Examples include binding a manufacturer to produce certain goods only for you, or ensuring a supplier will only provide a certain service to you in your industry sector, or by giving a distributor an exclusive right to sell your product in a territory.
‘Exclusivity agreements go beyond a non-compete or non-solicitation clause in a general commercial contractor or joint venture agreement. They actually set out a detailed longer-term plan and arrangement for the two parties concerned,’ comments Jeremy Redfern, Partner in the commercial law team with QualitySolicitors Parkinson Wright. ‘However, like most commercial decisions, an exclusivity agreement can have far-reaching consequences in the long term. It is therefore crucial to get professional advice on these agreements as soon as you start discussions.’
Jeremy provides an overview of the advantages an exclusivity agreement can bring, as well as highlighting the pitfalls, and outlining a brief checklist of issues to consider when contemplating one.
Advantages of an exclusivity agreement
There are several benefits an exclusivity agreement can bring to the table for two businesses with an established trading pattern. For example:
- fostering a longer-term business relationship, offering stability to the parties in knowing who they will be dealing with and on what basis, without having to worry about changing suppliers or distributors or finding a new customer;
- creating the opportunity to negotiate a better pricing structure, especially if volumes are consistently high or exceeding expectations and demand is predictable;
- encouraging commitment, such as training or sharing of intellectual property in the knowledge of strong contractual protections; and
- supporting investment, for example if new equipment is needed to produce an exclusive product, then the manufacturer would want reassurance that they would be able to recoup an adequate return on their investment.
Exclusivity agreements also play an important role for businesses which have not worked together before. For example, a company engaging a new PR or marketing agency for a product launch may wish to ensure that the agency does not work for any of other company in the same sector.
Disadvantages of exclusivity agreements
On the other hand, the idea of being tied in with just the one supplier, distributor or service provider is not without pitfalls. Putting all your eggs in one basket could be problematic for several reasons:
- your supplier could end up having more leverage to press for higher pricing if they know you are bound by the exclusivity agreement;
- you may be frustrated by the inability to shop around for better pricing, if market conditions change;
- if there is a significant shift in market demands, rules or regulations, the product or service provider may not have the requisite know-how or resources to adapt to what is being asked of them;
- if there is a breach of contract, you may not be able to replace the arrangement quickly; or
- similarly, your business may be vulnerable in the event of a significant event, such as a natural disaster or ill health of a key contact at the company which prevented them from delivering the agreed products or services.
By way of example, to keep up with trends, your confectionary company wishes to make another flavour of a chocolate bar (like Dubai chocolate which requires certain processes); but your current manufacturer would need specialist equipment or training to produce that product for you and this makes their cost-per-item uncompetitive.
Whether you must use them will depend on the nature of restrictions stipulated in your contract. If the exclusivity arrangement covers only existing flavours and no others, you may be free to shop around for a more cost-effective manufacturer.
The devil is in the detail in these agreements, which makes seeking legal advice essential.
Balance of power
One of the key issues when drafting an exclusivity agreement will be the balance of power. If clauses within the exclusivity agreement are found to be unfair or disproportionate to what is considered commercially reasonable, the agreement could be invalidated or partially or wholly unenforceable – a costly mistake.
It is therefore important to take legal advice and review the clauses in the agreement, ensuring they are not too far in favour of one party over the other.
Key issues to consider for success
With the right legal advice, there are ways to reap the benefits of a strong exclusivity agreement, while mitigating some of the disadvantages. Amongst others, here are some of the key clauses to consider when negotiating:
- Duration - It is important to include a duration in an exclusivity agreement and not to have the tenor of the arrangement undefined. While the length of the duration will be down to commercial negotiation, it is worth noting that the longer the duration, there will be less flexibility available to the parties to pursue other opportunities or review the relationship periodically.
- Territory - If the exclusive agreement is for supply or distribution, it will be essential to clearly define the territory that will be covered. The narrower the territory, the more flexibility you will have to seek distributors or suppliers in other territories and the more your risk is spread. If the territory is very wide or large, you have fewer suppliers to manage, but it could reduce flexibility to adapt to market changes and you could have a bigger problem if you need to find a replacement;
- Exclusions - the word ‘exclusivity’ has connotations with keeping other parties out, but within the arrangement, it is critical to consider what is deemed ‘exclusive’ and what the exclusions will need to be. For example, if the chocolate supplier has only agreed to supply certain specified flavours in the agreement, then could it be possible for you to source a supplier for different flavours without breaching the agreement. Exclusions need to be carefully and comprehensively drafted in a way that allows parties to have commercial flexibility without affecting the spirit of the exclusivity agreement;
- Competition law - in some jurisdictions, it is illegal to have exclusive agreements as they are deemed to be anti-competitive, or there are laws preventing the creation of market monopoly. Therefore, professional legal advice is essential to give you the comfort of knowing the agreement will not inadvertently breach international or competition law;
- Termination rights - it is prudent to include the ability for parties to come to either mutual agreement to terminate or to give notice to terminate if certain terms of the exclusivity are breached. For example, if a customer is not ordering volumes that were either set out in the agreement or anticipated, then you should have the right to review the exclusivity arrangement and terminate without a breach being triggered; and
- Dispute resolution - it is prudent to include a solid dispute resolution provision in the contract to ensure the parties have a mutually agreeable process for resolving any disputes.
Best practice during the term of an exclusivity agreement
To further nurture the success of an exclusivity agreement, it is good practice for both parties to review the agreement regularly against past performance, future trends and business plans. These reviews could lead to mutually agreeable amendments and preserve the relationship for even longer. Exclusivity agreements should evolve with the businesses and any negotiation of amendments and the actual wording of amendments should, of course, reflect that.
How we can help
Our team of solicitors can advise you, whether you are starting out on an exclusivity arrangement, or you already have one in place and need to review and amend it.
For further information, please contact Jeremy Redfern or a member of the corporate and commercial team on 01905 721600 or via email worcester@parkinsonwright.co.uk
This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.