Corporate and M&A

Introduction

It is common that agency and distribution contracts provide a minimum order undertaking for the agent and the distributor. According to such provisions, the agent or the distributor undertakes to purchase a minimum amount of product from the principal or the supplier. Under the contract, several consequences may be attached to the failure to purchase the pre-determined minimum amount.

In principal or supplier-friendly contracts, non-attainment of the guaranteed minimum order entitles the principal or supplier to terminate the contract without a notice period, to cancel the agent’s or the distributor’s exclusivity, to reduce the territory allocated to the agent or the distributor, and to claim for damages. In more balanced contracts, the principal or the supplier is entitled to the same rights as the principal or supplier-friendly contracts; however, the existence of objective reasons prevents the principal or the supplier to exercise its rights that cause non-fulfilment, and which the agent or the distributor could not foresee, and for which he is not responsible. Further, a right to catch-up may be granted to the agent or the distributor in subsequent years. Finally, the agent or distributor-friendly contracts do not consider non-attainment as a breach of contract.

This Newsletter examines the conditions and consequences of compensation of damages among the consequences of non-attainment of guaranteed minimum order in agency and distribution contracts.

Compensation of Damages / Loss of Profit

An agency or the distribution contract may explicitly provide for the principal or supplier’s right to claim for damages: In other words, for loss of profit. Pursuant to such provisions, the principal or the supplier is entitled to damages in the amount of its loss of profit due to the missing order in the relevant year. If the contract is silent with respect to damages, but the other consequences of non-attainment, such as termination, are expressly specified, one could argue that the parties intended to cover only the specified consequences and exclude the damages. In such a case, whether or not loss of profit may be claimed shall be determined in accordance with the applicable laws. Principals or suppliers choose to explicitly regulate their right to damages in the contract in order to prevent such possible disputes.

Another issue to be examined is the situation where the agent or the distributor was not at fault in the failure of its commitment, although damages are specified under the contract. In some jurisdictions, e.g. Turkey, the agent or the distributor will be released from liability for damages if the agent or the distributor was not at fault.

In order to avoid difficulties in evidencing the damages, and to prevent any possible disputes that may arise in relation to the calculation of the damages, it is common that the principals or the suppliers include in the contract a penalty in the amount of the missing order for the relevant year instead of compensation for damages. Accordingly, in case of failure to meet the guaranteed minimum order, the principal or the supplier would be entitled to the penalty amount determined under the contract without the need to evidence the amount of damages.

Period for which the Loss of Profit may be claimed

In considering definite term contracts, the principal or the supplier is entitled to claim for the loss of profit with respect to the time period until the end of the term of the contract. In indefinite-term contracts, it may bring such claim for the time period until the end of the following notice period for termination.

Previous Years’ Loss of Profit

In the event the principal or the supplier continues to be bound by the contract, although being aware of the non-attainment, i.e. the breach of the contract, whether or not loss of profit for the past years may be claimed may differ depending on applicable laws. In such cases, facts of each specific case should be evaluated. In most cases, claiming for the previous years’ loss of profit, although the contract has been active, is considered as a violation of the good faith principle, and the principal or the supplier is deemed to have waived its right to terminate the contract due to the previous years’ non-attainment. In such a case, the principal or the supplier should not be able to claim for the loss of profit of the preceding years, and can claim for damages only in the amount of the profit for the period in which it terminated the contract. The Turkish Court of Cassation has rendered differing decisions on the subject.

• Opinion of the Turkish Court of Cassation stating that the previous years’ loss of profit cannot be claimed: The 19^th Civil Chamber of the Court rendered a judgment in line with our above-explanations in its decisions dated 16 January 2014[1] and 24 April 2014[2] and stated that in the event of contracts containing a minimum order of commitments, including periodic performances, continuing to supply products following the end of a period without making a reservation or a notification, shall be deemed as a tacit waiver of the penalty claim pertaining to the previous period and, in such a case, the case penalty receivable may be claimed by the claimant for only the last year, and the defendant shall be liable only for such amount.
• Opinion of the Turkish Court of Cassation stating that the provisions relating to the guaranteed minimum order cannot be applicable to any period: On the other hand, in its decision dated 16 January 2013[3], the Assembly of Civil Chambers of the Court approved the decision of the court of first instance rendered on the grounds that “the claimant did not file a lawsuit, although the penalty that it claimed by way of a formal notification from the defendant due to missing product purchase within the first year following 06.10.1998 in which the distribution relationship was established, was unpaid by defendant; it maintained a distribution relationship with the distributor, although the defendant did not purchase products throughout the entire following 9 years in the amount it had committed to; this situation means that the claimant tacitly waived the enforcement of the tonnage undertaking and penalty provisions regulated under Article 15 of the distribution contract; the defendant did not purchase fuel oil products from third parties during the term of the contract, and the claimant continued to supply product to the defendant, and accepted the consideration of the products without making a reservation, although the defendant never purchased fuel oil products from the claimant in the minimum amount specified under the contract; in light of these circumstances, Article 15 of the contract has been de facto removed from the contract; a nine-year lasting practice has been established so that the minimum order commitment shall not apply, and a penalty shall not be claimed,” and ruled that the penalty cannot be claimed not only for the previous years but also for the last year.

