Termination of International Distributorship Agreements

Grounds for Termination of Distributorship Agreement

New merchandise may be required to expand sales. You may be introduced to a new product at an exhibition in Japan or overseas, and you may consider selling this product to Japanese customers by customizing it for the Japanese market. In such cases, you may often conclude a distribution agreement with the overseas manufacturer. Distribution agreements may be exclusive or non-exclusive. If you can obtain sole distributor status in Japan, you can sell your products through other distributors in Japan and thus gain greater market penetration. However, despite the distributorship agreement, it may become necessary to terminate the distributorship agreement if sales in the domestic market do not grow as expected, or for various other reasons, such as company selection and concentration. In other cases, the distributorship agreement may have to be terminated for the convenience of the overseas manufacturer, even though the Japanese distributor had hoped to maintain the agreement in the future.

Description of reasons for termination in the distributorship agreement

Regarding the termination of a distributorship agreement, it is likely that the procedure for such termination is written in the distributorship agreement. For example, unilateral termination without cause is not allowed during the term of the contract, or notice of termination can be given at any time during the term of the contract, but three months’ advance notice is required. Especially in the case of an exclusive distributorship agreement, the distributor itself may have made considerable capital investment to obtain the market in Japan. Therefore, the theory of termination of a continuing contractual relationship is applicable in judicial precedents, and even if the contract states that termination without cause is allowed, termination without reasonable cause may be judged invalid. As an agency that does not wish to terminate the contract, it may insist on the theory of continuous contractual relationship and demand renewal of the contract.

Agreement to Terminate the Contract

When terminating a distributorship agreement, the parties usually agree on the termination of the agreement and execute a Termination Agreement to confirm the contents of the agreement. For example, the parties confirm that the Distribution Agreement between the parties has been terminated as of June 30, 2020.

Considerations for Termination of the Agreement

Since the distributorship agreement is a continuous contractual relationship between the parties, it is necessary not only to confirm that the agreement has been terminated, but also to confirm various other matters such as inventory disposal, succession, non-competition, maintenance, use of trademarks, use of domains, ownership of copyrights and other industrial property rights. For example, it might be stipulated that the distributor will continue to sell the inventory already purchased on the market until the inventory is depleted or that the manufacturer will buy it back at a certain discounted price. If the new distributor continues to sell the product, the new distributor may be required to buy it back. If there are goods that have already been ordered, it may be decided that the contract should be executed and the goods delivered to Japan, or it may be decided that since the parties have already agreed to terminate the contract, any new orders that have not yet been executed may be terminated based on a new agreement between the parties, regardless of what the distributorship agreement states. The parties may decide to

Interim Termination Agreement

In the case of long-term contracts, there is often a grace period of 3 or 6 months between the notice of termination and the actual termination of the contract. For example, an Interim Termination Agreement may be concluded, with notice of termination at the end of June and termination at the end of December, and the legal status of both parties during the interim six months. For example, the distributor will make a good faith effort to sell out its inventory in Japan during this six-month period, and the manufacturer will purchase any unsold inventory at eight times the normal wholesale price at the end of December.

Treatment of Trademarks

In addition to the above, the treatment of trademarks is often an issue. If the manufacturer has filed an application for a trademark in Japan and owns the trademark, there is no particular problem. However, if the distributor owns the trademark or domain, it is necessary to stipulate how the trademark or domain owned by the distributor will be transferred to the manufacturer or the new distributor. Of course, if the rights are transferred free of charge and the parties agree on the procedure, it is sufficient to stipulate only the procedure. However, if other conditions, such as the purchase of shares, have not been determined, for example, the transfer of trademark rights may be considered as a condition in exchange for these conditions. In the end, the manufacturer and distributor have no choice but to reach a comprehensive agreement regarding the termination of the contract, which will cover all matters necessary to terminate the contractual relationship between the parties, including the handling of inventory, trademarks and domains, non-competition, stock purchase, and compensation for damages.

