Expert Article Library

Avoiding the Top 10 Mistakes in Representative Contracts

by Glen Balzer

By Glen Balzer (ExpertPages member page)

Great representative contracts are dependent upon several factors. Controversial clauses in a contract linking a supplier and a manufacturers’ representative are very visible at the end of the life of a representative agreement, but are much more difficult to spot at the time of their creation. In order to avoid problems at the time of termination, the creator of a representative contract must ensure that ambiguous clauses are not inserted and that certain mandatory clauses are not omitted. Avoiding ambiguity must be a goal of the supplier and the rep when creating and signing a new contract. Here is a checklist of ten common mistakes to avoid when drafting your next representative contract.

1. Annual Termination and Semiautomatic Renewal

Parties inexperienced with representative contracts sometimes attempt to minimize the opportunity for termination. Calling for annual termination and semiautomatic renewal is a routine procedure among experienced players. In theses cases, there is a provision in the contract calling for termination of the contract at the end of the first full calendar year after the contract is placed in effect, and each year thereafter. Simultaneously, there is a provision for automatic renewal of a new one-year contract unless either party objects. Terms and conditions allow either party to submit a Notice of Intention to Not Renew 30 days prior to the end of the calendar year.

When annual termination and semiautomatic renewal is written into the contract, both parties have the opportunity to exit the contract, without proving cause, once per year. Using this methodology, the partnership is held together by performance and not with a collection of words in the contract. Experienced partners always prefer to have performance as the binding force in the partnership.

2. Termination for Cause Only

Most representative contracts involving seasoned representatives and manufacturers allow for termination for cause and termination for convenience, (or no cause at all). Less experienced partners sometimes attempt to allow for termination for a limited set of specific causes. Termination for cause is sometimes straightforward and without controversy, as when one partner declares bankruptcy. However, partners often disagree over the presence of cause. And, partners often disagree over responsibility for cause.

The best representative contracts allow for termination for cause and convenience. When a contract allows for termination for convenience, a partner wishing to disengage from the contract serves notice of termination to its partner with not less than 30 days notice. When the convenience clause is invoked, cause and responsibility for cause need not be argued. More important, the representative contract does not end in a legal skirmish. Without a legal confrontation, the manufacturers’ representative and supplier are able to focus on their respective customers and businesses without consuming management time, corporate focus and financial resources on attorneys and courts.

3. Splitting Commissions

In the early days of modern manufacturing, a customer had a single site, designed product at that site, placed purchase orders from that site, took delivery of component parts at that site and shipped its finished goods from that site. As a result, the single point of interface between a customer and a manufacturers’ representative was one single salesperson working for the manufacturers’ representative. With the advent of globalization, customers spread their facilities beyond the single site and beyond the territory of a single manufacturers’ representative. During earlier decades, it has been increasingly common for a customer to perform engineering work in one site, issue purchase orders from a second site, and to receive components and perform manufacturing at a third site.

In order to accommodate the systematic handling of commissions across multiple territories, there must be a section in the representative contract that addresses how commissions are calculated and paid where more than one rep is involved in sales to a customer. One method of dividing commissions is to allocate one-third of normal commissions to the “Point of Engineering,” one-third to the “Point of Procurement” and one-third to the “Point of Manufacture.” Commissions need not be divided equally between the three manufacturers’ agents involved. If the energy applied at the point of engineering significantly exceeds the energies applied at the points of procurement and manufacture, 60 percent or more may be paid to the rep at the point of engineering. However, the cardinal rule that must never be broken is that the sum of the three commissions must never equal more than the normal commission allocated to a single rep.

4. Termination by Only One Party – Not Both

Representative contracts that allow for termination by only one partner are biased. Experience suggests that such lopsided contracts more frequently end in a legal dispute. Allowing both parties to terminate the contract demonstrates a balance of power between the rep and the manufacturer. Balanced contracts contribute to the longevity of representative relationships. By allowing both parties to terminate the contract, some legal disputes can be avoided. The best representative contracts allow either party to terminate the contract.

5. Amendments Allowed Once Per Year

Relationships between suppliers and manufacturers’ representatives are organic. They are born. They develop. They grow. They mature. They decay. Ultimately, they expire. External factors periodically apply pressure to the representative and supplier. Those pressures sometimes call for a change in the representative contract. If the contract allows changes to be made throughout the year, there is little problem. However, if the contract allows for changes only once per year, one or both partners must survive unnecessary pressure until the contract can accommodate an annual change. The best representative contracts allow changes to be made throughout the year.

6. Too Much Too Fast

Every new partnership between a manufacturers’ representative and a supplier is born in a period of bright optimism. Like marriage, there is a limit on the number of partnerships in which a supplier or representative may engage. By aligning with a new representative, a supplier is prohibited from singing an alternative rep. By matching up with a new supplier, a rep is prevented from signing an additional supplier. When casting its lot with a new representative, it is important to assign a territory that is not too large initially. If a representative is proven in only small territory, it is not prudent to assign a large territory and hope for the best. A better policy would be to open a new representative relationship in that representative’s proven territory and expand the territory gradually, after success in the smaller territory suggests that an expanded geography is wise.

