The recent Supreme Court judgment 137/2017 of 1 March (rec 2672/2014) considers that the criteria to calculate the amount of goodwill (clientele) compensation in a distribution contract cannot follow the criterion of the “gross margin” obtained by the distributor, but the “net margin”. In order to reach this conclusion, the Court follows its judgment 356/2016 of 30 May (rec 148/2014), which refers to the Judgement 39/2010 referring to 697/2007 of 22 June (rec. 2943/2000).

At present it seemed that the Supreme Court was inclined to calculate the clientele compensation in distribution agreements on “gross margin” as an analogy with Article 28 of Agency Act. Does this imply a change in case law?

According to well-established jurisprudence [see Supreme Court Judgment 1392/2008 of January 15, rec. 4344/2000)], a distributor may be entitled to goodwill (clientele) compensation if the inspirational idea of article 28 of the Agency Contract Law was applied by analogy. However, since there is no “remuneration” in distribution contracts such as that received by the agent (commissions or fixed amounts), but “commercial margins“, the question was whether the “gross margin” (difference between the purchase and resale price) or the “net margin” (the same difference but deducing other expenses and taxes) should be considered as the basis for this compensation. The conclusion accepted by the Supreme Court until now seemed that it was necessary to calculate the compensation on the “gross margin” being a magnitude more comparable to the “remuneration” of the agent: it was not possible to deduce other expenses and taxes, just as for the agent those same expenses and taxes were not deduced.

However, the new Judgment seems to accept the contrary and to support the calculation of clientele compensation in distribution agreements on net margins. Nevertheless, in my opinion, the reading done by the Supreme is not correct.

In the 2017 ruling, the difference between gross/net margin is mentioned referring to judgment 356/2016 of May 30. In that judgment of 2016, it was said that although in a previous Judgement 39/2010 was not concluded on whether the calculation had to be made on gross or net amounts, in a previous one (Judgment 296/2007) it was, nevertheless, accepted that the net profit obtained by the distributor (by deducing expenses and taxes) was similar to the remuneration of the agent, and not the gross margin which is the mere difference between prices of purchase and resale.

This said, in my opinion, in its Judgment of 2016, the Supreme Court did not use a correct reference when leaning on the one of 2007 for something that the latter did not say. In fact, in 2007, the Supreme Court did not quantify the goodwill (clientele) compensation, but the damages compensation. More specifically, the Court said in 2007 that “goodwill (clientele) compensation might be clearly requested in the complaint, without any confusion or ambiguity“, and after that, the Court concluded that it “should resolve according to the terms in which the debate … was raised in the initial claim. And since this one was interested in compensation for damages mainly based on the length of time the relationship … the most appropriate solution according to the case law of this Court … is to set as compensation for damages on an amount equivalent to the net profits that the plaintiff obtained by the distribution of the products of the defendant during the year immediately preceding the extinction of the contract“. Therefore, the Court did not analyse in 2007 goodwill (clientele) compensation, but damages compensation.

Then the conclusion followed in 2007 to calculate the damages indemnification on net margins, was then followed in 2016 but to calculate the clientele compensation and reiterated now in the 2017 Judgement with the same conclusions.

Regardless of all this, and also in my opinion, it does not make much sense that if the analogy with the Agency Contract is applied, any amount (such as taxes or other expenses) should be deducted from the gross margins to reach a net margin. If the intention is to analogously apply the “remuneration perceived by the agent”, it seems clear that the agent has also expenses and also pays taxes; nothing in Directive 86/653/EEC nor in the Spanish Agency Act says that it must be deducted anything from the “received” amount in order to calculate the goodwill (clientele) compensation. If the amounts the agent perceives are the commissions (from which he will pay his taxes, his rent expenses, employees, etc. obtaining his “net profit”), the same criteria should apply in a distribution contract.

In conclusion, and in my opinion, the Judgment of 137/2017 only emphasizes what I consider to be a previous error and adds additional confusion to a question that is already very much discussed: the analogous application of goodwill (clientele) compensation to distribution contracts and its method of calculation.

NOTE: The Supreme Court seems to confirm this judgement by a new one in May 19 2017 signed by the same Judge.

The book contains a detailed questionnaire for 17 different jurisdictions and permits to have a first approach to the subject not only in those countries but also to compare the regulations in each of them.

It intends to solve the main questions on Agency and Distribution agreements. The questions try to discuss about the following: the possibility of establishing a local company to import products (laws governing the formation of entities, how foreign parties are treated); distribution structures with reference to the termination of the agreement, compensations, transfer of rights, confidentiality; non-competition covenants (with reference to resealing prices, for instance), restrictions on territories or customers; other general issues arising in this sort of agreements such as advertising provisions, intellectual property clauses, consumer protections issues, warranties, employment connected conflicts; and also governing and choice of forum and dispute resolution remedies.

