Checklist: Termination of a distributorship agreement (USA)

Introduction

This checklist sets out some of the key considerations when terminating a distribution agreement. It will assist in-house counsel and private practitioners who are responsible for coordinating the termination of a distributorship agreement.

While the termination of any agreement requires an analysis of the specific facts and circumstances, this checklist provides an overview of the framework for terminating a distributorship agreement that can then be adapted to the organization’s individual situation. The checklist includes considerations specific to distributorship agreements, as well as the considerations that are present for the termination of any type of contract.

The checklist includes the following key steps:

1. Reviewing termination clauses in a distributorship agreement
2. Evaluating distributorship circumstances in relation to termination clauses
3. Initiating the termination of distributor
4. Post-termination considerations

The checklist is presented as a list of requirements that you can check off as they are addressed. At the end of each step, there are explanatory notes corresponding with each requirement in the checklist.

This checklist can be used in conjunction with the following How-to guides: How to assess antitrust law risks in agency and distribution agreements, Issues to consider when drafting a franchise agreement, How to terminate a sales representative agreement and Checklists: What to consider when terminating a contract.

Step 1 – Reviewing termination clauses in a distributorship agreement

Step 2 – Evaluating distributorship circumstances in relation to termination clauses

Step 3 – Initiating the termination of distributor

Step 4 – Post-termination considerations

Explanatory notes

Overview

A distributorship agreement is a contract between a manufacturer or wholesaler and a distributor where the distributor buys goods or services and resells them on its own behalf. Distribution has certain features in common with agency, but the legal structure is different. A distributor buys and sells on its own account, rather than for a principal, and the customer relationship is therefore with the distributor, not the manufacturer. The distributor thus assumes a legal and commercial risk that (usually) an agent does not.

Companies that enter into agreements with distributors will often decide to terminate the agreement. This may be due to poor performance, malfeasance, causes not attributable to either party, or even no cause. This checklist provides a roadmap for the termination of distributorship agreements that provide only for operations in the United States.

Step 1 – Reviewing termination clauses in the distributorship agreement

Most commercial contracts include terms that provide for termination. Open-ended agreements inevitably have legal ramifications if either party no longer wishes to be bound by the duties and responsibilities of the contract. Therefore, in terminating any agreement, the key starting point is to review the existing legal document for any provision that provides a valid basis for termination. For further information see Checklist: What to consider when terminating a contract for general guidance.

The termination provisions may significantly limit the ability to terminate the distributorship agreement and impose requirements for the termination to be effective under the agreement. For example, a Wisconsin federal court granted a temporary injunction preventing termination of a distribution agreement in part on the grounds that the company attempting to terminate the agreement failed to comply with the agreement’s notice and opportunity to cure provisions. Keen Edge Co v Wright Mfg, Inc, No 19-CV-1673-JPS (E.D. Wis. Aug. 21, 2020).

Listed below are some common termination-related clauses that impact the ability and methods of terminating a distributorship agreement.

1.1 When does the agreement expire?

Generally, the most common contractual expiration provisions are either date or event specific. For example, a distributorship agreement may terminate on a specified date, or it may terminate on the happening of some other event. Some agreements will provide for both types of termination provision as alternatives, for example, ‘This agreement will terminate on December 31, 2025, or upon the discontinuance of the manufacture of the product by the manufacturer, whichever comes first.’

1.1.1 Specific date of expiration

One type of termination clause provides for the expiration of the agreement as of a specific date or time period (eg, one, two, or five years) from when the contract was first executed. It is common to provide that the contract may then be extended by agreement between the parties.

If the date of expiration is close, and the reasons for wanting to end the agreement are not overwhelmingly severe, allowing the agreement to expire on its own without renewing it should avoid the legal ramifications of an involuntary termination.

Note that some state laws require notice if a certain type of distributorship agreement will not be renewed. See below at section 2.5.1 which sets out specific notice provisions that may apply eg, when the distributor can assert they are acting as ‘franchisee’.

