Switzerland – Goodwill indemnity for termination of a distribution agreement

Quick summary – Under Swiss law, a distributor may be entitled to a goodwill indemnity after termination of a distribution agreement. The Swiss Supreme Court has decided that the Swiss Code of Obligations, which provides commercial agents with an inalienable claim to a compensation for acquired customers at the end of the agency relationship, may be applied by analogy to distribution relationships under certain circumstances.

In Switzerland, distribution agreements are innominate contracts, i.e., agreements which are not specifically governed by the Swiss Code of Obligations (“CO”). Distribution agreements are primarily governed by the general provisions of Swiss contract law. In addition to that, certain provisions of Swiss agency law (articles 418a et seqq. CO) may be applied by analogy to distribution relationships.

Particularly with regard to the consequences of a termination of a distribution agreement, the Swiss Supreme Court has decided in a leading case of 2008 (BGE 134 III 497) concerning an exclusive distribution agreement that article 418u CO may be applied by analogy to distribution agreements. Article 418u CO entitles commercial agents to a goodwill indemnity (sometimes also referred to as “compensation for clientele“) at the end of the agency relationship. The goodwill indemnity serves as a mean to compensate an agent for “surrendering” its customer base to the principal upon termination of the agency relationship.

The assessment whether a distributor is entitled to a goodwill indemnity consists of two stages: In a first stage, it is necessary to analyse whether the requirements stipulated by the Swiss Supreme Court for an analogous application of article 418u CO to the distribution relationship at stake are met. If so, it must be analysed, in a second stage, whether all requirements for a goodwill indemnity set forth in article 418u CO are fulfilled.

Application by analogy of article 418u CO to the distribution agreement

An analogous application of Article 418u CO to distribution agreements requires that the distributor is integrated to a large extent into the supplier’s distribution organisation. Because of such strong integration, distributors must find themselves in an agent-like position and dispose of only limited economic autonomy.

The following criteria indicate a strong integration into the supplier’s distribution organisation:

• The distributor must comply with minimum purchase obligations.
• The supplier has the right to unilaterally change prices and delivery terms.
• The supplier has the right to unilaterally terminate the manufacturing and distribution of productscovered by the agreement.
• The distributor must comply with minimum marketing expenditure obligations.
• The distributor is obliged to maintain minimum stocks of contract products.
• The distribution agreement imposes periodical reporting obligations (e.g., regarding achieved sales and activities of competitors) on the distributor.
• The supplier is entitled to inspect the distributor’s books and to conduct audits.
• The distributor is prohibited from continuing distributing the products following the end of the distribution relationship.

The more of these elements are present in a distribution agreement, the higher the chance that article 418u CO may be applied by analogy to the distribution relationship at stake. If, however, none or only a few of these elements exist, article 418u CO will most likely not be applicable and no goodwill indemnity will be due.

Requirements for an entitlement to a goodwill indemnity

In case an analogous application of article 418u CO can be affirmed, the assessment continues. It must then be analysed whether all requirements for a goodwill indemnity set forth in article 418u CO are met. In that second stage, the assessment resembles the test to be carried out for “normal” commercial agency relationships.

Applied by analogy to distribution relationships, article 418u CO entitles distributors to a goodwill indemnity in cases where four requirements are met:

• Considerable expansion of customer base by distributor

First, the distributor’s activities must have resulted in a “considerable expansion” of the supplier’s customer base. The distributor’s activities may not only include targeting specific customers, but also building up a new brand of the supplier.

Due to the limited case law available from the Swiss Supreme Court, there is legal uncertainty as to what “considerable expansion” means. Two elements seem to be predominant: on the one hand the absolute number of customers and on the other hand the turnover achieved with such customers. The customer base existing at the beginning of the distribution relationship must be compared to the customer base upon termination of the agreement. The difference must be positive.

• Supplier must continue benefitting from customer base

Second, considerable benefits must accrue to the supplier even after the end of the distribution relationship from business relations with customers acquired by the distributor. That second requirement includes two important aspects:

Firstly, the supplier must have access to the customer base, i.e., know who customers are. In agency relationships, this is usually not an issue since contracts are concluded between customers and the principal, who will therefore know about the identity of customers. In distribution relationships, however, knowledge of the supplier about the identity of customers regularly requires a disclosure of customer lists by the distributor, may it be during or at the end of the distribution relationship.

