How to avoid (or not) to pay goodwill compensation (clientele) in agency contracts

6 February 2019

Europe
Spain

Agency

When should an agency agreement be considered “international”?

Pursuant to the international private rules applicable in Italy (Art.1 Reg. 593/08 “Rome I”) an agreement is deemed “international” in the presence of “situations involving a conflict of laws”.

The situations which more often involve a conflict of laws in agency agreements– making them “international” – are (i) the principal’s seat being located in a country different from the agent’s seat country; or (ii) the agreement being performed abroad, even when the principal’s and the agent’s seats are both located in the same country.

When does Italian law apply to an agency agreement?

Under the “Rome I” Regulation, in principle Italian law may apply to an international agency agreement (i) if it is chosen by the parties as the law governing the agreement (either expressly, or as otherwise allowed by Art.3); or (ii) absent any choice of law, when the agent has its residence or seat in Italy (according to the “residence” concept under Article 19).

What are the main regulations of agency agreements in Italy?

The substantial regulations of agency agreements in Italy, with particular regard to the principal-agent relationship, can be found mainly in articles from 1742 to 1753 of the Civil Code. Such rules have been repeatedly modified following the adoption of the Directive 653/86/EC.

What is the role of the collective bargaining agreements?

Since many years, collective bargaining agreements (CBAs) have also been regulating agency agreements. These are agreements made on a regular basis between the associations representing principals and agents in different sectors (manufacture, trade and several others).

From a legal effectiveness perspective, a distinction can be drawn between two types of CBAs, i.e. CBAs having the force of law (effective “erga omnes”) – whose rules are however quite broad and thus have a limited scope of application – and CBAs of a contractual nature (“di diritto comune”) that have been signed from time to time over the years, and are meant to bind only those principals and agents which are members of those associations.

In general, CBAs intend to implement the Civil Code rules and those of the Directive 653/86. However, contractual CBAs often deviate from those rules, and some deviations are substantial. For example, CBAs allow a principal to unilaterally modify the agent’s territory, the contractual products, the range of customers, the commission. CBAs determine in a partially different manner the duration of the notice period when indefinite term agreements are terminated. CBAs have their own calculation of the agent’s remuneration for the post-contractual non-competition covenant. CBAs have peculiar regulations concerning the termination indemnity.

With particular regard to the contract termination indemnity, there have been serious issues of compliance between the CBAs and the Directive 653/86/CE. Indeed, such issues still remain unsolved despite some rulings from the EUCJ, because the Italian courts’ constant jurisprudence keeps the CBAs’ indemnity provisions in force.

According to the majority of scholarly opinions and case law, CBAs’ geographical scope of application is limited to the Italian territory.

Therefore, CBAs automatically apply to agency agreements which are governed by Italian law and are performed by the agent in Italy; but – in case of contractual CBAs – subject to the further condition that both parties are members to associations that entered into such Agreements. According to some scholars, it is sufficient that the principal alone is a member of such an association.

Even in the absence of such cumulative conditions, however, contractual CBAs may nonetheless apply if they are expressly referred to in the agency agreement, or their provisions are constantly complied with by the parties.

What are the other main requirements in agency agreements?

The “Enasarco”

Enasarco is a private law Foundation with which agents in Italy must be registered by law.

The Enasarco Foundation mainly administers a supplementary pension fund for agents, and a termination indemnity fund, called “FIRR” (referring to the termination indemnity as calculated in accordance with the criteria set forth by the CBAs in the different sectors).

Typically, a principal in a “domestic” agency agreement registers the agent with the Enasarco and pays contributions to both the above funds on a regular basis throughout the whole term of the agency agreement.

However, while registration and contribution to the pension fund are always mandatory as they are provided for by the law, contributions to the FIRR are instead mandatory only for those agency agreements which are governed by contractual CBAs.

Which rules apply to international agency agreements?

As far as registration with the Enasarco is concerned, the law and regulatory provisions are not so clear. However, important clarifications were provided by the Ministry of Labor in 2013 answering to a specific question (19.11.13 n.32).

Making reference to the European legislation (EC Regulation n.883/2004 as amended by Regulation n. 987/2009) the Ministry stated that registration with the Enasarco is mandatory in the following cases:

agents operating in the Italian territory, in the name and on behalf of Italian or foreign principals having a seat or an office in Italy;
Italian or foreign agents operating in Italy in the name and/or on behalf of Italian or foreign principals with or without a seat or office in Italy;
agents residing in Italy and performing a substantial part of their activities in Italy;
agents not residing in Italy, but having their main center of interest in Italy;
agents habitually operating in Italy, but performing their activity exclusively abroad for a period not exceeding 24 months.

The above-mentioned Regulations obviously do not apply to those agency agreements that are to be performed outside the EU. Therefore, it should be checked case by case whether any international treaties binding the parties’ countries provide for the application of the Italian social security legislation.