Necessity of a comprehensive agreement

When terminating a distributorship agreement, even if the counterparty proposes only some of the above treatment, it is necessary to reach a comprehensive agreement on all possible issues, taking into consideration the fact that each condition affects each other and that the payment of money is agreed upon for the purpose of adjustment after taking all these relationships into consideration. The parties need to reach a comprehensive agreement on all possible issues. In cases where an overseas manufacturer is a party to the contract, the contract negotiation itself can be quite burdensome, but in many cases we have handled. The amount of compensation as an adjustment payment has often ranged from tens to hundreds of millions of yen, so it is important to negotiate carefully and persistently.

Termination Agreement

When terminating a distributorship agreement, the parties may agree to terminate the agreement and conclude a Termination Agreement to confirm the contents of the agreement. In cases where the parties have had a continuous contractual relationship, the contracting parties may have a strong interest in the terms of termination if the distributor has made a large upfront investment or developed a brand or sales channel. Also, upon termination, it may be necessary to agree again on what to do with previously ordered goods and inventory. For these reasons, a termination agreement is usually prepared at the end of a contract, even if the term of the contract is fixed.

Identification of the agreement to be terminated and the date of issuance of the termination agreement

When terminating a contract by agreement, it is necessary to identify the contract to be terminated by clarifying the date of execution, the parties to the contract, the amended or additional contract, and the relevant documents. It is also necessary to clearly stipulate when the original contract becomes invalid.

Provisions on necessary matters such as conditions for termination, inventory disposal upon termination, use of trademarks, etc.

Since the distributorship agreement is a continuous contract between the parties, it is necessary not only to confirm that the agreement has been terminated, but also to confirm various matters such as inventory disposal, succession, non-competition, maintenance, use of trademarks, use of domain names, ownership of copyrights and other industrial property rights.

Inventory disposal

For example, it might be stipulated that inventory purchased by the distributor will continue to be sold on the market until the inventory dies, or that the manufacturer will buy it back at a certain discounted price. If the new distributor continues to sell the product, the new distributor may be required to buy it back. If there are goods that have already been ordered, it may be decided that the contract should be executed and the goods delivered to Japan, or it may be decided that since the parties have already agreed to terminate the contract, any new orders that have not yet been executed may be terminated based on a new agreement between the parties, regardless of what the distributorship agreement states.

Interim Termination Agreement

In the case of long-term contracts, there is often a period of 3 or 6 months between the notice of termination and the actual termination of the contract. For example, an Interim Termination Agreement may be concluded, with notice of termination at the end of June and termination at the end of December. The distributor will make a good faith effort to sell out its inventory in Japan during this six-month period, and the manufacturer will purchase any unsold inventory at eight shades of the normal wholesale price at the end of December.

Use of trademarks, compensation for distributors

In addition to the above, there are many other issues related to the handling of trademarks. If the manufacturer has filed an application for a trademark in Japan and owns the trademark, there is no particular problem, but if the distributor owns the trademark or domain, it is necessary to stipulate how the trademark or domain owned by the distributor will be transferred to the manufacturer or the new distributor. The distributor may ask the manufacturer to compensate it in exchange for handing over the brand (goodwill) that it has established through its own investment. Of course, if the rights are transferred free of charge and the parties agree on the procedures, only those procedures need to be stipulated. However, if other conditions, such as the purchase of shares, have not been determined, for example, the transfer of trademark rights may be considered a condition in exchange for these conditions. In the end, the manufacturer and distributor have no choice but to reach a comprehensive agreement regarding the termination of the contract, which will stipulate all matters necessary to terminate the contractual relationship between the parties, including the handling of inventory, trademarks and domains, non-competition, stock purchase, and damages as described above.

Other points to note

When terminating a distributorship agreement, even if the counterparty proposes only some of the above treatment, it is necessary to reach a comprehensive agreement on all possible issues, taking into consideration the fact that each condition affects each other and that the payment of money is agreed upon as an adjustment to take into account all these relationships. The parties need to reach a comprehensive agreement on all possible issues.

