Distribution Agreements in the USA

In the USA, the term “distribution agreement” refers to an agreement between a manufacturer or supplier and a reseller of the manufacturer’s or supplier’s goods or services. The reseller generally is referred to as a “distributor” if it resells to other businesses for further resale. The reseller generally is referred to as a “dealer” (or sometimes as a “retail distributor”) if it resells to end users.

For example, a non-US automobile manufacturer typically sells its vehicles to a national distributor for the USA, which resells the vehicles to local automobile dealers, who in turn sell vehicles to consumers.

There is no regulatory scheme in the USA applicable to distribution agreements as a general class. In most cases, parties are free to enter into a distribution relationship on whatever terms they choose, without any mandated terms or formalities or oversight by any government body. General principles of contract law will apply. However, there are several bodies of law that can or will come into play, depending on the goods or services involved in the relationship.

Uniform Commercial Code

For product distributorships and dealerships, Article 2 of the Uniform Commercial Code (UCC) is an important body of law. Article 2 of the UCC deals with “transactions in goods.” Article 2 has been adopted, with various adjustments, in all 50 states of the USA. Article 2 will apply if the sale of goods is part of the relationship; in some states, the sale of goods must be the “dominant” or “predominant” part of the relationship for the UCC to apply. However, provisions of the UCC are not mandatory; rather, they act in a gap-filling capacity when the private contract of the parties fails to cover a particular issue. The parties are generally free to adopt contract provisions that vary from Article 2. UCC provisions address the formation and modification of a contract for the sale of goods, the performance obligations of seller and buyer, and breach and remedies.

Antitrust Law

Another body of law critical to distribution agreements is federal and state antitrust (competition) law. All distribution relationships in the USA are subject to these laws. The principal federal antitrust statutes are the Sherman Act, the Clayton Act, the Federal Trade Commission Act, and the Robinson-Patman Act. These laws are enforceable both by government agencies and (except for the FTC Act and portions of the Robinson-Patman Act) by private parties.

The federal antitrust statutes (and their state counterparts, discussed below) set out broad principles that have been refined through countless court decisions over many decades. For distribution agreements, the commercial practices of potential competitive concern are generally grouped as described below.

Vertical non-price restraints. Vertical non-price restraints include exclusive dealing arrangements, exclusive distributorships, customer restrictions, and territorial restrictions. The legality of such provisions has long been tested under a flexible “rule of reason” standard. This standard requires an analysis of the actual competitive effects of the restriction in a properly defined product and geographic market. In practice, vertical non-price restraints are rarely found to be unlawful, and then only in circumstances where the seller has “market power” in the properly defined market. The courts generally hold that a seller with less than a 30% share of the relevant market does not have market power.

Vertical price restraints. Vertical price restraints (also known as resale price maintenance or RPM) are restrictions by the seller on the resale pricing practices of buyers. For decades, dictating a buyer’s resale prices was deemed to be per se illegal – i.e., illegal without regard to proof of anti-competitive effects in the particular case. Therefore, a supplier could not set either the maximum price or the minimum price at which an independent distributor resold the supplier’s goods. However, in 1997, the US Supreme Court changed the federal antitrust rules with respect to setting maximum resale prices. Ten years later, the Supreme Court similarly changed the rules with respect to setting minimum resale prices. Since these landmark decisions, vertical price restraints under federal law – whether maximum or minimum prices – have been tested under the rule of reason, just like vertical non-price restraints. The 2007 Supreme Court decision to change the rule for minimum prices was controversial when announced; in particular, some prominent state enforcement authorities announced that they would not change the rule of per se illegality for minimum resale price restraints under their state antitrust laws.

