Distribution law in China

Agency Agreements

There are no specific provisions on Agency Agreements in the Peoples' Republic of China (PRC) law. The general provisions of the PRC Contract Law and, in particular, Articles 396 et. seq. regarding entrustment agreements and Articles 424 et. seq. regarding commission contracts apply.

Formation of Agency Agreement

Are there any formal requirements on concluding Agency Agreements?

Under PRC law, an Agency Agreement can be entered into both verbally or in writing. There are no special formalities to be taken into account. For evidentiary purposes, we recommend setting out the Agency Agreement in writing.

Under PRC law, written form means any form in writing, such as documents, letters and electronic data (including a telegram, telex, fax, electronic data exchange and email) which is capable of expressing the relevant contents in a tangible form. For contracts between a Chinese Principal and a foreign Commercial Agent the written form is also recommendable for reasons of foreign exchange control. All cross-border payments to be made from the PRC to a foreign country are subject to the control of the competent administration for foreign exchange. For current account transactions, certain documents must be submitted to the transferring bank. For the transfer of the agency fee to a foreign country, inter alia, the relevant contract and the invoice must be submitted.

Are there any specific information obligations on concluding Agency Agreements?

Statutory law does not provide for any specific information obligations regarding the conclusion of Agency Agreements.

Under PRC law, a general obligation exists to correctly answer questions and to provide certain crucial information without special request prior to entering into an agreement (culpa in contrahendo, see Article 42 of the PRC Contract Law). As far as we can see, there are, however, no relevant court precedents invoking culpa in contrahendo regarding information obligations when concluding Agency Agreements.

Are there any specific pitfalls which need to be borne in mind when concluding Agency Agreements?
  • While contracts between two PRC parties are mandatorily governed by PRC law, the parties to a foreign-related contract may choose the governing law, unless otherwise provided by mandatory PRC law. As a matter of principle, foreign-related contracts are in any case those in which at least one contracting party is a foreigner or a foreign company.
  • It is further recommendable to provide for a valid arbitration clause in an Agency Agreement to be concluded with a PRC party. Civil legal disputes which are not resolved through negotiations and amicable settlement between the parties can generally be finally resolved by either litigation or arbitration.According to PRC law, the parties to an Agency Agreement may either choose a court or an arbitration institution to resolve a dispute. In foreign-related Agency Agreements, the parties are allowed to choose a foreign court or a foreign arbitration tribunal. However, due to a lack of international treaties and reciprocity, judgments of many foreign courts are not enforceable in the PRC. Further, PRC People’s Courts sometimes still tend to protect the local party compared to a foreign party. Therefore, in most cases, arbitration is preferable compared to litigation. Foreign arbitral awards are generally enforceable in the PRC on the basis of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards.In Agency Agreements without a relevant foreign element, it is not possible to agree on a foreign court or a foreign arbitration institution under PRC law. In such case, arbitration before a Chinese arbitration institution such as CIETAC, SHIAC or Beijing Arbitration Commission is often a good alternative.
  • PRC law further differentiates – also in b2b situations – between individually agreed agreements and standard terms and conditions.
  • Standard terms and conditions are deemed to exist if the respective contract terms were prepared in advance by a party for repeated use and if they have not been negotiated with the other party in the course of concluding the contract.Article 39 of the PRC Contract Law generally requires that where a contract is concluded by use of standard terms and conditions, the party providing the standard terms and conditions shall abide by the principle of fairness when determining the rights and obligations of the parties, and shall, in a reasonable manner, draw the attention of the other party to clauses which restrict its liability and, if so requested by the other party, explain such clauses. In Article 6 of its Interpretation on Several Issues Concerning the Application of the PRC Contract Law, Part 2, the PRC Supreme People’s Court states that “reasonably drawing the other party’s attention” requires that the party providing the standard terms and conditions shall use, at the time of conclusion of the contract, a special indication, such as words, symbols or a font sufficient to draw the attention of the other party to provisions of such standard terms and conditions which restrict that party’s liability. According to Article 40 of the PRC Contract Law, a standard term is, inter alia, invalid if it excludes the liabilities of the party supplying such term, increases the liabilities of the other party or deprives the other party of any of its material rights.Regarding individually agreed contracts, generally, a vast freedom of contract exists. We, therefore, recommend to make an explicit reference to the application of standard terms and conditions in the respective individual contract and to stipulate the most essential contractual provisions also in an individual contract which shall be signed by both parties.

Scope of Commercial Agency

Are the parties free to agree on the scope of the Commercial Agency?

The Principal and the Commercial Agent are free to agree on the scope of the Commercial Agency. In particular, the parties may decide on instructing the Commercial Agent (1) worldwide or for a certain geographic region, (2) for all or only for certain products of the Principal, (3) for all or only certain customers of the Principal.

Generally, statutory PRC law does not prohibit the Principal from imposing a non-compete obligation on the Commercial Agent.

Chinese law generally allows a restriction on the Commercial Agent's freedom to pick up Commercial Agencies for third parties. The Commercial Agent may even be obliged to solely represent the Principal.

