ESTABLISHING
DISTRIBUTION
CHANNELS IN THE U. S.
One Commerce Plaza
Albany, New York 12260
P 518.487.7600
F 518.487.7777
www.woh.com
Leslie K. L. Thiele
Partner
International Practice Group
Overview
Issues when establishing a permanent presence in the U.S.
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Understanding key differences between an agent/sales
representative, a distributor, a subsidiary and a franchise
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Understanding the implications of the choices: tax, liability,
management involvement, control, IP protection, trade secrets
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Avoiding unintended consequences: fuzzy line in many states
between franchise arrangements and distributorship
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Complexities of federal and state regulation: patchwork of widely
varying industry-specific federal and state laws, overlapping laws
The decision involves much more than the naked agency, distribution or
franchise agreement, or buying a shelf corporation.
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Distributor vs. Subsidiary
Distributor: Foreign seller sells to U.S. distributor for resale, usually within
defined territory, on terms defined by contract. May be exclusive or not.
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Convenience: assumes sales and marketing responsibility for
foreign seller. May take on warranty service and regulatory
compliance
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Acts as importer of record
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Lower sales/credit risk to seller: a single buyer
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Loss of control: limits on how tightly a distributor can be controlled
re: marketing, choice of customers, buyers, customer lists, etc.
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Does not eliminate potential products liability or warranty exposure:
manufacturer remains ultimately liable
Result: Foreign seller generates U.S. sales, market presence at lower
margin but reduced cost and management time, some loss of control
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Distributor vs. Subsidiary
Subsidiary: Foreign parent establishes and directs a U.S. business
organization responsible for import and sales in US
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Parent bears all costs of establishing a U.S. entity/distribution
network: facilities, operations, regulatory compliance, development
of market channels and marketing materials,
Higher margins on sales, but carry cost of US subsidiary
Slower start to sales/profits without established sales structure
Sales risk: every buyer is a sales risk
High level of management involvement, especially in early stages
Complete control of U.S. sales (customer lists, markets, channels)
but concurrent risk from lack of experience with market .
Result: Foreign parent bears all costs but enjoys all rewards of U.S. sales,
maintaining corporate control (good and bad) over the U.S. market entry.
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Choice of Distributor vs. Subsidiary
Factors which influence the Distributor vs. Subsidiary choice:
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Costs: entry via subsidiary has higher up-front costs to establish a
U.S. operation
Management availability: entry via subsidiary requires higher level of
management involvement
Market knowledge: companies with track record in U.S., familiarity
with U.S./state regulatory systems may not need services distributor
can provide
Customers: sales risk depends on nature of customers, may not be
a problem for subsidiary sales
Product: some products need direct sales (IP issues, technology)
Foreign seller may plan to use a distributor as a segue to a later U.S. subsidiary
once product is established in U.S. market
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The Challenges of a Federal System
Regulation of distributors largely a matter of U.S. state law
▪ Constitution gives Federal government limited powers: limited to
ability to control INTERSTATE commerce
▪ All else (including law of sales) reserved to the individual states
▪ States regulate distributors within their borders, absent an alternate
choice of law by contract
Some federal statutes do reach through to distributors
▪ Petroleum Marketing Practices Act
▪ Automobile Dealers’ Day in Court Act
▪ Federal antitrust laws
Each representation must be reviewed for state-specific regulation and
possible federal consequences
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Statutory Regulation of Distributor
Relationships
No comprehensive national or state regulation of the role of a distributor
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Regulation evolved haphazardly to address specific abuses within
specific industries
- Federal “Automobile Dealers’ Day in Court” Act
- State laws almost always “Industry-specific” as well
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State regulations often address common problems:
- Termination: notice period
- Termination: requirement of “good cause”, exclusion of unfair
grounds
- Return/repurchase of inventory upon termination
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Chaos in terminology: “franchise” and “distributor” used at random
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Coping with State Regulation
Check for state legislation in EVERY STATE of distributor’s territory
▪ Industries frequently regulated by states include