Secondly, there must be some loyalty of the customers towards the supplier, so that the supplier can continue doing business with such customers after termination of the distribution relationship. This is the case, e.g., if retailers acquired by a former wholesale distributor continue buying products directly from the supplier once the relationship with the wholesale distributor ended. Furthermore, a supplier may also continue benefitting from customers acquired by the distributor if it can make profitable after-sales business, e.g., by supplying consumables, spare parts and providing maintenance and repair services.

Swiss case law distinguishes between two different kinds of customers: personal customers and real customers. The former are linked to the distributor because of a special relationship of trust and will usually remain with the distributor once the distribution relationship comes to an end. The latter are attached to a brand or product and normally follow the supplier. In principle, only real customers may give rise to a goodwill indemnity.

The development of the supplier’s turnover after the end of a distribution relationship may serve as an indication for the loyalty of customers. A sharp downfall of the turnover and a need on the part of the supplier (or new distributor) to acquire new or re-acquire former customers suggests that customers are not loyal, so that no goodwill indemnity would be due.

• Equitability of goodwill indemnity

Third, a goodwill indemnity must not be inequitable. The following circumstances could render a goodwill indemnity inequitable:

• The distributor was able to achieve an extraordinarily high margin or received further remunerations that constitute a sufficient consideration for the value of customers passed on to the supplier.
• The distribution relationship lasted for a long time, so that the distributor already had ample opportunity to economically benefit from the acquired customers.
• In return for complying with a post-contractual non-compete obligation, the distributor receives a special compensation.

In any event, courts dispose of a considerable discretion when deciding whether a goodwill indemnity is equitable.

• Termination not caused by distributor

Fourth, the distribution relationship must not have ended for a reason attributable to the distributor.

This will notably be the case if the supplier has terminated the distribution agreement because of a reason attributable to the distributor, e.g., in case of a breach of contractual obligations or an insufficient performance by the distributor.

Furthermore, no goodwill indemnity will be due in case the distributor has terminated the distribution agreement itself, unless such termination is justified by reasons attributable to the supplier (e.g., a violation of the exclusivity granted to the distributor by the supplier).

A goodwill indemnity cannot only be due in case a distribution agreement for an indefinite period of time ended due to a notice of termination, but also in case of the expiry respectively non-renewal of a fixed-term distribution relationship.

Quantum of a goodwill indemnity

Where article 418u CO is applicable by analogy to a distribution relationship and all above-mentioned requirements for a goodwill indemnity are met, the indemnity payable to the distributor may amount up to the distributor’s net annual earnings from the distribution relationship, calculated as the average earnings of the last five years. Where the distribution relationship lasted shorter, the average earnings over the entire duration of the distribution relationship are decisive.

In order to calculate the net annual earnings, the distributor must deduct from the income obtained through the distribution relationship (e.g., gross margin, further remunerations etc.) any costs linked to its activities (e.g., marketing expenses, travel costs, salaries, rental fees etc.). A loss-making business cannot give rise to a goodwill indemnity.

In case a distributor marketed products from various suppliers, it must calculate the net annual earnings on a product-specific basis, i.e., limited to the products from the specific supplier. The distributor cannot calculate a goodwill indemnity on the basis of its business as a whole. Fixed costs must be allocated proportionally, to the extent that they cannot be assigned to a specific distribution relationship.

Mandatory nature of the entitlement to a goodwill indemnity

Suppliers regularly attempt to exclude goodwill indemnities in distribution agreements. However, if an analogous application of article 418u CO to the distribution agreement is justified and all requirements for a goodwill indemnity are met, the entitlement is mandatory and cannot be contractually excluded in advance. Any such provisions would be null and void.

Having said that, specific provisions in distribution agreements dealing with a goodwill indemnity, as, e.g., contractual provisions that address how the supplier shall compensate the distributor for acquired customers, still remain relevant. Such rules could render an entitlement to a goodwill indemnity inequitable.