Chamber of Commerce and Register of Businesses

Anyone wanting to start a business as a commercial agent in Italy, must file a “SCIA” (Certified Notice of Business Start) with the Chamber of Commerce having local jurisdiction. The Chamber of Commerce then registers the agent with the Register of Businesses if the agent is organized as a business entity, otherwise it registers the agent with a special section of the “REA” (List of Business and Administrative Information) of the same Chamber (see Legislative Decree n.59 dated 26.3.2010, implementing the Directive 2006/123/EC “Services Directive”).

Such formalities have replaced the former registration to the agents’ roll (“ruolo agenti”) which was abolished by said law. The new law also provides for a number of other mandatory requirements for agents wishing to start an activity. Such requirements concern education, experience, clean criminal records, etc.

Although failure to comply with the new registration requirements does not affect the validity of the agency agreement, a principal should nevertheless check that the Italian agent is registered before appointing him, as this is a mandatory requirement anyway.

Venue for disputes (art.409 and following of the Civil Procedure Code)

Pursuant to Article 409 and following of the Civil Procedure Code, if the agent mainly performs its contractual duties as an individual even if independently (so-called “parasubordinato” i.e. “semi-subordinate” agent) – provided the agency agreement is governed by Italian laws and Italian courts have jurisdiction – any disputes arising from the agency agreement shall be submitted to the Labor Court in the district where the agent is domiciled (see article 413 of the CPC) and the court proceedings shall be conducted according to procedural rules similar to those applicable to employment-related disputes.

In principle, said rules shall apply when the agent enters into the agreement as an individual or sole entrepreneur, while according to the majority of scholars and jurisprudence they do not apply when the agent is a company.

Applying the rules above to the most common situations in international agency agreements

Let’s now try to apply the rules described until now to the most frequent situations in international agency agreements, keeping in mind that those below are simple examples, while in the “real world” one should carefully check the circumstances of each specific case.

Italian principal and foreign agent – agreement to be performed abroad

Italian law: it governs the agreement if chosen by the parties, without prejudice to any public policy (internationally mandatory) rules in the country where the agent has its residence and performs, pursuant to the Rome I Regulation.

CBAs: they do not govern the agreement automatically (because the agent performs abroad) but only when they have been expressly referred to in the agreement, or de facto applied. This could happen more or less intentionally, for example when an Italian principal uses with foreign agents the same contract forms as with Italian agents, which usually include many references to the CBAs.

Enasarco: typically, there are no registration or contribution obligations in favor of a non-Italian agent whose residence is abroad and performing his contractual duties only abroad.

Chamber of Commerce: there is no obligation to register in the above circumstances.

Procedural rules (article 409 and following, CPC): if Italian courts are properly chosen as the jurisdiction for all disputes, a foreign agent even if being an individual or sole entrepreneur may not take advantage of this provision to move the case to the courts of his own country. This is because art.413 cpc is a domestic provision on venue which presupposes the agent’s seat to be in Italy. Further, the jurisdiction rules set forth by the EU legislation should prevail, as was ruled by the Italian Court of Cassation and stated by important scholars.

Foreign principal and Italian agent – agreement to be performed in Italy

Italian law: it governs the agreement if chosen by the parties or, even in the absence of any choice, as an effect of the agent having his residence or seat in Italy.

CBAs: those having force of law (“erga omnes”) govern the agreement, whereas those having contractual nature are unlikely to apply automatically, as the foreign principal typically would not be a member to any of the Italian associations having signed a CBA. However, they might apply if referred to in the agreement or de facto applied.

Enasarco: a foreign principal shall register the Italian agent to the Enasarco. Failure to do so might imply penalties and/or damages claims from the agent. As a consequence of such registration, the principal will have to contribute to the social security fund, while he should not be obliged to contribute to the FIRR (fund for termination indemnity). However, a principal who makes regular contributions to the FIRR even when not due, might be considered as having impliedly accepted the CBAs as applicable to the agency agreement.

Chamber of Commerce: the Italian agent has to be registered with the Chamber of Commerce and therefore the principal should make sure that the agent has complied with this requirement before entering into the agreement.

Procedural rules (art.409 and following, CPC): if Italian courts have jurisdiction (whether by the parties’ choice or as the place of performance of the services pursuant to Regulation 1215/12) and the agent is an individual or a sole entrepreneur with a seat in Italy, these rules should apply.

Italian principal and Italian agent– agreement to be performed abroad

Italian law: it governs the agreement if chosen by the parties, or, in the absence of any choice, if the agent has his residence or seat in Italy.

CBAs: they would not apply (as the agent performs abroad) unless expressly referred to in the agreement, or de facto applied.

Enasarco: according to the Ministry of Labor’s opinion, registration is mandatory when the agent, although being engaged to work abroad, has his residence and performs a substantial part of his business in Italy, or has in Italy his center of interest, or performs abroad for a period not exceeding 24 months, provided the EU Regulations apply. In case the agency agreement is to be performed in a non-EU country, it has to assessed from time to time whether registration is mandatory.