- Heavy equipment / Farm equipment / Outdoor power equipment
- Alcoholic beverages
- Motor vehicles
▪ Less common industries include
- Marine products / watercraft
- Mobile home dealers
- Lawn & garden equipment
▪ Beware of miserable drafting:
- Failure to even define what is included in “industrial equipment”
- Word ‘franchise’ used when ‘distributor’ is meant
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Virginia: Example of Patchwork
Beer Franchise Act
Wine Franchise Act
Retail Franchising Act
Petroleum Products Franchise Act
Motor Vehicle Distribution Act
Farm Machinery Dealerships Act
Heavy Equipment Dealer Act
Common themes in the legislation include:
▪ Procedural & substantive termination safeguards
“good cause” and notice requirements for termination
▪ Repurchase of dealer’s required inventory of equipment
▪ Notice & opportunity to cure default
▪ ‘Good faith” required on part of dealer
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The “Accidental Franchisee” Problem
Franchise sales and relationships regulated at federal and state level
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Broad state definitions of “franchise” → distributor regulated as
franchise
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Common elements:
- Pays a franchise fee
- Operates under the trademark of the franchisor
- Shares a continuing interest in the success of the business or
operates under the marketing plan of the franchisor
NY: franchise fee and EITHER trademark rights OR marketing plan
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Unexpected negative outcome for manufacturer :
▪ Mandatory disclosure rules not complied with
▪ Limits on termination / grounds for termination / buyout
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Avoiding the “Accidental Franchisee”
Read the franchise statutes in the state where distributor is based
▪ Extra caution where definition of franchise is broad
▪ Franchise sales: consider compliance with state or federal
disclosure requirements if classification of relationship is fuzzy
▪ Franchise relationships: be prepared to comply with notice or
termination restrictions
Avoid characteristic indicia of franchises
▪ Avoid payments by distributor to manufacturer
▪ Avoid requirements which look like ‘franchise fees”, such as largerthen-normal inventory
▪ Avoid appearance of a business model imposed by manufacturer
▪ Expressly disclaim franchise (may help, no guarantee)
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Antitrust Issues
General rule: Exclusive distributorships long held to be presumptively
legal under federal antitrust laws :
▪ Vertical non-price restrictions often promote interbrand competition
▪ Exceptions mainly where supplier has substantial market power and
ability to restrain trade in relevant market
Pricing: Minimum resale price maintenance possible under conditions
▪ Federal law: since 2007, RPM viewed under “rule of reason”, i.e.,
looks at the anticompetitive effects of such programs, i.e., purpose,
duration, competitive environment, etc.
▪ State laws: RPM still “per se” illegal regardless of market effect
under some state antitrust laws: e.g., NY, CA, MD
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Issues in Drafting Distributor Agreements
American courts confronted with a distribution agreement will usually:
▪ Enforce a choice of law clause
▪ Observe a choice of forum clause –IF exclusive of other forums
▪ Enforce an arbitration requirement
▪ Follow the attorneys’ fees rules in the contract, if any
Termination compensation/ goodwill indemnity usually non-existent :
▪ Contract compensates distributor for set-up effort as part of the
price list, contract duration, etc.
▪ Termination notice a matter of contract, not law
▪ EXCEPTION: industry-specific legislation / state franchise rules
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Drafting Distributor Agreements - 2
Contracts for an indefinite period: may be terminated by either party on
“reasonable” notice
▪ “Reasonable”; duration of contract, performance and frequency of
product sales, or time needed to recapture initial outlays
▪ No statutory notice / indemnification
Products liability and warranties:
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Contractual shift to distributor will be ineffective.
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Exclude UCC statutory warranties with statutory language
Retention of title clause: ineffective under U.S. Uniform Commercial Code
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Creates only a ‘security interest’ in the goods in bankruptcy of
distributor
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Useless unless “perfected” by appropriate filings with state clerk
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Contact Information
The information in this presentation is intended as general background information on legal
issues arising in international business transactions in the U.S.. It is not to be considered as
legal advice with regard to any particular business relationship or transaction. U.S. and foreign
laws affecting international operations change often and information becomes rapidly outdated.
Businesses considering international transactions or investments should consult legal counsel
for advice on their particular issues.
Leslie K. L. Thiele, Esq.
International Practice Group
Tel: (518) 487-7636
Fax: (518) 487-7777
[email protected]
© 2011 Whiteman Osterman & Hanna
WHITEMAN OSTERMAN & HANNA LLP
One Commerce Plaza
Albany, New York 12260
USA
LLP
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