1.1.2 Event specific

The contract may contain a clause that allows for termination based on the occurrence of a specific event, for example, if the manufacturer is purchased by a company with an established internal distribution network. Such a provision in a distributorship agreement will usually provide for a notice period before termination becomes final, due to issues with returning unsold inventory and processing accepted but unfilled orders for merchandise.

1.2 Are there provisions for termination for cause?

An agreement with a distributor will often provide that the agreement may be terminated for cause if the distributor acts in violation of the best interests of the company. The 'for cause' provisions of a distributorship agreement will often be more detailed than in other types of agreement. This is because if a distributor’s actions are contrary to the best interests of the company, they may reflect badly on the company rather than solely on the distributor.

For cause violations will usually be set out in the agreement, although state laws relating to some types of distributorships (eg, motor vehicles or farm machinery) may limit the definition of cause that will justify termination. Some of the common types of for cause violations set out in a distributorship agreement include those listed below.

1.2.1 Breach of agreement by distributor

The agreement may provide for the company to terminate the agreement if the distributor acts in breach of the agreement. One example of this is when the distributor begins representing the products of a competitor when the agreement prohibits it. The procedure for termination is typically set out in the agreement.

Note that many distributorship agreements include catch-all provisions that allow termination for any breach of the agreement. Specific breaches may be included as examples; however, termination will be justified for any breach. It is risky for a company to overlook some breaches, as a distributor who is terminated for a breach later may make a claim that the right to terminate due to a specific breach was waived.

1.2.2 Lack of performance

Termination for lack of performance may occur when the distributor fails to hit benchmarks established in the agreement, such as a specified sales volume. In the absence of explicit benchmarks, an agreement could be terminated for unsatisfactory performance; however, such a termination would require showing that the distributor did not make a good faith effort to perform. For example, a company could show that the distributor did no or minimal advertising or marketing, or that a habit of making late deliveries was discouraging potential new customers from placing orders. See 2.2 below, regarding lack of performance.

1.2.3 Civil or criminal wrongdoing

A distributor’s civil or criminal wrongdoing may be listed as justification for termination. Alternately, there may be a provision allowing termination for misconduct by the distributor. Accusations of wrongdoing may not be considered sufficient cause for termination, and the grounds for termination may not be present until a final judgment or conviction. Unless the contract specifies, a single act of ordinary negligence may not be sufficient cause to terminate an agreement.

1.2.4 Factors outside the control of the parties

Distribution agreements may also contain provisions that allow an agreement to be terminated due to unforeseen factors that are beyond the control of either party. These types of provisions are referred to as force majeure. Traditionally, these provisions referred to events such as natural disasters or acts of war. More recently, the applicability of force majeure clauses has become especially critical during the COVID-19 pandemic when many businesses were shut down due to circumstances beyond their control.

1.3 Is there the ability to terminate without cause?

A distribution agreement may contain language that provides for termination with no cause, at the sole discretion of the manufacturer or supplier.

1.4 Requirement for sufficient notice

Contract provisions allowing for termination with no cause typically provide for some period of notice to the terminated distributor, such as 30 days or three months. Some types of distributorships, such as auto dealerships or farm machinery dealerships, may be covered by state or federal law provisions that require a specific notice period.

Step 2 - Evaluating distributorship circumstances in relation to termination clauses

After reviewing the contract termination provisions, the next step is to evaluate the distributorship circumstances and the conduct of the distributor to determine if there is a sufficient legal basis to terminate the contract. This includes consideration of the factors listed below.

2.1 What are the potential reasons for termination?

When considering the facts and circumstances of the distributorship in relation to the contract language, one or more justifications may present themselves as reasons for termination of the agreement. In preparing for termination of the distributor, the list of justifications should be set out with the highest and best argument listed first. Each subsequent justification should be listed as an ‘in the alternative’ argument. Note that this hierarchy of justifications may change as documentation is reviewed and accumulated.

