International Distribution Contracts: Russian Law and ICC Standards

 

April 30, 2024

BRACE Law Firm ©

 

International distribution contracts (contracts, agreements) enable foreign trade participants to obtain necessary goods and sell them at the most favorable prices.

Some manufacturers prefer to sell their goods under a distribution agreement, through which a distributor acquires the right to distribute specific products within a designated territory. The relationships between the parties to such an agreement are often long-term and frequently, though not always, exclusive.

A distribution agreement is an agreement under which one party (the distributor) undertakes to purchase goods from another party (the supplier) and to perform or organize their promotion within a certain territory. In turn, the supplier undertakes not to supply the goods for sale in that territory independently or with the involvement of third parties, including not selling the goods to third parties for distribution within that territory.

A distribution agreement is a contract not named in the Civil Code of the Russian Federation (the "Civil Code") and is not regulated by special legislation; therefore, the parties are free to determine its terms. [1] Pursuant to Article 421 of the Civil Code, parties may conclude a contract that is either provided for or not provided for by law. Such a contract may contain elements of various contracts provided for by law or other legal acts (a mixed contract). Given that a distribution agreement combines features of various contracts, such as an agency agreement, purchase and sale, supply, carriage, and other types of obligations, the rules on contracts whose elements are contained in the mixed contract apply to the relations of the parties in relevant parts, unless otherwise follows from the agreement of the parties or the essence of the mixed contract. However, courts do not always qualify distribution agreements as mixed contracts and instead determine the type of a specific distribution agreement based on the specific agreement and the norms reflected therein.

Qualification of an International Distribution Contract (Contract, Agreement)

Given the ambiguity in qualifying a distribution agreement, norms from various sources of law — both national and international — are used when drafting such an agreement. For example, the Model Rules of European Private Law (the "Model Rules") [2] characterize a distribution agreement as a relationship where one party, the supplier, undertakes to supply a product to the other party, the distributor, on a continuous basis, and the distributor undertakes to purchase it or to accept, pay for, and sell it to third parties in its own name and interests.

The following types of distribution contracts are distinguished:

• Exclusive, under which the supplier undertakes to supply the product within a certain territory or for a specific group of consumers to only one distributor;
• Selective, under which the supplier undertakes to supply the product directly or indirectly only to distributors who meet a certain criterion;
• Exclusive purchase agreement, under which the distributor undertakes to purchase, accept, and pay for the product only from a specific supplier or a person designated by the supplier.

The Model Rules assume that the supplier must provide the distributor with information necessary to perform the distribution agreement regarding:

• Product characteristics;
• Prices and product delivery terms;
• Recommended prices and terms for the resale of the product to consumers;
• Relevant links between the supplier and consumers;
• Relevant advertising campaigns.

At the same time, Russian legislation does not classify a distribution agreement as a separate type of contract. The lack of clear consolidation of the distribution agreement in legal acts allows foreign trade participants to formulate the subject matter and other terms at their discretion and establish mutual rights and obligations. For instance, courts may:

• Deem such a transaction a mixed contract, [3] which includes a wide variety of terms;
• Apply the provisions on agency agreements [4] or the provision of services for a fee. In this case, the law of the country of the agent or the service provider will apply,[5] which coincides with the distributor;
• Classify the distribution agreement as a supply contract due to the predominance of purchase and sale elements. In a purchase and sale agreement, the party performing the characteristic execution is the seller. [6] If the buyer assumes significant non-monetary obligations under the contract (e.g., an obligation to provide advertising and marketing of the seller's goods in a certain territory, or to sell goods for a certain minimum amount), the court, based on an assessment of the terms and essence of the contract as well as the totality of other circumstances, may conclude that the party performing the characteristic execution is the buyer; [7]
• Qualify it as an agreement to organize relations for the supply of products with the provision of services for finding buyers; [8]
• Qualify it as a framework contract. [9]

During proceedings, the court examines specific terms and applies rules provided for similar terms in agency agreements, purchase and sale agreements, supply contracts, and other named transactions. The court always evaluates the complexity of the terms in a distribution agreement, which complicates the court's work in qualifying specific contractual relations. Despite the complexity of qualification, distribution agreements in Russia are a common form of contractual relations and are used in various fields of distribution.

