Dealer contract explained
Dealer contracts, also known as dealer agreements, are legal contracts between a dealer and a supplier, distributor, or manufacturer that outline the terms and conditions of their business relationship. Dealer contracts are found in a variety of industries, but have become most familiar to consumers through major companies such as McDonald’s and Boeing. In the context of a franchisor and franchisee, dealer contracts define the basic relationship between the parties, including trademark licensing terms, franchisor obligations , and obligations of the franchisee and any affiliates of the franchisee(s). A well-crafted dealer contract can advance your business objectives and provide you benefits far into the future.
An agreement between a supplier and a dealer or distributor is also typically called a dealer agreement or distribution agreement. These agreements vary widely in terms and content. Some examples discussed in this section include territories, exclusive territories, term, termination, default and cure, parties, governing law, and arbitration.
Variances to a Dealer Contract
A dealer contract will almost always start with a statement of the dealer’s interest. If the dealer is a product distributor, this may include some portion of a warehouse commitment, moving product into the warehouse within a period of time set forth in the dealer contract. It may state a particular level of sales which the dealer is committed to upholding in order to keep to commitments made to, for example, retailers, brokers, or pharmacies.
The dealer contract will typically commit the manufacture or supplier to warranty the products against defects, including those in manufacturing, and to provide a level of service commitment and use of the dealer’s own marketing outlets. There will be a statement about maintaining the dealer’s leasehold and tax obligations as to the particular product and their locations and use.
There will typically be a statement regarding the terms of sale, whether on credit or via consignment, as well as any rebate programs. The dealer contract will often address the discount levels on cost as an expression of those obligations.
There often is a statement regarding how the manufacturer or supplier will handle promotion, advertising and marketing, including the use of the internet, through advertisements, and other forms.
There will be an entire section on requirements and benefits for the dealer, including perhaps a requirement that the dealer will obtain a particular bonding level, that individual warehouse employees will be bonded, and that the dealer maintain appropriate insurance. There may be a statement of what the dealer can expect from the supplier or manufacturer. It may include terms clause as to purchases for fronting, returns and the like.
Other sections may include statements on dispute resolution, including arbitration or other mediation clauses, and provisions as to those procedures for finding and resolving a breach.
Dealer Contracts Modifications
The multi-faceted relationship among dealers, distributors and manufacturers requires that dealer contracts be tailored to the specific business. Many clauses may or should be modified to address these relationship issues in order to achieve the intended business result. For example:
Territory provisions – the territory clause must not only describe the territory, but also protect all of the manufacturing, distribution, dispensing, warehousing, storage, wholesale, retail, medical practice and other activities required to properly and efficiently operate a business in the industry. Beyond physical territory, these clauses should also deal with Internet territory, as well as territory in cyberspace. In this age of on-line marketing and digital sales, a comprehensive territory provision is more important than ever.
Pricing – while it is common to use "rack price" or "list price" in the dealer contracts, in many industries the rack price leaves significant room for discounting or discount-off pricing. Alternatively, "suggested discount-off pricing" provides information but not a mandate on the part of the manufacturer. The first choice (rack or list pricing) is preferred by most manufacturers, while the latter is commonly drafted by manufacturers who have regressive pricing features. Regardless of which is favored by the manufacturer, the favored approach should be used consistently across all dealer contracts.
Sample Dealer Contract
The following dealer contract sample is a basic representation of a contract that would be used between a company and a dealer/distributor. This is a sample of a dealer contract. Each section below addresses a different component typical to dealer contracts.
A. Introduction
A brief introductory sentence that state what the company is offering the dealer.
B. Qualifications
i. Selection and acceptance criteria
ii. Termination procedure
iii. Performance criteria
iv. Inventory Requirements
v. Training requirements
vi. Advertising or co-op fees
C. Obligations
i. Sales commitments (minimum standards)
ii. Exclusivity (product, territory, etc)
iii. Reporting requirements
iv. Warranty obligations
v. Inventory management (shelf space, new products, etc)
vi. Product training
vii. Promotion and marketing involvement
viii. Research assistance or input
D. Financial Obligations
i. Discounts
ii. Royalties
iii. Co-op fees or advertising support
iv. Buy-back or take-back agreements for returns or goods damaged in delivery
v. Payment terms and conditions
vi. Dispute resolution provisions
E. The Fine Print
i. Liability limitations
ii. Indemnification
iii. Confidentiality
iv. Warranty disclaimers and limitations
V. Territorial Limitations
Legal issues related to Dealer Contracts
In addition to the business considerations described above, there are many legal considerations both statutory and judicially imposed obligations on manufacturers with regard to the relationships with their distributors or dealers. Much of the law in this area is established by statute. States generally have some type of Franchise or Relationship Law which are designed to protect the dealer from overreaching or other abuses by the manufacturer. Portions of these statutes may address compensation and termination issues. The relationship laws also tend to impose certain obligations on the manufacturers such as (a) timely performance of orders; (b) protecting the confidentiality of the dealers’ records; (c) providing promotional and marketing assistance; and (d) granting fair access to supply lines.
Most laws also focus on preventing abusive allocation and discrimination practices by the manufacturer. Some examples of discriminatory practices would be: (a) paying different distribution costs; (b) converting one dealer from a dealer principal to a dealer under a subsidiary; (c) providing rebates or financing only to selected dealers , assumedly receiving services in return; and (d) favoring specific dealers in terms of programs and incentives that are afforded to other dealers. Manufacturers are also not supposed to engage in sham or no competition agreements and are not supposed to enter into any unlawful arrangements regarding the sale of aftermarket products or services.