2.2 Accumulate existing documentation to substantiate termination for one or multiple reasons

As potential reasons (eg, not meeting performance goals) for termination of the distributorship are developed, accumulate the existing documentation relating to the distributor’s performance or behavior to substantiate each potential reason for termination. The type and nature of the documentation may vary depending on the claim for termination. Termination for non-performance can be supported by records and ledgers that show the sales generated by the distributor, while termination for misconduct may be shown by court or administrative agency records that show a violation. Listed below are some examples of the types of documentation to gather.

2.2.1 Comparison of actual distributorship activity to standards of performance

If lack of performance is alleged, the basis for the claim must be a comparison of actual performance with the standards or key performance indicators established and agreed upon within the actual contract, addenda, or within other ancillary correspondence. For example, a distributor may agree to meet a certain level of sales over a defined time period, but may have failed to meet those standards. It is important to demonstrate acknowledgment of the standards by the distributor, as well as the length of poor performance, and the degree to which the distributor failed to meet the standards.

2.2.2 Emails or other correspondence to distributor regarding performance levels

If lack of performance is alleged as the basis for termination of a distributorship, you should identify emails or other correspondence that document the poor performance and that provide verification that the distributor was notified of the failure.

2.3 Consider any additional relevant documents

Consider whether there are any other types of documentation available to substantiate the specific reasons for termination of the distributor. The additional documentation might be from outside sources or third parties and may include those listed below.

2.3.1 Feedback from customers and other stakeholders

When collating documents to demonstrate a contractual lack of performance by the distributor, one source of information may be feedback from customers or other stakeholders that have had dealings with the distributor. For example, poor customer service or lack of follow-up by the distributor would further the claim that there are performance issues.

2.4 Assemble file of documentation

It is good practice to prepare a file of evidence in respect of each argument for termination. These files should be prepared to provide justification for the termination within the provisions of the contract. This is also helpful in re-evaluating the hierarchy of claims against the distributor.

2.5 Develop memorandum summarizing the hierarchy of potential reasons for termination

Using the file of documentation, it is then a good idea to prepare a memorandum that summarizes the basis for each of the potential grounds for termination. Issues to consider in respect of each potential claim may include those listed below.

2.5.1 Implications of applicable law

Address the potential implications of applicable federal and state laws. There may be certain notice requirements as well as laws that require a distributor to remedy the issues that might justify termination.

Some states have enacted industry-specific laws. For example, in Minnesota agricultural implement and heavy equipment distributor relationships are regulated. Minnesota law requires that manufacturers of farm machinery give dealers at least 90 days prior written notice of ‘termination, cancellation, or nonrenewal of the dealership agreement.’

See, Minn Stat sections 325E.05 and 325E.068.

Other states, such as Missouri, also have industry-specific statutes governing distributorship relations that require ‘good cause’ before an agreement can be terminated, and then only after notice and an ‘opportunity to cure’ period is provided. See, for example, Mo. Rev. Stat. section 407.840 and Mo. Rev. Stat. section 407.842.

Another important consideration is whether the distributor is able to assert that they were operating as a franchisee, requiring a franchisor’s disclosures under the US Federal Trade Commission (FTC) regulations and some state registration laws.

Further, if a franchise relationship exists, some state statutes require that at least 60 or 90 days’ notice must be provided to a franchisee in the event an agreement is terminated. For example, the Illinois Motor Vehicle Franchise Act provides that a vehicle manufacturer or distributor that does not intend to renew a franchise agreement for the sale and distribution of motor vehicles must ‘send a letter by certified mail, return receipt requested, to the affected franchisee at least 60 days before the effective date of the proposed action.’ The Illinois Franchise Disclosure Act also requires notice to franchisees of termination of the franchise relationship. 815 ILCA 705/1, et. seq.

