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THE COMMERCIAL DISTRIBUTION IN THE US MARKET


Despite facing challenges at the domestic level along with a rapidly transforming global landscape, the U.S. economy is still the largest and most important in the world. The U.S. economy represents about 20% of total global output, and is still larger than that of China. Moreover, according to the IMF, the U.S. has the sixth highest per capita GDP (PPP). The U.S. economy features a highly-developed and technologically-advanced services sector, which accounts for about 80% of its output. The U.S. economy is dominated by services-oriented companies in areas such as technology, financial services, healthcare and retail. Large U.S. corporations also play a major role on the global stage, with more than a fifth of companies on the Fortune Global 500 coming from the United States.

Even though the services sector is the main engine of the economy, the U.S. also has an important manufacturing base, which represents roughly 15% of output. The U.S. is the second largest manufacturer in the world and a leader in higher-value industries such as automobiles, aerospace, machinery, telecommunications and chemicals. Meanwhile, agriculture represents less than 2% of output. However, large amounts of arable land, advanced farming technology and generous government subsidies make the U.S. a net exporter of food and the largest agricultural exporting country in the world.                                                         .                      

The U.S. is the 2nd leading exporter of goods and services in the world and the number one leading importer The U.S. has consistently run a trade deficit, mainly due to the dependence on foreign oil to meet its energy needs and high domestic demand for consumer goods produced abroad, however thanks to advances in domestic oil production, the energy gap is closing. The main trading partners of the U.S. are Canada, China, Mexico and Japan. Canada is the main destination for U.S. exports, whereas China is the main source of imports.                               

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Before setting a real presence of the company in the US a company has to consider if it worths it. They have to consider the cost of the presence as the cost of HR, staff, offices, insurances, consultants, compliance, the product liability and the approach to the market, the Law, distances, consumers’ habits and if there’s a different language.
A company can consider different entry strategies and different organizational models.

About the distribution model, a company can distribute directly through a subsidiary in the US and it can be by agents or by distributors, or directly by sales representatives or indirectly through third party distributors.
In the US a great importance is given to the written contracts. A company must consider also the brand protection, eventual visas for the employees, the Law and the compliances to export products in the US.
Distribution models:

  • Distribution: a company buys the products and it earns with the mark up. In this model exists a market risk, there’s the need of a warehouse and for these characteristics it’s an expensive model.
  • Agents: in this model the agents don’t buy and resell the products but they earn only a commission.
  • Franchise: the company has the license of the brand and it pays a “franchise fee”. There’s a control on the sales process.

The written contracts in the US (distribution, agents, sales, joint ventures, etc) are very long due to cultural motivations, litigation risk, freedom of bargaining, and because the Civil Code is less strict.

It is foundamental to prepare contracts to manage the following risks:
·        In stores: prices, timing of payments, description of products or services, ownership, etc.
·        Legal risks: warranties, compensation, dissolution, arbitration, etc.
A bound contract could be not written (verbal, purchase orders, email, correspondence).

In a contract there are fixed clauses:
1.     Warranties: declared in the contract or implicit (Uniform Commercial Code, Article 2 for the trade of goods, warranties for “merchantability” and “fitness for intended purpose”). The implicit ones are inaccurate in favor of the buyer, often on the trade of specialized goods between merchants. They are applicable if they are not expressly excluded (magic language).
2.     Indemnification: area, restrictions, direct damages and indirect/consequential damages, lost profits.
3.     Territory
4.     Duration
5.   Obligations of the distributors: objectives, minimum of selling, marketing, limits to distribution to authorised retailers.
6.     Resolution: predict causes which attribute rights of termination and generally the termination is required from one part and it doesn’t give rise to compensation cause.
7.     Autonomy: provide the total autonomy of the Italian Company in respect to the counterparty in order to avoid the responsibility for act of the distributors or qualification of the counterparty as employer.
8.     Antitrust: Vertical Restraints – Rule of Reason

How to choose the legal entity
The advantages of set up a new company (NewCo) instead of a branch in the US are that in the US the set up of a NewCo is faster and cheaper than in Italy, there are less formalities, the disclosure is limited to the parent company and the shareolders, there's the need of a minimal capitalization even if there’s a thin capitalization for credibility on the market and with the Authorities. It’s important to decide where to open the New Co (Delaware vs other states).

