Young companies can avoid difficult and costly long-term problems by setting up airtight contracts from the start.
Our fictional brewery, Slapstick Brewing Company, had developed such a large following that its owner decided it was ready to expand its market and distribute outside New York. Unfortunately, the distributor it had always worked with was not licensed to distribute outside the state. Assuming that it would be easier to work with one national company rather than several regional distributors, the brewery chose the national distributor. In the process, Slapstick learned five difficult and expensive lessons. I share those here so you can avoid making the same mistakes.
1. Verify the Distributor’s Claims Before Signing On
Although the distributor stated it was national, Slapstick later learned that the distributor only actively pursued markets in California, Texas, Washington, Pennsylvania, and Massachusetts. If a retailer requested it, the distributor would sell in other states, but it did not have offices, warehouses, or an active salesforce covering every state.
The lesson Slapstick learned was that when working with a new distributor, the territory should be limited to only those markets showing demonstrable results. Rather than granting the distributor a territory that is too large initially, Slapstick will begin a new distributor relationship in that distributor's proven territory and expand the territory gradually, and only after results in the smaller territory suggest that an expanded geography is warranted.
2. Don’t Get Locked Into an Inflexible Contract
The distributor told Slapstick that it was taking a chance on an unproven brand in the new markets, and that it would be investing a lot of time and money creating a market for Slapstick’s beer all over the U.S. In exchange for this investment, the distributor was unwilling to accept a contract that made it easy for the distributor to be replaced. Further, the agreement did not include a provision for termination for cause or termination for convenience. The distributor only allowed for termination for a limited set of specific causes. In its first year with the new distributor, Slapstick learned that manufacturers and distributors often disagree over the presence of and responsibility for termination cause. These details must be set clearly in the contract to protect all parties.
After attending a few craft brew symposiums, Slapstick learned that distributor agreements should be renewed annually, and allow for termination for cause and for termination for convenience. When an agreement allows termination for convenience, a party wishing to disengage from the relationship serves Notice of Termination to the other party with 30 days notice. Without a legal confrontation, the distributor and manufacturer can focus on their respective customers and businesses without consuming management time, corporate focus, and financial resources on attorneys, courts, and arbitration.
3. Avoid an Exclusive Agreement
The distributors argued for an exclusive territory, because without it, the distributor said it had no incentive to allocate adequate resources toward development of sales for the manufacturer. Distributor franchises may be either exclusive, whereby there are no other distributor franchised in the territory; or nonexclusive, in which the new distributor might be one of several distributors franchised in the territory. Although it sounded reasonable at the outset, Slapstick learned that assignment of an exclusive distributor in a territory represents an unnecessary leap of faith without a proven track record to justify such a monopoly. Because Slapstick agreed to an exclusive territory, however, it forfeited the opportunity to franchise an additional distributor when sales were below targets or when the sales team was underperforming. At the craft brewery symposium, Slapstick learned that it was better to draft the distribution agreement in such a way that the distributor is nonexclusive, but to franchise only one distributor. A verbal understanding would suggest that if a supplier's objectives were met, no additional distributor would be added to the nonexclusive territory. Such an arrangement provides encouragement for the distributor to perform without restricting options of the manufacturer.
4. Allow for Price Changes and Contract Amendments
The distributor included a provision that Slapstick could adjust prices only once per year. Slapstick learned that this benefitted the distributor at the expense of the brewery. During periods of inflation or other rising costs, the brewery did not have the opportunity to pass along increases in cost. Next time, it will insist upon a provision allowing an increase in prices upon 30-day notice.
Relationships between craft beverage producers and distributors begin and develop over time. They grow. They mature. Sometimes they decay. Ultimately, they expire. External factors periodically create pressure on the distributor and the craft beverage producer that call for a change in the distributor agreement upon 30-days notice. If the agreement allows changes to be made throughout the year, there is little problem. However, if the agreement allows for changes only once per year, one or both partners must survive undue pressure until the agreement can accommodate such an annual change. The best distributor agreements allow changes to be made throughout the year.
5. Spell Out Termination Details
After about 18 months, it was clear that the relationship had deteriorated and a new distributor would have to be selected. As any business owner knows, the true test of any agreement is what happens when the parties part ways. The agreement failed to spell out which products would be returned for credit and the timetable for such returns. The already tense situation was made worse as a result of each side’s different expectations about issues involved in the transition period.
Slapstick now knows that a distribution agreement must clearly state the responsibilities and obligations of both parties during the life of the agreement, upon notice of termination, and after the agreement is terminated officially. The distributor agreement must spell out responsibilities of both parties during and after the life of the agreement.
Learn From Slapstick's Mistakes
Drafting an agreement that avoids unsound clauses and includes strategic clauses to protect the parties in the event of a dispute is the art and science of negotiating a good distribution arrangement. You now have a checklist of five common mistakes to avoid when drafting your next distributor agreement. Distribution agreements are an integral tool in the construction of a relationship between a distributor and a craft beverage producer. A well-written agreement can assist in developing that relationship. The agreement cannot extend the life of a relationship once the relationship expires. A poorly written agreement often leads to a legal quarrel that consumes management time, financial resources, and the involvement of attorneys, courts, and arbitration. A well-written agreement can eliminate expenditure of resources on these unproductive activities and encourage the distributor and manufacturer to go about their respective businesses upon expiration of the relationship.
Next time: Learn how to prevent unexpected costs with your distributor what to ask a distributor before signing on the dotted line.