See also Missouri law which sets out the requirement for at least 90 days advance notice in writing to terminate a franchise agreement: Mo. Rev. Stat. section 407.400 and section 407.405.

See FTC, Franchise Rule Compliance Guide (2008).

2.5.2 Do arbitration clauses apply?

State law, or even other provisions within the agreement, may require arbitration when seeking to terminate the distributor. If the agreement says that ‘any disputes arising out of this agreement must be submitted to arbitration,’ and the distributor disputes the termination, the termination may not be effective unless an arbitrator makes a decision finding in favor of the manufacturer or supplier.

2.5.3 Antitrust implications

Consider antitrust laws in the termination. There are potential penalties for wrongful termination. The organization should be especially mindful that the termination does not give the appearance that the terminated distributor is being treated differently from other distributors. See: How-to guide: How to assess antitrust law risks in agency and distribution agreements for additional information.

The memorandum should contemplate and outline a plan of action going forward that takes all the above considerations into account.

Step 3 – Initiating the termination of distributor

Upon the conclusion of the groundwork completed in the prior steps, the next step is to begin the process for termination.

3.1 Coordinate termination with internal stakeholders

Typically, the termination of a distributor is likely to represent a major pivot in the operations of the business, so it is important to ensure that the process is properly coordinated with all internal stakeholders including, for example, key members of the management, marketing, sales, manufacturing, and shipping departments.

3.1.1 Determine date of termination

With input from the key stakeholders, determine the actual date of termination of the distributor. It is a good idea to choose a date which minimizes any disruption to business operations where possible.

3.1.2 Return of company-owned property

Develop a list of company-owned property that is in the possession of the distributor and that needs to be returned. In addition, consider whether stock purchased by the distributor should be repurchased.

3.1.3 Transition of responsibilities

Consider how the duties of the distributor will be fulfilled going forward. For example, has a new distributor been contracted, or will the duties be handled internally? Also, will the company fill orders submitted by the distributor prior to the termination date?

3.1.4 Calculate fees or commissions due

Prepare a preliminary calculation of commissions or other fees that will be due to the distributor as of the termination date, based on orders received and processed. If allowed by the contract or by the applicable law, consider a ‘holdback’ for damages against the distributor that may arise subsequent to termination. Note that the difficulty in estimating the damages in advance may make a holdback impractical.

If the distributor is an individual, some state laws may require payment of all commissions due within a certain time frame. New York law, for example, states “[A]ll earned commissions shall be paid within five business days after termination or within five business days after they become due in the case of earned commissions not due when the contract is terminated.” See, NY Lab Code section 191-C.

In a recent case, a dispute arose with regards to commissions due to salespersons post termination. Here, a number of distributors were initially engaged to sell medical products when the company was in its infancy. Subsequently, the business expanded both in volume and also into other areas of medical devices. At first, the only products offered were those related to joint replacements but, later, included many other medical products (eg, sports medicine devices, electro-stimulation devices, trauma-related products, and other product lines as well, including dental, spinal, and biopharmaceutical).

The dispute arose concerning whether the commissions due to the distributors upon retirement included earnings only from the initial product offering or whether it should include the new product line sales. Essentially, the company contended that the payments to these initial distributors included only sales related to the products offered when they were first engaged. However, due to ambiguity in the contracts the court stated that this contract ambiguity led to a conclusion that ‘reasonable people could come to different conclusions as to its meaning.’ While the court ultimately sided predominately with the company, this case illustrates the importance of attention to detail in drafting distributorship agreements, and also to an ongoing process of monitoring of existing contracts as facts and circumstances of the relationship changes. See, Hess v Biomet, Inc, 105 F.4th 912 (7th Cir. 2024).

3.1.5 Potential damages due from distributor

Make preparation for potential counterclaims and damage assessments that will likely be made by the terminated distributor, including any claims for wrongful termination. This includes a review of all communications and correspondence with the distributor, even those that do not necessarily relate to the cause for termination. A deep search of news sources is also advisable, to learn of any rumors or external factors that may have an impact on the relationship.

