Why relying on a distribution agreement "on a handshake" could be risky

Three recent cases show the risk that suppliers run when trying to rely on the terms of agreements made “on a handshake”. All three suppliers found to their cost that the agreements had either ceased to exist or did not protect them in the way in which a written agreement would have been likely to have done.

In Cepia HK Limited v The Character Group Plc, a case decided by the English High Court in December 2016, the supplier (a manufacturer of children’s toys) sought to exercise an option to purchase an equity stake in its UK distributor.

The distributor had agreed in 2010 to grant the supplier an option to purchase up to 1 million shares in the distributor at a certain price.  The option agreement provided that the supplier could only exercise the option if the distribution agreement between the parties continued in existence from the date of the option agreement to the date on which the supplier exercised the option.

The supplier tried to exercise the option in July 2015, but the distributor claimed that the exercise of the option was invalid because the distribution agreement was no longer in existence.  Unfortunately for the supplier, although the distributor had acted as the supplier’s UK distributor for a number of years, there was no written distribution agreement.

The Court therefore had to consider what the terms of the distribution were, and whether it had continued in existence until the date upon which the supplier tried to exercise the option.  Following a lengthy consideration of the details of various meetings and emails between the parties, the Court concluded on the basis of the supplier’s conduct that the distribution agreement (in the sense of the prior course of dealing between the parties) had not continued in existence beyond October 2014. As a result, the supplier was not entitled to exercise the option to purchase a shareholding in the distributor.

Even if an unwritten agreement is still in existence when the supplier seeks to rely on it in a dispute with its distributor, failing to put a full written agreement in place can cost the supplier dear in other ways. When doing deals, parties rarely give any thought to issues as seemingly obscure as which law is to govern the agreement, or which courts will have the jurisdiction to hear any disputes arising between the parties. Such points are invariably only covered off if a formal written agreement is put in place. However, failing to agree on the governing law of the agreement or the courts which will hear any disputes can, if a dispute arises, lead to expensive and lengthy proceedings regarding which court is to hear the dispute, before the actual question which the parties have fallen out about is even considered! A case heard by the Court of Justice of the European Union in 2016 demonstrates this.

Ambrosi (a French distributor) brought a claim in the Court of Marseille against Granarolo (its Italian supplier), following the sudden termination by the supplier of the distribution agreement between them. There was no written agreement in place.

The Court of Marseille considered that it could hear the dispute, but this was challenged by the supplier, who asserted that the Court of Bologna (its home Court) had jurisdiction to hear the dispute.

Because there had been no agreement between the parties at the outset of the relationship relating to which courts could hear any dispute, the matter had to be decided with reference to EU law, which lays down rules on how the question of jurisdiction is to be determined in such cases. The European Court of Justice was asked to give its ruling on various issues relating to the question of jurisdiction. The European Court decided that if the “characteristic obligation” of the distribution agreement was the supply of goods, then the distribution agreement should be classified as a contract for the supply of goods (meaning that the supplier’s home courts would have jurisdiction, because goods were delivered ex works in Italy). Alternatively, if the characteristic obligation of the contract was the supply of services (the distribution services), the contract was to be classified as a contract for the provision of services (meaning that the distributor’s home courts would have jurisdiction).

The matter has been referred back to the French court to be decided. The parties are likely to have spent a considerable amount of time and money arguing about where the case is to be heard, without even considering the substance of the actual dispute which led them to court in the first place!

Similarly in a case decided 2 years earlier by the European Court which concerned a French supplier and a Belgian distributor and where there was no formal distributorship agreement.

Many commercial agreements are made “on a handshake”, especially where the parties have a strong pre-existing relationship. Often, where the parties agree the commercial terms of a deal at a face to face meeting, they do not follow up with a written agreement. Business people are busy, and there can be a feeling that insisting on a written agreement may damage the relationship or slow the parties down from getting on and doing business. But these cases show the dangers of a supplier not formalising its relationship with a distributor. The benefit of a formal written agreement is certainty - each party knows what the agreed terms between them are. Where there is a dispute between the parties, the cost of not having a formal written agreement can outweigh the cost of having put one in place at the outset of the relationship.

The contents of this article are intended for general information purposes only and shall not be deemed to be, or constitute legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article.
Emma Roake
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