China Distributor Relationships Make Sense, Especially Now
My law firm’s China lawyers have drafted more China product distribution agreements in the last three years than in the ten years prior. Foreign companies want to profit from China’s consumer and industrial markets, but they are wary of going into China (or remaining in China) in a way that might subject them to problems foreign companies have been incurring in China.
The China lawyers at my law firm are fans of China distributors marketing and selling foreign company products in China, based on the following:
1. We have seen many Western companies spend too much time and money trying to sell their products into China.
2. We have seen many Western companies fail in selling their products into China.
3. China is a difficult country. Most of the marketing clichés about it are true. It is not one market. You can succeed in Shanghai and never succeed anywhere else. You can succeed in one province and never succeed anywhere else. China is big and diverse. And for many products, its distribution/retail/wholesale networks are a mess. Add in the cultural and language unfamiliarity that accompanies all of this for most Western companies and, . . . . well, you get the point.
4. From a legal perspective, China distribution agreements are relatively clear-cut and simple and not terribly different from distribution contracts in the United States or Europe. Our China lawyers can draft a distribution agreement that works for both China and our clients.
This post will explore what is driving the increasing popularity of China distribution agreements, and then lay out the practical steps businesses should take to succeed with China distribution relationships.
The Evolving Landscape of Doing Business in China
Over the past few years, China’s changing landscape has led many foreign companies to reconsider their operational strategies. Due to increasing risks and supply chain shifts, distribution agreements have become a popular way for foreign companies to retain a sales presence in China without full exposure. These distribution relationships serve as a bridge, allowing foreign companies to keep profiting from China’s market potential while reducing on-the-ground hassles and risks.
Why China Distribution Agreements Are on the Rise: Geopolitical Risks
China is becoming increasingly risky, yet distribution relationships allow companies to profit from selling into China without subjecting assets or personnel to China’s constantly increasing in-country risks.
1. Shifting Trade Dynamics
Having a distribution agreement in China, as opposed to setting up full-fledged operations, can give your company greater flexibility to adapt to changing trade policies regulations.
2. Mitigating Risk
Partnering with Chinese distributors lets foreign companies stay active in China’s large market without risking a lot of money in investments
3. Localized Expertise
A Chinese distribution partner can provide valuable insights into the Chinese market, regulatory environment, and consumer preferences, making it easier for a company to tailor its products and strategies to China market demands.
4. Learning from What Happened in Russia and is Happening in China
Foreign businesses with operations in Russia faced severe disruptions from Russia’s invasion of Ukraine. Most companies are now keen to avoid and mitigate similar risks in China. For a small taste of what has been happening of late to foreign companies in China, I urge you to read this CNN article, entitled, China Hasn’t Been This Scary for Investors in 25 Years.
For a bit more flavor on what has been happening in China, I recently communicated with an Australian who was allowed to leave China after having been banned from doing so for three years. Amazingly, the Chinese judge that said this person would be free to leave China told this person that he “had been held in China for three years because of what had been happening between China and Australia.” His release came after China-Australian relations started warming due to Australia’s new Prime Minister. But just yesterday, Australia-China tensions rose again and it is quite possible this will lead to dozens of Australians getting banned from exiting China. The point is that every foreign company and every foreigner is always at some risk.
Working with a local distributor in China can provide a buffer against these challenges. Your Chinese distributor is your buffer, and your distribution structure ensures that your assets and operations are somewhat shielded, and the immediate brunt of CCP randomness/anger would be borne by the local distributor.
We have many clients who are widely viewed as being “in” China because their name and their products or services are there, but they really are not. They are “in China” only through their Chinese distributor.
China Product Distribution Success
The key to succeeding with China distribution relationships is finding the right Chinese distribution partner and properly formalizing the relationship with that distribution partner. This is typically achieved by the following:
- Conducting thorough due diligence to choose a Chinese distributor with extensive experience and a proven track record.