3.2 Develop notice to distributor using internal memorandum

Prepare the notice of termination to be delivered to the distributor. The internal memorandum (described above) can be used as a guide in the preparation of the notice, although the level of detail should be significantly less and the specific documentation may be omitted.

3.3 How will the notice of termination be delivered?

The agreement may contain a provision for how notices to either party are to be delivered. If not, consider the optimal method of delivery of the notice of termination. Logistics will play an important factor in the decision. Methods of delivery may include face-to-face meeting, virtual meeting, or certified delivery of the notice.

3.4 Deliver notice to distributor

Prepare and deliver the notice of termination to the distributor.

3.5 Obtain acknowledgment of notice of termination from distributor

Regardless of the method of delivery, include documentation that requires the distributor to acknowledge the notice of termination.

Step 4 – Post-termination considerations

Once notice of termination has been served on the distributor, a number of events will likely occur. Customers of the distributorship may express concerns about their ability to continue purchasing the products of the manufacturer or supplier and may begin looking for substitute products from others. Depending on the nature and location of the distributorship, there may be public relations issues. For example, the termination of a long-established distributorship that is one of the principal employers in a small town may generate negative publicity for the manufacturer or supplier. Advance preparation will help mitigate the disruptive influence on business operations.

4.1 What is the potential legal response from the distributor?

The terminated distributor may respond with counterclaims and claims of wrongful termination. The documentation and memorandum developed will serve as an important tool in responding to these claims by the terminated distributor. In some circumstances, a terminated distributor may seek injunctive relief from a court to preserve the status quo and prevent termination. See, for example, Heck Implement Inc v Deere & Co, 926 FSupp 138 (WD Mo 1996).

4.2 Have external stakeholders been notified?

Give notice to external stakeholders that the distributor no longer serves in any representative capacity for your organization. Redirect customers to new resources to obtain the company’s products or services. It is usually best not to state the reasons for termination to outside stakeholders. If it is necessary to inform them of reasons, take care to ensure that any statements made regarding the terminated distributor are factually accurate so that the terminated distributor is not able to claim that they are defamatory.

4.3 Develop a plan to transition responsibilities to new distributor, if necessary

Consult internal stakeholders to develop a plan for the transition of the distributor’s responsibilities. This may include developing an internal distribution network or contracting with a new distributor. As indicated above, the process should include, for example, key members of the management, marketing, sales, manufacturing, and shipping departments.

Note that terminating a distributor could have a detrimental impact on the market presence of the company and, potentially, create a negative perception on the business in the marketplace. Optimally, the business should have another distributor already on line in the market, or be ready to commence representing the business as soon as practicable after the release of the existing representative.

4.4 What is the final payout to the terminated distributor?

Calculate the final payout for the terminated distributor, based upon the terms of the agreement. It may not be possible to pay the distributor for anything due immediately at the time of termination, for example, if there are orders that still need to be processed. Consult contract terms to determine how future orders from customers of the outgoing distributor should be compensated.

4.4.1 Consider holdbacks

Give consideration to holding back some amount of compensation due based upon potential future damages attributable to the conduct of the terminated distributor. Such damages may include a failure to return property or damage to the company’s reputation.

The terms of the contract may allow for holdback of some portion of compensation. The terminated distributor should be notified of the holdback, and the amount and reason for the holdback should be explained in detail.

Additional Resources

Small Business, Chron.com, ‘Termination of Distributorship Agreement’
Robert Ping, ‘(Buyer-Seller) Relationship Termination’

Related Lexology Pro content

How-to guides:

How to assess antitrust law risks in agency and distribution agreements
Issues to consider when drafting a franchise agreement
How to terminate a sales representative agreement

Checklists:

Appointing a local distributor
Appointing a local sales or marketing agent
Drafting an agency agreement
What to consider when terminating a contract

Clauses:

Termination

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