International Treaties Applicable to the Regulation of Distribution Agreements

Given that participants in foreign trade contracts are residents of different countries, international and national laws of the foreign trade participants serve as regulatory frameworks when concluding international transactions. These sources of law help to formalize a foreign trade transaction, regulate all necessary sections of the contract, and formulate all essential terms. Such sources of law include:

• United Nations Convention on Contracts for the International Sale of Goods,[10] the provisions of which may apply to distribution agreements if they fall under the definition of a contract for the sale of goods;
• Convention on the Contract for the International Carriage of Goods by Road (CMR);[11]
• UNIDROIT Principles of International Commercial Contracts;
• Convention on the Law Applicable to International Sales of Goods;[12]
• Convention on the Law Applicable to the Transfer of Title in International Sales of Goods;[13]
• Convention on the Law Applicable to Agency;[14]
• Guide to Drafting International Distribution Agreements, Publication No. 441E;
• Model Rules of European Private Law;
• ICC Model Distributorship Contract. Sole Importer-Distributor, Publication No. 646E[15], etc.

Each of these regulatory documents may apply to the legal relations governing distribution agreements. The model distribution contract contains basic terms regarding the distributor's sale of the supplier's products, after-sales service, the use of trademarks, brand names, or other designations of the supplier, etc. The interaction between parties under a distribution agreement often has a cross-border nature. It is important to note that defining the territory to which the contract will apply is one of the essential terms of a distribution agreement.

ICC Model Distributorship Contract

The International Chamber of Commerce developed the Model Distributorship Contract, which considers the interests of both parties (the supplier-exporter and the distributor-importer). Pursuant to Article 4 of the Model Contract, the distributor may not represent, manufacture, market, or sell products competing with the supplier's products in the contract territory without the supplier's prior consent. Under the terms of the Model Contract, the supplier and the distributor may agree on the sales volume for the coming year and determine a guaranteed minimum sales level, which is intended to protect the supplier's interests if the distributor fails to fulfill its obligations.

Pricing within the framework of the Model Contract can be structured in two ways:

• The distributor is granted the right to determine the resale price independently, while the supplier may set only a maximum price, without restricting the distributor's right to introduce lower prices;
• The supplier sets the resale price, which the distributor undertakes to use in relations with its buyers.

It is important to note that the distributor's use of a price determined by the supplier in Russia contradicts the rules of antimonopoly legislation. Granting a distributor exclusive rights to sell goods and the absence of sales to other persons leads to a restriction of competition. Since they ensure the movement of goods in the chain from the manufacturer to the final consumer, distribution agreements are classified as "vertical agreements". [16] The inclusion of a term regarding minimum or fixed prices for the sale of relevant goods in a "vertical" agreement reached between economic entities may be considered by FAS Russia as a violation of Clause 1 of Part 2 of Article 11 of the Law on Protection of Competition, provided that the share of at least one of the economic entities participating in the agreement in the market for the product that is the subject of this agreement exceeds twenty percent. [17]

At the same time, the Model Contract also provides for an exclusive provision of the distribution agreement, according to which the supplier undertakes not to grant the right to marketing or goods to third parties in the contract territory, and not to sell goods to consumers located therein, except in the following two cases:

• The supplier may make sales to consumers outside the territory if this does not involve the goal of bypassing the exclusivity term;
• The supplier undertakes not to sell products to consumers outside the contract territory if the supplier is aware of their intention to resell them in the territory assigned to the distributor.

It should also be noted that the governing law clause reflected in the Model Contract may be presented in the following variants:

• The distribution agreement is governed by the terms of the agreement itself as well as the UNIDROIT Principles;
• The distribution agreement is governed by national law.

Often, the first option is preferred and is used in the absence of a choice by foreign trade participants of any alternative solution.

Stages of Concluding an International Distribution Agreement

Like most international contracts, a distribution agreement involves a certain sequence of actions for its conclusion. This is due to the need for detailed elaboration of the contract terms, consideration of the specifics of concluding such contracts, and accounting for the national legislation of each party to the transaction. As a rule, several stages of concluding an international distribution agreement are distinguished:

• Selection of the foreign trade transaction participant, due diligence on the counterparty, its business reputation, and solvency;
• Negotiation of the terms and provisions of the distribution agreement, taking into account international and national legislation;
• Preparation of the text of the agreement, its acceptance by the parties, and establishment of authenticity in different languages;
• Signing of the contract.

