Limited Risk Distribution Agreements – Key Considerations for Documenting Intercompany Arrangements

Limited risk distributors are a relatively common feature of intercompany arrangements within multinational groups. The essence of the arrangement is of course to de-risk the role of the intra-group distributor, resulting in a correspondingly lower return or margin for the distributor. In many ways, the position of the distributor is commercially analogous with that of a commercial agent or commissionaire.

So how does that translate into the terms of the intercompany agreement required to be in place between the principal (as supplier) and the group company distributor? The following is a non-exhaustive list of considerations as regards the legal terms which may be included in a limited risk distribution agreement, to reflect the allocation of risk and reward between the parties. As within any intra-group relationship, the legal design of the arrangement should go hand-in-hand with the tax and transfer pricing analysis (including functional analysis, comparables, VAT and customs duties).

Risks and obligations

• Buying risk / inventory risk – this may be reflected by the absence of any minimum purchase obligations imposed on the distributor, together with an obligation on the supplier to repurchase any unsold stock (akin to a ‘sale or return’ arrangement). Alternatively, the relationship may be structured as a consignment stock arrangement, so that the stock remains the property and risk of the supplier until the point of sale to the distributor’s customer.
• Credit risks – may be addressed through deferred payment terms for purchase of stock by distributor or, alternatively, by a supplier’s duty to purchase any outstanding book debts of the distributor at face value.
• Product liability and intellectual property infringement risks – the distributor may be entitled to an uncapped indemnity against any product liability-type claims, whether arising in contract or tort, including the costs of dealing with any warranty claims and infringement of intellectual property claims.
• Market investment risks – the cost of entering a new market or maintaining and developing a market position may be borne by the supplier, either by allocating the relevant obligations to the supplier, or by entitling the distributor to reimbursement of all relevant costs.
• Currency risk – this is primarily a function of the distributor’s exposure to different currencies for buying and selling the supplier’s products, but may also be addressed by guaranteeing the distributor a minimum operating margin on the terms of the intercompany agreement.

Ability to derive ongoing benefit

Limited risk will typically be associated with a limited ability on the part of the distributor to derive an ongoing benefit from the arrangements. This may be reflected in the contractual terms dealing with the following matters:

• Ownership of customer lists;
• Ownership of reputation and goodwill created through the distributor’s activities; and
• Exclusion of any right on the part of the distributor to receive any payment by way of compensation or indemnity on termination of the intercompany agreement (subject to any mandatory provisions of local law).

Pricing structure

In traditional distribution arrangements, the primary pricing mechanism relates to the price for goods supplied and the level of discount offered against list prices. In addition, the distributor may be required to pay a one-of or annual fee for the privilege of acting as a distributor, similar to a franchise fee.

For an intra-group distribution arrangement, the cost of goods supplied may still be the primary payment mechanism. However, there would typically be a price adjustment clause to allow the distributor an appropriate fixed or minimum operating profit, consistent with the group’s transfer pricing compliance strategy.

Corporate governance

As with any intra-group arrangements, a written intercompany agreement is essential from a corporate governance perspective. Without such an agreement, the directors or officers of the participating entities (particularly the distributor) have no clear point of focus for determining whether the arrangement is one which they can properly approve.

A template distribution agreement is included in LCN Legal's suite of template intercompany agreements for transfer pricing compliance. Email us at info@lcnlegal.com for information on the pricing of the template agreements and what they cover.