Termination Notice

In contrast to the termination based on the agreement at the time of termination as described above, when a notice of non-renewal is given in accordance with the provisions of an automatic renewal clause, or when a notice of termination is given for breach of contract, the following type of Termination Notice should be sent to the other party, for example. In such a unilateral notice of termination, it is important to clearly indicate the provisions on which the termination is based.

“Pursuant to the provisions of Article 20 (Term and Renewal) of the Franchise Agreement dated April 1, 2018 with you, we, ABC Corporation, hereby give you a notice that we do not have the intention to extend the Franchise Agreement with you after the expiry date set forth in the Franchise Agreement. Accordingly, you are kindly reminded that the Franchise Agreement will become null and void after the midnight of March 31, 2022.”

Restrictions on Dissolution of Continuing Agreements

If the contracting parties have a continuing business relationship, such as a distributorship agreement, and the contract provides that the contracting parties have the right to terminate or refuse to renew the contract, the termination of the contract may be limited for reasons of good faith, etc., even though the contract may be terminated in accordance with the contractual relationship as stipulated by the contracting parties. However, there are cases in which the dissolution of the contract may be restricted for reasons of fiduciary principles. In this regard, a number of court decisions have attempted to place restrictions on the dissolution of a continuing contract by requiring “compelling reasons” for the dissolution of the contract, or by general provisions such as the principle of good faith.

Tokyo High Court, September 14, 1994 (HANREI JIHO No. 1507, p. 43)

This case concerned a cosmetics distributor agreement. The plaintiff, a distributor for the defendant, started catalog sales in violation of its obligation to conduct face-to-face sales under the distributorship agreement. When the plaintiff failed to comply with the defendant’s repeated recommendations for correction, the defendant terminated the special distributorship agreement in accordance with the mid-term termination clause and stopped shipments. The plaintiff therefore demanded confirmation of its status to take delivery of the goods and delivery of the goods.
The court ruled as follows, holding that there were compelling reasons for the termination of the contract, not merely because it was a continuing contract, but because the relationship of trust under the continuing supply contract had been seriously broken, taking individual circumstances into consideration.
It goes without saying that the right to terminate such a contract can be reserved by agreement. However, even though this distributorship agreement is a contract with a fixed term of one year, it has an automatic renewal clause and is usually expected to continue for a considerable period of time (the contract with the appellant is also for a long period of time, 28 years). In addition, it is considered that each retailer has a business plan based on the premise of continuous transactions over such a long period of time, and that the party receiving the supply of goods is required to invest a certain amount of capital and develop a business structure, and that termination of transactions in a short period of time or arbitrary termination of the contract could cause significant and unexpected damage to the retailers. It is reasonable to conclude that the exercise of the right of contract cancellation requires compelling reasons such as the existence of an act of bad faith that makes it difficult to continue the business relationship. “Failure to use sales methods such as face-to-face sales constitutes a default under the Special Agency Agreement.” The appellant first recommended that the sales methods used by the appellant be improved, and then, after repeated negotiations with the appellant through its attorney, both parties promised that the appellant would follow the sales methods in accordance with the contract with the appellant, but the appellant continued to use sales methods that were contrary to those methods. In light of the fact that the appellant continued to use sales methods contrary to those promised, refused the appellant’s repeated requests to fulfill the promises, and had no intention of changing its previous sales methods, the appellant’s failure to use the sales methods stipulated in the distributorship agreement in this case cannot be said to be minor in nature, and is a serious breach of the relationship of trust under the continuous supply contract. In this case, there are compelling reasons to terminate the contract.