Contents of an International Distribution Agreement

Given that an international distribution agreement is an agreement between foreign trade participants, like any other foreign trade contract, a distribution agreement typically contains the following basic terms:

• Subject Matter of the Transaction.One of the main terms of a distribution agreement, reflecting the entire essence of the transaction, its details, and terms that are essential for both parties. This section may also include an exclusivity term, according to which only the distributor may purchase goods from the supplier during the term of the distribution agreement. Additionally, this section may define a minimum sales level to ensure the protection of the supplier's interests if the distributor fails to fulfill its obligations.
• Obligations of the Parties.Each party to the contract has certain obligations, which the parties stipulate in the text of the distribution agreement and perform in full compliance with the terms of the transaction. Violation of the obligations provided for by the contract leads to the parties being held liable, as defined by a separate section of the contract. The supplier's primary obligation is to prepare the goods and transfer them to the other party. Under a distribution agreement, the supplier transfers the goods to the distributor's ownership, and the distributor pays for the goods and assumes the obligation to sell them. A specific feature of a distribution agreement is that the distributor receives the right to sell the goods within a certain period; if the goods are not sold, the distributor may return the goods to the supplier. In this case, the return of goods under a distribution agreement is carried out at a price not lower than the price at which they were purchased. The main duty of a distributor acting under a selective distribution agreement or an exclusive distribution agreement is to promote the distribution of the products. In addition, the distributor must provide the supplier with information regarding:
  • Declared or possible claims of third parties regarding the supplier's intellectual property rights;
  • Facts of infringement of the supplier's intellectual property rights by third parties.
• Product Delivery Terms.In this section, the parties determine how the goods will be delivered under the distribution agreement, how the other party accepts the goods, how they are packaged, who delivers them, etc.
• Sales Volume and Guaranteed Minimum Sales.The parties agree annually on the sales volume for the coming year. They make every effort to achieve the agreed sales volume; however, failure to achieve it is not a breach of contract by a party, except in cases of clear fault. Additionally, the distributor agrees to maintain a sufficient stock of goods and spare parts in the warehouse throughout the term of the agreement for the normal needs of the territory.
• Payment Terms under the Distribution Agreement.This section reflects all main payment terms, including what day is considered the day of payment, the amount and procedure for payment, and the supplier's ability to change product prices if the transaction is concluded for a long term.
• Trademarks and Other Intellectual Property Objects.The distributor undertakes to use the trademarks, brand names, or other designations of the supplier only in the supplier's interests.
• Term of the Contract and Termination Conditions.Typically, such a term is limited to one year, with the possibility of further prolongation. This section also reflects conditions for the parties to terminate the distribution agreement unilaterally or by mutual agreement.
• Liability of the Parties.Liability is provided for both parties for non-performance or improper performance of the terms of the distribution agreement. This may take the form of statutory compensation,[18] the accrual of penalties for delay in performance, fines, etc. It is important to include a separate fine in this section for violation of the exclusivity of the transfer of rights to the goods. Furthermore, a provision may be included stating that the parties' liability is limited to actual damage, and the parties expressly block the recovery of lost profits by a separate term. A party's failure to fulfill its obligations leads to the need for the other party to send a claim regarding non-performance or improper performance. As a rule, all conditions under which one party may file a claim are defined in the terms of the distribution agreement.
• Final Provisions.A section reflecting additional terms of the transaction that were not included in other sections, such as the choice of governing law, a statement that the transaction is not a major transaction for the parties, etc.
• Party Details.A mandatory section for reflecting addresses, bank details, and other information related to the counterparty's data.
• Signatures of the Parties.The signing of the agreement is carried out by authorized representatives of the counterparties. Scanned copies may be used to speed up the process, followed by an exchange of originals. It is important to note that despite the widespread development of electronic document management, the use of an electronic signature for this type of contract remains difficult.

