Many foreign brands targeting Chinese consumers prefer to collaborate with local distributors in China to sell their products, aiming to save on market operational costs. From the perspective of Chinese distributors, intellectual property (IP) clauses are often the focal points of their distribution agreements with brand owners.
Besides carefully scrutinising conventional IP clauses, conducting antitrust scrutiny on relevant terms is a crucial step that cannot be overlooked.
Typically, to maintain effective brand operations, brand owners often impose strong controls on distributors regarding distribution channels, pricing and markets. As relatively weaker parties, distributors often accept such constraints.
However, if these controls exceed the limits permitted by law, distributors should promptly identify them, avoid making commitments beyond their scope, and also steer clear of antitrust penalties.
IP clauses
Senior Associate
Shanghai Pacific Legal
Brand owners often protect their IP through robust IP clauses. These typically include:
- Prohibition of IP registration/challenge clauses;
- Restrictions on the use of relevant brand identifiers and trademarks;
- Infringement notice and enforcement co-operation clauses;
- Post-termination IP disposal clauses; and
- IP-related audit clauses.
From the brand owner’s perspective, the clauses can protect their IP from being adversely affected or harmed by a distributor’s unreasonable business operations. However, from the distributor’s perspective, brand owners attaching requirements beyond normal brand protection in these clauses could potentially harm the distributor’s commercial interests.
Regarding these clauses, distributors can strive for the following during initial negotiations:
Prohibiting registration clauses.
Registering trademarks without hitchhiking, distributors can insist on registering their own IP while also requiring a clear delineation of respective IP rights in the agreement. Additionally, concerning patents, if brand owners prohibit distributors from applying for patents in the same technical field as their products, or challenge the validity of their IP, it could trigger relevant antitrust provisions.
Restricting brand identifiers and trademark usage clauses.
Distributors can demand clear guidelines on relevant identifiers and trademark usage instructions from brand owners. Additionally, in the contract, they can stipulate reasonable deadlines for brand owners to review related marketing materials to uphold their legitimate operating rights.
Infringement-related clauses.
Distributors co-operating with brand owners in responding to infringement notices and enforcement actions also contribute to maintaining the distributors’ relevant market share. However, regarding the allocation of enforcement costs and compensation amounts, distributors should negotiate and agree with brand owners in advance to avoid disputes later on.
Audit clauses.
Besides negotiating audit clauses, distributors should pay attention to protecting other business secrets beyond the scope allowed for audit. For example, distributors should agree with brand owners on the scope of data disclosed during audit activities, to prevent leakage of other business information.
Ownership agreements for IP.
During negotiations, distributors should ensure clear agreements on the ownership of IP generated during the distribution relationship, striving for ownership of IP they newly develop independently, and joint ownership of IP developed jointly with the brand owner.
Channel control
Brand owners typically implement channel control for specific markets to control the sale of their products in those markets. Channel control includes measures such as sales territory control, price control, product control, and research and development control.
However, while channel control brings more advantages to brand owners, it significantly limits the operating actions distributors can take, weakening their competitiveness with other distributors. Therefore, some channel control measures may raise antitrust issues, and distributors should identify and guard against monopoly-related risks.
Minimum resale price maintenance.
Price control is one of the most common channel control measures used by brand owners, often manifested as setting minimum resale prices for distributors. Brand owners typically include price control clauses in distribution contracts to avoid brand devaluation from low-price competition and prevent distributors from free-riding.
However, minimum resale price restrictions often have anti-competitive attributes and may constitute monopolistic behaviour in violation of the Anti-Monopoly Law, leading to adverse legal consequences.
Market division.
The Anti-Monopoly Law prohibits monopolistic agreements between operators with competitive relationships from dividing sales markets. However, in practice, both parties in the distribution relationship may wish for distributors to sell within their respective sales territories.
Additionally, in many cases, brand owners not only use distributors but also directly import goods into mainland China for sale. Consequently, brand owners and distributors may have a competitive relationship in the market. In such cases, if brand owners still negotiate and reach agreements with their distributors on territorial division in the sales market, they may incur penalties for violating the Anti-Monopoly Law.
In conclusion, even though distributors may be in a weaker position in their business relationships with brand owners, when facing terms with associated legal risks, they should promptly identify them and negotiate with brand owners to seek alternative means of achieving balance. This can help avoid facing administrative penalties or even civil litigation compensation later on.
Ding Xiaodi is a senior associate at Shanghai Pacific Legal
Room 2709, 27/F, Plaza 66 II
1266 Nanjing Road West
Shanghai 200040, China
Tel: +86 21 6086 0199
Fax: +86 21 6086 0111
Email: xiaodi.ding@shanghaipacificlegal.com