Tokyo District Court, March 15, 2011 (2009 (wa) No. 6917, 2009 (wa) No. 39399)

In this case, the validity of the refusal to enter into a new contract was disputed in a case in which a supplier under a special motor vehicle sales contract, which stipulated that the supplier could terminate the contract in the event of poor performance by the supplier, refused to enter into a new contract on the grounds that the supplier’s performance was poor.
The court held that the refusal to conclude a new contract without any reasonable reason was against the principle of faith, because the contract was a continuous contractual relationship and the distributor was highly dependent on the contract, etc. Based on the individual circumstances of the parties in this case, the court concluded that there was a reasonable reason for not accepting the conclusion of a new contract and that the refusal was against the principle of faith. The court then held that, based on the individual circumstances of the parties in this case, there was a reasonable reason for refusing to enter into a new contract and that it was not against the rule of faith.
The plaintiff and the defendant have continued to do business by concluding a special sales contract with a contract period of one year each year…. The Agreement … clearly states that the Agreement will terminate on December 31, 2007 and will not be automatically extended. However, on the other hand, in general, automobile dealers invest a large amount of money in the early stages of their business and recover their investment over a number of years, and there is an aspect of acquiring fixed customers by accumulating sales results, and it is presumed that the defendant naturally understood this and concluded the contract with the plaintiff. In addition, when one party to a contract makes an investment based on the premise of continued transactions based on an agreement between the parties, the other party is considered to have a duty of care under the rule of faith to cooperate for the continuation of transactions to a certain extent, regardless of the contract period stipulated. Therefore, it is not permissible for the defendant to terminate the special sales contract relationship with the plaintiff by refusing to enter into a new contract without any reasonable reason, as it would be a breach of faith. The plaintiff’s sales performance must be said to have been unacceptably poor, since the difference between the plaintiff’s achievement rate of the agreed number of units and the national average was about 48% in 2004, about 30% in 2005, about 42% in 2006, and about 40% in 2007.”
On the other hand, “(i) the design plan and location of the showroom were selected and decided by the plaintiff, and its conversion was possible, and in reality it has already been converted into a used car center,” and “(ii) the plaintiff, in addition to its business with the defendant, is an authorized dealer for I-cars and a cooperative store for XX cars. In addition to each brand, they were engaged in the sale of XX cars and XXX cars, used car sales, and car inspections, and from 2004 to 2006, of the plaintiff’s total sales of new cars, used cars, maintenance, commissions, and insurance, the percentage of sales related to XXX cars handled by the defendant was only around 20%. (iii) the market share of △△Car was not high in Japan, (iv) the plaintiff had been warned repeatedly in writing about the poor performance and the possibility of termination of the contract several years prior to the actual termination of the contractual relationship, and there was a period of about six months between the oral formal offer and the termination, and (v) the defendant offered to continue the service and parts contracts in 2008, and did not immediately terminate all transactions regardless of the plaintiff’s intention,” “Taking all of these facts into consideration, there were reasonable grounds for the defendant not to accept the conclusion of a new contract after 2008 in this case. In this case, there was a reasonable reason for the defendant’s refusal to enter into a new contract after 2008, and this refusal cannot be said to be impermissible as a matter of faith and credit.

Individual circumstances considered in judicial precedents

In the cases that have appeared in court decisions regarding the termination of a continuing contract, including those mentioned above, various factors have been taken into consideration as elements in making the decision. Specifically, (i) the existence of an automatic renewal clause or the fact that the contract was in fact expected to continue for a long period of time, as automatic renewals were repeated, (ii) the fact that the terminated party had invested a large amount of money in capital investment and development of the sales system for the transaction, or the degree of economic dependence of the terminated party on the other party, etc., etc. (iii) the extent to which the termination of the contractual relationship affects the terminated party; (iv) the terminated party’s breach of contract, breach of trust, or change in circumstances such as credit uncertainty, deterioration of financial condition, or change in organizational structure; and (v) the existence of a notice period for termination or compensation for loss. Based on these factors for consideration, it can be considered that not all contract terminations can be freely made, but in certain cases, regardless of the contract language, termination of the contract may be restricted under the rules of fiduciary duty.