You can have a free pdf copy of the Spanish chapter by clicking Distribution and Agency 2016.

Reproduced with permission from Law Business Research Ltd. This article was first published in Getting the Deal Through: Distribution & Agency 2016, (published in March 2016; contributing editor: Andre R Jaglom, Tannenbaum Helpern Syracuse & Hirschtritt LLP). For further information please visit www.gettingthedealthrough.com.

Conflicts when terminating agency and distribution contracts arise mainly in claiming compensation for clientele. Agency Act provides that when the contract expires, the agent is entitled to compensation, which, by analogy (with caveats and nuances), can be extended to distributors. For this compensation it is necessary that the agent has brought new customers or significantly increased operations with the pre-existing, that his previous activity can continue producing substantial benefits to the principal and that is equitable. Such compensation may not exceed one year’s remunerations (annual average received during the last five years or the duration of the contract if lower).

Because of these inaccuracies (new clients, significant increase, can bring substantial benefits, equitable) claims are usually supported by expert reports. There is, however, a tendency to claim directly the maximum standard (one year of remuneration) without going into further analysis. But doing so there is the risk that a judge rejects the request as unfounded. We herein give some hints to help to get the maximum amount of compensation. According to our experience, it is convenient that the agent and the expert take into account the following:

1. Check what has been the contribution of the agent: if there were customers before the contract and what volume of sales existed (it is a previous condition to have increased the number of customers or transactions with them).
2. Analyse the importance of such clients in order to ensure future benefits for the Principal: their recurrence, fidelity (to the Principal and not to the agent), the migration rate (how many remain with the Principal at the end of the contract). It will be difficult to recognise a “clientele” with sporadic, occasional, non-recurring clients or that still remain in the area of ​​agent.
3. How the agent remains after the termination: does the contract prevent the agent to compete with the Principal? Is this competition difficult because of the kind of market, the products or the type of agent? If the agent continues to serve the same clients but for a different Principal, clientele compensation could be put into question.
4. Is this compensation fair? Examine how the agent has acted in the past: the degree of fulfilment of his obligations, his work in introducing products or new markets, the possible development of such products or services in the future, etc.
5. What commissions does the agent lose in the future? See the exclusivity that he had; the difficulty to sign a new agency contract (because of his age, crisis, etc.) or a new source of revenue, the sales trend in recent years (those considered for compensation), etc.
6. Calculate the maximum that can be received as compensation: the yearly average perceived during the contract period (or 5 years if it lasted more) including all fix amounts such as commissions, bonuses, awards, etc. or gross margins in case of distributors.
7. And finally, if there is an expert report, do include in it all the documents used to reach the conclusions, otherwise a judge could refuse it all.

Note: In order to prepare this post, I have also considered the Commission Report of 23 July 1996 COM (96) 364 and the Judgement of the European Court of Justice of 26 March 2009, Case C-348/07

Negotiating and drafting international Agency or Distribution agreements not always an easy question because it regards what is governed during the agreement but also the important consequences (in term of legal requirements and economic consequences) of the termination.

This paper is a mere summary of what has been presented and discussed in Munich in September 10 2016 by Ignacio Alonso at the occasion of the Workshop-Seminar «Drafting Effective International Contracts: International Sales, Agency and Distributorship Contracts» of the UIA joint session of the Contract Law and International Sale of Goods Commissions. The information has been obtained, among other sources, from the International Distribution Institute Reports (www.idiproject.com).

It contains some clues on what to take into account when drafting Agency and Distribution contracts regarding the goodwill indemnity and damages compensation after the termination of the agreements.

The facts

A few days ago I got a call from a Spanish winemaker (I will call it “the Producer”), he had received an order online from a French company (I will call it “the Distributor”) who wanted to sell their wines in the UK. The distributor had sent his French Kbis extract (similar to our simple registration note), a scanned copy of the manager identity document, and all this from an email address whose domain included the name of the company and was signed by the  Sales Manager (salesmanager@distribuidor.com).

The Producer verified the correctness of the KBis, its intra UE Tax number (VIES) and SEED, asked a bank guarantee covering the amount of the first shipment (43,000 euro), whose copy the Producer received scanned by email.

The bottles were received in the UK and the Distributor and Producer exchanged joyful emails and the Producer sent the bill also by email. The wines were being very well received in the UK so the Distributor made a second order (around 75,000 euro) to be delivered in s different store, also in the UK. The Distributor emailed a second bank guarantee for the new amount and the wines were sent.