Minimum purchase targets and restrictions on sources of supply. Purchasing requirements and restrictions imposed by a supplier on a distributor may raise exclusive dealing issues or “tying” issues under the antitrust laws. A tying arrangement is one in which the supplier conditions the sale of one product (the “tying product”) on the buyer’s agreement to purchase a separate product (the “tied product”) from the supplier or its affiliate, or from a third party who pays a rebate or commission to the supplier. Tying arrangements can be challenged by a buyer who is subject to the restriction or by a competing seller who is foreclosed from the buyer by the restriction. Under general principles of tying law, a tying arrangement will not be deemed unlawful unless the seller possesses sufficient market power in the market for the tying product to enable it to restrain trade appreciably in the market for the tied product.

Price discrimination. The Robinson-Patman Act prohibits certain forms of price discrimination by a seller between competing buyers. The Act applies only to the sale of tangible goods. If one distributor must pay the supplier a higher price for goods than the supplier charges to other buyers with whom the “disfavored” distributor competes, the disfavored buyer may be able to assert a price discrimination claim. A competing seller also can challenge price discrimination. However, the jurisdictional requirements for a claim under the R-P Act are many, and proof of a violation is extremely difficult.

State antitrust laws. All 50 states and the District of Columbia, Puerto Rico and the U.S. Virgin Islands have their own antitrust statutes, such as the Cartwright Act in California and the Donnelly Act in New York. Most states, either by statute or by case law, give deference to case law precedent under the federal antitrust laws in applying the state antitrust statute. However, some state antitrust authorities strongly opposed the change in federal law regarding vertical minimum price restraints. Enforcement authorities in New York, California, Illinois and Michigan publicly took the position that minimum resale price maintenance would remain per se illegal under their existing state laws, and the state of Maryland passed legislation to codify the rule of per se illegality for minimum price restraints in that state.

Nevertheless, in practice, there have been few recent lawsuits or state government enforcement actions targeting minimum RPM in distribution networks. One possible reason is that few suppliers, in practice, have been setting minimum resale prices, because of the continued uncertainty and risk at the state level. Suppliers wishing to set minimum prices for US distributors must recognize that this practice could still be considered per se illegal in certain states. In practice, when suppliers do impose resale pricing restrictions, they are usually maximum prices. Another possible reason for the lack of RPM lawsuits is that suppliers have satisfied their business objectives by using techniques that have been found not to constitute RPM, such as “minimum advertised price” or “MAP” policies.

Industry-specific laws

The third body of law critical to distribution agreements is federal and state statutes governing termination or other aspects of distribution relationships in particular industries. At the federal level, the Automobile Dealers Day in Court Act and the Petroleum Marketing Practices Act govern relationships between suppliers and automobile dealers and gasoline retailers, respectively. At the state level, the industries affected include car, truck and motorcycle dealers, farm equipment dealers, construction and industrial equipment dealers, liquor wholesalers, beer and wine distributors, boat and snowmobile dealers, applicance dealers, and garden equipment dealers, among others.

A few states and US territories have statutes governing termination of dealerships generally. These include Alaska, Delaware, Maryland, Rhode Island, Wisconsin, Puerto Rico, and the U.S. Virgin Islands.

A word on Franchise laws

While a properly constructed distribution agreement will not constitute a “franchise” under federal and state franchise investment laws, it is not difficult for a distribution agreement to cross the line. The principal distinction is that the distributor does not pay any up-front or ongoing fee for the privilege of selling the supplier’s goods. Although distributors do pay the supplier for products, the federal and most state franchise laws provide that the purchase of products at a bona fide wholesale price for resale does not constitute a “franchise fee,” and thus no franchise exists. In addition, the control that the supplier exercises over the distributor’s business operations may fall short of the level of control necessary to create a franchise relationship.

However, there is a long line of cases, typically involving the termination of a distributor or dealer, in which the terminated party has claimed to be a “franchisee” and thus entitled to statutory protections for franchisees. Minimum purchase requirements are relevant to this issue; in jurisdictions where the payment of a “franchise fee” is an element of the “franchise” definition, requirements to buy excessive amounts of inventory have sometimes been deemed to satisfy the “franchise fee” element.