In addition to the above, it is important to define the main concepts that will be used during the execution of the transaction. To avoid double interpretation of the contract's norms, the parties define the main concepts of the distribution agreement. Such a section may be highlighted in a separate block or fixed in a separate appendix to the contract.

In most cases, this is the main list of sections in a distribution agreement; however, given the specifics of the national legislation of the parties to the foreign trade contract, other sections may also be reflected in the text.

Specific Features of International Distribution Agreements

Despite the established practice of concluding distribution agreements, such contracts have their own specifics:

• The subject matter includes the parties' obligations to organize supplies, where the distributor systematically purchases goods from the manufacturer for subsequent resale to third parties. Additionally, the manufacturer may grant the distributor the right to use means of individualization and to advertise the goods;
• Continuing nature and a permanent basis;
• Privileged position for each party because the distributor receives exclusive rights to sell goods in a specific territory;
• The contract is aimed at the marketing, promotion, and distribution of goods in a certain territory;
• A contract for a fee, as the activities of each party are aimed at generating profit from distribution;
• The contracts are reciprocal;
• Distribution agreements are concluded in writing.

Exclusivity of Supplies in International Distribution

The exclusivity of product supplies is formed based on the terms of the contract between the parties and requires detailed elaboration. Typically, exclusivity is defined in a distribution agreement where a party receives the right of a sole buyer. The key conditions for exclusivity of supplies are:

• A limited territory of the exclusivity right;
• A prohibition on the seller supplying the goods to other buyers in the designated territory;
• A prohibition on the buyer purchasing similar goods from other manufacturers and suppliers;
• Conditions for the seller's liability if a fact of supply to other buyers is identified, etc.

When including a section on exclusivity of supplies in a distribution agreement, additional terms of the foreign trade contract must also be provided, such as:

• Defining clear criteria for the goods covered by the exclusivity terms;
• Establishing delivery terms;
• The procedure for actions when a direct request is received from other persons to purchase goods covered by the exclusivity terms;
• Contract termination conditions and the consequences of termination;
• Fines for violating the exclusivity of product supply, etc.

Liability of the Distributor in an International Contract

The liability of the parties when concluding a distribution agreement is reflected in a separate section of the agreement and determines the consequences for the parties in case of breach of their obligations:

• The manufacturer is responsible for the production of products, their quality, and delivery in the volume stipulated in the agreement and at the established time;
• The distributor assumes the promotion, search for buyers, advertising, and sale of the goods.

The terms of the parties' liability are not prescribed in the ICC Model Contract. This position is explained by the fact that different states apply different laws to the liability of parties under such types of agreements. Given that distribution agreements are cross-border in nature, this norm is determined separately when drafting the transaction, considering all the features of the national legislation of each participant and international law.

It is important to note that in addition to main liability measures such as statutory compensation, [19] penalties, and fines, a norm reflected in the contract in the form of a restriction of the parties' rights [20] is applied to the participants of a distribution agreement. The restriction of the supplier's rights is manifested in the fact that the supplier does not have the right to conclude contracts for the distribution of goods in a specific territory limited by the distribution agreement, not only independently but also with the help of other distributors. The distributor's restriction [21] is manifested in the prohibition reflected in the agreement on trading the goods in other territories, as well as the prohibition on concluding similar agreements with other suppliers for the distribution of competing goods in the designated territory.

Distribution Practice within the EAEU for Medicinal Products

Regarding certain types of goods, activities within the EAEU are regulated by the Union's regulatory documents. For example, the Decision of the Council of the Eurasian Economic Commission No. 80 dated November 3, 2016, On Approval of the Rules of Good Distribution Practice within the Eurasian Economic Union (the "Council Decision No. 80"), established conditions for ensuring quality during the distribution of medicinal products. Additionally, Council Decision No. 80 established that distribution constitutes activities related to the purchase, storage, import, export, and sale (excluding sales to the public) without volume restrictions, and the transportation of medicinal products.

Within the EAEU, it is determined that distribution activities for medicinal products must meet certain conditions, such as:

• Distributors create and maintain a quality system that defines the duties, processes, and principles of risk management regarding their activities;
• The distributor must have a sufficient number of qualified personnel to solve all tasks for which the organization is responsible;
• The distributor must have suitable premises and equipment to ensure the proper storage and distribution of medicinal products. Premises must be clean and dry, and the required temperature and humidity must be maintained.

