The Importance of Distribution or Agency Contract for SMEs – Accountant’s Perspective
In a typical day to day operation of SMEs, the movement of goods and services between the business and supplier takes the center stage. It is the lifeline of a business in any given market by ensuring goods and services are available to the end consumer on a predictable and consistent manner.
For Malaysian entities, the business and supplier relationship would normally be governed by 2 main legislations, namely the Contract Act 1950 and Sales of Goods Act 1957. These legislations provide guidelines on how a contract should be drafted and executed in protecting the interest of the business and supplier engaging in commercial transactions in Malaysia. However, if the supplier is a foreign entity, the default distribution or agency contract may be drafted by the foreign supplier and executed in such a manner that the provision of the contract is to be only enforceable at the court of law where the foreign supplier is originated from, in this case in a foreign country. It is important to note that certain foreign legislation may not be adopting “common law” basis of judgement on civil cases arising from breach of contract as what is practiced in the court of law in Malaysia, for example, in Germany, the basis of judgement is based on codified or civil law provision, which is entirely different from Malaysia. Furthermore, as non-EU member company litigating in Germany on contract matters, you may not be entitled to exemplary damages that typically available to EU member companies. Therefore, Malaysian SMEs must consider these differences before executing the contract and be aware of the consequences and its implication on the quantum of compensation and exemplary damages (if any) in the event of dispute. Ideally, the jurisdiction of the contract should be negotiated to allow neutral footing for both parties when resolving certain issues.
Despite the availability of the Acts in Malaysia to protect the interest of various parties, some SMEs fail to maximize this opportunity. For instance, many SMEs do not form a contract with its main suppliers. Their relationship remains informal and typically based on trust. The reasons for not negotiating contracts can differ greatly from one company to another. Often, SMEs worry about the imposition of strict requirements when negotiating a contract. Consequently, in the absence of a contract, the possibility that a supplier might choose not to serve the business and instead divert supplies to a larger competitor is being overlooked and neglected. The inability to secure continuous supply may cause the business to suffer greatly financially if the supplier’s product makes up the bulk of its revenue. In the absence of a written contract, the chances to remedy the situation can be greatly impaired, at times can be costly as well.
In other instances, Malaysian based SMEs that are representing foreign suppliers as its exclusive distributor/agent in Malaysia fail to form an exclusive distribution/agency contract, instead SMEs rely merely on a “letter of representation/appointment as exclusive distributor/agent in Malaysia” issued by the foreign suppliers in believing that this letter can protect its business interest in Malaysia in the event of dispute. In essence, the said exclusive representation/appointment letter may not be considered as a contract as it may not possess the terms and conditions worthy of a contract such as provisions to deal to with specific situation such as legal status of the relationship (exclusivity), territories granted, contract validity period, termination clause, jurisdiction clause, arbitration clause, liquidated damages and many others, like how a full-blown contract should be. Without specific terms and conditions, the legal status of the relationship between the foreign supplier and the Malaysian distributor/agent is questionable and doubtful, less sustainable and unpredictable especially in the event of dispute. In a common law situation, at least implied actions can be considered by taking into account precedent judgements, in addition to any written confirmation, even though the written confirmation is questionable. However, in a codified or civil law provision situation, the exclusive representation/appointment letter lacking the terms and conditions of a contract may be open to dispute on the validity and existence of any legal relationship between parties. In this case, the business can be regarded as just merely “an ad hoc” distributor with no mutual commitments.
The importance of contract in commercial transactions is so significant. Becoming a distributor/agent of a particular product, either exclusive or non-exclusive basis, requires large amount of capital, not to mention the amount of time required to be invested over a long period of time to build the brand loyalty and acceptance. Payback period of such investment can take years. Therefore, it is quite logical for any responsible businesses to execute contract in protecting the interest of the business. With a contract intact, any unforeseen circumstances with supplier, such as unlawful termination or other contract breaches can be remedied and compensated sufficiently.
In addition, the existence of contract with reputable supplier can provide premium valuation should the business is offered for sale to willing buyer.
Although this article refers mainly on the contract relationship between the business and its supplier, it is also equally important to form contract between the business and its customer. Similar principle can be applied.
This article is the property of the firm and for information purposely only. Written approval is required from the firm for personal and/or commercial use by third party/parties. Further, this is not a legal opinion. Businesses are required to engage professional accountants and legal practitioners in formulating a contract.
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