According to the Assembly of Civil Chambers, due to the long-established business relationship between the parties, the fact that a party replied to the order of the other party directly by sending the product after a time without making an acceptance declaration (de facto acceptance) within the scope of the practice until then, creates a sense of trust so that the situation will continue the same as before[4]. Accordingly, the Assembly states that the continuance of the commercial relationship by the parties for the contract’s remaining period of nine years despite the formal notifications, sale by the defendant distributor of products in an amount below what he had committed to sell each year under the contract, and the fact that the claimant company did not respond (or remained silent) to the formal notification served by the defendant distributor, and supplied products to the defendant company throughout the term of the contract created a justified trust in the defendant distributor that the Article regulating the penalty of the distribution contract between the parties shall not be applicable, also considering that this distribution relationship lasted between the parties for the remaining term of the contract. The defendant distributor continued to purchase products from the claimant company due to such justified trust; however, it has been unexpectedly requested by the claimant company to pay the penalty following the termination of the contract. Therefore, the source of the fact that has arisen due to the agreement not to apply Article 15 of the distribution contract is a justified trust. Such trust liability is a condition of the principle of good faith. More importantly, the fact that the claimant company requests a penalty following the termination of the contract in breach of the trust it created in the defendant distributor constitutes the prohibition of contradictory behaviour, and such behaviour cannot be expected to be protected in legal terms.

On the other hand, the principal or the supplier would have the right to terminate the contract and claim for the past years’ loss of profit, if it proves that it tolerated such breach in the past year, trusting that the agent or the distributor would remedy the breach; or it notified the agent or the distributor to cure the breach, and explicitly reserved its rights arising from such breach; or the relationship became unbearable (e.g. the agent or the distributor not making any efforts to reach the targets, or making less purchases than before).

• Opinion of the Turkish Court of Cassation stating that the previous years’ loss of profit shall not be deemed to have been waived: In the decision of the 19^th Civil Chamber of the Court dated 13 May 2013[5], the following is argued: “The fact that the claimant continued to supply products at the end of each year despite the breach of the commitment does not mean a waiver of the penalties to be applicable in case of breach of the commitment regulated under the contract. This is because there is a possibility that the distributor may fulfil its commitment in the continuing process and such a supply is a right granted to the distributor. In the specific case, it is understood that the defendant company failed to fulfil its commitment in the continuing process, including the legal proceedings, despite such right that it is entitled to.” Here, as explained above, the supplier expects the distributor to fulfil its commitment in the upcoming years. It is probable that, in the distribution contract subject to the lawsuit, a right to catch-up might have be granted to the distributor in subsequent years.

No Waiver Clauses

The consequences should be evaluated also in the event that there is a “no waiver” clause under the contract. “No waiver” clauses regulate that non-exercise of the rights under a contract, in whole or in part, does not mean a waiver, and reserve such rights. If the principal or the supplier remains silent for a long period of time after the violation, it could be argued that the “no waiver” clause will not be effective, and that such clause itself was waived. General “no waiver” clauses are usually not deemed valid; however, if it is specifically regulated under the contract that non-exercise by the principal or the supplier of its right to termination in the event of non-attainment by the agent or the distributor would not constitute a waiver of such right, it is possible that such a clause will be considered valid by the courts and the previous years’ loss of profit will also be awarded.

Conclusion

It is common that agency and distribution contracts provide a minimum order undertaking, and entitle the principal or supplier to terminate the contract without a notice period, to cancel the agent’s or the distributor’s exclusivity, to reduce the territory allocated to the agent or the distributor, and to claim damages for non-attainment. In accordance with the relevant provisions, the principal or the supplier is entitled to damages in the amount of its loss of profit due to the missing order in the relevant year.

In the event the principal or the supplier continues to be bound by the contract although being aware of the non-attainment, i.e. the breach of contract, whether or not the loss of profit for the past years may be claimed may differ depending on applicable laws. In such cases, the facts of each specific case should be evaluated. The Turkish Court of Cassation has rendered differing decisions on the subject. Claiming for the previous years’ damages, although the contract has continued, is usually deemed as a violation of the good faith principle, and it is accepted that the principal or the supplier has tacitly waived its claims pertaining to the previous years’ damages, and that it can request the compensation of its damages only for the period in which it terminated the contract.