Chamber of Commerce: an agent having started his business and established as an entity in Italy is in principle obliged to register with the Chamber of Commerce.

Procedural Rules (articles 409 and following of the CPC): the rules apply if the agent is an Italian based individual or sole entrepreneur and the Italian jurisdiction is agreed upon.

Foreign principal and foreign agent – agreement to be performed in Italy

Italian law: in principle, it governs the agreement only if chosen by the parties.

CBAs: if the agreement is governed by Italian law, the CBAs having force of law apply, while those having contractual value will not apply unless expressly referred to, or de facto applied.

Enasarco: according to the Ministry of Labor’s opinion, when EU Regulations apply, registration may be required from a foreign principal in favor of an agent residing abroad, if such agent operates in Italy or has his center of interest in Italy. Otherwise, a case by case analysis will be needed under the applicable laws.

Chamber of Commerce: in principle, an agent established as an entity abroad is not obliged to register in Italy. However, the issue could be more complex if the agent has a seat and performs his activity mainly in Italy. Such circumstances may also affect the determination of the law governing the agency agreement.

Procedural Rules (articles 409 and following of the CPC): absent any different choice, Italian courts might have jurisdiction as Italy is the place of performance of the services. However, the above-mentioned rules should not apply if the agent has no seat or residence in Italy.

Conclusive remarks

Hopefully this analysis, though not exhaustive, can help understanding the possible consequences of applying Italian law to an international agency agreement, and to make prudent choices when drafting the agreement. As always, we recommend not to rely on standard contract forms or precedents without having paid due attention to all the circumstances of each case.

The Spanish Law of the Agency Contract and the European Directive provide for the agent -except in certain cases-, goodwill compensation (clientele) when the relationship is terminated, based on the remuneration received by the Agent during the life of the contract. It is, then, a burden that in general every Principal will have pending when the contract ends.

The temptation is to try to get rid of that payment and for this clients consult us frequently about strategies or tactics. I will try to summarize some of them indicating the chances of success (or not) that may have, both in the negotiation / drafting phase of the contract, and in the resolution phase.

Change the name of the contract

The first idea is to make a contract “similar” to the agency or call it in a different way (services, intermediation, representation contracts…). However, the change of name does not have any incidence since the contracts “are what they are” and not what the parties call them. So if there is a continued mediation in exchange for remuneration, there is a good chance that a judge will consider it an agency contract, whatever we call it, and with all its consequences.

Limitation of compensation in the contract

Another temptation in the drafting phase of the contract is to agree compensation less than the maximum legally envisaged, provide for payment in advance for the duration of the contract, or directly eliminate it.

None of these solutions would be valid if they try to reduce the possibility of the Agent to receive the legal maximum, or for reasons not foreseen in the Law or the Directive. The law is imperative.

Linking different agency contracts

Given that the compensation is calculated according to the remunerations of the last five years and the clientele created, the temptation is to link several shorter contracts to consider only the clients of the last period.

This will not necessarily be a good idea if most of the customers were created last year for instance, but it may also be useless because the Spanish law and the Directive provide that the fixed-term contract that continues to be executed becomes indefinite. The judge may consider all linked contracts as one.

For this strategy to have the possibility of being useful, it would be necessary to liquidate each substituted contract, declare that “nothing has to be claimed by the parties” and that the successive contracts are sufficiently separated and have different entities, drafting, extension, etc. If the procedure is well thought out, it could be a way to get rid of a greater indemnity by clientele: a well-written pact whereby the agent declares the compensation received, and the following contract does not mimic the content and immediately to the previous one.

Submitting the agreement to a foreign law

In international contracts the temptation is to submit the contract to a right that is not Spanish, particularly when the Principal has that citizenship.

The idea can be good or bad according to the chosen law and as long as it has some relation with the business. As is known, in the EU the Directive establishes minimum conditions that national laws must respect. But nothing prevents these laws from providing more advantageous conditions for agents. This means that, for example, choosing French law would be, in general, a bad idea for the Principal because compensation in that country is usually higher.

In some cases, the choice of a law outside the European Union that does not provide compensation for clientele when the agent is European has been rejected because that the minimum right recognized in the Directive has not been respected.

Submit the contract to non-national rules and judges

Another less frequent possibility is to submit the contract to rules not from a country, but to general commercial norms (Lex Mercatoria) and to agree on a lower compensation.

This is very uncommon and may not be very useful depending on who is to interpret the contract and where the agent resides. If, for example, the agent resides in Spain and who is going to interpret the contract is a Spanish judge, he will most likely interpret the contract according to his/her own rules without being bound by what the contract envisages. This clause would have been useless.

