Distribution Agreements in China

There is no specific regulation applicable to distribution contracts in China.

Distribution agreements are governed by the Contract Law (1999) which is a hybrid with elements of socialist, Roman, German systems, and international conventions. Important principles, to be kept in mind when drafting distribution agreements with a Chinese partner, are equality (“pingdeng” – art. 3) free will (“ziyuan” – art. 4) equity (“gongping” – art. 5) and good faith (“chengshixinyong”- art. 6).

For this reason, even if a distribution contract is validly entered into verbally or even de facto, it is important to draft a clear, balanced and complete contract, as this document will be the main source of discipline of the parties’ obligations.

When it comes to the individual sales contracts, remember that China is a member to the UN Convention on the International Sale of Goods (CISG), while it is not 100% clear whether Hong Kong and Macao should be considered contracting states after the sovereignty transfer to China: it is advisable, thus, when contracting with companies based in such territories, to provide expressly for the application of CISG (“opt in”).

Both in case of distribution and sales contracts, it is advisable to negotiate and execute a bilingual agreement (English-Chinese): although the contract is valid even only in a foreign language, providing a Chinese version avoids misunderstandings on the content and is also important should the contract needed to be used or enforced in China, as Chinese is the only official language admitted in courts and before public bodies.

Finally, one should know that it is a good practice not only to sign the contract but also to stamp it with the company chop: this is a unique piece of wood, crafted when the company is incorporated, held by the person who has the power to represent the company: thus, the stamping of a contract is an important indication that the signer is an authorized representative of the company

During contract negotiations, this is often the main battlefield.

The distributor generally insists to obtain the exclusive right of distribution, while the manufacturer wishes to avoid the concentration of all sales in one company.

It should be borne in mind that China is a country of continental dimensions and infrastructures in certain areas of the country are still limited.

It is therefore advisable to limit the geographical exclusivity to one or more provinces and to provide, if necessary, that the exclusive territory be extended in case the distributor reaches certain commercial objectives that the parties have agreed upon. In the event that the exclusivity is granted, another good practice is to provide Minimum Targets, i.e. to establish minimum business goals to be achieved in a certain period of time, with the express provision that in case of failure to achieve these objectives, the exclusivity may be revoked, or the contract terminated.

Finally, although Hong Kong and Macau are under Chinese sovereignty, it is advisable to expressly mention whether the contract grants to the distributor the right to sell the products also in such territories.

Another important clause that should be in place from the onset regards non-competition, especially in those cases where the distributor already represents and sells products which are similar to those of the manufacturer.

It is advisable to attach to the contract a list of products of other companies which are allowed for sale by the distributor, and a list of those products which the distributor cannot represent, with express provision that any change must be agreed in writing.

This is a key provision for the start and continuance of a healthy relationship, so it is useful to foresee that the manufacturer is allowed to audit the accounts and inspect the facilities of the distributor, and to establish the right to terminate the agreement in case of breach of the non-compete covenants by the distributor.

Internet sales in China have grown exponentially over the last twenty years: China is today by far the biggest market for B2C e-commerce, and digital sales play a major role also in B2B transactions.

While until a few years ago a distribution contract could be structured in a fairly simple way, i.e. with the appointment of one or more distributors, in charge of certain areas, today it is important to consider right from the start the possibility that the products be also be sold through web channels.

There are several ways to sell products via e-commerce in China (onshore and offshore marketplaces, cross-border or on-shore ecommerce websites, social commerce) and the system need to be integrated seamlessly online/offline in order to be effective and to avoid conflicts among the different players in the distribution system.

While the possibility to sell via e-commerce platforms can be excluded in a distribution agreement, products often end up on e-marketplaces anyway: the focus should be, therefore, on the construction of a balanced and well-integrated distribution system, where the distributors are assigned specific sales channels from the start and the manufacturer has a way to monitor how the distribution system works.

When drafting a distribution agreement, therefore, the obligations of promotion, budgets, investments and business development activities need to be consistent with the overall omnichannel strategy and to be coordinated among the different players.

It may happen that a company sell their products in China both through distributors and commercial agents: the latter is the case especially for custom-made, complex products, turn-key plants, and machinery.

While it is possible to foresee that a distributor, in certain cases, may act as a commercial agent, therefore promoting the sale of products directly from the manufacturer to the end client based in China, this should be clearly defined in the contract and should remain an ancillary business. Should the promotional activity become the main obligation of the commercial partner, it is preferable to negotiate and enter into a commercial agency contract: you can read this Guide to know more.

A specific and separate license agreement to allow the distributor to use the manufacturer’s trademarks in China s not necessary: this right can be set forth in the distribution contract, with a specific indication of the authorized use of trademarks.

It must be kept in mind, though, that counterfeiting and trademark squatting are still a major problem in China: before entering the Chinese market foreign companies should make sure that all trademarks are registered in China (more information on this topic here) and the distribution agreement should expressly forbid the registration of the trademarks, or similar trademarks (including in Chinese characters) by the distributor and its controlled or associated companies.

Distribution contracts can be for a fix term or open-ended and it is possible to establish automatic renewal in case the contract continues to be performed after the initial term.

There is no minimum termination notice period provided by law: it is advisable, anyway, to agree upon a reasonable prior notice before termination (generally 6 months, but a longer period is recommended in case of long-term relationships) and to foresee the right of the parties to agree on the waiver of the right to continue performance until the end date.

The notice period before termination is usually the moment when it is most likely that the parties may have differences, therefore a clause that establishes special rules applicable for this period is very important.

For instance, the contract may establish different payment terms, a value cap for orders, or the possibility for the manufacturer to audit the distributor’s existing stock of products.

The fact that the old distributor continues to sell the products after termination of the contract can be problematic for the manufacturer and/or for the newly appointed Chinese distributor, for instance because the stock is sold at discounted prices or in ways that damage the brand's image and reputation.

Clauses that establish the right (not the obligation) of the manufacturer to buy back the existing stock, at predetermined prices, are valid in China and represent a good option to avoid post-termination conflicts within the commercial network.

The parties are free to apply a foreign law to the contract between a foreign manufacturer and a Chinese distributor: however, the choice of law must be coherent with the dispute resolution mechanism and should consider that the contract must be performed in China, so it is advisable to foresee that the laws of the People’s Republic of China apply to the agreement and to establish that any dispute related to the contract be decided either by a Chinese court or by a Chinese arbitral institution (see next question).

The parties to a distribution agreement are free to determine whether they want any dispute to be decided by a Chinese or foreign judge, or by arbitration in China or overseas.

This is a very important clause of any sino-foreign contract.

Firstly, a foreign jurisdiction should not be chosen in case there is no agreement for the recognition of judicial decisions between China and the country where the foreign court is seated.

The process of recognition and enforcement of a foreign sentence in China is lengthy and complicated, and the lack of a bilateral treaty makes things even worse.

Secondly, to establish that disputes will be heard by foreign court may not be an effective solution since the contract is performed in China and the parties have an interest to obtain a quick decision on the case which is enforceable in China, or even to seek urgent interim measures, which is not possible if the trial is pending overseas.

For distribution agreements it is often advisable to consider the provision of an arbitration clause, stating that any dispute will be managed by one of the main arbitration chambers in China or in Hong Kong, the most important of which is the China International Economic and Trade Arbitration Commission (CIETAC).

Since China is a member to the New York Convention of 1958 on the Recognition and Enforcement of Arbitral awards, in case the parties agree upon an arbitration in a foreign jurisdiction the award will be recognized and enforced in China, even though the process is usually lengthy and complex.