- Creating a China-specific distribution contract that protects your intellectual property, sets definite sales goals, and explains how the contract can be ended
- Making sure your trademarks are registered in China before you start doing business there.
- Working closely with your distributor on tailored branding and marketing to connect with Chinese consumers.
- Monitoring progress continuously to ensure performance goals are met.
Below we will walk you through the context, strategies, and legal considerations to build the right relationships and avoid pitfalls.
Typical China Distribution Issues
The following are some of the more common issues we see arise in the Chinese distribution contracts we draft:
1. Will your Chinese distributor be your agent?
Do you want to structure your deal so your Chinese distributor essentially becomes your agent in China, and you pay it by commissions, with the actual sales transactions being between you and the end user (as opposed to being between the end user and your distributor)? We usually suggest the deal be done with you simply selling your product to your Chinese distributor and your Chinese distributor — in turn — selling your product to end users.
2. How can you integrate franchise and pricing control terms?
When negotiating distribution terms, be aware of two areas of Chinese regulations.
First, ensure you do not inadvertently create a franchise arrangement which would trigger added compliance requirements. If your agreement excessively dictates your distributor’s operations under your branding, it can be deemed to be a franchise model by Chinese authorities. Maintain the distributor’s independence.
Second, since China’s Anti-Monopoly Law bans setting minimum resale prices, your distribution agreement shouldn’t dictate the prices at which your distributor sells to others.
3. Will your Chinese distributor get exclusivity?
Will your Chinese distributor have an exclusive territory, customer type or product range? If so, for how long? Generally, if you grant your Chinese distributor an exclusive, you should be sure to set sales performance targets that will allow you to terminate the contract if those performance targets are not met.
My law firm has been contacted by too many companies that granted their Chinese distributors long term exclusive distributorships, only to have the Chinese company do nothing to try to sell the foreign companies’ products in China. Beware the Chinese company that wants exclusive distribution rights to your product not to sell it, but to mothball your products so they do not compete with their own products or with the products of other companies for which it is already a distributor.
Setting adequately high minimum sales targets will protect you from getting stuck with an under-performing or non-performing distributor. Usually, the agreement requires meeting minimum sales targets, either in dollars or in units sold. Your Chinese distributor’s failure to meet the minimum for a certain period can result in termination or to it losing exclusivity.
4. Who is responsible for what on sales and marketing?
The key here is clarity. Chinese distributors often expect their foreign product supplier to engage and pay for at least some of the China sales and marketing costs. There is no right way to handle this other than being sure both sides of the distribution deal understand who is responsible for what and to have a China-centric contract that makes all this clear.
5. What Happens if your China distribution relationship terminates?
A good distribution contract makes clear what happens upon termination because doing so greatly improves your chances of smoothly transitioning to a new distributor. Is your distributor allowed to sell down its remaining inventory of your product, or must it cease sales immediately? Are you required to buy back the inventory and, if so, at what price?
The Two Keys to Successful China Product Distribution
Two main factors lead to successful product distribution in China: choosing a reliable distributor and having a solid distribution contract.
1. Choosing the Right Distributor
In How to Find the Right Overseas Distributor, Laurel Delaney sets out 50 specific questions you should pose to a potential distributor. I like the following ten of her questions best:
1. How long have you been in business?
2. Can you share some success stories about similar products you have sold?
3. Have you represented other foreign companies? Explain what you did.
4. How long has your relationship lasted with the top three companies you represent?
5. How will our line fit in with your existing portfolio of products?
6. What’s your game plan for building our brand in your country?
7. Do you have good market coverage, including a trained and educated sales force?
8. What specific territory are you interested in covering?
9. Can you deliver on pre-agreed sales targets?
10. Where do you see our brand in 3, 5 or 10 years?
You will be establishing a long-term and important relationship with your Chinese distributor, and that means you should find out whatever you can about them before you do the deal with them. Conduct thorough due diligence.