Submit the contract to arbitration

The question will be different if the contract is subject to arbitration. In this case, arbitrators are not necessarily subject to interpreting a contract according to their own national regulations if the contract is subject to different one. In this case, it would be possible that they felt freer to consider the contract exclusively, especially when the agent was not of their nationality, did not know what the law of the agent’s country and was not bound by the guarantees provided for his protection.

Mediation in the agency contract

Mediation is an alternative dispute resolution system that can also be used in agency contracts. In mediation, the parties resolve the dispute by themselves with the help of a mediator.

In this case, given that the mediator is not deciding, it is possible for the parties to freely reach an agreement whereby the agent agrees to a minor indemnification if, for example, other advantages are conferred upon him, if he comes to the conviction of having less right, difficulty of proof, if he prefers to save other costs, time, energy for your new business, etc.

Mediators ensure the balance of the parties, but nothing prevents them to agree a compensation lower than the legal maximum (after the conclusion of the contract it is possible to negotiate a lower than the legal maximum). To foresee the possibility of mediation in the agency contract is, therefore, a good idea: this will permit the parties to better address and negotiate this compensation. In addition, providing for mediation does not limit the rights of any of the parties to withdraw and continue through the courts demanding the legal maximum.

Imputing to the agent a previous breach

When the contract ends, this is undoubtedly the cause that is most often attempted: when the contract is to be resolved, the Principal tries to argue that the Agent has previously failed to comply and that this is why the contract is being resolved.

The law and the Directive exempt the payment of goodwill compensation when the agent has breach his obligations. But in that case, the Principal must be able to prove it when the agent discusses it. And it will not always be easy. The Principal must provide clear evidence and for this it will be convenient to collect information and documentation on the breach sufficiently and in advance and of sufficient importance (minor breaches are not usually accepted). Therefore, if the Principal wishes to follow this path it is advisable to prepare the arguments and evidences time before the agreement ends. It is strongly recommend contacting an expert advisor as soon as possible: he will help you to minimize the risks.

Commercial agents are very suitable for expanding one’s business into new markets – especially for two reasons: First, because they generally have a good expertise of the market (especially if they reside in that country). Second, because their remuneration (“commission”) can be configurated completely profit-oriented (= remunerated only if they successfully negotiate a new transaction), and related to the turnover they generate.

Nevertheless, both the supplier and the commercial agent may feel the need for an initial period, in which both get to know each other, the product, the market and the customers as good as possible to subsequently evaluate how to proceed on that market. Therefore, they may agree on a trial period within which the commercial agency contract can be terminated more easily and sooner than without or after such trial period, e.g.:

“This Agreement shall come into effect on [●] and shall be in force for a trial period of [●] months (“Trial Period”) during which each Party can terminate the Agreement with [●] months written notice. After such Trial Period, the Agreement shall continue indefinitely, unless terminated according to the rules below.”

Even if the agency agreement is terminated within such trial period, however, the agent may be entitled to indemnity or compensation – as the Court of Justice of the EU just now confirmed (Case Conseils et mise en relations (CMR) SARL, decision of 19 April 2018, C-645/16).

The court basically argues with the wording, context and objective of the Commercial Agency Directive:

The Commercial Agency Directive also applies to ‘”trial periods”.
Ending a commercial agency contract – even within an agreed trial period – constitutes a “termination” of the agency contract, which triggers the claims for indemnity or compensation – because the commercial agency contract has already been definitively concluded (understanding contrary to French case law, e.g. Cour de Cassation, Case No. 14-17894).
Goodwill indemnity or compensation are not forfeited because termination within the trial period is not included in the exhaustive list of exceptions in Article 18 Commercial Agency Directive.
The parties may derogate from the commercial agent’s mandatory rights only from the end of the contract (Article 19 Commercial Agency Directive) because the Commercial Agency Directive aims to protect the commercial agent vis-à-vis the principal (recital 2 of the Commercial Agency Directive).

Practical tips

Parties are free to agree on trial periods because it is covered by freedom of contract.
At termination, the commercial agent is, as a matter of principle, entitled to an indemnity or compensation – to “indemnify the agent for his past services from which the principal will continue to benefit beyond the termination”, as the EU Court of Justice now put it. Whether the agent can claim indemnity or compensation depends on the law chosen by the parties (or, in absence of choice, by the law of the country where the commercial agent has his habitual residence).
As far as the indemnity (payable e.g. according to German law) is concerned, its amount strongly depends on the commercial agent’s performance during the term of the contract – because the claim accrues if and to the extent that (i) the agent has brought the principal new customers or (ii) has significantly increased the business with existing customers and (iii) the principal continues to derive substantial benefits from such business, plus (iv) such indemnity must be equitable. As a maximum, the indemnity shall not exceed of the past five years’ average annual remuneration (including commissions and other payments). Such possible costs should therefore be included in one’s business planning before starting to distribute products or services through commercial agents.
Throughout the EU, agency agreements are widespread in a vast variety of industries: roughly 740,000 commercial agents operate for 1.7 million companies and generate sales of EUR 260 billion. These figures from 2012 keep growing as indicate Eurostat’s data, reported by the European Commission in its Refit Evaluation. The EU Member States with the most commercial agents are Slovakia (35k) Czech Republic (42k), Germany (42k), France (50k), Spain (50k) and – by far – Italy (220k). If the agent operates outside the European Economic Area, Principals and commercial agents are free to derogate even from the otherwise mandatory Commercial Agency Directive, especially if German law is chosen. For details, please see the article “Commercial Agents outside the EEA – No Goodwill Indemnity (Ingmar reloaded)”.
Alternatively, one can also do business through distributors or franchisees or other intermediaries – where, however, an indemnity may arise at well, especially vis-à-vis distributors. For details, see the article “German Distributor Indemnity – How to avoid it”.