Furthermore, all actions of the distributor must be carried out in such a way that the identity of the medicinal products is not lost and the requirements indicated on the packaging of the medicinal products are observed. The distributor must take necessary measures to minimize the risk of falsified medicinal products entering the sales chain.

The distributor is often bound by quite strict contract terms with the manufacturer, such as a ban on promoting and selling competitors' products. Violation of a distribution agreement can threaten a company not just with the loss of cooperation but also with litigation. Companies seeking direct cooperation with a manufacturer must have solid legal support to protect against unforeseen problems and lawsuits. Not all companies having the appropriate license for the circulation of medicinal products are distributors, but all distributors engaged in the circulation of medicinal products must have a corresponding license. [22]

Given that the parties to a distribution agreement are significantly limited by the lack of clearly formulated regulatory documents that would reflect the entire specifics of such a contract and define all essential terms, rights, and obligations, foreign trade participants must exercise extreme caution when concluding a distribution agreement. They must consider all important and essential aspects of such a transaction to avoid the contract being declared invalid.

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References

[1] Resolution of the Seventh Arbitration Appellate Court dated February 3, 2022, No. 07AP-11392/2021 in Case No. A03-9731/2021.

[2] Model Rules of European Private Law / Transl. from English; Ed. by N.Yu. Rasskazova. M.: Statut, 2013. 989 p.

[3] Resolution of the Arbitration Court of the North Caucasus District dated March 18, 2020, No. F08-12650/2019 in Case No. A63-22543/2018.

[4] Resolution of the Nineteenth Arbitration Appellate Court dated June 26, 2014, in Case No. A14-1157/2014.

[5] Subclauses 15 and 16 of Clause 2 of Article 1211 of the Civil Code.

[6] Subclause 1 of Clause 2 of Article 1211 of the Civil Code.

[7] Clause 34 of the Resolution of the Plenum of the Supreme Court of the Russian Federation No. 24 dated July 9, 2019, On the Application of Private International Law Norms by Courts of the Russian Federation.

[8] Resolution of the Presidium of the Supreme Arbitration Court of the Russian Federation dated May 18, 1999, No. 7073/98 in Case No. A40-9311/98-55-54. According to the court, references to the contract in the defendant's orders and payment documents are proper evidence of the supply of products under the distribution agreement, and the plaintiff is entitled to file a claim against the defendant in accordance with this agreement. The agreement is essentially an agreement to organize relations for the supply of products with the provision of services for finding buyers.

[9] Resolution of the Arbitration Court of the West Siberian District dated November 17, 2021, No. F04-6265/2021 in Case No. A03-15223/2020 On Declaring the Decision of the Antimonopoly Authority Illegal and Obliging to Hold a Third Party Liable. As follows from the materials of the case, a framework contract for the supply of goods with exclusive distributor rights for the buyer was concluded, according to which the supplier transfers the goods to the distributor without an obligation to deliver them, and the distributor pays for and accepts these goods. In terminating the consideration of the case on the violation of antimonopoly legislation by the third party, the authority proceeded from the fact that the sale of the remains of products manufactured under the contract and by exclusive order does not provide unjustified advantages in the performance of entrepreneurial activity due to the absence of the fact of introducing its own goods into civil circulation under the guise of goods sold under the "Vedel products for life" logo. The claim was satisfied because the actions of the third party were aimed at obtaining advantages in entrepreneurial activity, contradicted the legislation and customs of business, and created the possibility of misleading buyers. By the Ruling of the Supreme Court of the Russian Federation dated March 10, 2022, No. 304-ES22-477, the transfer of Case No. A03-15223/2020 to the Judicial Collegium for Economic Disputes of the Supreme Court of the Russian Federation for review in the order of cassation proceedings of this resolution was denied.

[10] Concluded in Vienna on April 11, 1980. The USSR joined the document by Resolution of the Supreme Soviet of the USSR No. 1511-I dated May 23, 1990, with a declaration.

[11] Concluded in Geneva on May 19, 1956.

[12] Concluded in The Hague on June 15, 1955.

[13] Concluded in The Hague on April 15, 1958.

[14] Concluded in The Hague on March 14, 1978.

