“German” Distributor Indemnity – How to avoid it

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:

1. 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).

2. 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).

3. 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.

4. 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).

5. 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).