Another aspect to consider is the kind of entity the company wants to set up: a Corporation or a Limited Liability Company.
A Corporation is the most known legal and fiscal entity with limited liability. From the fiscal view it has a permanent establishment and it doesn’t need to file the Income Tax Return of the parent company.
The hierarchy includes stakeholders, directors and officers and there’s also a Board of Directors (“The business and affairs of the corporation shall be managed by, or under the direction of the Board of Directors”- Delaware GCA Section 141a).
A Limited Liability Company has only a legal personality (“pass through”) and its consituition is more expensive but at the same time it’s more flexible.


 

 

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Distribution Agreements under US Law
(Excerpts from Chapter 19 of “International Commercial Agency and Distribution Agreements: Case Law and Contract Clauses”, Second Edition, published on April 20, 2017 (Wolters Kluwer))

Understanding the interplay between federal and state statutory and common law in the US legal system is important to understanding the regulation of exclusive distribution agreements in the US. Under the US Constitution all power not specifically reserved for the federal government remains with the states. Federal law has exclusive jurisdiction only over certain types of cases (e.g., those involving federal laws, controversies between states and cases involving foreign governments), and share jurisdiction with the states courts in certain other areas. In the vast majority of cases, however, state law has exclusive jurisdiction.

Furthermore, because a distributor is typically an unaffiliated third party acting on its own account rather than on behalf of the supplier as principal, distribution agreements are subject to greater regulation under US federal and state antitrust law. Such law, among other things, (i) regulates whether and the degree to which a supplier in a distribution arrangement may seek in a contract or otherwise to dictate the price at which the distributor will resell products supplied; (ii) imposes restrictions on suppliers that engage in “dual distribution”; and (iii) may limit the suppliers’ ability to sell product to different distributors at a different price. Antitrust law also regulates exclusivity and selective distribution arrangements, as well as distribution relationships in certain industries.

Under the law of most states (including New York), exclusive distribution exists when a supplier grants a distributor exclusive rights to promote and sell the contract goods or services within a territory or to a specific group of customers. Exclusive rights in a distribution arrangement are often granted by the supplier for the distribution of high quality or technically complex products that require a relatively high level of expertise by the distributor, including staff that is specially training to sell the goods or specialized after-sales repair and maintenance or other services. In contrast to a distributor, a commercial agent does not take title to product, does not hold inventory and typically has no contractual liability to the customer (including risk of customer non-payment). Conversely, a distributor, in line with the greater risk of its activities, typically can expect greater upside economically in terms of margins on resale relative to an agent’s profit through earned commissions.

Sub-distributors:
Under the law of most states (including New York), a distributor may appoint subdistributors absent any restrictions to the contrary in the agency agreement. Commercially, the appointment of a sub-distributor may have an adverse effect on the supplier by reducing the supplier’s control over its distribution channel activities or increasing the supplier’s potential liability exposure given the increased number of distributors whose actions may be attributed to the supplier.

Rights and Obligations of the Exclusive Distributor:

  • Sales organization: suppliers are not required to establish sales organizations in exclusive distribution agreements.
  • Sales’ target: there are no mandatory rules under federal law or state law (including New York) generally regarding sales targets in exclusive distribution agreements.
  • Guaranteed minimum target: minimum sales requirements are common in exclusive distribution agreements. As a commercial matter, a supplier as a requirement to give, or maintain, exclusivity with one distributor, will seek through such requirements to ensure that economically the distributor is performing satisfactorily.
  • Minimum stock: there are no mandatory rules in federal law or the law of the majority of states (including New York) regarding minimum stock. A supplier may seek to have the distributor agree, contractually, to maintain adequate levels of stock relative to market demands as well as to store the product properly.
  • After-sales service: the parties to a distribution agreement are generally free to agree as they deem appropriate with respect to after-sale service regarding products.
  • Resale Prices: the Exclusive Distributor is free to fix the resale prices. State law (including New York law) generally does not limit the ability of an exclusive distributor to fix resale prices. A supplier’s ability to set resale prices for distributors is subject to limitations under federal and state antitrust law.

