Thinking of Terminating a Distributor?

Do you have a distributor who is chronically late making payments? Or do you think someone else might do a better job marketing and selling your products?  Or is the distributor just a pain for any number of reasons?  Terminating a distributor can be a tricky process depending on the circumstances. 

If you have a written agreement with a distributor, this is the first place to look prior to taking any action.  Typically a distribution agreement will contain provisions for termination.  Contractual termination provisions fall into the following general categories:

·         Termination for Convenience.  The right to terminate for convenience may be given to one or both parties and permits a party to terminate the relationship for any reason or no reason at all.  The parties simply part ways sometimes subject to winding down provisions such as supplier’s obligation to fulfill existing purchase orders.  Some written notice is usually specified in the agreement – anywhere from 30-180 days would not be unusual. But be careful, even if you have the right to terminate a distributor for convenience, if you are terminating the distributor because it will not knuckle under to your pricing demands, you may have a lawsuit on your hands based on anti-trust laws.

·         Termination for Breach.  The right to terminate for breach is virtually universal and permits either party to terminate the agreement if the other party breaches its obligations.  There is usually a notice and cure period – cure periods can be as short as 3 days or as long as 60 days.  Many agreements will require a “material
 breach” or breach of a “material obligation” but even if your agreement does not have language to this effect, you may still find yourself in trouble if you abruptly terminate a distributor for something like the submission of reports a few days late unless you suffer real harm as a result. 

·         Termination for Failure to Meet Performance Requirements.  The right to terminate for failure to meet performance requirements is usually granted to suppliers/manufacturers where the distributor has been granted exclusive rights in a territory.  If you summarily reject purchase orders, are chronically late in making products available to the distributor, or you have a high volume of rejects, the distributor may successfully argue that but for your conduct, it would have met the performance requirements.

Whether or not you have a written contract with a distributor with specific termination provisions, there may still be ways for the distributor to claim foul.  The two most common are:

·         The distributor claims that it is actually your franchisee.  The distributor may claim this because in most states, statutes bar termination, cancellation or nonrenewal of the franchise except for "good cause."

·         Your termination was in bad faith and violated the concept of fair dealing or violated anti-trust laws.

“Franchise” is generally defined as an oral or written agreement in which (1) the franchisee is granted the right to distribute goods under a marketing plan substantially prescribed by the franchiser, and (2) the franchisee's business operations are substantially associated with the franchiser's trademark, trade name or logo.  So the more you control the distributor’s business and more closely that distributor is tied to you from a branding perspective, the easier it may be for the distributor to claim franchisee status.  You may still have “good cause” to terminate the relationship but now you will have to prove it and/or give the distributor the statutory notice period (usually a written notice of not less than 90 days).

Anti-trust law prohibits you from terminating a distributor for anticompetitive reasons.  For instance, you cannot terminate one of your distributors because of pressure from your other distributors who are angry about its price cutting practices.  This is price fixing and is illegal.  If you control a large percentage of the market, anti-trust claims with teeth become easier for a distributor to make.

In addition to anti-trust claims, you should also be aware that a distributor can simply claim that you treated it unfairly.  When the issue is fairness, here are some factors that courts have considered in the past:

·         What is your motive behind the termination? Is it to avoid paying an incentive or other bonus that would otherwise be payable if you did not terminate the distributor?

·         Will the distributor basically go out of business without your products?  If so, the more advance notice you can give the better so the distributor can find other sources of supply.

·         Did you give the distributor a chance to shape up and remedy a problem?  This is perhaps the most basic issue when assessing fairness.

·         Will you repurchase inventory or fill orders submitted by the distributor prior to the termination date?  If you do one or both you are less likely to disrupt or destroy the distributor’s business.

·         Have you treated all of your distributors in the same way?  It’s suspect to fire one distributor for not meeting a quota or paying late but let everyone else get by.

Whether or not you have a written agreement with a distributor, an abrupt termination is likely to cause economic hardship and/or animosity.  If you have an agreement, follow it both in word and spirit.  And whether or not you have an agreement, be reasonable and be aware of how the law (and a jury of your peers) may interpret your behavior.