In such cases, the court ruled numerous of times that the manufacturer may terminate the exclusive distribution agreement, subject to providing a prior notice, the duration of which is between 30 days in the easier cases and even up to 12 months in cases in which the distributer’s damage would be severe, and if his businesses had greatly relied on the distribution of the specific products.
In this context it is important to note that in 2012, the Agency Contract Law (Commercial Agent and Vendor) 5772 – 2012 entered into force, specifying the duration of the prior notice required for terminating the agency agreement, and sets forth the total compensation due to the agent (in contrast with a distributer, a commercial agent does not purchase the products from the manufacturer and sells them to clients, rather serves as kind of a mediator and sells the products to clients on behalf of the manufacturer). It is important to understand that the aforesaid law does not apply to distribution agreements. Furthermore, we will add that within the EU, there exists a directive which specifies provisions regarding the termination of agency contracts with commercial agents; however such directive is also difficult to apply on distribution agreements.
Another argument a distributer can raise relates to third-party liability, where a new distributer is appointed as his subordinate. These varied arguments could be raised as part of Tort law as “Interference with business relations” where such third party is, allegedly, liable for damages caused to the first distributer due to the termination of the agreement with him.
Exclusive distribution agreements bear large economic advantages for both the manufacturing company and the distributing factor. As a result of the many, complex interests related in such agreements, there is great importance to each party’s pricing of the cases and circumstances in which he could be released from the agreement, and also in certain cases, the proper and fair compensation mechanisms that will be considered for granting to a distributor thereupon agreement termination.