While carrying, the French Distributor received at its headquarters in France the original bill for the first shipment (until then only the copy was sent by email). His manager (remember: the Producer had a scanned copy of his ID, and the company had confirmed the Kbis), informed then the Producer that the Distributor had never made an order, that did not have headquarters or warehouse in the UK, had never received the first order and, therefore, that he had no intention to pay the bill.

The teachings

This well planned fraud encourages me to propose three simple recommendations to implement by anyone who is considering the distribution of his products abroad or in his own country so as to prevent something similar to this case. It all depends on the previous advice of a lawyer.

First. Signing a contract (supply, distribution, agency) is not a requirement for the validity of the sale, but its negotiation will allow to obtain certain guarantees that will prevent most problems: the verification of the existence of the distributor and its representative with a correspondent lawyer (beyond the mere registration information), the acceptance of conditions, application credentials, compliance in the past, etc.

Second. If even overcome all these filters an agreement with a distributor was reached (which it seems to me far more complicated), the checking of bank guarantees would add security to the transaction. By checking the guarantee (the issuing entity, representative, duration, amount, etc.) and by receiving the original document (a copy is not enough) will be considered usual practices in any business relationship and that a lawyer would not overlook.

Third. Said attorney may also propose other means of guarantee to have a safer transaction: prepayment of a first order, letters of credit, severally guarantees issued by solvents third parties, etc. All this will imply greater efficiency.

In conclusion, it is understandable that a manufacturer is thrilled by the prospective of large international sales that can also result in a permanent relationship with a foreign distributor, but it should keep cool head. An expert advice —whose cost, it is important to underline, will be much lower than the damages suffered in this case— will allow the wish come true.

Quite often the purchase/resell commercial relationships between a manufacturer and its retailors is carried out without signing a contract, but with subsequent orders: the manufacturer receives it, then he sends the products, the retailor pays and then he resells to the final customer.

In Spain, as it is known, there is not a “distribution contracts Act”, but courts have accepted a certain analogy with the agency agreement. In a certain way, courts say that agency and distribution are not the same sort of agreements, though some consequences of the agency can apply by analogy to the distribution. This is, for example, goodwill compensation (clientele) in case of contract termination.

Therefore, it is quite usual that when a company continuously buys products from a manufacturer to resell them, its intention is to consider this a “distribution contract”. And why? Mainly because of the goodwill compensation (clientele): this compensation does not apply to the supply contracts, but it is possible in a distribution agreement precisely because of that analogy. And if the manufacturer-retailor relationship has lasted several years, the amount of this compensation can be of some importance (until the annual average of gross margins over the past five years).

But beware, because not all the continuous supply contracts can be considered to be a “distribution contract”. You should ask for advice in each particular case. In Spain, a distribution contract requires something more than a series of purchase and resale of products. The following list will help you to verify whether a particular commercial relationship is closer to a continuous supply agreement or to a distribution one with the possibility, in this case, of claiming the mentioned goodwill compensation:

1. In a supply agreement products are purchased for resale. Its purpose is the resale with a margin without any further conditions.

2. These agreements are usually a succession of orders, with delivery conditions (billing and payment) normally agreed.

3. The distribution agreement, however, involves a “more intense” in the business relationship that does not exist in the mere succession of sales transactions.

4. The distribution agreement involves the mutual cooperation between manufacturer and distributor for distributing a product and is intended to be stable over the time.

5. The distribution agreement gives greater trade integration of the reseller in the distribution network of the manufacturer, and the manufacturer influences more the commercial management of the distributor than with a mere reseller.

6. In the distribution contracts there are usually additional conditions relating to the purchase and resale agreements not limited to the pricing and payment conditions. These may be, amongst others, covenants on minimum periodic purchases, volume discounts, resale areas, exclusivity, prohibition for the sale of competing products, support obligations to end customers, repurchase of non-resold goods.

7. The distribution contracts can also provide other agreements relating to the operation of the business relationship: investments by the distributor, how to place orders, goods transportation, storage and maintenance of stocks, covenants not to compete, compensation for non-compliance, payments and guarantees to ensure compliance, etc .;

8. Finally, distribution contracts usually include agreements for the use of the manufacturer’s trademark (license) with the obligation for the on manufacturer to advertise or to provide special labelling or packaging, etc. and a certain uniformity for distributors (obligations related to the affixing of the trademark, harmonized image, etc.).

In conclusion: if you want to end a relationship of this kind whose nature is unclear, you should analyse the above list to, at least, have an initial idea of ​​what can be claimed or not. In any case, unfortunately this is not an automatic list and it is wise to ask for specific and expert advice before taking any decision.