There are no special rules or procedures in the USA for forming a distribution agreement, provided that it does not constitute a franchise. In some circumstances, however, an oral agreement may be insufficient. For example, under Article 2 of the UCC, the general rule is that a contract for the sale of goods for the price of $500 or more is not enforceable absent a writing sufficient to indicate that a contract has been made and signed by the party against whom enforcement is sought. In any case, a written agreement is highly advisable to reduce the chances of a dispute.

Key clauses of a distribution agreement will include the duration of the appointment, the distributor’s authorized territory or customers, the scope of exclusivity (or an express statement that there is no exclusivity), the terms and conditions of sale of the products or services (prices, ordering procedures, payment terms, shipping, inspection, etc.), any distributor minimum performance obligations, any provision for use of the supplier’s trademarks or other intellectual property, termination rights, obligations after expiration or termination of the contract, and choice of law and dispute resolution.

Generally, the parties to a distribution agreement in the USA are free to determine any restrictions on the territory within which, or the customers to whom, the distributor may sell. They are also free to determine the scope of any exclusivity granted to the distributor for the designated territory or customers.

An “exclusive distributorship” is one in which the distributor receives the right to be the sole outlet for the supplier’s products or services in a given area or for a given set of customers. In analyzing exclusive distributorships and the associated territory or customer restrictions under the antitrust laws, US courts apply the “rule of reason” (see Question 1) to determine the actual or likely competitive effects of the arrangement. Courts will consider the market structure, the strength of inter-brand competition, the geographic scope and duration of the agreement, and any other relevant factors. These restrictions are rarely found to be unlawful.

The parties also are generally free to determine the distributor’s authorized resale channels. US law does not have specific rules for “active” versus “passive” sales, online versus offline activities, or single-brand versus multi-brand resellers. In principle, suppliers can prohibit distributors from e-commerce sales (either on a distributor site or a third-party platform) and use of social media if the supplier wishes to reserve those channels to itself or another reseller. Like any other vertical non-price restraints, such restrictions will be subject to antitrust challenge if they have net anticompetitive effects on inter-brand competition, but not simply because of the nature of the restriction.

The parties also may agree that the distributor will not carry competing products of other suppliers, or the supplier may establish a pricing policy that creates strong disincentives for the distributor to purchase from the supplier’s competitors. These and other types of “exclusive dealing” arrangements are similarly subject to antitrust challenge if they substantially decrease inter-brand competition – in this case, by foreclosing competitors of the supplier from reaching the market. But such challenges will not succeed if competing suppliers can compete effectively by selling to other distributors or through alternative distribution channels.

Minimum turnover clauses are valid and enforceable in the USA. Clauses imposing other types of minimum performance standards (for example, minimum purchasing requirements, minimum unit sales, and minimum market penetration goals) are also generally valid and enforceable. In practice, however, a distributor is unlikely to agree to a minimum performance obligation unless the distributor receives some degree of exclusivity from the supplier.

The distribution agreement typically provides that the supplier may terminate the distributorship, revoke the distributor’s exclusivity, or reduce the territory for failure to achieve the required minimum turnover. US courts generally uphold these clauses unless the distributor can prove that the supplier breached its own obligations in a way that prevented the distributor from achieving the required performance.

Of course, the minimum turnover agreed by the parties at the outset of the relationship may turn out to be not readily achievable. The parties therefore might wish to cushion the adverse consequences to the distributor. Best practices in drafting may include periodic re-setting of the minimum based on actual experience, measuring performance on a rolling time period rather than a static period, and/or permitting termination or reduction of territory only if the distributor’s performance falls short in multiple periods.

In general, the parties to a distribution agreement can specify the grounds and procedures for termination, and the contract provisions will be enforced unless deemed by a court or arbitrator to be unconscionable or contrary to public policy. However, if a federal or state dealership law applies to the relationship, the statute may supersede the termination provisions of the contract.