[15] ICC Model Distributorship Contract. Sole Importer-Distributor. ICC Publication No. 646E. 2nd ed. in Russian and English. M., 2005.

[16] Clause 19 of Article 4 of Federal Law No. 135-FZ dated July 26, 2006, On Protection of Competition.

[17] Clarification No. 2 of the Presidium of FAS Russia "Vertical" Agreements, Including Dealer Agreements, approved by the protocol of the Presidium of FAS Russia No. 3 dated February 17, 2016.

[18] Decision of the panel of arbitrators of the ICAC at the CCI of the RF dated February 15, 2018, in Case No. M-82/2017 On the Recovery of Debt under a Distribution Agreement and Statutory Compensation. ICAC satisfied the claim for debt recovery under the distribution agreement and statutory compensation in connection with the defendant's improper performance of its obligations under the distribution agreement. As a party to the obligation, the plaintiff was entitled to expect timely payment by the defendant for the goods received; however, this did not occur. Such behavior of the defendant violates the plaintiff's rights, and therefore judicial protection of its violated rights by recovering the debt must be provided in accordance with Articles 11 and 12 of the Civil Code. During the consideration of the case, the panel of arbitrators concluded that the plaintiff's claim for recovery of the cost of the goods received from the defendant is lawful, justified, and subject to satisfaction in the declared amount.

[19] Decision of the ICAC at the CCI of the RF dated July 13, 2012, in Case No. 196/2011 On the Recovery of the Main Debt under the Agreement, Statutory Compensation, and Arbitration Fee. The defendant violated its payment obligation, did not provide a single documented case of the impossibility of making payment for the goods, and did not make payments within the terms indicated in the invoices. Based on the case materials, the ICAC concluded that the defendant not only failed to fulfill its obligation to pay in full for the goods supplied by the plaintiff and accepted by the defendant but also failed to fulfill the requirement of Article 54 of the Vienna Convention, which obliges the buyer to take such measures and comply with such formalities as may be required under the contract or under laws and regulations to make payment possible. In view of the above, the ICAC concluded that the plaintiff's claim for the recovery of the main debt from the defendant in full must be satisfied.

[20] Resolution of the Arbitration Court of the North Caucasus District dated March 27, 2015, No. F08-1156/2015 in Case No. A53-13397/2014 On Declaring the Customs Authority's Decision on Adjustment of Customs Value Illegal. The customs authority considered the declared customs value of the goods not documented and adjusted the declared customs value using the sixth (reserve) method. According to the petitioner of the cassation appeal, the company did not provide all the necessary documents to confirm the customs value of the goods; the first method of determining the customs value by the price of the transaction with the imported goods is inapplicable. The agency-distribution contract No. 90-2007 dated September 5, 2007, provides for conditions that limit the buyer's rights to use and dispose of the goods and affect their price. The claim was satisfied due to the lack of grounds for adjustment; the company provided all documents required by customs legislation necessary for the application of the first method for determining the customs value of imported goods.

[21] Resolution of the Arbitration Court of the Moscow District dated October 6, 2020, No. F05-14982/2020 in Case No. A40-167818/2019 On Recovery of Lost Profits. The distributor argued that in violation of the distribution agreement terms prohibiting the supplier from selling the goods in the territory assigned to the distributor, the supplier sold the goods through other persons, and therefore the cost of the goods sold bypassing the distributor constitutes its lost profits. The courts rightfully indicated that when concluding the contract, the parties reached an agreement granting the distributor the right to trade the goods through a specific sales channel, and the supplier was prohibited by this contract from selling the goods specifically through this sales channel. No other restrictions were established by the subject matter of the contract. The court denied the claim because the distributor did not prove the existence of legal grounds for recovering lost profits.

[22] Decision of the Arbitration Court of the Republic of Ingushetia dated January 14, 2022, in Case No. A18-5614/2021 On Declaring the Resolution of the Territorial Body of Roszdravnadzor Illegal and Canceling It. Officials of the Territorial Body of Roszdravnadzor, due to incorrect interpretation of the law, equated distribution activity to the licensed activity of selling medicinal products. The claim was satisfied; the resolution of the Federal Service for Surveillance in Healthcare was declared illegal and canceled.