Critical to the role of a distributor is growing the business of a manufacturer by all means – including mutual support and clearly understood and shared performance metrics. Distributors invest significant amounts of time, effort, and resources in marketing, logistics, sales, and relationship-building to create a strong value proposition with their manufacturing partners. Nonetheless, relationships can sour and be easily eviscerated if the manufacturer, either out of opportunism, bad faith, or otherwise, seeks to take the hard work of a distributor in establishing end-user opportunities and deal directly with customers.
To guard against these opportunistic outcomes, many distributions include (and should include from the start) anti-circumvention clauses, sometimes referred to as “non-circumvention” or “direct dealing” provisions. These clauses are designed to prohibit manufacturers or suppliers from bypassing the distributor to deal directly with customers or sub-distributors within the distributor’s territory or network.
What Does a Typical Anti-Circumvention Clause Say and What Does It Accomplish?
In a distribution agreement, a basic anti-circumvention provision may read something like this:
“The Supplier [or Manufacturer] shall not, directly or indirectly, sell or solicit sales of the Products to any customer, dealer, or end user within Distributor’s territory without Distributor’s prior written consent.”
This provision essentially prevents the supplier or manufacturer from undercutting the distributor’s diligence in securing profitable opportunities for its supply partner by selling directly into the distributor’s established market or its existing customer base.
Trust Is Not Enough
While trust is yet another hallmark of a strong distribution relationship, distributors must protect themselves from the outset from risks if and when a relationship deteriorates as contemplated here. Distributors often bear not-insignificant upfront costs when ramping up a supplier/manufacturer relationship, including marketing expenses, warehousing, hiring sales staff, developing engineering support, and assuming the commercial risk of holding inventory. Without anti-circumvention protection, a manufacturer could reap the benefits of all that investment by using the distributor’s spadework to establish direct sales relationships.
For example, a U.S.-based distributor spends several years and considerable resources building a market for a European manufacturer’s products, attending trade shows and conventions, promoting brand awareness through advertising and marketing efforts, and securing one or more major accounts. Once sales volume in the States reaches desired results, the manufacturer may be tempted to tell the distributor, “Thanks for all the hard work,” and start selling directly to avoid paying for that work.
Anti-circumvention clauses deter this behavior by making such direct sales a breach of the underlying distribution agreement and providing a legal remedy for a distributor that has been exploited by a manufacturer/supplier.
Common Forms of Anti-Circumvention Clauses
Depending on the structure and nature of the relationship, anti-circumvention provisions can take several forms, including:
- Territory-Based Clauses: These clauses prohibit the manufacturer from making direct sales within the distributor’s assigned geographic territory.
- Customer-Based Clauses: These restrict the manufacturer from selling directly to customers or accounts developed or maintained by the distributor (subject to specific, objective standards).
- Non-Solicitation Clauses: These prevent the manufacturer from contacting or soliciting the distributor’s customers, market channel partners, or employees.
- Post-Termination Protections: Some clauses extend the restriction for a defined period after the contract ends, ensuring the manufacturer cannot immediately step in and take over the distributor’s relationships.
Legal and Practical Challenges
Should a distributor find itself in this quandary, the first thing to consider is the provisions of the underlying distribution agreement, which should contain one or a combination of these anti-circumvention provisions. The next step is to ensure the clause(s) fits the circumstances, as quite often a manufacturer intending to oust a distributor will have evaluated the risk exposure, including consulting with counsel.
Weak, overly broad or poorly drafted clauses can invite legal disputes, even to the point where some courts have found such clauses to be unenforceable (e.g., if found to be prohibitively anti-competitive under applicable law). Clauses that are overbroad in territorial scope, or that impact how far a distribution agreement “carves up” territories, may be struck down as unreasonable restraints on trade and/or violative of anti-trust provisions.
The assessment of what to do does not start and stop with the quality of one or more anti-circumvention clause, as the “boilerplate” can have a meaningful impact on the legal practicalities of pursuing a distributor’s rights – choice of law, choice of forum/venue, legal fee and cost shifting provisions, and similar provisions. Further, enforcement can be difficult, especially if sales occur surreptitiously or through intermediaries or online channels. To mitigate this risk, and for other advantageous reasons, distribution agreements should include audit rights or reporting requirements that allow the distributor to monitor sales activity.
Best Practices For Negotiating and Drafting Anti-Circumvention Provisions
When negotiating or drafting anti-circumvention clauses, ambiguity and overreach are two significant challenges that can disrupt conflicts or impede dispute resolution. As such, protective provisions should be carefully tailored to the unique dynamics of any distribution relationship and should:
- Clearly Define Scope: Specify whether the restriction applies to a geographic territory, a customer list, or engraft specific, objective criteria for determining when liability may exist (i.e., triggers for enforcement).
- Limited Duration: Courts are more likely to enforce clauses that apply for defined, reasonable periods, based on legitimate business objectives, and otherwise drawn narrowly to prohibit specific tactics.
- Allowance for Exceptions: Manufacturers may need limited rights to sell directly in specific circumstances (e.g., government contracts or online platforms).
- Notification and Consent Requirements: Instead of an outright ban on direct end-customer relationships, some clauses require the manufacturer to notify or obtain the distributor’s consent before making direct sales in the territory – which can prevent or aid in dispute resolution.
- Strong Remedies and Enforcement Mechanisms: Specify consequences for breach, such as particularized damages, injunctive relief, and/or termination rights, to ensure the any anti-circumvention clause has teeth.
Anti-circumvention clauses are a powerful tool for distributors seeking to safeguard their investments and prevent manufacturers from bypassing them once their hard work has established a solid market for the manufacturer’s goods. However, these clauses must be drafted carefully to ensure they are enforceable, reasonable in scope, and aligned with competition and related laws.
If you have questions about anti-circumvention provisions or would like assistance with reviewing or drafting such language, please contact me at 312-840-7004 or fmendelsohn@burkelaw.com.