The dealership statutes (see Question 1) typically require “good cause” for termination, as well as notice of default and an opportunity to cure. Most of them provide that good cause includes failure by the dealer to comply with any lawful (and in some cases, “material” or “reasonable”) requirement of the agreement. Most of the statutes define good cause in a non-exhaustive manner, leaving room to argue that good cause exists even in circumstances where the facts do not match any of the examples of good cause in the statute. Some statutes specify circumstances (such as the distributor’s voluntary abandonment of the business, conviction of a crime, or repeated defaults) in which the supplier is not required to provide notice and an opportunity to cure. No two statutory formulations are exactly alike, so the specific statute must always be consulted.

If no dealership statute applies, the terms of the distribution agreement will govern. If the parties have not specified conditions for termination, then UCC provisions may apply. A few specific circumstances are listed below:

The agreement permits termination without cause. Absent a superseding statute, an agreement that expressly permits termination “without cause” or “for any reason” generally will be enforced according to its terms.

No grounds for termination are specified and the agreement has no definite duration. Under both common law contract principles and UCC § 2-309, if the parties have not specified the grounds for termination and the agreement has no definite duration, the agreement is valid for a reasonable time and either party may terminate at any time on reasonable notice.

Good faith, course of dealing, etc. State common law, the UCC, and certain industry-specific dealer statutes impose good faith obligations on the parties to a contract. However, under both common law and the UCC, a general obligation of good faith cannot be used to override or contradict the express terms of an agreement. Accordingly, if a distribution agreement clearly authorizes termination in particular circumstances, good faith principles will not preclude a party from exercising the contractual right to terminate. The same is true for principles of “course of performance,” “course of dealing,” and “usage of trade.” This is a significant difference from civil law jurisdictions, where good faith principles may be used to override the contract terms.

Distributors generally are not entitled to any compensation under state statutory law or common law upon termination or expiration of a distribution arrangement—a concept typically referred to in Europe as a “goodwill indemnity.” Although a few special industry laws require the supplier to repurchase inventory from a terminated distributor, there is no goodwill indemnity based on clientele developed by the distributor.

Any rights of a distributor to payment from the supplier on termination or expiration of a distribution arrangement would have to be provided for in the distribution agreement itself—a feature virtually non-existent in US distribution arrangements. Partly for this reason, suppliers and distributors in US distribution arrangements typically, or ideally, agree to a contractual regime—notably duration, exclusivity and termination clauses—that essentially establish a distributor’s expected return on investment for efforts and monies contributed to the development of a market for the supplier’s product. A distributor thus will typically seek a long enough, and firm, expiration date, with tight termination and exclusivity provisions, to allow the opportunity for a proper investment return, and a supplier will typically seek the opposite to maintain flexibility. However, a supplier should be wary of negotiating “too good of a deal” with an eager would-be distributor, because a distributor with too short of a contract term, or distribution rights that can be too easily terminated, may not be sufficiently incentivized to promote the supplier’s product adequately.

At the core of these differing approaches in the USA and Europe is the question who benefits from appreciation in the business as between supplier and distributor during the term of the relationship. In certain European jurisdictions, the answer tends to be the distributor (and, even more often, the agent), reflecting the view that the distributor effectively becomes the “owner” of the business during the term of the distribution arrangement, akin to a homeowner enjoying appreciation of a real estate asset during the period of ownership. In the USA, the supplier benefits from appreciation in the business, reflecting the supplier’s continued legal and economic ownership of the business during the term of the distribution arrangement, with the distributor more akin to a tenant with limited usage rights.

Non-US suppliers are often concerned about product liability claims that may be brought against the supplier in the USA. This concern is rational, given the greater incidence and cost of product liability litigation in the USA compared to other countries (and the fact that, contrary to the rule in many other countries, a prevailing defendant in a US litigation generally is responsible for its own legal defense costs). As a result, it is common that suppliers, even when not at fault or likely to be liable for a claim, may pay out of pocket to settle a dispute rather than endure the time, expense, and distraction of litigating a case in court.