2. Using a China-Specific Distribution Agreement
As for the deal itself and the contract you use to reflect that deal, the issues are like what you would face in the United States or in Europe, but with additional legal issues relating to the legality of your product and the duties/tariffs you will incur in bringing your products into China.
Distribution contracts in China share similarities with those in the US and EU, but there are differences too. For instance, Chinese law doesn’t offer special rights to distributors. This allows my law firm’s China lawyers to create enforceable agreements that are more favorable to our clients under Chinese law.
Selling, Licensing and Distributing Products and Services into China
Many of the companies that come to us to draft their distribution contracts with Chinese distributors are already experienced with distributor relationships and already have a “standard” distribution contract. Though China distribution agreements have much in common with American/European/Australian/ distribution agreements, they also have interesting differences.
Our clients’ standard distribution agreements (usually with an American Australian, or European company) typically make for an excellent starting point in our drafting of their Chinese distribution agreements. These existing distribution contracts have been refined over time to meet our clients’ specific needs and goals in their global distributor relationships
But we also always need to modify those distribution agreements to make them work for China.
One reason for this is that the United States and Europe generally provide distributors with all sorts of legal protections that can make it difficult or expensive to terminate a distributor.
Chinese law has virtually no special protections for distributors. In particular, there is no Chinese legal requirement for payment of any special compensation to a distributor upon termination of a distribution agreement. All of our China distribution agreements call for applying Chinese law and we usually remove these sorts of legal protections when drafting a China distribution contract.
One other difference between Chinese distribution agreements and those for America, Europe or Australia is that the signature line in a Chinese distribution contract should provide a place for the distributor to affix its company seal. See China Company Chops: The Basics.
China Distribution Contracts
1. Key Provisions in China Distribution Contracts
The below is a quick list of the most common issues foreign companies usually need to discuss with potential China distributors before setting them up as a distributor, and most of these go into the China distribution contracts my law firm drafts. Our China distribution contracts typically provide for the following:
- An exclusivity provision, or not
- Whether the distributor can subcontract out distribution, or not
- The geographic and market territory given to the distributor
- The term of the distribution agreement and what must be done to renew or terminate it
- The specific products covered by the distribution agreement
- The methods the distributor can use to sell the products
- The pricing the distributor can use for the products
- Payment terms
- The distributor’s performance and sale requirements
- Ordering and shipping procedures
- Who is in charge of what when it comes to such things as defective products, advertising, warranties, technical support, obtaining permits, marketing materials, etc.
- Rights regarding new or modified products
- Whether the distributor can or cannot sell the products of others
- All sorts of things relating to intellectual property (trade secrets, trademarks, patents, copyrights, etc.)
- Agreeing not to compete with each other during and after the distribution agreement is in effect
- FCPA compliance. Anti-corruption compliance
- Damages for breaches
- Dispute resolution (venue, choice of law, etc.)
And as noted in China Trademarks and Your Chinese Distributor, our China attorneys also intensively focus on protecting our clients’ intellectual property even before any distribution agreement gets signed.
2. China Distribution Contracts: The Top Ten Questions We Ask
The below are some of the more important distribution issues you should be discussing with your potential (or existing) Chinese distributor and clarifying in your China distribution contract.
1. What will the payment and shipping terms be? If you ship your products before receiving payment for them, you are taking the full risk of not getting paid. Conservative manufacturers usually require full payment before they ship. Less risk averse manufacturers ship on Net30 terms. These manufacturers provide for the right to shift to payment before ship terms if there is a problem. Shipping terms can be CIF or ExWorks. ExWorks is more common, since estimating shipping and insurance costs can be difficult.
2. Will you have sales targets? This is always a good idea in an exclusive distributor arrangement. Sales targets for distributors are usually set on a quarterly basis. The issue of sales targets is usually a big issue, so setting them in a way that is clear and simple to understand is important.
