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Adapting the U.S. Distribution Agreement for International Sales: A Case Study

JULY 1993

Software companies often make their initial foray into international sales by engaging a local distributor to open the market of another country. Frequently, the software company may attempt to use its existing U.S. distribution contracts as the model for the deals with its foreign distributors.

However, the routine use of a U.S. form contract is risky: Many countries impose extensive controls over distribution agreements between their nationals and foreign companies, and failure to take these laws and regulations into account can result in particular clauses, or even the entire agreement, becoming unenforceable. These restrictions may surprise the U.S. company, because they may deal with aspects of the distribution relationship that are essentially unrestricted in the U.S. We frequently draft and negotiate such agreements and our recent experience in preparing a software distribution agreement for use in South Korea provides a useful illustration of the surprises that local law can hold, and how, working with the client and local counsel, we were able to develop an agreement which met the software vendor’s needs.

Government Review: Most distribution contracts in the U.S. are purely private dealings between the parties. However, many countries require a government agency to review contracts with local distributors. This process is intended to prevent foreign companies from using superior bargaining strength to force the local distributor to accept contract terms which are illegal under local law. In South Korea, software distribution agreements of more than one year must be filed with the Korean Fair Trade Commission (the “Commission”). The Commission promulgates regulations covering distribution agreements, and can order changes in the agreement that it deems necessary to comply with the regulations.

Sales Quotas: Many vendors view sales quotas, and the right to terminate the agreement for failure meet the quotas, as an essential part of a distribution deal, yet the Commission regulations prohibited such a clause. We were able to obtain similar protection for our client by requiring the distributor to submit a business plan, with sales forecasts, and to use “best efforts” to achieve those forecasts, coupled with a clause allowing the vendor to terminate the agreement if the distributor materially breached the agreement.

Territorial Limits: The Commission regulations specify that the Korean distributor cannot be prohibited from selling into a country outside South Korea, unless the U.S. vendor is already operating in the region in question. Besides the obvious problems that this creates for the U.S. vendor that is planning to enter other markets, the U.S. vendor needs to be concerned that this regulation could result in the Korean distributor selling the software into countries where copyright or patent protection is weak or nonexistent. As a safeguard against such an undesired occurrence, our client provided that any sales outside South Korea would require prior notice to it, and that the vendor could terminate the entire agreement if, in its judgment, the sale would be to a country that did not provide adequate protection for software.

Sub-distributors: The very common requirement for the vendor to approve the appointment of sub-distributors is prohibited by the Commission. However, the agreement may require that the distributor “consult” with the vendor in advance of the appointment.

Noncompetition Clauses: The software vendor will usually prefer that its distributor not market competing products. The Commission regulations prohibit a noncompetition clause for nonexclusive distributors, even during the term of the agreement. However, for exclusive distributors, a noncompetition clause should be effective for the term of the agreement. This clause can be drafted so that if the agreement is terminated early for certain defaults by the distributor, the noncompetition clause will stay in effect for the term that the agreement was originally supposed to last.

TLB Comment : One problem we encountered in working on this project was that many of the Commission regulations were expressed in very general terms, making it difficult to determine how they would apply to particular elements of our client’s transaction. Here, it was helpful to draw on the services of our correspondent counsel in South Korea, who could get background readings from the Commission on how the regulations would be applied to our specific circumstances. This was particularly useful when the Commission issued revised regulations in while the negotiations were in progress.