It is important that suppliers in a US distribution arrangement avail themselves of various strategies to mitigate this risk. These strategies include, among other things, obtaining proper insurance to cover the US market, negotiating liability limitations and other risk allocation provisions in the distribution agreement (in particular, to limit exposure for third party claims), and utilizing a properly structured separate legal entity for the US business (to afford limited liability relative to the supplier’s other assets and businesses).

Product liability law lawsuits in the USA may be based on common law theories of negligence, breach of warranty, or strict liability. In addition, several states have created a statutory cause of action for product liability claims.

Under a negligence theory, manufacturers may be liable if they do not act with reasonable care to ensure that their product is designed and manufactured for safe use. To make this determination, US courts examine two primary factors: the risk of harm to those who can reasonably be expected to make use of the product, and the manner in which the products foreseeably can be used. A plaintiff making a claim under a negligence theory must prove that the manufacturer breached its duty of care and caused damages.

Under a breach of warranty theory, manufacturers may be liable if they breach an express or implied contract with respect to the fitness of the product. An express warranty is a promise or affirmation of fact about the product on which a purchaser reasonably relied, such as a statement included in a product’s instruction manual. An implied warranty attaches to the sale of a product as a matter of law and, unless expressly excluded, implicitly warrants that a given product is suitable for the ordinary purpose for which it is used, or for the particular purpose for which it is sold. Manufacturers often include written disclaimers of implied warranties with their products to avoid these claims.

Under a strict liability theory, a manufacturer who sells a defective product that is unreasonably dangerous to the user may be liable for all injuries to the consumer or the consumer’s property. Strict liability applies even if the manufacturer was not negligent or if it had no contractual relationship with the consumer. The consumer must only prove that the product was defective or that the manufacturer failed to warn users of a dangerous foreseeable use, that the defect or failure existed when product left the manufacturer, and that the defect or failure injured the consumer, so long as the consumer’s use of the product was reasonably foreseeable.

Each of the above claims may allege a manufacturing defect, a design defect, or a warning defect. A manufacturing defect occurs if the product left the manufacturer’s control with a material deviation from its intended design specifications. A design defect occurs when the product is designed in a way that is unreasonably dangerous for consumers, and a safer feasible alternative design exists or could exist. A warning defect occurs when a manufacturer fails to include an adequate warning to consumers of a reasonably foreseeable risk of harm, and the omission of such a warning makes the product unsafe.

US jurisprudence tends to favor consumers in product liability suits. Consumers injured by a product often can recover compensatory damages, including compensation for medical costs, property damage, and pain and suffering. US courts may also award punitive damages in product liability cases if the plaintiff proves with clear and convincing evidence that the manufacturer acted willfully or recklessly. And if these claims go to trial, the damages may be determined by a jury that may be more sympathetic to consumers than to manufacturers.

A manufacturer may not be able to avoid liability for some claims brought by an end consumer, particularly if the claim is based on a strict liability theory. However, the manufacturer can mitigate its risk of exposure to claims from its direct customer, the distributor. As noted above, properly negotiating certain risk allocation provisions in the distribution agreement can prove critical.

A non-US manufacturer may be exposed to product liability claims in the USA even if the manufacturer does not have a presence in the USA. A foreign manufacturer potentially can be sued in any state in which its products are distributed, thus subjecting it to the product liability laws of that state. If a foreign manufacturer knows that its product is being sold in or distributed to the USA, or if there is evidence of ongoing regular contact between the foreign manufacturer and the USA, then courts will typically find that the foreign manufacturer is subject to personal jurisdiction of a US court. However, the foreign manufacturer’s home country may not necessarily enforce a court judgment from the USA, depending on the home country’s laws.

