Going through old emails and found an email from one of our international manufacturing lawyers to a client that needed help drafting up a term sheet for one of its suppliers that had agreed to grant it an exclusive on various products. I have modified the email slightly to remove any potential identifiers and I run it below. I am running this email because it nicely sets out some of the more common issues that arise with exclusive purchasing agreements. We are big fans of terms sheets because they quickly and cheaply can reveal whether it makes sense to move forward with drafting a contract or not.
I will be working on your term sheet. I have reviewed your outline statement of what you want and I have the following initial questions:
1. Key Business Issues. Your outline does not mention various key business issues, such as price, quantity, delivery date, product quality. Do you want to leave that out in this term sheet? If yes, then we will state that all of the business issues would be resolved in a separate contract manufacturing agreement between the parties.
Note that it is normally not possible to address these issues later. On this issue please note the following two issues have consistently arisen in other exclusivity agreements that we have done:
a. The factory virtually always refuses to agree to exclusivity without an agreement on price and quantity. The factories generally want a fixed price and a fixed minimum sales quantity for each year of the agreement and a provision stating that a failure to achieve these minimum sales amounts at the agreed price terminates the exclusivity provision. Where exclusivity cuts the factory out of key markets like North America and Europe, many factories also will require payment of a substantial amount in advance, payment of the remaining amount on a fixed schedule, and a premium price.
b. Once the amounts at a. have been paid, factories tend to slack off on both QC and on-time delivery. They see this as part of your “price” for exclusivity.
We can deal with the slacking issue with the Manufacturing Agreement. The issues at 1. a. normally should be confronted as an integral part of the exclusivity agreement.
Please advise how you wish to proceed. You may decide to defer the price/quantity issue until after you have reached agreement on the basic exclusivity issue. If you decide to go that way, we will draft accordingly.
2. Contract Term. You mention wanting a five year term, but what will be the rule for renewal? Normally, the renewal rule is that if you reach the sales minimum in the first term, you have the absolute right to renew for an additional 5 year term. You could, however, provide that you have the right to renew entirely at your discretion. Please advise on how you wish to proceed on this issue.
3. Territory. You have provided several different descriptions of what will be your exclusive territory. For this type of agreement, it is necessary the initial territory be stated with specificity. If you will have the option to expand the territory during the term, then we must state the rules for adding new territories. For now, we can provide for a clear initial territory and then state that you have the right to add additional countries to that territory by notice to the factory. The only restriction will be that the factory is not selling into that territory. Note that most factories will want to increase the minimum sales amount upon each expansion of territory.
4. Exclusive product. The basic method is the following:
a. The factory product is base product.
b. The product modified for your use is the custom product. The custom product includes product with your logo/trademark and any modifications made exclusively for you.
a. The factory cannot sell custom product anywhere in the world.
b. The factory’s base product is subject to the exclusivity rules noted above. That is, the factory is not permitted to sell the base product into the exclusive territory during the exclusivity period.
For this system to work, a very clear definition of what constitutes the base product is required. This can be based on current models made by the factory or by a general description of the product covered. You will need to provide us with the appropriate description.
5. Expansion of base product/exclusive product. You will have the right to treat new products from the factory as base products, subject to modification into custom product and subject to treatment as exclusive product.
You will need to clarify this provision. If base product is defined with a general description, any new product that fits that description is automatically covered and is automatically treated as exclusive product. So this provision would only be required if the new product is a product that does NOT fit into the definition of base product.
Please advise on what you intend for this provision.
6. Advertising. You mention your factory currently advertises on various online marketplaces and so you want them to send you any North American, Latin American and European inquiries they get.
I assume you mean if they receive an enquiry concerning the factory base product from a customer in the exclusive territory, the factory will not sell to that customer, but instead forward the enquiry to you. As discussed at 7. below, this assumes the factory will not be permitted to advertise your custom products on any factory website or on any e-sales platform anywhere in the world. Normally we require the factory state the limitations on their sales territory in any Internet or other advertising.
7. You stated that you will establish and enforce the criteria regarding which dealers are deemed “acceptable” to sell your brand.
But remember that you will be the exclusive seller of your products in the territory; the factory will have not have any right to sell your products to anyone but you. The factory will not have the right to sell any base products into the territory. For these reasons, it appears this provision is not required. Please advise.
Please advise on the above. After we clarify the terms, I will draft the term sheet. If you have questions or need clarification on issues raised, please let me know.