Rights and Obligations of the Supplier:

  • Exclusive Distributor undertaking to supply: generally, state statutes do not specifically provide that a supplier in a distribution relationship has a duty to supply specific levels of product to a distributor, with such obligations generally be established by contractual provision. However, a supplier does have an implied covenant of good faith and fair dealing toward the distributor under state law generally, which generally requires that a party to a commercial agreement not do anything which injures the right of the other to receive the benefits of the agreement. Under the foregoing, a supplier may be deemed to have an obligation to supply product to a distributor. However, even where such a duty were found to exist, the quantity and frequency of product supply and other details often remain unclear.
  • Pricing Policy of the Supplier;
  • Retention of title: typically, in sales transactions on credit in the US, title is passed at the moment of initial sale. The buyer typically grants the supplier a security interest in the goods purchased, which if proper perfected under state law, affords the supplier with a priority position relative to other creditors with respect to the products provided (inventory) in the event of non-payment and enforcement.

The supplier and distributor can allocate third-party liabilities and related attorneys fees as between themselves through warranty and other indemnification provisions.
Exclusive-dealing provisions – under which the distributor undertakes not to distribute competing products in the territory – are quite common in distribution agreements.

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Commercial Agency Agreement under US Law
To understand the regulation of commercial agency agreements in the US, it is helpful to remember the interplay between federal and state statutory and common law in the US legal system.

Commercial agency is regulated at the state level rather than by US federal law. Almost two-thirds of the US states have adopted specific legislation for commercial agency relationships with non-employees. Most state statutes regulating commercial agency relate to the relationship between a principal and an agent that solicits orders for the purchase of the principal’s products, mainly in wholesale rather than retail transactions (although state law often has special rules for agency relationships with respect to real estate transactions and insurance policies). A second, overarching theme of note to understand the regulation of commercial agency agreements in the US is the primary importance of the doctrine of freedom of contract under state law jurisprudence.

General Legal Provisions Applicable to Agency Agreements:
 As noted, commercial agency is mostly regulated at the state level in the US State laws on agency mainly address commissioned agency, and, where in force, is primarily aimed at ensuring that the principal timely pays the agent the commissions that are owed by imposing liability on the principal for a multiple (often two to four times) of unpaid commissions, as well as for reimbursement of the agent’s attorneys’ fees and costs incurred in collecting the unpaid amount.

Formalities for the Creation of an Agency:
 New York law does not impose particular formalities for the creation of an agency relationship. In fact, under New York law, absent circumstances under which New York’s general Statute of Frauds rules apply as set forth in § 5-701 of the General Obligations Law, parties may be deemed to be in an agency relationship even without signing an agreement evidencing the agreement consideration or any writing which evidences their agreement. New York law does regulate the payment of sales commissions under New York labor law. New York labor law defines a sales representative as an independent contractor who solicits orders in New York for the wholesale purchase of a supplier’s product or is compensated entirely or partly by commission.

Agency Elements and Purpose:
Under the law of New York and the majority of states, an “agent” is a person or entity who, by agreement with another called the “principal,” represents the principal in dealings with third persons or transacts business, manages some affair or does some service for the principal. The key elements of an agency are: (i) mutual consent of the parties; (ii) the agent’s fiduciary duties, and (iii) the principal’s control over the agent. A principal may act on a disclosed, undisclosed, or partially disclosed basis in dealing with third parties.

A defining element of agency under New York law and the law of the majority of states is the principal’s control over the agent. Indeed, whether the principal will be bound by the agent’s acts will depend, in large part, on whether the agent had actual or apparent authority to act on behalf of the principal. Two of the many factors taken into account in determining whether such a relationship could be characterized as one of employment include whether the agent: (i) provides the services according to her own methods and (ii) is subject to the control of the principal.