If you want to develop your distribution network abroad, a network of commercial agents is the easiest way, and France is no exception. Before entering into an agency contract ruled by French law, it is nevertheless advisable to know its main features, which will be discussed in this post.

Definition

A commercial agent is a professional representative who negotiates and eventually concludes contracts in the name of and on behalf of his principal.

The French Commercial Code (Article L134-1) defines a commercial agent precisely as:

«L’agent commercial est défini comme un mandataire qui, à titre de profession indépendante, sans être lié par un contrat de louage de services, est chargé, de façon permanente, de négocier et, éventuellement, de conclure des contrats de vente, d’achat, de location ou de prestation de services, au nom et pour le compte de producteurs, d’industriels de commerçants ou d’autres agents commerciaux.»

«The commercial agent is an agent who, as an independent professional, without being bound by an employment contract, is in a permanent position to negotiate and eventually to enter into contracts for the sale, purchase, rent/hire or performance of service in the name and on behalf of manufacturers, industrialists, traders or other commercial agents.»

The definition shows that the agent is independent: he/she is free to organise his/her own employment activity and business (sole agency, limited company etc.). This notion is fundamental, because the more the agent will be present and active in the organisation of the principal activity, the more the contract will be at risk of being requalified as a VRP (employee contract of sales representative) contract by the courts.

In the spirit of the contractual relationship and in the drafting of the contract itself, one must be very careful not to confuse an agent with a VRP since, according to French law, the latter is considered an employee, with greater rights and compensation for termination of contract.

Requirements

The agent must be registered in the register of commercial agents at the Registry of the Commercial Court at his place of domicile.

Contract form

The written form is not mandatory but strongly recommended. Article L134-2 of the Commercial Code provides that each party may request both the contract and addenda to be in writing.

Execution of the contract – important clauses

Duration: for a fixed period or indefinite.
Fee: a commission freely defined between the parties.
Territory: it is very important to define the territory with precision and avoid wide generic clauses such as “world”.
Exclusive: the clause must specify whether the exclusivity is in relation to the territory and/or on the clientele in a precise manner and if the principal reserves the right to intervene.
Notice of withdrawal (Article L134-11, paragraph 3 of the Commercial Code): 1 month for the first year, 2 months for the second year, 3 months thereafter.

Post-contract – important clauses

Post-contractual non-competition clauses (Article L134-14 of the Commercial Code) must be in written form and limited to a maximum of 2 years post-contract.

The non-competition clauses restriction (territory, customers, products) must not be so restrictive as to prohibit the agent from working after the end of the contract. Therefore customers and products included in the agreement must be competitors of the type of goods subject of the agency contract. Otherwise, the courts will consider the clause as null and non-existent, entitling the agent to claim compensation.

French law does not provide any compensation for compliance with this clause.

After termination of the contract, the agent is entitled to an indemnity for termination as compensation (Article L134-12 of the Commercial Code). It is a rule of public order, therefore, the clause that provides for an exemption of this entitlement will be considered null and non-existent.

The agent has one year to assert this right to severance indemnity.

There is no requirement of keeping it in writing, however, it is advisable to write a notice of receipt as proof of the termination.

The amount of the compensation is equal to two years of commissions (gross) received by the agent. This is to be seen as a maximum measure and it is up to the principal to prove the reason as to why the agent should be entitled to a lower compensation.

In the event of litigation, the courts will at their discretion evaluate the amount of the request of a maximum of two years.

Cases in which compensation is not due:

Assignment of the contract to another agent;
Termination of the contract by the agent;
Serious non-fulfilment of the contract by the agent.

Serious breach of contract can result from the non-fulfilment of clauses that are defined in the contract as important or must be assessed from time to time with the advice of your lawyer.

Focus: the termination of contract due to retirement

The agent is entitled to the indemnity for termination as compensation also when he/she ceases the activity and retires.

French jurisprudence (in particular the jurisprudence of the Court of Cassation), however, requires a more specific check of the reason for the termination of the contract: the agent must not only claim to be entitled to the retirement pension, he should also assert he is not in physical conditions to be able to work anymore.

Which is the competent French court?

