Keep distribution house in order

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“If you don’t have a written contract for your distribution channel, you still have a contract — you just don’t know what it is. Having some form of written contract is imperative.” Jon P. Christiansen Foley & Lardner

Two key elements for avoiding distribution problems are maintaining comprehensive contracts and ensuring that staff members have a good understanding of antitrust principles.

Jon P. Christiansen, a partner at Foley & Lardner, listed those among a collection of suggestions made during his presentation entitled “How Do I Know If My Distribution House Is In Order?” Christiansen spoke to several hundred businesspeople and in-house counsel during his firm’s 12th Annual Law of Product Distribution and Franchise Seminar, last month.

Christiansen noted that of the clients who come in seeking his help with problems, approximately 20 percent do not have contracts in place.

“I’ve had lots of clients, who have dealt for years and years without contracts and it’s been fine,” he recalled during an interview, “then the lightning bolt hits.”

“So many of the situations that we see that have evolved into problems could have been solved if they had an appropriate contract in place.”

Define the Relationship

It’s all about reducing the company’s risk of loss, Christiansen told the group. He noted that many times, relationships develop between sellers and buyers based on oral agreements or handshakes. However, the parties do not have a written contract spelling out the details of their relationships.

“If you don’t have a written contract for your distribution channel, you still have a contract — you just don’t know what it is,” he told the group. “Having some form of written contract is imperative.”

Changes in business, changes in the market and changes in personnel make it important to have contracts that survive those changes and can be adapted to them.

“You may remember what an oral agreement was,” Christiansen said. “You may have a letter that you exchanged. There may have been a barstool conversation and people may remember it perfectly clearly, but that’s today. What about tomorrow? What about when the handshaker leaves? What about when somebody gets fired? What about when the company gets sold?”

He explained that all of those things need to be taken into account and companies need to make sure there is a record of the promises that were made.

Another important contract issue arises regarding a manufacturer’s relationship with a distributor. Christiansen stressed the importance of establishing realistic and clearly articulated sales goals, utilizing input from the distributor. Not only does it help to develop a better relationship with well-defined expectations, but it is beneficial if things go awry and the decision is made to terminate a relationship with a distributor.

Conflicting Terms

In-house counsel also needs to look closely at conflicting terms in agreements. Often sellers will develop a list of conditions of sale, which explain the terms under which they will do business with the buyer and what indemnification they provide. Buyers will develop their own list of conditions under which they will purchase products.

When elements of each contract conflict and are not resolved, problems arise.

“It happens a million times a day where somebody’s offer is met with somebody’s acceptance and the terms conflict, yet the parties go about performing the contract as if they had agreement and nobody stops to negotiate the conflicting terms,” Christiansen explained.

He provided the example of a buyer who says, he wants 10 widgets for $100. In addition, he wants them to conform to the ordinary standards of merchantability in the trade. In other words, they have to fit the purpose for which they are intended.

The seller responds with an order acknowledgement stating that the order for 10 widgets at $100 is accepted. It also states that the seller has a limited express warranty of repair or replacement
of defective parts including labor for one year. The seller does not accept liability for consequential damages, there is no liability for lost profits, and there’s no other warranty except for the one provided. All other warranties, including the warranty of merchantability, or the warranty of fitness for a specific purpose, are excluded.

This scenario sets up a battle of forms over the conflicting provisions on warranties or remedies.

“What happens is that the terms that conflict drop out, so that neither the buyer gets their terms nor the seller gets their terms,” Christiansen said. “The Uniform Commercial Code (UCC), anticipating that this will happen, provides what are called gap-filler terms. These are the terms that will apply if the parties either haven’t agreed or have simply ignored them.”

This scenario creates the potential for unlimited liability on the part of the seller, Christiansen said, noting that the terms of the UCC “almost uniformly, favor the buyer, so that if the terms that I suggested in the hypothetical fall out, the buyer has the opportunity to recover full damages, lost profits, any other consequential damages and they get a warranty of merchantability.”

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The seller does not expect that and the people in the order-entry department, who accept those orders typically have not been trained how to recognize or avoid that type of problem. The seller ends up selling the product at a price that does not anticipate the potential liability of a company’s production line going down, therefore, the seller has unknowlingly contracted for unlimited economic loss if the product is known to have caused the loss.

More Training

Christiansen went on to discuss another important area of staff training — antitrust. In-house counsel needs to make sure that its client’s staff has a clear understanding of antitrust principles. Failure in that area can result in criminal liability for the client.

“Business people generally understand that you don’t get together and fix prices or divide territories,” Christiansen told the group. “Beyond that, it gets a little fuzzy. When I talk about keeping your distribution house in order, what I mean is you need to have your people trained on what’s over the line, what’s at the line and what you shouldn’t even approach from a distance.”

Christiansen’s discussion served as the springboard for a day of programs covering a variety of topics, including changing distribution channels to include the Internet and mass distributors, a discussion of the do’s and don’ts of talking with competitors at trade shows and things to consider when thinking about terminating distributor relationships.

David Ziemer can be reached by email.