This week’s post is authored by Andrew Howey, non-lawyer intern. Andrew had a great summer with us and the post below was generated after discussions we had recently with manufacturers about how to exit distributor agreements. Andrew’s comments were in consultation with other members of our manufacturing team.
When negotiating distribution agreements, sometimes manufacturers overlook the significance of termination clauses. After all, if you are in the process of making an agreement with a new distributor, why take the time to worry about what will happen if the agreement needs to end? Yet this mistake can often prove to be problematic for manufacturers. Frequently, manufacturers later feel the need to terminate the agreement, and must rely on vague or unfocused termination clauses.
Terminating a distribution agreement is never a pleasant process, but what if the distributor is not at fault? There are times when the distributor has upheld its side of the agreement, but the manufacturer simply wishes to find greener pastures, either with another distributor or to distribute the product themselves. When this occurs, it can leave a distributor feeling betrayed and hostile, and with a weak termination clause, this can result in drawn-out litigation that will cost manufacturers an excessive amount of time and money, in addition to killing any chances of future collaboration between the two sides. To summarize, the consequences of a poorly-written termination clause can put a manufacturer in a very bad position.
What can a manufacturer do to terminate a relationship with a performing distributor without creating animosity? Sometimes, a termination for convenience clause will exist that will allow a manufacturer to get out immediately. Oftentimes, however, such a clause will not be present (particularly with distributors that have significant leverage) and the manufacturer has to resort to claiming termination for cause and the prospect of extended hostile litigation. Lawyers that represent manufacturers often focus on the litigation aspects of these terminations by drafting long, drawn-out forum selection (i.e. where the lawsuit will take place) and dispute resolution (i.e. how the litigation will unfold) clauses. Of course, sometimes these clauses have no chance of being held enforceable in the country-at-issue. Yet even if they are enforceable, such clauses rarely function as the be-all, end-all of termination disputes. Arbitration, which is often the preferred course in distributor disputes, is costly and rarely expedient. Mediation, while slightly less adversarial, can have the same impact.
So what can be done to avoid litigation for terminating a distribution agreement when the distributor is not at fault? The key to avoiding hostility and litigation with a distributor is to find ways to disincentivize the distributor from pursuing litigation and leaving the door open to future relationships between the manufacturer and the distributor. This way of thinking about the termination as both a legal and business process will serve to both avoid the hostility that comes with prolonged litigation and to expedite the process of termination.
One method for an expedited resolution is to draft a termination clause that the distributor will view as more ideal than pursuing prolonged litigation. One possible avenue is to include the payment of an expedited resolution fee to the distributor if termination without cause is contemplated. This fee could be equal to compensation for all of the work completed by the distributor up to the date of termination, or it could equal the dollar amount of supplies sold up to the date of termination, or it could be a different number entirely. The main point is that this fee would serve to compensate the distributor for a job well done and speed up the process of resolving the relationship between the manufacturer and the distributor. There are other possible options as well – all designed to put the dispute on a defined path of early resolution.
In the end, if you can draft a termination clause that both expedites the termination process and is generous enough to a distributor that its stipulations are favorable to prolonged litigation, you can often seamlessly terminate the resolution without the hostility and financial burden that often comes with termination.