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Selecting and Working With An International Distributor

April 1992

In choosing an international distributor, a U.S. company needs to be aware that the rules governing the relationship will be different than would be the case if the distributor was based in the U.S. In addition to the obvious “business” concerns, such as whether the U.S. company and its distributor speak a common language and whether they have compatible product lines, the U.S. company needs to be aware of the legal and tax implications of doing business abroad.

Non-U.S. laws may impose unexpected constraints on the relationship with a foreign distributor. Termination provisions are a good example. In the U.S., a distribution arrangement can usually be terminated without penalty. In some countries (such as Belgium), a company may have to pay the terminated distributor a significant amount for the “good will” he has established on the company’s behalf. Applicability of termination laws may depend on whether the distributor is an “agent” (someone acting on the company’s behalf) or a “distributor” (someone acting independently who happens to sell the company’s product). The distinction can be highly technical and varies from country to country.

Exclusivity provisions (or lack thereof) may also cause problems. For example, Indonesia prohibits appointing more than one distributor in the country. Some countries imply exclusivity unless the contract provides otherwise. Other countries do not permit exclusive arrangements at all.

Antitrust laws may be of concern, especially if the distributor is to have an exclusive territory within the European Economic Community. Unless the arrangement is exempt from regulation, the U.S. company may be subject to fines for antitrust violations if it grants a distributor the right to sell in one EEC country and prohibits it from selling in another EEC country.

Some countries require that distribution agreements be reviewed by, and be acceptable to, government authorities. For example, licensing agreements with a Japanese distributor must be submitted to the Japanese Fair Trade Commission, which may require changes to avoid “unfair trade practices.”

As in any domestic transaction, tax implications of the relationship with a foreign distributor must be carefully explored before the relationship is finalized, since a U.S. company may subject itself to foreign taxation by selling into another country. While the U.S. company may be able to credit foreign taxes paid against income generated from foreign sales, this will depend upon the tax treaty (if any) between the U.S. and the foreign country. There may be structures which minimize tax liabilities. For example, using a foreign sales corporation (sometimes called a “FSC”) as an intermediary between the U.S. company and the foreign distributor may reduce the U.S. tax bite.

Foreign withholding taxes should be of special concern. For example, Japan imposes a withholding tax on licensing transactions (such as licensing of computer software). Sometimes these taxes can be avoided by carefully structuring the arrangement with the distributor. Where the tax cannot be avoided, the parties should be sure to allocate responsibility for payment between them.

TLB Comment: This article mentions only a few of the traps an unwary U.S. company can fall into when venturing into international commerce. Before signing any agreement with a foreign distributor, it is imperative that a U.S. company carefully consider the best legal the best structure for the relationship. Moreover, the participation of local counsel may be critical to a full understanding of foreign laws, and the company should be sure its U.S. attorneys have appropriate contacts in the countries where the company plans to operate.