The PRC Competition Law only plays a limited role in the field of Agency Agreements (in the field of Distribution Agreements it plays a significant role, see below). However, whether it could apply to the Commercial Agent in the individual case should be assessed at the beginning of a cooperation and this could have significant legal implications.

What are the primary obligations of the Commercial Agent and the Principal?

Generally, the Commercial Agent has the following primary obligations based on statutory law:

  • to handle the entrusted affairs of the Principal, i.e. usually to acquire business for the Principal and to provide the Principal with the opportunity to enter into contracts with customers or even conclude such contracts itself in the name of the Principal;
  • to provide the Principal with relevant information regarding the affairs he shall handle for the Principal and to provide true information concerning matters relevant to the conclusion of the proposed contract. Where the Commercial Agent intentionally conceals any material fact or provides false information in connection with the conclusion of the proposed contract, thereby harming the Principal's interests, the Commercial Agent shall not be entitled to require payment of any remuneration and shall be liable for damages;
  • any property acquired by the Commercial Agent in the course of handling the entrusted affairs shall be turned over to the Principal;
  • the Commercial Agent shall, generally, personally handle the entrusted affair. Only after consent by the Principal, the Commercial Agent may delegate the agency to a third person. If the delegation is approved, the Principal may issue instructions concerning the entrusted affair directly to the delegate, and the Commercial Agent is only responsible for its selection of the delegate or its own instructions thereto. Where the agency is delegated without consent, the Commercial Agent shall be liable for any act of the delegate, except in an emergency where the agent needs to delegate the agency in order to safeguard the interests of the Principal;
  • under a commercial Agency Agreement against payment of agency fees, if the Principal sustains any loss due to the fault of the Commercial Agent, the Principal may claim damages. Under an Agency Agreement without payment of agency fees, if the Principal sustains any loss due to the Commercial Agent's intentional misconduct or gross negligence, the Principal may claim damages;
  • where the Commercial Agent acts beyond the scope of its authorization by the Principal, thereby causing loss to the Principal, it shall pay damages;
  • PRC law does not provide for a statutory obligation of the Commercial Agent to maintain confidentiality. This should be specifically be agreed in the respective Agency Agreement; and
  • PRC law does not provide for statutory non-compete obligations during the contractual term. This should be specifically be agreed in the respective Agency Agreement.

Generally, the Principal has the following primary obligations based on statutory law:

  • to pay commission to the Commercial Agent (see below);
  • to prepay the expenses for handling the entrusted affair. Any expense necessary for handling the entrusted affair advanced by the Commercial Agent shall be repaid with interest by the Principal. These stipulations are, however, not mandatory and it is recommended to agree on different, specific stipulations in the Agency Agreement.For a pure intermediary agent (who does not conclude any contracts with customers on behalf of the Principal by itself) the following applies: if the intermediary agent facilitated the formation of the proposed contract, the related expenses shall be borne by the intermediary agent himself. This is due to the fact that the intermediary agent is entitled to remuneration if the proposed contract is concluded and the intermediary agent’s expenses are compensated with such remuneration. If the proposed contract is not concluded, the intermediary agent has no claim to remuneration against the Principal, but a claim to reimbursement of its necessary expenses;
  • If a Commercial Agent suffers losses during the performance of the contract for which he is not responsible, the Principal must compensate him for these losses. In order to limit this liability of the Principal towards the Commercial Agent, it is advisable to provide for limitations of liability in the contract where appropriate.

We strongly recommend detailing in the Agency Agreement the obligations of the Commercial Agent and the Principal. Statutory PRC law does not provide for certain important issues, such as confidentiality and non-compete obligations during the contractual term, etc.

How is the Commercial Agent paid?

Generally, the Commercial Agent is entitled to commission for business transactions between the Principal and customers within the scope of the Commercial Agent's instruction.

During the contractual term, generally, the Commercial Agent can claim commission if:

  • the entrusted matter has been settled.
    For a pure intermediary agent (who does not conclude any contracts with customers on behalf of the Principal by itself) the following applies: remuneration must only be paid if the business transaction has been concluded as a result of its action; i.e. was acquired by it (joint causality between Commercial Agent's actions and other causes is sufficient). If the proposed contract is not concluded, the intermediary agent has no right to remuneration from the Principal but only a right to reimbursement of necessary expenses;
  • The amount of the remuneration can be freely agreed between the contracting parties. In practice, an agency commission amounting to a certain percentage of the contract volume of concluded contracts is most commonly agreed in Agency Agreements. However, this is not mandatory and the parties of an Agency Agreement may agree differently.

Statutory PRC law does not provide for any stipulations on a commission for business transactions which are concluded after the contractual term has ended.

The statutory rules on the Commercial Agent's remuneration are not mandatory. We recommend stipulating in the Agency Agreement the exact way the Commercial Agent's commission will be calculated in order to avoid statutory law leading to a result which the Principal and/or the Commercial Agent did not desire.

Term and Termination of Agency Agreement

Term of the Agency Agreement

There are no statutory rules on the term of Agency Agreements. The parties are, thus, generally, free to set out the parameters of the contractual term, for example in agreeing on a fixed term or an indefinite term or a combination.