Note. In preparing this post I have followed some judgments of Spanish courts which may be useful to consult if you want additional information: AP Salamanca 330/2001 of 29 June; TS (Civil Chamber, Section 1) 70/2004 of 5 February; TS 332/2009 of May 18; AP Madrid (Section 11th) 736/2010 of 30 September; AP 553/2010 of 5 October Barcelona; AP Zamora (Section 1) 100/2015 of June 8.

The book contains a detailed questionnaire for 17 different jurisdictions and permits to have a first approach to the subject not only in those countries but also to compare the regulations in each of them.

It intends to solve the main questions on Agency and Distribution agreements. The questions try to discuss about the following: the possibility of establishing a local company to import products (laws governing the formation of entities, how foreign parties are treated); distribution structures with reference to the termination of the agreement, compensations, transfer of rights, confidentiality; non-competition covenants (with reference to resealing prices, for instance), restrictions on territories or customers; other general issues arising in this sort of agreements such as advertising provisions, intellectual property clauses, consumer protections issues, warranties, employment connected conflicts; and also governing and choice of forum and dispute resolution remedies.

You can have a free pdf copy of the Spanish chapter by clicking here.

Reproduced with permission from Law Business Research Ltd. This article was first published in Getting the Deal Through: Distribution & Agency 2015, (published in March 2015; contributing editor: Andre R Jaglom, Tannenbaum Helpern Syracuse & Hirschtritt LLP). For further information please visit www.gettingthedealthrough.com.

The Supreme Court has confirmed in a Judgement of December 11, 2014 that the excessive turnover agreed by the parties could not be considered reasonable and, therefore, could not justify a unilateral termination by the Supplier because of a previous infringement of the Distributor.

The parties were Agco Iberia S.A. (Massey Ferguson) as Supplier, and the Distributor Agrícola Madrileña who asked for a global indemnity of 1 723 112 euros [including lack of previous notice, non-amortized stock, dismissal of personnel, damages in goods and goodwill (clientele) compensation].

First Instance Court accepted partially the amount claimed (60 % for the dismissal of employees and excluding the indemnities for non-amortized stock and damages in goods) and granted a total indemnity of 1 075 197 euros (including all the amount claimed for clientele and lack of previous notice). The Court of Appeal (Audiencia Provincial) in Madrid accepted this decision.

The distribution agreement dated of March 11, 1988. The parties had agreed the territory of Eastern Andalusia and signed a clause accepting that “none of the parties will be responsible before the other party of any compensation, loss or damages caused by the termination of the agreement”. An additional clause also included a provision stating that termination (in any form it may occur) will be effective without prejudice of any rights or obligations generated until the termination date. The agreement also permitted to terminate it without previous notice in case of a previous infringement of the other party.

According to the Supplier, the Distributor did not attaint the minimum purchases indicated for 2007; and following his interpretation, this permitted the termination without previous notice and no indemnity.

The Supreme Court considered, however, that the turnover fixed for 2007 (a rate of 11.25 % in the agreed territory compared to a 4.6 % in the rest of the Spanish territory with different Distributors) was not clear enough; was in a sort of way imposed by the Supplier and outside of any reasonable possibility of attainment (based in the testimony of a former Sales Director). For those reasons, the non-attainment of that minimum turnover was not a previous infringement of the Distributor, did not justify the immediate termination of the agreement by the Supplier and, therefore, a previous notice was needed.

The court has then interpreted that the “rights or obligations generated until the termination date” included the damages indemnity, the indemnity for lack of previous notice and the goodwill (clientele) indemnity during the duration of the agreement (more than 20 years). The Distributor had, therefore, the right to claim for them and confirmed the previous courts judgements.

In this procedure, the principal argued that the agent had appointed two sub-agents without his express authorisation and, therefore, he had breached his legal obligations. The agent, on his side, considered that these two persons were not sub-agents but employees. The High Provincial Court of Burgos in a Judgment of June 13, 2014 has specified some elements to take into account in order to distinguish “sub-agents” from “employees”.

According to the Court, the principal knew and accepted that the agent was helped by two persons but nothing in the procedure proved that these persons had an independent organization from the agent’s and evidences showed, instead, that they were part of the agent’s commercial organization: some mails included these persons as members of the agent’s commercial department and according to some witnesses they acted as employees of the agent.

The Court has stated, therefore, that in order to verify if a person is acting as a sub-agent instead of as a employee, it should be verified if this person has an independent organization or if this person is acting as a part of the agent’s commercial structure.

