When a contracting party decides that the counterparty is worth an exclusive commitment, such a decision often rests on some minimum expectations and basic assumptions. But, in light of Murphy’s law, it may be worthwhile to put the proposed union through a stress test.
Exclusive contractual relationships can take several forms, such as an exclusive supplier, distributor, or licensee. Depending on the nature of the relationship and the particular circumstances, some “it’s just not working out” scenarios may be more plausible than others.
Tensions could rise due to the following:
- Lack of Effort
- The supplier may not diligently deliver high-quality timely products/services
- The licensee may not dedicate many resources to developing the proposed commercial offering
- The distributor may not widely sell and distribute the products/services
- Lack of Resources
- The counterparty may have financial difficulties
- The supplier may experience shortages
- The licensee may be a startup that cannot scale quickly
- Changes
- The counterparty may be sold to or merge with a new company
- The counterparty may pivot its business model or focus
- The counterparty may become a competitor, possibly due to an acquisition or other corporate change
- The market or intellectual property landscape could change significantly
- Antitrust or other regulatory constraints could materialize
- Bickering
- One or both parties may challenge the other’s intellectual property rights
- One or both parties may disparage the other publicly
- One or both parties may be in material breach of the contract
In connection with one or more of these scenarios, a licensee or distributor, for example, might market and sell the products/services merely part of the time or only in a small portion of the territory or field. One way to incentivize and verify diligence is to establish milestones or minimums that, if not met, can serve as objective triggers. Other triggers could include a bankruptcy event, certain delivery failures or other breaches, or a change of control.
Note that the parties can decide how best to respond to a trigger:
- Making Things Right
- Example: The licensee pays a minimum fee to maintain exclusivity
- Example: The counterparty gets an opportunity to cure the failure if it provides a detailed plan for doing so
- Taking a Break
- Example: Exclusivity does not apply until the missed milestone is achieved by a certain date
- Example: Exclusivity does not apply until the supplier has a minimum inventory of the products
- Just Being Friends
- Example: The exclusive license becomes nonexclusive thereafter
- Example: The excusive territory or field is narrowed
- Calling it Quits
As always, the actual agreement language matters. For example, if the exclusivity or noncompetition provision prohibits not just the activity itself (e.g., buying the product from a third party) but also prohibits reaching an agreement to engage in the activity (even if the actual conduct is in the future and/or conditional), then, when exclusivity eventually ends, a party may find itself with no practical alternative for months while it negotiates with the new supplier, licensee, or distributor.
When parties are excited about a new opportunity and want to demonstrate their commitment, they may feel that including a long list of exceptions to exclusivity will send the wrong signal. One way to explain the need for this contract language, and discussion, is to give examples of situations where exclusivity would be unworkable, such as where the supplier’s inventory is too low to meet demand. Another proven approach, of course, is to “blame the lawyers.” Through a healthy discussion and careful drafting, the parties might find themselves better prepared to productively handle a difficult situation without resorting to a battle or a breakup.