Courts in the USA typically will apply a foreign law agreed to in an international distribution agreement unless there is no substantial connection between the jurisdiction of the foreign law and the parties or the subject of the agreement. As an exception to that general rule, New York courts will respect a choice of law provision designating New York law as the governing law, even if neither the parties nor the subject matter of the contract bear any connection to New York State, so long as the agreement was made for, or contains an obligation involving, more than $250,000.

If a distribution agreement is silent on what law applies, a US state court will apply a conflicts of law analysis to determine which law to apply to the agreement. Courts in some states, like Florida and Virginia, apply the law of the jurisdiction where the contract was made. Courts in other states, like New York and California, apply the law of the jurisdiction with the most substantial connection to the agreement or the dispute.

US courts, however, will decline to apply a foreign law if it violates a fundamental policy of the court’s state, such as by permitting an excessively high interest rate for lending arrangements or by applying an overly burdensome non-competition restriction in certain contexts. A US court may also decline to apply a foreign law if it determines that the foreign law does not differ substantially from the local law.

While US courts generally will apply foreign law, subject to the limitations identified above, the parties to a US distribution agreement should consider whether, strategically, it is advantageous to designate the law of another country. For example, often a European supplier wishing to enter into a distribution agreement with a US distributor may seek to have the law of its home jurisdiction, say Germany or Italy, apply to disputes that may arise. This often happens because the European supplier is simply more familiar with its own laws, and has relationships with its regular home-country counsel. However, US law typically is more favorable overall to foreign suppliers, notwithstanding product liability concerns. For example, European civil law jurisdictions tend to have statutory protections, such as so-called “goodwill indemnity” payment rights and limitations on termination rights, not generally found in US law.

Lastly, the USA is a signatory of the United Nations Convention on the International Sale of Goods (the “CISG”). In disputes involving parties to an international distribution agreement where the contracting parties are from different countries that are signatories to the CISG, a US court will often apply the CISG, even if the parties specify a different law, unless the parties expressly disclaim application of the CISG. It is thus important that the distribution agreement contain appropriate language to exclude application of the CISG (unless its application is desired).

US courts generally will dismiss contract disputes when the parties have agreed contractually to resolve their disputes in a different court or in arbitration. However, US courts may disregard a forum selection or arbitration clause if the chosen forum is so inconvenient (through the doctrine of forum non conveniens) as to be unreasonable.

Because US courts generally will enforce forum selection and arbitration clauses, the parties to a distribution agreement should consider strategically which venue may be most advantageous. This calculus, of course, is based on many considerations, including perceived fairness of the venues, logistics, and cost (including the cost of US-style discovery procedures).

One factor that parties should consider when deciding in which forum to litigate disputes is the enforceability of the judgment issued. In making this decision, a supplier or distributor should consider whether it is more likely to sue or be sued under the agreement. For example, a supplier may believe that it is more likely to sue for non-payment of goods, and perhaps for an injunction on IP matters, than to be sued for quality issues. In that case, to maximize ease of enforcement, the supplier may wish to negotiate for a clause requiring legal claims to be filed in a court in a jurisdiction in which the distributor holds assets or, alternatively, in arbitration. These options would be preferable for the supplier because, while there is no international convention for the enforcement by one country of a court judgment issued by a court in another country, such a convention – the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (commonly referred to as the “New York Convention”) – exists for arbitral awards. The USA, along with 164 other contracting nations as of August 2020, is a signatory of the New York Convention. Of course, a party that believes it is more likely to be sued may wish to negotiate for dispute resolution in a venue whose judgments are more difficult and costly to enforce, thereby disincentivizing the other side from bringing a claim in the first place.

If a distribution agreement is silent on the selection of venue for the resolution of disputes, US courts may dismiss a claim brought by one of the parties if the court lacks personal jurisdiction over the defendant or under the forum non conveniens doctrine. These doctrines require a complex analysis of the connection between the defendant, the contract, and the forum.