Two key safety valves for contracts with distributors

This week’s musings on tech contracts

Here are two tips for software distribution contracts. They’re for any software provider retaining another company as a distributor. That includes value-added reseller (VAR) and original equipment manufacturer (OEM) deals.

If you get a percentage of distributor revenues, set a minimum royalty.

Imagine you get a 20% royalty on sales of your software (or sales of the distributor’s VAR or OEM product containing your software). The distributor makes sales and charges its customers … little or nothing. You get (a) 20% of little or (b) 20% of nothing (hint: nothing).

Why would your distributor do that? It might sell for chump-change as part of a larger deal — one that includes its other products. Or it might give your product away as a promotion.

The solution is a minimum royalty. “Distributor shall pay Provider a royalty of 20% of gross revenues received for the Software, provided such royalty will not fall below $__ per copy of the Software distributed.” That should solve it.

You might think you could instead give the distributor a minimum price. The distributor won’t sell for less than $X. But fixing a price has high odds of violating antitrust law (“price fixing”). A minimum royalty does not. (If you really want a minimum price clause, talk to an antitrust / unfair competition lawyer.)

If you grant exclusive rights to distribute, add “reasonable efforts” or another safety valve.

What if you grant exclusive distribution rights in a territory or worldwide … and your distributor doesn’t work hard on sales? You’ve basically shelved your software. You can improve the situation with the ever-popular, never clear reasonable efforts requirement. “Distributor shall exercise reasonable efforts to market and sell the software.” That’s doesn’t clearly demand the sales efforts you want. But if your distributor just doesn’t bother, it’s in breach. And if your distributor tries but not much … it could be in breach, and you want that to worry your distributor. (You could play with the language: “best efforts,” “super-powered efforts,” etc. But these hierarchies of efforts are mostly meaningless.)

You’ll get more protection with more specific terms. Give yourself the right to terminate the contract or at least to terminate exclusivity if the distributor misses a sales mark. “If Distributor fails to collect gross revenues of $___ from Software distribution during any calendar year, Provider may terminate this Agreement at any time during January of such calendar year.”

If you’d like to learn more, check out The Tech Contracts Master Class™, which covers software distribution terms, among many other IT contract provisions. See also Chapters I.G.2 and II.G of of The Tech Contracts Handbook.