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Distribution agreements in China can protect foreign companies of growing risks

Foreign companies operating in China have faced in the past few years increasing risks and supply chain shifts, pushing many to reconsider their business footprint in the country. Due to these and other challenges, distribution agreements have become a popular way for foreign companies to retain a sales presence in China without full exposure.  


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These distribution relationships serve as a bridge, allowing foreign companies to keep profiting from China’s market potential while reducing on-the-ground hassles. They allow companies to profit from selling into China without subjecting assets or personnel to increasing in-country risks. 


From escalating trade tensions to regulatory clampdowns, businesses have been navigating a minefield of risks in the country. 


These uncertainties, compounded by the global shift in supply chain strategies and China’s evolving relationship with other major economies, have pushed many companies to reconsider their operational strategies in the region.  


Shifting Trade Dynamics 


Having a distribution agreement in China, as opposed to setting up full-fledged operations, can give foreign companies greater flexibility to adapt to changing trade policies regulations. 


China offers a massive profitable market. Many businesses want to ensure that their products remain accessible in the Chinese market, even if they are not produced there. This backdrop has made China distribution agreements more critical than ever before.  


Partnering with Chinese distributors, who can provide valuable insights on the local market, lets foreign companies stay active in China without risking a lot of money in investments. Through this relationship, a company can tailor its products and strategies to market demands. 


Having seen the impact of Russia’s invasion of Ukraine in the business world, most companies are now keen to avoid and mitigate similar risks in China.  


A local distribution structure in China can act as a buffer against some of these challenges and shield the company’s assets and operations.  


Product Distribution   


The key to success in distribution relationships is finding the right Chinese distribution partner and properly formalizing the relationship. This can be accomplished by doing 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 intellectual property, sets definite sales goals, and explains how the contract can be ended. 

  • Making sure trademarks are registered in China before starting the business. 

  • Working closely with the distributor on tailored branding and marketing to connect with Chinese consumers. 

  • Regularly monitoring progress to ensure performance goals are met. 


A China specific distribution contract should include, among other things: 

  • 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.) 

  • Non-competition during or after the term of the distribution agreement 

  • FCPA compliance. Anti-corruption compliance 

  • Damages for breaches 

  • Dispute resolution (venue, choice of law, etc.) 

 

Distribution Issues 

There are several common issues that arise in the Chinese distribution contracts, such as if the Chinese distributor will be the company’s agent. In general, lawyers suggest that the deal be done with the company simply selling products to the Chinese distributor and the Chinese distributor — in turn — selling products to end users. 


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When negotiating distribution terms, two areas of Chinese regulations should be considered. First, ensure not to inadvertently create a franchise arrangement which would trigger added compliance requirements. If the agreement excessively dictates the 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, the distribution agreement shouldn’t dictate the prices at which the distributor sells to others. 


Exclusivity is another important factor to determine. Will the Chinese distributor have an exclusive territory, customer type or product range? If so, for how long? Generally, if a company grants the Chinese distributor an exclusive, sales performance targets should be set so if they are not met, the contract can be terminated.  


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. The Chinese distributor’s failure to meet the minimum for a certain period can result in termination or losing exclusivity. 


Another important aspect to clarify is who is responsible for what on sales and marketing.

Chinese distributors often expect their foreign product supplier to engage and pay for at least some of the 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. 


Termination of contract  


A good distribution contract makes clear what happens upon termination because doing so greatly improves the chances of smoothly transitioning to a new distributor. Is your distributor allowed to sell down its remaining inventory of product, or must it cease sales immediately? Are you required to buy back the inventory and, if so, at what price? 


China specific contract 

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. They should include issues relating to the legality of your product and the duties/tariffs you will incur in bringing the 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 companies to create enforceable agreements that are more favorable.  


Chinese law has virtually no special protections for distributors. There is no legal requirement for payment of any special compensation to a distributor upon termination of a distribution agreement.  


Another difference between Chinese distribution agreements and those for US, Europe or Australia is that the signature line should provide a place for the distributor to affix its company seal.  


Foreign companies should discuss a series of important issues with their potential Chinese distributors before signing an agreement, such as terms of payment and shipping, sales targets, the law that will govern the distribution relationship, protection of trade secrets (NNN -non-use, no disclosure, non-circumvention), warranties, and training, among other things. 

 

Trademark protection  


It is both common and easy for a China distributor to take a trademark. Fortunately, it is also easy and relatively inexpensive to prevent that. 


The easy way to do it is to register the trademark in China and not allow anyone to use it without a properly registered trademark licensing agreement that explicitly permits them to do so. Without this, there is a serious risk of losing the brand in China.  


To ensure that the trademark remains yours in China, your distribution agreement should license the limited use of the trademark to the 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. 


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To “further” protect a company’s IP, distribution agreements should include a “no registration” provision. In this provision, the distributor agrees that the company 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 the company’s IP.  


China can be an interesting market for any business. However, it comes attached to certain potential risks. Any company looking to distribute in China should have a distribution agreement in place and ensure that it is comprehensive, tailored, and properly executed.  


By choosing the right distribution partner, formalizing the distribution relationship, protecting IP, and collaborating closely on execution, any business can profit from China without taking on full operational risks and exposure. 


 

Woodburn Accountants & Advisors is one of China’s most trusted business setup advisory firms.


Woodburn Accountants & Advisors is specialized in inbound investment to China and Hong Kong. We focus on eliminating the complexities of corporate services and compliance administration. We help clients with services ranging from trademark registration and company incorporation to the full outsourcing solution for accounting, tax, and human resource services. Our advisory services can be tailor-made based on the companies’ objectives, goals and needs which vary depending on the stage they are at on their journey.

 

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