These ideas are relevant when companies intend to start their commercial relationship but they should not be neglected and verified even when there are already existing contacts.

1. The signature of the contract. Although it could seem obvious, the signature of a distribution agreement is less common than it might seem. It often happens that along the extended relationship, the corporate structures change and what once was signed with an entity, has not been renewed, adapted, modified or replaced when the situation has been transformed. It is very convenient to have well documented the relationship at every moment of its existence and to be sure that what has been covered legally is also enforceable y the day-to-day commercial relationship. It is advisable this work to be carried out by legal specialists closely with the commercial department of the company. Perfectly drafted clauses from a legal standpoint will be useless if overtaken or not understood by the day-to-day activity. And, of course, no contract is signed as a “mere formality” and then modified by verbal agreements or practices.

2. The proper choice of contract. If the signature of the distribution contract is important, the choice of the correct type is essential. Many of the conflicts that occur, especially in long-term relationships, begin with the interpretation of the type of relationship that has been signed. Even with a written text (and with an express title), the intention of the parties remains often unclear (and so the agreement). Is the “distributor” really so? Does he buy and resell or there are only sporadic supply relationships [if you want to have further information I will participate in a workshop in June 14 2014 in Turin (Italy) at the Annual Conference of the International Distribution Institute: www.idiproject.com]? Is there just a representative activity (ie, the distributor is actually an “agent“)? Is there a mixed relationship (sometimes represents, sometimes buys and resells)? The list could continue indefinitely. Even in many of the relationships that currently exist I am sure that the interpretation given by the Supplier and the Distributor could be different.

3. Monitoring of legal and business relations. If it is quite frequent not to have a clear written contract, it happens in almost all the distribution relationships than once the agreement has been signed, the day-to-day commercial activity modifies what has been agreed. Why commercial relations seem to neglect what has been written in an agreement? It is quite frequent contracts in which certain obligations for distributors are included (reporting on the market, customers, minimum purchases), but which in practice are not respected (it seems complicated, there is a good relationship between the parties, nobody remembers what was agreed by people no longer working at the company…). However, it is also quite frequent to try to use these (real?) defaults later on when the relationship starts having problems. At that moment, parties try to hide behind these violations to terminate the contracts although these practices were, in a sort of way, accepted as a new procedure. Of course no agreement can last forever and for that reason is highly recommendable a joint and periodical monitoring between the legal adviser (preferably an independent one with the support of the general managers) and the commercial department to take into account new practices and to have a provision in the contractual documents.

4. Evidences about customers. In distribution contracts evidences about customers will be essential in case of termination. Parties (mainly the supplier) are quite interested in showing evidences on who (supplier or distributor) procured the customers. Are they a result of the distributor activity or are they obtained as a consequence of the reputation of the trademark? Evidences on customers could simplify or even avoid future conflicts. The importance of the clientele and its possible future activity will be a key element to define the compensation to which the distributor will pretend to be eligible.

5. Evidences on purchases and sales. Another essential element and quite often forgotten is the justification of purchases to the supplier and subsequent sales by distributors. In any distribution agreement distributors acquire the products and resell them to the final customers. A future compensation to the distributor will consider the difference between the purchase prices and resale prices (the margin). It is therefore advisable to be able to establish the correspondent evidence on such information in order to better prepare a possible claim.

6. Damages in case of termination of contracts. Similarly, it would be convenient to justify what damages have been suffered as a result of the termination of a contract: has the distributor made investments by indication of the supplier that are still to be amortized? Has the distributor hired new employees for a line of business that have to be dismissed because of the termination of the contract (costs of compensation)? Has the distributor rented new premises signing long-term contracts due to the expectations on the agreement? Please, take into account that the Distributor is an independent trader and, as such, he assumes the risks of his activity. But to the extent he is acting on a distribution network he shall be subject to the directions, suggestions and expectations created by the supplier. These may be relevant to later determine the damages caused by the termination of the contract.

BONUS EXAMPLES. One of my first claims as a lawyer in distribution agreements was against a big beverages supplier. The agreement with the Spanish Distributor was a mere letter of three paragraphs in which only the second one (no more than five lines) regulated all the relationship for more than 20 years. The drafting was so confusing that our first concern was to verify what sort of agreement we were facing (it seemed a distribution agreement but with some elements of an agency agreement). The claim was for almost 2.5 million euro and it could, probably, have had a higher possibility of extrajudicial solution with a (better) agreement.

I also remember one case where the supplier had accepted for more than 10 years that the distributor never sends the information he was obliged to according to the agreement. Once the supplier decided to change the distributor, then he realised that this (previously accepted) could be used to cancel the agreement for a breaching of the agreement. What do you think?