Product Pricing

Table of Contents:

Each distribution agreement will clearly articulate who is responsible for determining the price of the product and the royalty payment to be made to the manufacturer for each product sold. The distribution agreement will also articulate who is responsible for collecting fees (usually the distributor). In the software context, this will include the price of the initial license as well as the price for any add-on services such as support and maintenance. In the subscription-based model, this will include the price of the initial subscription as well as each renewal subscription. The parties should also determine in the contract who is responsible for shipping costs and taxes (usually the distributor) as well as the allocation of responsibility for expenses incurred by the parties in the distribution effort (usually each party is responsible for any expenses it incurs). It is also common for the distributor to be responsible for invoicing and collection of fees for any products distributed.

■ The distributor’s obligations commonly include a requirement to report on all sales of products periodically (e.g., on a monthly basis). The distributor should also be required to report on marketing efforts undertaken and the names and addresses and other contact information for prospects. Audit rights are also common in distribution transactions where royalty payments are to be made. If it is discovered that the audit payments were inaccurate during the period reviewed as part of the audit, the distributor should be required to immediately pay the discrepancy (or, in the event of an overpayment, the manufacturer should pay the overage). It is also common in distribution agreements to shift the burden of payment for the audit to the distributor if the underpayment amount reaches a predetermined percentage of total fees paid (e.g., more than 10% or 15%).

■ It is important that both parties maintain records for a lengthy period of time following any termination or expiration of the distribution agreement to ensure that accurate audits can be conducted.

Additional Considerations

■ Confidentiality. While it may certainly be the case that little or no confidential information exchanges hands as part of a distribution relationship, if confidential information will be exchanged, the distribution agreement should include a standard confidentiality clause (under most circumstances mutual) protecting the confidential information that is shared. Include obligations that each party maintain the confidential information of the other party, use the other party’s confidential information only as required to perform its obligations under the agreement, and return the other party’s confidential information upon request and upon any termination or expiration of the agreement.

■ Term. The parties to the distribution agreement will want to agree upon an initial term of the relationship and renewal rights. It is common to include an automatic termination in the event that the distributor does not reach a specified number of distributed products within an agreed period of time (e.g., six months). Additional termination rights commonly include:

  • - Failure of a party to comply with the terms of the agreement (after, perhaps, notice and a reasonable cure period).
  • - The other party’s bankruptcy.
  • - The mutual agreement of the parties to part ways.
  • - If either party is acquired or merges with another entity.

Upon any termination, it is important to ensure that the existing licensees or purchasers revert back to the manufacturer for continued support and future sales of the software or goods that were distributed. Where software has been incorporated into the distributor’s software, it is common to permit the distributor to continue distributing the combined product after termination for a specified period of time (e.g., six months) or until all of the combined products have been licensed. In this case, it is critical that certain terms of the agreement (e.g., payment) survive termination of the agreement. Further, after termination or expiration of the agreement,

the distributor’s rights are limited to distributing combined products created prior to the termination or expiration. The distributor would commonly be restricted from creating new combined products after termination or expiration.

■ Warranties. Generally speaking, the manufacturer will not make any warranties with respect to its product in the distribution agreement. Any warranties related to the product to be distributed will be found in the end-user agreement, not the distribution agreement. Warranties may be added relating to each party’s authority to enter into the agreement and compliance with all laws and regulations applicable to each party’s obligations under the agreement.

■ Indemnification. Indemnification by both parties of the other party is common in distribution agreements. The manufacturer will commonly indemnify the distributor for third-party claims that any marks licensed to the distributor infringe or misappropriate the third party’s intellectual property rights. Common exclusions to the requirement of the manufacturer to indemnify the distributor include modifications to the manufacturer’s marks, combination of the manufacturer’s marks with other products or services, and the failure of the distributor to use updates to the manufacturer’s marks. The manufacturer’s obligations to indemnify should also include a remedy that if the mark is subject to a claim of infringement or may be subject to such a claim, then the manufacturer can procure for the distributor the right to continue to use the mark or replace the mark with a noninfringing mark. If neither of these options is available to the manufacturer, then the manufacturer is commonly afforded the right to terminate the agreement.

The distributor commonly has broader indemnification obligations that include indemnification for third-party claims to the extent arising out of a combination of the manufacturer’s product with other products or any alteration of the manufacturer’s products.

■ Risk of Loss. The distributor should take responsibility for the risk of loss of the product after it is delivered to the distributor from the manufacturer. It is common in these types of agreements for the manufacturer to disclaim all liability for loss or damage caused by the distributor’s failure to perform the distributor’s obligations to protect the products from damage.

■ Limitation of liability. Distribution agreements will generally include a limitation of liability that disclaims certain types of damages and limits recovery on other types of damages. While the presence of such terms is generally not objectionable, care should be taken to ensure that the scope of the limits is appropriate for the transaction.

- The limitation of liability should be mutual—it should protect both parties.

  • — Most limitations of liability are drafted to exclude consequential damages and to cap recovery for direct damages at some specified amount or a multiple of fees that are paid under the agreement. The preference is to ensure that the cap is tied to all of the fees paid under the agreement during the life of the agreement. Since fewer fees will likely be paid early in the relationship, it is necessary to consider a minimum level of liability until enough fees have been paid to make the cap meaningful. Such an initial cap is commonly a percentage (e.g., 50% or 75%) of the anticipated fees to be paid during the first year of the arrangement.
  • - Ensure that damages arising out of certain breaches and expenses, to be paid pursuant to certain terms in the agreement, are excluded from the limitations and exclusions of liability under the agreement. For example, it is common to exclude from caps and exclusions damages arising out of a party’s breach of the obligations with respect to confidentiality under the agreement. Another common exclusion is damages arising out of and expenses to be paid pursuant to a party’s obligation to indemnify the other party under the agreement. Finally, it is common to draft the contract so that damages arising out of a party’s breach of its obligations to keep the other party’s information and data secure are carved out (i.e., not included) in the damage caps and exclusion of certain types of damages.

■ Intellectual property. Most distributors will want the manufacturer to acknowledge and warrant that that there are no suits, claims, or other proceedings against the manufacturer that would prevent the distribution of the software or goods being distributed. Further, distributors commonly require a warranty that the manufacturer has not violated any intellectual property or proprietary rights of a third party in developing the software or goods to be distributed by the distributor. Tire manufacturer should clearly retain all ownership interests in the software or goods being distributed and ensure that ownership of the goods and software is not, under any circumstances, transferred to the distributor.

Summary

Distribution agreements can take many forms. They can be for the distribution of software or goods and can include obligations with respect to collaboration, development, and marketing. The most important elements of these types of agreements are ensuring that the distributor’s rights are broad enough to enable the distributor to distribute the software or goods as required by the contract, including protections of the manufacturer with respect to intellectual property ownership of the manufacturer’s software or goods, ensuring that the manufacturer has access to the information of customers who license or purchase the software or goods that are being distributed, and setting up a fees and payment structure that promotes performance of the parties.

 
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