Distribution agreements – an introduction

A distribution agreement (Distribution Agreement) is a form of commercial contract where  one party, the distributor (Distributor) is granted the right to distribute goods or services of another supplier (Supplier) to clients or customers usually in a distinct territory.

Distribution Agreements range from very simple and straightforward agreements through to complex relationships depending on the types of goods or services distributed and the industry that the Supplier operates in.  Dundas Lawyers has experience in negotiating, drafting and reviewing distribution agreements at all levels of complexity, from the standard to the bespoke.

Common clauses in Distribution Agreements

Most Distribution Agreements will include clauses such as:

• the payment of a sign-on fee by the Distributor on commencement (Sign-on Fee);
• the term of the appointment of the Distributor, that is, the length of time for which the agreement will run (Term);
• the territory in which the Distributor may distribute the goods or services (Territory);
• the manner in which the Distributor must pay the Supplier for the goods or services (Payment Terms);
• whether or not the Supplier may appoint other distributors within the Territory (Exclusivity);
• whether the agreement may be renewed or extended and if so at what cost (Renewal); and
• how the agreement may be terminated (Termination).

As the commercial arrangement between the parties increases in complexity, it is not uncommon for the Distribution Agreement to it also include clauses that:

• allow the Distributor to use intellectual property of the Supplier to market the goods or services (IP Licences);
• compel the Distributor to market or advertise the goods or services (Marketing);
• compel the Distributor to meet key performance indicators (Sales Targets), and to report financial information to the Supplier (Reporting Obligations);
• restrain the Distributor from competing with the Supplier during the life of the agreement and after its termination or expiration (Restraints on Competition); and
• grant a security interest over the assets of the Distributor in favour of the Supplier to secure the funds owing to the Distributor (PPSA Clauses).

Of course there are many other variations depending on the rights held by the Supplier, whether goods or services are being distributed and the characteristics of the goods or services themselves.

Common “pitfalls”

For parties entering into Distribution Agreements there is much to consider.  The risks include, but are certainly not limited to:

from the perspective of the Supplier:

• an Exclusivity arrangement causing it to infringe the Competition and Consumer Act 2010 (Cth);
• the lack of any Sales Targets resulting in a poor performing or lack of motivation from a Distributor;
• any IP Licences or Marketing that does not adequately protect the interests of the Supplier; and
• a failure to include an appropriate period of time that applies as the Term;
• as a whole, the Distribution Agreement itself creating an unintended relationship such as employee, franchisee or agency; and

from the perspective of the Distributor:

• the lack of an Exclusivity effectively watering down their Territory;
• not considering online sales channels which allow the distributor to in effect usurp the Territory;
• the imposition of onerous Sales Targets and Reporting Obligations;
• the imposition of Restraints on Competition affecting the future prospects; and
• the granting of a security interest in favour of the Supplier pursuant to a PPSA Clause.

Each situation will depend on the negotiating power of each respective party and the rights and obligations that they are able to negotiate.

Recent cases involving Distribution Agreements

Distribution Agreement held to be franchise agreement

In Workplace Safety Australia v Simple OHS Solutions Pty Ltd [2015] NSWCA 84 the respondent, Simple OHS Solutions Pty Ltd (Simple), entered into a Distribution Agreement with the appellant, Workplace Safety Australia Ltd (WSA), to be the exclusive distributor of WSA’s subscription packages.  Relevantly, the agreement required Simple to:

• set out a business plan indicating how it intended to operate its business;
• administer all sales in accordance with a process prescribed by WSA (including pay WSA a Customer List Fee);
• use standard forms prescribed by WSA;
• comply with a manual provided by WSA; and
• comply with all reasonable directions of WSA.

The Court held that the Distribution Agreement was in fact a franchise agreement within the meaning of the Franchising Code of Conduct (Code).   Because WSA had not complied with the requirements of the Code, it was in breach of the Competition and Consumer Act 2010 (Cth) and was required to pay Simple over $200,000 in damages.

Distribution Agreements and questions of taxation

In International Business Machines Corp v Commissioner of Taxation [2011] FCA 335, the International Business Machines Corporation (IBM) submitted that their agreement with IBM Australia (IBMA) was essentially a distribution agreement under which the principal right granted to IBMA was the right to “use, distribute and market” IBM software.

The Commissioner argued for a more expansive reading, submitting that the agreement granted intellectual property rights to the extent necessary for IBMA to carry out its function as the user, distributer and marketer of IBM goods.  Justice Bennett accepted the Commissioner’s more expansive reading, and thus, consideration paid under the agreement was held to be “royalties” for taxation purposes.

Takeaways

A distribution agreement is a useful tool for commercialising goods or services.  In a lot of industries they are essential.  That said, they can also be complex legal relationships that neither party should enter into without first consulting a suitably qualified legal practitioner.

Cases

International Business Machines Corp v Commissioner of Taxation [2011] FCA 335

Toll (FGCT) Pty Ltd  v  Alphapharm Pty Ltd  [2004] HCA 52

Workplace Safety Australia v Simple OHS Solutions Pty Ltd [2015] NSWCA 84

Further information about commercial law and services agreements

If you need assistance drafting or negotiating the terms of a Distribution Agreement, contact us for a confidential and obligation-free discussion: 

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