Even if the agent is a trading company, the nature of the contract is still civil. By virtue of this, the competent court varies according to the person who brings the claim.

If the agent is the claimant, he can choose between “tribunal de grande instance” and “tribunal de commerce”.

If, on the other hand, the principal is the claimant, he must also begin the claim before the “tribunal de grande instance”.

Based on our experience in many years advising and representing companies in the commercial distribution (in Spanish jurisdiction but with foreign manufacturers or distributors), the following are the six key essential elements for manufacturers (suppliers) and retailers (distributors) when establishing a distribution relationship.

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.

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.

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? 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.

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, and 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.

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.

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.

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.

Brazilian legislation requires every nonresident that holds quotas, capital or shares of a Brazilian company appoints an attorney-in-fact that resides in the country, with powers to receive service of process.

Besides granting the power required by law, foreign partners usually grant other powers to their attorneys-in-fact, in order to facilitate the procedures, since all documents executed abroad must be notarized and Apostilled, and once they arrive in Brazil they must be translated by a sworn translator and registered before the Public Registry of Titles and Documents, in order to be valid in Brazil, which is time and money consuming.

Also, all foreign companies holding quotas, capital or shares of the Brazilian company, need a Taxpayer number, called CNPJ. The taxpayer number is not for tax payment purposes, but for controlling purposes only. The foreign partners / holder need to grant a power of attorney for their enrollment at CNPJ, and representation before the Federal Revenue in all matters.

By the time the company is incorporated the Power of Attorney granting the above-mentioned mandatory powers must be presented before the Board of Trade.

Moreover, all Foreign Direct Investment must be registered at the Central Bank of Brazil. This means that every time the foreign shareholder/partner transfers money to the Brazilian company as investment, the respective exchange agreement must be registered at the Central Bank. Such registration is done electronically.

The main effects of such registration are the possibility of remitting dividends and of repatriating the capital invested.

In view of the above, the documents to be presented at the incorporation of a company in Brazil are:

Power of Attorney granting to a Brazilian resident powers to accept service of process, for enrollment at CNPJ and representation before the Federal Revenue;
In case the foreign partners/shareholders/holder are/is a natural person, a copy of his/her passport;
In case the foreign partners/shareholders/holder are/is a legal entity:

– Copy of the passport of the legal representative of the foreign partners/shareholders/holder; and

– Updated Certificate issued by the Board of Trade of the foreign partners/shareholders/holder’s head offices attesting: (a) its existence and good standing, and (b) its legal representatives for the purposes of evidencing that the company was duly represented in the Power of Attorney granted. This document (or a separate one issued by a public authority) must also contain the head offices address, name of shareholders, capital and objectives.

Note that all documents need to be duly notarized and apostilled. Once they arrive in Brazil, they will undergo sworn translation and will be registered at the Public Registry Office in order to be valid.

We would like to point out that the Federal Revenue and commercial banks have increasingly been requesting a series of complementary documents for compliance reasons, so that the final beneficiaries (natural person) of each foreign company holding quotas, capital or shares of Brazilian entities may be identified.

At the chosen bank’s own discretion, other documents may be necessary, as balance sheets, statements and corporate documentation until the end controller (natural person) is identified. These documents must be presented for the opening of a bank account, and banks have been taking quite some time to open the account.

A reduction in capital requires a resolution by the general meeting of shareholders amending the articles. Such an amendment cannot be passed unless a special audit report shows that all claims of creditors are fully covered in spite of the reduction in capital. The auditors’ report must be prepared by a qualified auditor. Prior to implementing the reduction, the board of directors is required to publish the decision three times in the Swiss Official Gazette of Commerce. Creditors are to be informed. An exception is made for reductions in the event of capital deficiency. Under no circumstance may the share capital be reduced below SFr. 100,000. In the case of a financial restructuring of the company, the par value of the old shares may however be reduced to less than SFr. 10 each. In spite of a reduction in the par value, a share may still carry the same voting rights as before reduction.

A company may be dissolved for any voluntary reason provided for by the articles or by decision of the general meeting of shareholders. An involuntary dissolution can be imposed upon the company by bankruptcy or a court decision. A court can dissolve a company, for example, in cases where serious violations of legal or statutory provisions have occurred. Furthermore, shareholders representing at least ten per cent of share capital may request dissolution by the court if they have good cause (for example, if minority rights have been violated).

Except in the case of a bankruptcy, the board must register the dissolution of the company with the Commercial Register. During the period of liquidation, the company remains a legal entity and retains its name with the addition in liquidation. Unless the company appoints special liquidators, the liquidation procedures are carried out by the board. The name of the liquidators is to be registered. At least one of the liquidators must be domiciled in Switzerland and have authority to represent the company.

The term liquidation means that the company’s normal business activities are discontinued and restricted to such operations as are necessary to settle all pending matters. The liquidators must prepare a balance sheet upon assuming their duties. If the balance sheet shows an excess of liabilities over assets, the liquidators must file an application for bankruptcy, unless arrangements can be made for an amicable settlement with the creditors.