3. What will be the term of your distribution agreement? If you are going to have here an exclusive agreement, its term/length becomes of critical importance. Usually, the contract length is set to allow the distributor enough time to profit from their efforts in marketing your products. A three-year term is typically the minimum, with five years more common. Most distributors that plan to put in substantial work to market and sell your products will require the distribution agreement automatically renew if they achieve their sales targets and they often want a provision stating that if the parties cannot agree on new targets after the end of the first term, renewal will be automatic based on some predetermined formula. Distributors that do not require something like this are oftentimes not planning to do the work necessary to succeed.
5. What law will govern your distribution relationship? You will usually (but not always) want the governing law to be Chinese law.
6. How will you protect your trade secrets? NNN (non-use, no disclosure, non-circumvention) language should go into your distribution agreement and if your distributor does not accept this, it will usually make sense for you to find a new distributor.
7. Who will pay for what? Are you going to pay for marketing/advertising your product in China or will your distributor do that, or will you share? Clarity is the key here. Will your technical product documents be translated into Chinese? If yes, who will do this and who will pay for this? There are many more such who will pay for what questions that will likely require answers before you get started.
8. How are you planning to deal with warranties? A standard approach is for you to draft the warranty and then have your distributer provide this warranty to buyers without any changes. Under this approach you will need to work with your distributor to craft a warranty that a) works for your products, b) works for your company and your distributer, c) meets China market demands, and d) complies with Chinese law.
Another option is letting the distributor set their own warranty terms. In this situation, your warranty is with your Chinese distributor, and you will not cover any warranty beyond that which you have specifically agreed to with your distributor. Under this sort of arrangement, you have no contractual relationship with the downstream buyers and the downstream buyers have no legal basis to assert warranty claims against you; they are limited to making claims only against your distributor. This option is consistent with the legal status of a distributor that buys and then resells your products. However, under this approach you no longer control the nature of the warranty and many companies do not want to give up this control. Much will depend on the nature of your product, your ultimate end users, and your trust in your distributer.
9. Who determines the sales price to downstream customers? Normally, the distributor is free to set the prices it wants for the products, since it has purchased the product and therefore owns them. However, many of our clients wish to exercise at least some pricing control. But since China generally prohibits resale price maintenance you can get into big trouble if you try to dictate the sales price. There are sometimes workarounds, but oftentimes they are not worth the risks.
10. What training will you provide your distributor? Where will you provide this (in your home country or in the foreign country)? How will training costs be determined and who will pay those costs?
Much can depend on the nature of your product, your downstream customers, and your trust in your distributer.
How To Stop Your Chinese Distributor from Stealing Your Trademark
It is both incredibly common and incredibly easy for your China distributor to take your trademark. Fortunately, it is also incredibly easy and relatively inexpensive to prevent that.
Despite this, the following is pretty typical of what our China lawyers often see in terms of China distribution relationships.
- An American, Australian, or European company wants to sell its products in China.
- The American, Australian, or European company is already manufacturing its products in China, and it sees the China market as yet another market to which it should be selling its products.
- The American, Australian, or European company seeks out someone in China to sell its products for it in China.
- Someone in China (oftentimes the company already manufacturing the products for the American, Australian, or European company is brought on to sell the products in China.
Often, these companies don’t go any further. They don’t sign a contract, register a trademark, or set up licensing for it.
The easy way to prevent your Chinese distributor from “taking” your trademark for China is for you to register it in China and do not allow anyone to use it without a properly registered trademark licensing agreement that explicitly permits them to do so. Without this, you are putting yourself at risk of forever losing your name in China. If you are going to sell your product into China (whether through a distributor or otherwise), you must register your trademark in China before doing so and you must register that trademark in your company’s name, not that of your distributor.
To be sure your trademark remains yours in China, your distribution agreement should license the limited use of your trademark to your China distributor and make clear that use of your trademark is subject to compliance with the contract by your distributor and to compliance with the limitations on the use of your trademark.
