International distribution contracts are the new black and this is a good thing. I estimate that the international lawyers at our firm will have done about double the number of international distribution contracts in 2018 than in 2017.
I see this increase due in large part to companies better realizing that doing business in a foreign country by setting up a company in that country (be it a wholly owned subsidiary or a joint venture) is almost always invariably difficult, time-consuming, and expensive and that is especially true of China. Going into a foreign country via a distribution contract (or a reseller agreement) is a relatively fast, easy and inexpensive way to stick your corporate toes into a country’s waters.
And here’s one more thing that distribution agreements have over foreign direct investment (which usually means going into a foreign country by forming a company in that country) is that they allow for a company to enter into multiple companies all at roughly the same time. These days, it is almost as common for a company to use our international lawyers for multiple distribution agreements as for one. In other words, these companies are pushing their products into many countries all at once and all via distributors and distribution contracts.
Let’s though focus on China.
As our regular readers know well, forming a WFOE in China and then operating that business in China is difficult and expensive. See e.g., Forming a China WFOE: Ten Things To Consider and also Doing Business in China with Deportation or Worse Hanging Over Your Head on why having a WFOE is a must if you will be doing business within China. Perhaps most importantly, the typical US or EU or Canadian or Australian company is not experienced at selling products or services within China and is hindered from doing so by China’s discriminatory Internet regime. Selling products and services into China via a distribution agreement is a way to offload these complicated issues on an experienced China company. For the basics on what is involved in establishing a distribution relationship with a Chinese company, check out the following:
- China Trademarks and Your Chinese Distributor
- Getting Your Product Into China Via Distributorship. A Legal Piece Of Cake.
- That’s Hot: China Distribution Contracts
- Exclusivity In China Distribution Agreements
Today’s post focuses on the following key questions you should be asking yourself and your potential China distributor if you are looking to do distribution agreements with Chinese companies — to a great extent, these same questions apply pretty much everywhere in the world.
1. What will be the payment and shipping terms? China’s letter of credit system is not very effective. If you ship your products before receiving payment for them, you are taking the full risk that the Chinese side will not pay. Conservative manufacturers usually require full payment before they ship. Less risk averse manufacturers ship on 30 days after the date of shipment (Net30) terms. These manufacturers provide for the right to shift to payment before ship terms if there is a problem. Shipping terms can be CIF or ExWorks. ExWorks is more common, since estimating shipping and insurance costs can be difficult.
2. Will you have sales milestones? This is always a good idea in an exclusive distributor arrangement. Sales milestones for China distributors are usually set on a quarterly basis and not broken down by province. The issue of sales milestone is usually a big issue, so setting the milestones in a way that is clear and simple to understand is important.
3. What will be the term of your distribution agreement? f you are going to have here an exclusive agreement its term/length becomes of critical importance. The normal procedure is to provide for a term long enough to give the Chinese distributor time to earn back its efforts in promoting your products. A three year term is typically the minimum, with five years more common. Most China distributors that plan to put in substantial work to market and sell your products will require the distribution agreement to automatically renew if they achieve their sales milestones. The China side will often want a provision stating that if the parties cannot agree on new milestones after the end of the first term, renewal will be automatic based on some predetermined formula. Chinese distributors that do not require something like this are oftentimes not planning to do the work necessary to succeed.
4. What about your brand name? When selling products in China, you typically will need Chinese and English language trademark protection for each product that will be sold. Serious distributors insist such protections be in place. You can use your own China trademark lawyers to handle the appropriate China trademark registrations or you can have your distributor take care of this on your behalf as your agent. In either case, you should take care of the trademark registrations as soon as possible, preferably before any distribution gets signed or, better yet, before any negotiations even begin. See China Trademarks: Register Yours BEFORE You Do ANYTHING Else. If your distributor takes care of this for you, you will want to ensure that the registrations are done in your name and not in theirs.
5. What law will govern your distribution relationship? This really should not even be in the form of a question in that you are going to need your distribution agreement to be enforceable in the PRC and for that to be the case it must be drafted with Chinese law as the governing law and the Chinese language as its controlling language, and with enforcement in a Chinese court. For why we draft our China contracts this way, check out China Contracts that Work and China Contracts: Make Them Enforceable Or Don’t Bother.
6. How will you protect your trade secrets? China NNN (non-use, no disclosure, non-circumvention) language should go into your distribution agreement and if your China distributor will not accept this, find a new distributor.
7. Who will pay for what? Are you going to pay for marketing/advertising your product in China or will your distributor do that or will you share. Clarity is the key here. Will your technical product documents be translated into Chinese? If yes, who will do this and who will pay for this?
8. How are you planning to deal with warranties? A standard approach is for you to draft the warranty and then have your distributer provide this warranty to consumers without any changes. Under this approach you will need to work with your distributor to design an appropriate warranty that a) works for your products, b) works for your company and your distributer, c) meets market demands, and d) complies with Chinese law. The alternative is to allow your distributor to provide whatever warranty it wants to consumers. Your warranty is with the distributor and you will not cover any warranty beyond that which you have specifically agreed with your distributor. Under this sort of arrangement you have no contractual relationship with the consumers and the consumers have no legal basis to assert warranty claims against you. They are limited to making claims only against your distributor. This option is consistent with the legal status of a distributor that buys and then resells your products. However, under this approach you no longer control the nature of the warranty and many companies do not want to give up this control. Much will depend on the nature of your product, your consumers and your trust in your distributer.
9. Who determines the sales price to consumers? Normally, the China distributor is free to set the prices it wants for the products, since it has purchased the product and therefore owns them. However, many of our clients wish to exercise at least some pricing control. Absolute resale price maintenance is not legal in China so you cannot dictate the sales price. You can, however, require your distributor to work with you on pricing and even set a pricing product range, both maximum and minimum.
10. What training will you provide your distributor? Where will your provided this (in China or in your home country)? How will training costs be determined and who will pay those costs?
Go forth and prosper.