Appointment of Sub-agents:
 Under New York law and the law of the majority of states, a principal may authorize an agent to appoint another agent to act on the principal’s behalf. The second agent may be a subagent or a co-agent. A “subagent” is commonly defined as a person appointed by an agent to perform functions that the agent has consented to perform on behalf of the agent’s principal and for whose conduct the appointing agent is responsible to the principal.

Rights and Obligations of the Agent:
Generally, the following are the most important duties of the agent under state common law: (a). Agent must not act outside of its express and implied authority.  (b). Agent must use care, competence and diligence in acting for the principal.  (c). Agent must obey the principal’s instructions as long as they are legal.  (d). Agent must avoid conduct which will damage the principal’s business. (e). Agent must not act for an adverse party to a transaction with the principal.  (f). Agent cannot compete with the principal in the same business in which the agent acts in such capacity for the principal without the principal’s consent. (g). Agent must provide the principal with information relevant to the marketing of the principal’s products. (h). Agent must separate, account for and remit to the principal all collections for the principal’s account and other property of the principal. (i). Agent must not receive compensation from any third party in connection with transactions or actions on which the agent is acting on behalf of the principal. (j). Agent must maintain the confidentiality of, and not misuse, the principal’s confidential information.

Rights and Obligations of the Principal:
 The following are the most important duties of the principal under state common law: (a). Principals must promptly pay terminated agents the commissions that they are owed; in most states, failure to pay can result in penalties, including multiple-damages.
 (b). Under the law of some states, an agency arrangement must be in writing, and certain formalities complied with, for the agency arrangement to be binding.
State law generally does not contain mandatory provisions on exclusivity. Indirectly, certain rules (such as the Statute of Frauds under New York law that requires that exclusivity provisions be in writing if they will exceed one year) may apply. Otherwise, parties to a commercial agency arrangement generally may agree contractually on the terms of exclusivity.

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Franchise Agreements under US Law

The interplay between federal and state statutory and common law in the US legal system is important to understanding the regulation of franchise agreements in the US. Franchise arrangements in the US are regulated at the federal and state levels. At the federal level, franchise arrangements are regulated by the US Federal Trade Commission (“FTC”) under the so called “FTC Franchise Rule,” while at the state level franchise arrangements are typically regulated by state agencies. In New York, franchise arrangements are regulated by the New York Antitrust Bureau under New York’s General Business Law. The FTC Franchise Rule applies everywhere in the US, while generally state franchise legislation requires contact with the state.

Under the FTC Franchise Rule, a franchise exists if the following elements exist: (i) the franchisee is given the right to distribute goods and services that bear the franchisor’s trademark, service mark, trade name, logo or other commercial symbol; (ii) the franchisor has significant control of, or provides significance to, the franchisee’s method of operation; and (iii) the franchisee is required to pay the franchisor (or an affiliate of the franchisor) at least US$USD 500 before (or within six6 months after) opening for business.

If a franchise is deemed to exist under the FTC Franchise Rule or under state law (and an exemption under such law is unavailable), the franchisor is required to comply with requirements that generally fall into three categories: disclosure laws, registration laws and relationship laws.

Formalities (registration, etc.):
 Registration laws like disclosure laws are pre-sale laws. There is no federal registration requirement. However, fourteen US states have registration laws (including California and New York). In the remainder of states, franchisors that comply with the Franchise Rule’s disclosure requirements can sell in states that do not require registration without having to file their document with any governmental authority.
Under most state registration laws, a franchisor must: (i) register in the jurisdiction before offering to sell or selling franchises in the jurisdiction by filing its FDD (or FOP), plus various application forms with the jurisdiction’s applicable regulatory agency, and (ii) update or renew its registration annually. As of 2016, franchise registration initial filing fees range from USD $250 (Hawaii, Michigan, North Dakota and South Dakota) to USD$ 750 (New York).

A franchise agreement typically grants the right to operate the business using the franchisor’s marks and system at a particular location and/or within a particular territory.
Sub-franchisee:
 There are two typical structures for franchise agreements: (i) a one tier structure consisting of a franchise agreement between a franchisor and a franchisee, or (ii) or a two-tier structure through a master franchise agreement where the franchisor grants the right and imposes a duty on a franchisee to operate the franchise itself within a particular territory, and to grant subfranchises to third parties within that territory.
 