In all other cases, the liquidators must attempt to wind up the business (termination of contracts, collection of receivables, payment of outstanding debts) with a view to reaching a final settlement with creditors and shareholders. In this connection, creditors reflected in the books of the company or known in any other way shall be informed of the dissolution of the company in writing and requested to file their claims; unknown creditors and creditors whose domiciles are not known are notified by publication in the Swiss Official Gazette of Commerce. In order to protect unknown or disputed creditors who have failed to lodge their claims, an appropriate amount of money must be deposited in escrow. A distribution of net assets is postponed until such liabilities have been settled.

After settlement of all liabilities, the remaining net assets of the liquidated company may be distributed among the shareholders in proportion to their holdings and in accordance with the rights attached to their shares. Upon termination of liquidation procedures, the liquidators apply for deregistration and designate a safe place where the books must be kept for a period of ten years. Deregistration is contingent upon express approval by the Federal and Cantonal Tax Administration, to ensure that all taxes on income, capital and distribution have been paid in full.

A resolution dealing with the merger of companies may only be passed at the general meeting of the shareholders, if at least two thirds of the shares are represented. Creditors of merging companies are given special protection.

The merger procedures can be summarized as follows:

The board of directors of the acquiring company must issue a call for registration of claims by the creditors of the company to be dissolved.
The net assets of the company to be dissolved must be administered separately by the acquiring company until creditors are satisfied or secured.
The dissolution of the absorbed company must be registered in the Commercial Register as soon as creditors have been satisfied or secured.
Subsequent to this registration, shares of the acquiring company may be delivered to the shareholders of the absorbed company, according to the contract.

The members of the board of the acquiring company are personally, jointly and severally liable to the creditors of the absorbed company. The net assets of the absorbed company may be used exclusively for the satisfaction of that company’s creditors.

A corporation can be converted into a limited liability company, provided that the capital of the limited liability company is not less than the corporation’s share capital, that shareholders are informed about the possibility of becoming participants in the newly created company, and that their participations amount to at least two thirds of the share capital of the transformed company. Any retiring shareholder is entitled to a proportionate share of the net assets valued at fair market price. With regard to the creditors of the transformed company, the same provisions apply as for mergers. A limited liability company may not be transformed into a corporation. It must be liquidated and a new corporation formed.

When entering new markets, there are different distribution strategies to choose from (I.). In retail, car and wholesale trade, distributorship agreements are quite common (II.). In international distributorship agreements, the parties may choose the applicable law (III.). Whether chosen or not, the applicable law may contain unpleasant surprises like goodwill indemnity for distributors under German law (IV.). Such surprises can be avoided – the post shows how, considering the latest 2016 decisions by the German Federal Court of Justice (V.).

I. Entering new Markets

When entering new markets, different structures exist. Which one to choose depends on the strategy desired: from direct sales with own employees or sales agents to indirect distribution via distributors, franchisees, commission agents, the sale of white label products or licensing with the scope of manufacture and sale by third parties. For details on distribution in Germany see the Legalmondo post on “Distribution agreements in Germany”.

II. Distributorship Agreements

In retail (especially electronics, cosmetics, jewelery, and sometimes fashion), car and wholesale trade, distributorship systems are particularly common – regardless of whether the sales intermediary is referred to as a “distributor”, “trader”, “dealer”, “specialist retailer”, “concessionary” or “authorized dealer”. Distributors are self-employed, independent contractors who constantly sell and promote the products in their own name and on their own account. They bear the sales risk, for which – vice versa –manufacturers’ margins are rather low. Distributors are generally less protected than commercial agents (to whom within the European Union, the Directive on self-employed commercial agents of 1986 applies, as implemented in the national law of the respective EU Member State). Contrary to agreements with sales agents, distributorship agreements are restricted by antitrust law. Restrictions of competition are, in principal, prohibited, unless they do not appreciably restrict competition under Article 101 TFEU (Treaty on the Functioning of the European Union). For details on distribution online see the Legalmondo post on “Restrictions on Distributors in E-Commerce”.

III. Distribution international and Choice of law

When a manufacturer distributes its products or services internationally, the manufacturer’s and the distributors’ national laws “collide”. Frequently, the parties will choose the applicable law in order to solve such collision and create legal certainty. Typically, each party will try to take its “own”, and perhaps not more favourable, but at least well-known law abroad. Alternatively, the parties may agree on the law of a “neutral”, third country – e.g. Swiss law between an Italian manufacturer and a German distributor, which, by the way, also gives more freedom as regards standard form contracts. Even with a choice of law, there can nevertheless be unpleasant surprises in international trade – approximately as in the saying “different countries, different customs“:

First, because a choice of law may not be effective – as, for example, in some South American countries and in the Middle East.
Second, because there may be internationally mandatory provisions (“overriding mandatory provisions”, “lois des police” or “Eingriffsnormen“) which are so important for safeguarding a country’s public interests that they practically “override” the choice of law, i.e. apply despite the otherwise effective choice of law.
Third, because the chosen law may contain unpleasant surprises, such as the German goodwill indemnity for distributors.