7. What Happens after Termination?

The representative contract must spell out responsibilities and obligations of both parties during and after the life of the contract. All suppliers and manufacturers’ representatives understand that responsibilities of the parties must be defined during the period that the contract is operational. However, fewer truly understand that responsibilities must be thoroughly defined for the period after termination. Manufacturers and manufacturers’ agents must be particularly careful to document the sales upon which commissions will be paid upon termination. A question that must be answered in the contract is whether the rep is paid on shipments for 30 days, (or whatever number of days is agreed) after the “notice date” or after the “effective date” of termination. Although this might be considered a relatively slight nuance, these kinds of details are the elements that lead to legal proceedings upon termination. Precise wording cannot prohibit or delay termination, but unambiguous text can help avoid the expenditure of financial resources and management time spent with the legal system. A solid contract must clearly state the responsibilities and obligations of both parties during the operating life of the contract, upon notice of intention to terminate, and after the contract is officially terminated.

8. Comparison with Standard Industry Contracts

Most mistakes written into representative contracts are made by parties lacking experience with creation and negotiation of those contracts. Most large companies with years of experience with contracts rarely write mistakes into those contracts. Many mistakes are the result of one partner attempting to gain advantage over the other partner by inserting a bias into the contract favoring the party with greater experience.

How does an inexperienced party to representative contracts level the playing field during negotiation? There are several methods: First, solicit a model contract from your industry’s manufacturers’ representatives or trade association. Many associations provide a model contract free or at modest cost to their membership, (Electronics Representatives Association, Manufacturers’ Agents National Association, etc.). The model is a good baseline from which to compare the contract that you are being asked to sign.

Second, use your network of friends in the industry. Although it is unlikely that a direct competitor would lend a copy of its contract, friends at indirect competitors rarely fear sharing a contract that has proven over time to be problem free.

Third, if you are attempting to sign a representative contract in a foreign land, use the foreign network. American Chambers of Commerce can be found in most countries around the world, (US-China Chamber of Commerce, American Chamber of Commerce in Poland, etc.). If your foreign subsidiary does not yet have a connection with the local chamber of commerce, initiate one immediately. The cost of membership in these organizations is miniscule and the benefits can be enormous.

Fourth, ask the representative or supplier with which you are negotiating for a contract for a blind copy of two or three contracts that are currently in effect. You need not know the name of the parties in the contract; you are just looking to establish a feel for what is considered normal.

9. Leaving the Negotiation Process Strictly to Attorneys

Problems with representative contracts quite often are discovered after the contracts are negotiated and signed, even when the contracts were reviewed by corporate counsel or outside attorneys. How does this happen? Too often, attorneys eliminate onerous clauses, but are simply not aware of industry norms. They lack an understanding of the problems with contracts that arise most frequently. It is a good practice to have the contract reviewed by both a legal professional and an industry professional. If your company lacks an industry professional experienced with representative contracts, such assistance should be sought. Having a legal professional review a representative contract is necessary, but never sufficient to ensure a solid contract.

10. Acquisition of Supplier

Reps sometimes have a natural fear of suppliers, particularly start-up suppliers. Successful start-up suppliers are often acquired by larger and more established competitors. History suggests that the surviving rep is most often the rep of the larger acquiring supplier. The rep of the successful start-up is often terminated during the merging of the acquiring and acquired suppliers’ sales organizations. A rep’s natural fear of a supplier’s acquisition is well founded. The fear may manifest itself in two manners: First, a rep may decline the opportunity to engage with a start-up supplier. Second, if the rep engages with the start-up supplier, that fear may dampen the energy it puts forward in the representative relationship.

A simple solution to the rep’s fear of acquisition is to insert a “double trigger” mechanism into the contract. Such a clause provides for commissions to be paid to the rep for a period of time beyond the effective date of termination if termination occurs within six-month period from the date of a change of ownership of the supplier. The clause is referred to as a “double trigger” since two events must occur before the rep is eligible for extended commissions: First, the rep must be terminated in accordance with terms of the representative contract. Second, the start-up supplier must be acquired. Inclusion of the double trigger clause removes the fear that reps might have when matching up with a start-up supplier. The expense of extended commissions becomes real to the supplier only if it becomes very successful and simultaneously becomes acquired.

Conclusion

Representative agreements are an integral tool in the creation of a relationship between a manufacturers’ representative and a supplier. A well-written contract can assist in developing that relationship. The contract cannot extend the life of a relationship once the relationship expires. A poorly written contract often leads to a legal quarrel that in turn consumes management time, financial resources and the involvement of attorneys and courts. A well-written contract can eliminate expenditure of resources on these unproductive activities and encourage the representative and manufacturer to go about their respective businesses upon expiration of the relationship.