Pitfalls in a Dealer Contract
There are several common pitfalls that occur within Dealer Contracts. One example is the issue of Confidentiality. Some businesses use Dealer Contracts as a blanket agreement for all of their products. In many instances, the terms of each Dealer Contract can differ greatly based on product lines, pricing, manufacturing locations, etc. When an issue arises and the Dealer is making demands for information under a Contract that are not technically required, a vendor may run the risk of disclosing confidential information that may conflict with their other Dealer Contracts. Moreover, the disclosure may run counter to the Vendor’s disclosure requirements in its agreements with its suppliers, customers and/or other dealers.
The best practice for Vendors is to use a separate Confidentiality / Non-Disclosure Agreement and not try to contain all of the Vendor’s obligations in a single Dealer Contract.
Another common mistake lies in the loyalty requirement. This is another area where a Vendor will try to cut costs. By including a broad warranty and indemnity, that requires the Dealer to meet all of the Vendor’s obligations as if it were a direct customer of the supplier, the Vendor pegs pricing as a percentage of volume only. What happens when a Vendor doesn’t get the benefit of this additional revenue if the Dealer sells competing products? Moreover, many Vendors have minimal obligations to its suppliers, particularly, in the area of warranties. Thus, if the Dealer is required to pay a Vendor such a high amount if it starts selling unapproved product lines, or represents competing brands in violation of the Contract, then the Vendor may end up facing lawsuits from its suppliers for every sale of the dealer that is in violation of its Contract. A Vendor needs to properly assess the damages in order to make sure it has sufficient resources to cover its breach. If a Vendor cannot sustain the volume of the penalties, or does not have sufficient funds to cover the damage, then those obligations need to be narrowly tailored so that the Vendor is not facing substantial damages from different suppliers.
Lastly, enforceability of the proposed Dealer Contract is an often overlooked area. For example, a Court will not enforce a Dealer Contract. A vendor may have made a substantial investment to enter into a new territory and has expended substantial resources developing the market. In many cases, the Dealer may have no market share for years as it continued to promote the Vendor’s product to get others to use it. If the Dealer Contract is not enforceable, it may prevent other dealers from following the lead of the Dealer and therefore restrict sales. This could very well damage the development of that market. Thus, it is important to review your Dealer Contract with counsel to make sure that its enforceable.
Negotiation Of a Dealer Contract
An essential part of the contract review process is a thorough analysis that identifies pitfalls that can be costly in terms of limited future options or expensive litigation. The contract should be reviewed to ensure it does what it is supposed to do, pursuant to the intention of the dealer and manufacturer, that is: (i) protect the investment of both parties; and (ii) comply with applicable state laws.
The review should be composed of two parts. The first part involves a review of the basic legal structure or compliance of the contract. Does it do what it is supposed to do? Has it been properly drafted pursuant to the requirements of applicable state law? The second part of the analysis involves looking "behind the page" to determine if the contract is truly representative of the parties’ mutual intention. There are obvious issues to consider that concern general "lawyerly" concerns of structure. You may simply start looking for "red flags." However, to really add value, you need to dig deeper. You need to determine if there are areas that involve mutual intention or intent, and if there are "hidden gems" that are in the contract that may not be readily apparent. Questions raised that need to be answered are: The review should be active, in the sense that you are running through different scenarios to see how the contract will operate in various circumstances. You need to consider unusual events, outlier circumstances that are not contemplated by the parties. In other words, how flexible is the agreement? Can it evolve into something workable to the satisfaction of the parties? Alternatively, does it have an unsustainable core? This should be done methodically and over time. After you finish your first review, take a break and come back in 48-72 hours. Take a fresh look at the agreement. The following week read it again. In the meantime, talk to people who are familiar with the agreement on both sides. This process may uncover surprises that may change the way the agreement is interpreted by the parties.
Reading a Dealer Contract
The first step in the negotiation process is to decide if you want to hire counsel. While there may be good reasons to do so, like time restrictions, sometimes a person who is familiar with the lease agreement may be able to negotiate successfully for themselves. However, be careful. One of the best ways to get burned in the negotiating process is by not reading the contract. There is a point where counsel can review an agreement that takes up much of their time and gives little in return. However, I continually see clients willing to pay $15K or more for construction of a dealership buildings and pay only $1,500 for a lease that will last ten years or more.
Know What You Have
The first step in negotiating is to have an understanding about whether or not the terms are similar to what you have now. A review of the contract will help you determine this. Here are some examples:
- Does the new contract have a shorter term?
- Is the rent higher?
- Will I have to replace the HVAC units (this is almost always ignored).
- Have the obligations to provide goods changed?
- Is the new location the same size?
Know What You Want and How to Get It
The next step is determining what you want. Before you or counsel negotiate you need to understand your objectives . Understand that if you put it on the table you will probably get it. However, you cannot put unrealistic expectations on the table. For example, if your monthly rent on a ten year lease is $20,000 per month it is not realistic to ask for a monthly rent of $1,000. The most important thing is to figure out your objectives before you negotiate. Put it down on a piece of paper and then as you negotiate check-off those issues that are resolved in your favor. For example:
- No guarantee of rent increases, no decreases.
- Three percent annual rent increase.
- Cross easement of parking.
- Transfer without consent.
- Parking lot maintenance.
The Best Negotiation Strategy
As a lawyer I am trained to "negotiate" an agreement. However, as a businessman I want to do business. Therefore, the goal is to end the negotiations and be able to do business as quickly as possible. Some suggestions:
- Identify the parties who are authorized to make agreements;
- Let the counsel do the negotiating but be involved at the end of the negotiations;
- Clarify any issues they CIAs have at the beginning that may be deal breakers;
- Set a date when you want to sign;
- Don’t torture the other side, this builds resentment that can cloud negotiations.