A foreign company that sells its products in China through a Chinese distributor is entrusting its brand, its market position, and its China revenue to a third party that it may never have met in person. The distributor controls the pricing, the marketing, the customer relationships, and the after-sales service — and if the distributor does a bad job, it’s the foreign brand that’s damaged, not the distributor’s brand.
A well-drafted distributor agreement is the foreign company’s primary tool for managing the distributor relationship. It defines what the distributor can and can’t do, and it gives the foreign company the right to terminate the relationship if the distributor doesn’t perform. Here’s what the agreement should cover and how to make it enforceable in China.
The Territory and the Exclusivity
The territory clause defines the geographic area in which the distributor is authorized to sell the products. A nationwide territory — “the People’s Republic of China” — gives the distributor the right to sell anywhere in China, and the foreign company can’t appoint another distributor in the same territory. A provincial territory — “Guangdong Province” — limits the distributor to a specific region, and the foreign company can appoint other distributors in other provinces.
The exclusivity clause defines whether the distributor is the exclusive distributor in the territory, or whether the foreign company can sell directly to customers in the territory or can appoint other distributors. An exclusive distributor has the sole right to sell the products in the territory, and the foreign company commits not to sell to any other party in the territory. A non-exclusive distributor shares the territory with other distributors or with the foreign company’s direct sales.
The exclusivity decision is a strategic trade-off. An exclusive distributor is more motivated to invest in the brand and to build the market, because the distributor captures the full benefit of the investment. But an exclusive distributor that’s not performing is hard to replace — the foreign company terminated the exclusive distributor and appointed a new one, but the new distributor is starting from scratch, and the market was built by the old distributor.
A better approach for a foreign company that’s entering the China market is a limited exclusivity — the distributor is exclusive for a trial period — twelve months, eighteen months, twenty-four months — and the exclusivity continues only if the distributor meets the performance targets. The limited exclusivity gives the distributor the incentive to invest, and it gives the foreign company the right to terminate the exclusivity — or to terminate the agreement entirely — if the distributor doesn’t perform.
The Performance Targets
The distributor agreement should include performance targets — the minimum sales volume, the minimum sales revenue, the minimum market share, or the minimum number of customers that the distributor must achieve. The targets should be specific, measurable, and achievable — a target that’s set too high is demotivating, and a target that’s set too low doesn’t drive performance.
The performance targets should be reviewed annually and adjusted for the market conditions, the product changes, and the competitive environment. A target that was set in 2024 based on the 2023 market may be unrealistic in 2025 if the market has changed. The annual review gives both parties the opportunity to discuss the market and to agree on the targets for the next year.
The consequence of failing to meet the performance targets should be specified. The foreign company should have the right to terminate the exclusivity — the distributor becomes non-exclusive — or to terminate the agreement entirely — the distributor is replaced. The right to terminate for non-performance is the foreign company’s ultimate leverage, and it should be exercisable without penalty.
The Pricing and Payment Terms
The distributor agreement should define the pricing structure — the ex-works price, the FOB price, or the CIF price — and the payment terms — the deposit with the order, the balance against the shipment documents, or the open account with a credit limit.
The pricing should be in a stable currency that both parties accept — the US dollar is the most common currency for international distribution agreements, though the RMB is increasingly used. The currency choice affects the foreign exchange risk — a US dollar price shifts the foreign exchange risk to the Chinese distributor, who must convert RMB to dollars to pay the foreign company — and the foreign exchange controls — the distributor must obtain the foreign exchange from the bank, and the bank requires the import documentation.
The payment terms should protect the foreign company’s cash flow. A deposit with the order — typically 30% — covers the foreign company’s production cost and reduces the risk of a cancelled order. The balance against the shipment documents — the bill of lading, the commercial invoice, the packing list — ensures that the foreign company receives payment before the goods are released to the distributor. An open account — the distributor pays 30 days or 60 days after receiving the goods — is the most favorable to the distributor and the riskiest for the foreign company, and it should be offered only to a distributor with an established payment history.
The payment terms should also address the late payment consequences — the interest on overdue payments, the suspension of further shipments, and the right to terminate the agreement. A distributor that’s consistently late in paying is a credit risk, and the foreign company should have the right to stop supplying until the overdue payments are made.
The Brand Protection
The distributor agreement should protect the foreign company’s brand in China. The distributor should be required to use the foreign company’s trademarks, logos, and marketing materials in the form and the manner specified by the foreign company. The distributor should not be permitted to modify the trademarks, to create composite marks that combine the foreign company’s mark with the distributor’s mark, or to register the foreign company’s marks — or confusingly similar marks — in China.
The trademark registration is a critical issue. The foreign company should register its trademarks in China — through the China National Intellectual Property Administration — before entering into the distributor agreement. A distributor that’s asked to register the foreign company’s trademark in China — “we’ll handle the trademark registration for you” — may register the trademark in the distributor’s own name, and the foreign company loses control of its brand in China. The foreign company should own the Chinese trademark registration, and the distributor should be a licensed user.
The distributor agreement should also prohibit the distributor from manufacturing, selling, or distributing products that compete with the foreign company’s products. The non-compete should apply during the term of the agreement and for a reasonable period after the termination — typically twelve to twenty-four months — and it should cover the distributor’s affiliates and the distributor’s key personnel.
The Termination and the Transition
The termination clause is the most important clause in the distributor agreement from the foreign company’s perspective. The foreign company must have the right to terminate the agreement for cause — the distributor’s breach of the agreement, the distributor’s failure to meet the performance targets, the distributor’s insolvency — and for convenience — the foreign company decides to change its distribution strategy or to establish its own WFOE in China.
The termination for cause should be effective on notice — the foreign company sends a termination notice, and the agreement is terminated. The termination for convenience should be effective on a notice period — typically three to six months — that gives the distributor time to wind down the distribution and to sell the remaining inventory.
The transition upon termination should be managed through the agreement. The distributor should be required to sell the remaining inventory to the foreign company — at the original purchase price, or at a discount — or to return the inventory to the foreign company. The distributor should be required to transfer the customer information — the customer names, the contact details, the purchase history — to the foreign company or to the successor distributor. The distributor should be required to cease using the foreign company’s trademarks, to remove the foreign company’s signage from the distributor’s premises, and to return the foreign company’s marketing materials and technical documentation.
The transition is the hardest part of the termination because the distributor has the customer relationships and the market knowledge, and the foreign company — or the successor distributor — must rebuild those relationships. A smooth transition requires the distributor’s cooperation, and the cooperation is more likely if the termination terms are fair and if the distributor has an incentive to cooperate — the termination compensation, the inventory buyback, or the ongoing business relationship with the foreign company in other markets.