IV. “German” Distributor Indemnity

Also German law may provide surprises – in particular in form of the distributor’s claim to goodwill indemnity at termination. Though there are no explicit rules on distributors under German law, there is extensive case law and various agency rules apply also to distributors if two conditions are given:

The distributor is

integrated into the supplier’s sales organisation; and
obliged (due to agreement or factually) to forward customer data during or at termination of contract.

If given, the distributor is basically also entitled to claim goodwill indemnity at termination (under the same conditions as an agent). The calculation of such goodwill indemnity is, in general, based on the distributor’s margin made in the last year with new customers brought by the distributor or with existing customers where the distributor has significantly increased the business. Details vary; different ways of calculation are accepted by German courts.

V. How to avoid “German” Goodwill Indemnity for Distributors

For a long time, it was disputed whether the distributor’s goodwill indemnity under German law, granted in analogue application of agency law (sec. 89b German Commercial Code) could be excluded in advance (i.e. before termination of contract) when the distributor operates outside Germany, but in the European Economic Area (“EEA”).

The question was now put to the test before the German Federal Court (decision of 25/02/2016, ref. no. VII ZR 102/15). The defendant, established in Germany, manufactured equipment for the electrical industry. The plaintiff was operating as a distributor in Sweden and other EEA States. The distributorship agreement provided for German law; any postcontractual compensation or remuneration was excluded. After termination by the defendant, the plaintiff claimed goodwill indemnity as distributor. The plaintiff did not succeed in the lower courts, but the German Federal Court now decided in the plaintiff’s favour (as, by the way, in a similar matter did the Higher Regional Court of Frankfurt on 06/02/2016, ref. no. 11 U 136/14 [Kart]).

The decision focuses on the territorial scope of the provision on goodwill indemnity (sec. 89b of the German Commercial Code). Pursuant to that provision, the agent’s goodwill indemnity cannot be excluded in advance. In settled case law, this provision may apply analogously to distributors (see above). However, it was disputed whether the distributor’s goodwill indemnity is also mandatory if the distributor operates outside Germany, but within the EU / EEA. The German Federal Court has now confirmed that – arguing especially with (i) the historic development of agency law and (ii) its objective to protect the agent respectively the distributor: also distributors operating in other EEA countries than Germany were to be protected as those operating in Germany; the relevant provision was intended to protect against unfavorable agreements resulting from economic dependence on manufacturers / suppliers. Finally, the Federal Court of Justice deemed it not necessary to refer this question to the Court of Justice of the EU because it did not fall within the scope of the Directive on self-employed commercial agents of 1986.

The new decision is consistent with existing case-law: it was quite likely that the German Federal Court would continue on its way of largely applying agency law to distributors by analogy.

Five practical tips for contractual practice and future contract drafting:

Goodwill indemnity is a cost which arises only in the wake of a distributorship agreement, but should be considered beforehand – and also, if such cost can be avoided or stipulated differently beforehand (e.g. stipulate entry payments).

If the distributor operates outside the EEA, the claim for goodwill indemnity can be excluded at any time, i.e. already in the distributorship agreement itself (sec. 92c German Commercial Code; cf. Higher Regional Court of Munich, decision of 11/01/2002, ref. no. 23 U 4416/01).

If the distributor operates in the EEA, German law applies and the two above conditions are met, the distributor’s claim to goodwill indemnity cannot be excluded before termination.

Distributor’s German goodwill indemnity can be excluded beforehand especially if the parties

(i) exclude the transfer of the customer data; or

(ii) oblige the manufacturer to block, stop using and, if necessary, delete such customer data at termination (German Federal Court, decision of 05/02/2015, ref. no. VII ZR 315/13); or

(iii) chose another law (and, consequently, another jurisdiction or arbitration).

Alternatively, the parties may cushion the claim for goodwill imdemnity by agreeing on “entry payments” (“Einstandszahlungen”) – which could even be deferred until termination and then offset against the claim for goodwill indemnity. However, such entry payment should not be unreasonably high (Federal Court of Justice, decision of 24/02/1983, ref. no. I ZR 14/81), respectively it should correspond to a value in return, e.g. a particularly high distributor discount or a very long contract term (Higher Regional Court of Munich, decision of 04/12/1996, ref. no. 7 U 3915/96, Higher Regional Court of Saarbrücken, decision of 30/08/2013, ref. no. 1 U 161/12). In short: the manufacturer must prove that the parties would not have agreed a higher commission, even without the entry payment (as just decided by the German Federal Court on 14 July 2016, ref. no. VII ZR 297/15).

Ignacio Alonso

Practice areas

Agency
Corporate
Distribution
Franchising

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