To “further” protect the IP of our clients, our China distribution agreements usually have what we call a “no registration” provision. In this provision, the distributor agrees that our client exclusively owns all trademarks or other IP that might be at risk, the distributor gains no rights to those trademarks, and the distributor will not register any IP in any way related to our client’s IP. We use the words “further protect” because the first line of protection for trademarks and other IP in China is registering them in China. See also How And Why To Trademark In China.
Here are the basic steps related to protecting your IP in China when contemplating a distribution relationship.
- Register trademarks, copyrights, and patents in your own company name before entering China. Do not rely on your distributor to handle this.
- Include strong IP provisions in the contract restricting your distributor’s rights. Make clear that all trademarks remain owned by your company.
- Add a “no registration clause” barring your distributor from registering any IP related to your trademarks or products.
- Limit your distributor’s use of your brand identity and trademarks to only what is necessary for the specified contractual purposes.
- If licensing your distributor to use your brand, ensure it is done in a defined, restrictive manner with clear guidelines.
- Require your distributor to notify you of any potential IP infringements so you can take swift action.
- Mandate that all marketing materials using your brand must be approved by you beforehand.
- Specify that upon termination of the distribution relationship, your distributor must immediately cease using your brand and IP.
- Conduct periodic IP audits and watch for improper activity or infringements. Chinese distributors often “quietly” sell knockoffs.
Registering your own trademarks and structuring agreements to limit rights are crucial first steps. But you also need ongoing vigilance, proper brand management, and active enforcement to protect your greatest assets when entering China. Don’t let an eager distributor exploit your IP — take control from the start.
China Distribution and Resale Price Maintenance
If you are selling your product in China through a third company, you need at least a passing familiarity with China’s resale price maintenance laws. Wikipedia explains resale price maintenance as follows:
Resale price maintenance is the practice whereby a manufacturer and its distributors agree that the latter will sell the former’s product at certain prices (resale price maintenance), at or above a price floor (minimum resale price maintenance) or at or below a price ceiling (maximum resale price maintenance). If a reseller refuses to maintain prices, either openly or covertly (see grey market), the manufacturer may stop doing business with it.
China prohibits resale price maintenance. Article 14 of China’s Anti-Monopoly Law prohibits fixing resale prices (particularly minimum prices) to third parties. In other words, Manufacturer A is prohibited from stipulating that Distributor B must resell Manufacturer A’s goods at a certain price to Retailer C.
I have seen a number of foreign companies get tripped up on China’s resale price maintenance laws and when our China lawyers write contracts with China distributors, we are always mindful of it. We typically see problems when the foreign company’s agreement with the Chinese company requires the Chinese company sell the foreign company’s product at a certain minimum amount to prevent the Chinese company from undercutting either the foreign company (which is also selling its product in China) or the foreign company’s other China distributors.
Understanding China’s laws on resale price maintenance helps you weigh the risks of allowing a Chinese company to set their own prices for your products.
China’s prohibition on resale price maintenance is not absolute, and it can be avoided if an entity can prove that it fixed resale prices to fulfill certain objectives. If you find it essential to engage in resale price maintenance in China, you should explicitly set out in your distributorship agreement why you are mandating price requirements and you should make sure your reason(s) track one or more explicitly permitted exceptions to China’s resale price maintenance prohibitions.
Conclusion: Navigating the Complexities of the Chinese Market
China can still be a great market for many businesses. But with this great opportunity comes inherent risk. The provisions outlined above are the shields that protect foreign businesses from potential pitfalls and ensure that their interests are safeguarded. For any company looking to distribute in China, it’s essential not only to have a distribution agreement in place but to ensure that it is comprehensive, tailored, and forward-looking. In doing so, businesses can maintain a competitive edge, navigate the complexities of the Chinese market with confidence, and drive sustainable growth.
China distribution agreements can give foreign companies a flexible pathway to get their products into the Chinese market without taking on the risks of fully immersing the company itself into China. By choosing the right distribution partner, formalizing the distribution relationship properly, protecting your IP completely, and collaborating closely on execution, your business can profit from China without taking on full operational risks and exposure.