China Distribution Contracts: Same-Same but Different
Ever since COVID, our China lawyers have been seeing a big increase in foreign companies entering into distribution contracts with Chinese distributors, due mostly to the difficulties and risks foreign companies face when they go into China directly. Many of the companies that come to us to draft their distribution contracts with Chinese distributors are already experienced with distributor relationships and already have a “standard” distribution contract. Though China distribution agreements have much in common with American/European/Australasian distribution agreements, they also have stark and interesting differences.
Many of our clients come to us with distribution agreements they’ve successfully used in the United States, Canada, or Europe. These contracts have been finely tuned over time to fit their global business needs. However, when it comes to China, it’s not a simple copy-paste job. The Chinese market has its unique demands and legal environment, requiring us to significantly adapt these existing agreements. It’s like tailoring a well-loved suit to fit a different body shape – the original quality is there, but adjustments are necessary for the perfect fit.
One reason for this is that the United States/Europe generally provide distributors with all sorts of legal protections. These countries often make it difficult or expensive to terminate a distributor and it is common for distributors in these countries to sue or threaten to sue when a distribution relationship sours.
Chinese law has virtually no special protections for distributors. In particular, there is no Chinese legal requirement for payment of any special compensation to a distributor upon termination of the distribution agreement. All of our China distribution agreements call for applying Chinese law and we usually remove these sorts of payment provisions from our client’s US/European distribution contracts when we re-write them for China.
How to Protect Your IP in Your China Distribution Agreement
We also add in what we call a “no registration” provision to further protect our clients’ China trademarks. In this provision, the distributor agrees that our client has exclusive ownership of all trademarks, and it merely has the right to use those trademarks on our client’s behalf. This provision is important because under Chinese law, you lose your trademark if you go three years without using it and Chinese courts usually find that your distributer using your trademark is NOT the same thing as you using your trademark. We also put in a provision making clear that the distributor gains no rights to those trademarks, and that the distributor will not register any trademarks in any way related to our client’s trademarks.
I use the words “further protect” because the first line of protection for your trademarks in China is to register them properly in China. This provision is important because under Chinese law, you lose your trademark if you go three years without using it and Chinese courts usually find that your distributer using your trademark is NOT the same thing as you using your trademark. See How And Why To Trademark In China.
How to Get Your China Distribution Agreement Properly Signed
One other difference between Chinese distribution agreements and those for America, Europe or Australia is that the signature line in a Chinese distribution contract should provide a place for the distributor to affix its company seal. See China Company Chops: The Basics.
How to Handle Exclusivity in Your China Distribution Agreement
Exclusivity is another thing our clients often must grapple with when doing a China distribution agreement is exclusivity. China distribution agreements present a unique set of challenges and opportunities when it comes to exclusivity. Exclusivity in Chinese distribution agreements is usually handled in one (or more of the following four ways)
1. Provide for a non-exclusive agreement. Note, however, that two distributors in the same market is usually not a workable situation. Option two below is therefore more common.
2. Limit the territory. You could limit this particular distributor to City1/City2/City3.
3. Limit the contract term to one year, with you having the exclusive right to renew. This is a common solution when the product does not require the distributor put in extensive time or money to create the sales market. This solution is not common if the distributor will need to put in extensive time or money to create the market.
4. Provide for a specific sales target. If the distributor reaches the sales target, renewal of the distribution agreement is automatic. If the distributor fails to reach the target, you have the option to terminate and appoint other distributors. Usually, the sales term is for three to five years, with the sales targets set for each year.
Some agreements provide for automatic renewal at the end of the initial term with a fixed percentage increase in sales targets. Other agreements require negotiation of a new agreement with negotiation of new sales targets as part of that process. This approach is most common where the distributor will be investing considerable time and/or expense in the early years of the distribution cycle to create a market for the product.
In our experience, option 3 is the most common in China. Chinese companies seem to have a problem with negotiating specific sales targets. Worldwide, options 3 and option 4 are common, depending on the specific circumstances.
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