Rights and Obligations of the Franchisee:
·        Fees and Royalties: under a typical franchise arrangement the franchisee is required to pay the franchisor an up-front franchise fee and royalties over time, in order to join the franchise network. Franchise fees can be large with a substantial profit element, or smaller to assist the franchisee to set up the franchise in a target territory. Because a franchise fee is a requirement under the FTC Franchise Rule and the laws of many states in order for a franchise to be deemed to exist, there is considerable jurisprudence on the question of what is considered to be a “franchise fee” for these purposes.
·        Marketing: typically a franchisee is required by the provisions of a franchise agreement to undertake advertising of the products in strict accordance with the franchisor’s instructions. A franchisor normally is prohibited from carrying out advertisement and promotional activities in a manner that could harm the franchisor’s brand or is inconsistent with the franchisor’s other advertising efforts.
·        Compliance with the franchisor’s standards: maintenance of consistent appearance, operations and array of products and services across multiple franchises is a hallmark of franchise arrangements in the US Most franchise agreements require that franchisees strictly abide by specifications, standards and operating procedures, each of which is built into the agreements. Given the difficulty of providing for all of these standards in a franchise agreement, many franchise agreements afford franchisors the right periodically to modify and increase the applicable specifications, standards (e.g., accounting) and operating procedures, usually by providing updates to the base operating manual.

Rights and Obligations of the Franchisor:
(A) Communication of know-how: initial know-how that may be communicated from franchisor to franchisee often relates to the specifications, standards and operating procedures that relate to the products to be sold and related site that are built into franchise agreements, as discussed above.
 (B) Ownership of improvements and modifications: franchise agreements typically contain acknowledgement by the franchisee that the trademark (and intellectual property generally) licensed under the franchise agreement and all related goodwill are property of the owner of the trademark (usually the franchisor). Therefore, all improvements to such intellectual property are property of the licensor.
(C) Assistance to the benefit of the franchisee: there are no statutory obligations on the federal and state level for initial or continuing assistance by the franchisor for the benefit of the franchisee.

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Summary of Changes under U.S. Tax Law Affecting U.S. Subsidiaries of Non-U.S. Manufacturing Groups

The 2017 Tax Cuts and Jobs Act (the "TCJA"), signed into law by President Trump on December 22, 2017, introduces sweeping changes in U.S. tax law, affecting businesses of all kinds.  This Practice Note focuses on a few key provisions of the TCJA particularly relevant to non-U.S. manufacturing corporations with U.S. distribution subsidiaries.  These changes in U.S. tax law may impact these companies operate now, as well as future plans for entering the U.S. market. 

Federal Corporate Income Tax Rate: 
Most significantly, the US federal corporate tax rate has permanently been reduced from 35% to 21%.  In addition, the corporate alternative minimum tax (which applied when higher than the regular corporate tax) has been repealed. 
The reduction of the headline U.S. federal corporate tax rate to 21%, which is a lower rate than in many of the home countries of non-U.S. corporations, will obviously benefit non-U.S. manufacturers with existing U.S. subsidiaries, and may influence those who sell directly into the U.S. to consider forming US subsidiaries and expanding their U.S. presence.

Under the TCJA, net business interest deductions are generally limited to 30% of "adjusted taxable income," which is essentially EBITDA (taxable income plus depreciation and amortization deductions) for years 2018-2021 and EBIT (taxable income without adding back depreciation/amortization). Disallowed interest expense is carried forward indefinitely. Before the TCJA, interest was generally deductible when paid or accrued, subject to numerous limitations, including debt/equity ratios and taxable income.  U.S. corporations - other than small businesses (average annual gross receipts under $25 million, on an affiliated group basis) - are subject to these limitations. 
The TCJA's limitation on interest deductions are designed to protect the U.S. tax base.  As a result, non-U.S. manufactures with existing U.S. subsidiaries, and those planning to establish U.S. subsidiaries, may decide to reduce or limit the amount of debt in their U.S. subsidiaries.
 
At the following link you can find more material about the US Distribution:                

 

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