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  August 7th, 2016 | Written by

Examining the International Distribution Buyback Clause

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  • Should you include an escape clause in your international distribution contract?
  • A buyback clause in a distribution agreement is the equivalent to the dating profile that specifies “nothing serious.”
  • A strictly legal perspective is only one facet of a complex business relationship.

Many U.S. exporters, in an effort to keep their options open, include an escape clause in their distribution contract. In essence, the clause gives them the option to dissolve a bad distribution partnership after a specified time. Usually, some form of buyback (either of unsold inventory or of a distributor’s built market equity) is built into the provision, leading to the buyback clause nomenclature. At first blush, the escape option seems like a great idea. More options equal greater leverage, which equals reduced risk for the multinational, right? Not necessarily.

David Arnold argues in the Harvard Business Review that the buyback clause may actually undermine your distribution arrangement. Paradoxically, if he is right, the escape option may cause the very thing it aims to protect you from. Arnold’s rationale? In trying to hedge its bets, the multinational signals to its international distributors that it lacks commitment to long-term, quality relationships. It’s the equivalent to the dating profile that specifies “nothing serious.”

If your overseas partner senses, correctly or not, that you’re using them as a short-term market-entry vehicle, their own selfish interest would dictate that they mine the relationship for as much short-term profit as they can. This rarely benefits you, the exporter. Arnold reports that “the manager of a consumer goods company” had multiple foreign distributors drop their prices to boost short-term revenue. These distributors believed that gross revenue determined the buyback prices, so their goal centered on getting the best buyback deal possible. While this made sense to the distributors, given the expected short-term nature of the relationship, it sabotaged the multinational, which had its “market positioning strategies” completely undermined.

In business, as in diplomatic relations, perception is everything. The First World War was largely precipitated by the perceptions (and misperceptions) of Russia, England, Austria, France, Germany, and various other players about the intentions of the rest. In the same way, the perceptions you have about your distributor’s intentions—long-term or short, benefitting both parties or primarily one at the expense of the other—are everything. And vice versa. Acting on perception of the other’s intentions, you each act accordingly, influencing the course of the relationship from the outset.

Caterpillar does the opposite. It’s how the company avoided losing its global market share to the lower-priced Komatsu. (Full disclosure: Komatsu is a US Translation Company client). In the battle between the two heavy equipment manufacturers, Caterpillar built a superior distribution network, with distributors treated as absolutely vital to Caterpillar’s success, which they were. In turn, distributorships typically remained in the same hands for decades, often being passed down to subsequent generations of the same family.

As though further reason were needed to avoid the buyback clause, such clauses are often worthless, or nearly so. If the distributor refuses to honor the buyback, they can drag the multinational into their local courts for a protracted battle. Not only do you risk spending vast amounts on legal fees, you run the gamble that a foreign court will rule in favor of your distributor.

Don’t take this as legal advice. It’s not. Hopefully, this article gets you thinking about the pros and cons of the escape clause, and how those apply to your particular distribution situation. Some sectors may be more suited to the clause than others. Naturally, any attorney would recoil in horror at the thought of the omission of a buyback clause. And their perspective is not wrong. However, the strictly legal perspective is only one facet of a complex business relationship. Other dynamics demand careful consideration before you decide whether or not to include an escape route in your distribution contract.

Jacob Andra heads research and marketing for US Translation Company, a localization firm that helps US exporters customize their product offerings for foreign markets.