The Life and Death of a Distributor Agreement

The renewal and termination of distributor agreements all comes down to the language used at their conception

By Glen Balzer, Contributing Editor -- Industrial Distribution, 12/1/2004

For every agreement, there is a birth, life and death. The length of life is always a variable, but the birth and death are surely unavoidable. The language used during the agreement's conception is as important as the renewal conditions and the circumstances under which the agreement can be terminated.

Creating and developing customer relationships, expanding relationships and growing the importance of customers to their suppliers requires a lot of hard work on the part of distributors. That hard work usually ensures a long-term relationship. However, it is not appropriate to believe that the relationship will last forever. All relationships ultimately end.

The importance of both parties to each other is the only factor that leads to a long-term relationship. The words in a distributor agreement neither prevent nor postpone the expiration of a relationship. Perceived value of each partner to the other is the only factor that determines the longevity of the relationship between a manufacturer and a distributor. The agreement cannot be used as a tool to ensure a long relationship.

One technique that has proven valuable to both manufacturers and distributors is the insertion of language in the distributor agreement that calls for annual renewal of the agreement.

The most typical clause includes words that say, "This agreement shall be in effect until the end of the first full calendar year in which the agreement was signed. The agreement shall be automatically renewed for an additional one-year period thereafter, unless terminated by written notice from either party to the other, not less than 30 days prior to the end of the initial or any subsequent one-year term."

A simple annual renewal clause accomplishes a number of objectives.

First, the annual renewal clause forces both the supplier and the distributor to review the terms and conditions of that agreement at least once each year. Since dissolution of the agreement at the end of the year represents a real possibility, neither party to the agreement is likely to take its partner for granted. If there are terms or conditions in the agreement that are unpleasant to one of the parties, that party might spend time during the year discussing a change with the other party during the middle of the year, when neither party is up against a deadline for printing and signing a new agreement. Modified contract language can be negotiated for insertion at the beginning of what becomes the annual agreement cycle. When both parties propose minor changes during the middle of the year, neither party feels compelled to make a decision under the duress of the calendar.

Second, another benefit of an annual renewal clause is that the supplier has an opportunity to rank all the distributors in the network. Such a forced ranking brings into focus the relative performance of each distributor. When this happens, little corrective action needs to be taken with the top performers. Moderate corrective action needs to be taken with the middle-performers. Termination needs to be considered seriously with the distributors at the bottom of the forced ranking.

Simultaneously, when the agreement includes an annual renewal clause, the distributor is compelled to evaluate the value of the supplier. If the return on its time is low, relative to the rest of the suppliers on the distributor's line card, a decision must be made whether to continue the relationship. The annual renewal clause affords both parties the opportunity to terminate the relationship without stating or demonstrating cause.

Third, once the distribution agreement includes an annual renewal clause, both parties are forced to evaluate the relationship at least once per year. Too often, the relationship is not critically evaluated frequently, and it is allowed to languish until something catastrophic happens. When that occurs, there is usually a shopping list of problems in the mind of both parties. Repair of the relationship is difficult when both parties carry around that shopping list. The annual renewal clause forces the frequent evaluation of the relationship, and individual problems can be addressed one at a time.

An annual renewal provision is a proven technique that prevents problems from growing out of control. When the relationship between a manufacturer and distributor approaches the end of life, the same clause provides a relatively painless method of termination. In this case, both the distributor and the supplier spend the final weeks of the relationship dealing with customer issues while avoiding expenditure of management time and financial resources arguing over old problems. Do not sign a new agreement without an annual renewal clause.

Industrial distributors and manufacturers occasionally seek the opportunity to gain advantage over their partners by inserting words in distribution agreements that make it more difficult for one party to terminate the agreement than the other.

The intention of this imbalance is generally to increase the difficulty with which a partner might terminate an agreement. In practice, where an imbalance exists in the agreement that makes termination of one partner more difficult than termination of the other partner, termination is no less likely. During the operating life of a distributor agreement with unbalanced termination clauses, either the distributor or the manufacturer is prohibited from optimizing the relationship. Both parties should have the opportunity to terminate the agreement.

There are two forms of termination: for cause, and for convenience.

Sometimes, termination for cause is clear and straightforward. Cause may not be contested when one distributor is acquired by another distributor. In this case, both parties may choose to disengage from the relationship. Another example where cause may not be challenged includes the case where a supplier files for bankruptcy.

In both examples, termination for cause would probably not be contested. The agreement would be terminated relatively quickly and painlessly, allowing both parties to pursue their interests individually. Where cause is straightforward, arguments and legal skirmishes are avoided.

Too often, however, only one of the partners agrees that cause exists, while the other partner fails to agree that a "cause" is valid.

One example where cause would be contested, is where the supplier feels that the distributor does not expend adequate resources on behalf of the manufacturer. A disagreement as to the appropriate level of energy expended by a distributor prohibits mutual agreement regarding cause. A distributor, for example, might feel that the supplier does not allocate adequate resources promoting its product line, making it too difficult to generate sales.

In this example, the supplier may not agree, and disagree that cause is present. The simple solution to squabbles over cause is to include a clause in the agreement that allows for termination for convenience, sometimes written as termination without cause. When a distributor agreement contains a clause including termination for convenience, either party may terminate the agreement, and mutual agreement regarding termination is not required. Conflict is avoided.

Just as important as proper wording in the distributor agreement regarding how to terminate, is spelling out the obligations of both parties upon termination. The distributor and the manufacturer have responsibilities upon termination, and it is important to describe those obligations in the agreement before the agreement is signed. Paying attention to and spelling out those obligations is important, since doing so eliminates unnecessary arguments upon termination.

The relationship between a manufacturer and a distributor is constantly in flux. The relationship is born—it develops, matures, declines and dies.

During the life of a distributor agreement, both the supplier and the distributor strive to develop and expand the relationship. Natural forces are constantly at work to diminish or even kill the relationship and agreement. Clever wording in a distributor agreement rarely prolongs or extends the life of a relationship.

Ultimately, all relationships between distributors and manufacturers end. Ease the process by addressing termination adequately and fairly when the agreement is being drafted. When the terms and conditions regarding termination are clearly spelled out, arguments can be avoided, and time spent on resolving those arguments can be channeled into activities that are more productive.