It is advisable to expressly stipulate the contract term in the Agency Agreement. In the absence of such a stipulation and if no contract term can be determined by interpretation of the contract or trade customs, the contract shall be deemed to be concluded for an indefinite period.

If the parties agree on a fixed term and, after the expiry of the fixed term, continue to perform the Agency Agreement, the Agency Agreement may be considered to have been tacitly renewed for an indefinite term.

In accordance with Articles 91 et seq. of the PRC Contract Law, the Agency Agreement ends upon expiry of its agreed term, by mutual cancellation of the agreement or by termination. Article 411 of the PRC Contract Law further stipulates that an Agency Agreement as an entrustment agreement (Article 396 PRC Contract Law: "An entrustment contract is a contract whereby the principal and the agent agree that the agent shall handle the affairs of the principal.") terminates when either the Principal or the Commercial Agent die, become legally incapacitated or insolvent.

Termination of the Agency Agreement and the contractual right to terminate unilaterally

According to Article 410 of the PRC Contract Law, an Agency Agreement can, generally, be terminated by both the Commercial Agent and the Principal at any time. The terminating contractual partner shall compensate the other contractual partner for any damage resulting from the termination, unless the terminating contractual partner is not responsible for the damage.

For Agency Agreements with an indefinite term, the parties should agree on a contractual right to terminate unilaterally with a prior notice period in the Agency Agreement. It should further be stipulated that in case of a contractual right to terminate unilaterally, no claims for damages as set out under Article 410 of the PRC Contract Law apply. It is also possible to determine a fixed contract term with automatic renewal, if none of the contracting parties terminates within a certain period before expiry.

Extraordinary termination

According to Article 94 of the PRC Contract Law, a contracting party may terminate the contract without prior notice period, inter alia, due to a material breach of contract by the other contracting party which has not been remedied within a reasonable period of time after having received a reminder or if the purpose of the contract cannot be achieved due to force majeure. In this case, the terminating party shall not be liable for damages due to such termination.

Pursuant to Article 93 para. 2 of the PRC Contract Law, the parties may agree in the contract on further conditions for an extraordinary termination of the contract.

An Agency Agreement should expressly stipulate the reasons for extraordinary termination in order to prevent disputes about the existence of a reason for termination. For example, the law does not define the period within which a defaulting contractual partner has the right to remedy a breach of contract in order to avert the termination. It is therefore advisable to define such time period. In addition, payment delays of a certain duration, an event of force majeure of a certain duration or the failure of a certain minimum turnover of the Commercial Agent are often agreed as extraordinary reasons for termination.

The indemnification claim as a consequence of the Agency Agreement's termination

As set out above, according to Article 410 of the PRC Contract Law, either the Principal or the Commercial Agent may, generally, terminate the Agency Agreement at any time which may lead to indemnification claims, if the non-terminating party sustains any loss due to the termination, unless such loss is due to a reason not attributable to the terminating party. However, Article 410 of the PRC Contract Law is not mandatory and the parties can agree otherwise. Statutory PRC law does not provide for any stipulations on a commission for business transactions which are concluded after the contractual term has ended.

Other consequences of the Agency Agreement's termination

In the absence of a contractual agreement to the contrary, PRC law does not stipulate a post-contractual non-compete obligation of the Commercial Agent. PRC law, however, allows an agreement on such post-contractual non-compete obligation of the Commercial Agent as long as the period is justifiable.

Any claim arising from an Agency Agreement is, generally, subject to a three-year limitation period, starting from the date on which the creditor (e.g. the Commercial Agent) knew or ought to be aware of the debtor and the circumstances creating the obligation. In absence of such knowledge, there is a maximum limitation period of 20 years from the date on which the claim arose.

During the last six months of the limitation period, if the claim cannot be exercised due certain circumstances which have caused the right holder to fail in making claims (e.g. force majeure), the limitation shall be suspended.

Further, the limitation of action shall be discontinued if (1) the creditor requests performance from the debtor; (2) the debtor agrees to fulfil its obligations; (3) the creditor initiates court proceedings or applies for arbitration or (4) other circumstances equal to initiating court proceedings or arbitration. In such case, the calculation of the limitation period will re-start. For “requesting performance” in the above sense, it is sufficient if the creditor verifiably requests the debtor to discharge its obligations.

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Distribution Agreements

There are also no specific provisions on Distribution Agreements in PRC law. The general provisions of the PRC Contract Law and, in particular, Articles 130 et. seq. regarding sales contracts apply.

Formation of Distribution Agreement

Are there any formal requirements on concluding Distribution Agreements?

Under PRC law, a Distribution Agreement can be entered into both verbally or in writing. There are no special formalities to be taken into account. For evidentiary purposes, we recommend setting out the Distribution Agreement in writing.

Are there any specific information obligations on concluding Distribution Agreements?

Statutory law does not provide for any specific information obligations regarding Distribution Agreements.

Under PRC law, a general obligation exists to correctly answer questions and to provide certain crucial information without special request prior to entering into an agreement (culpa in contrahendo, see Article 42 of the PRC Contract Law). As far as we can see, there are no relevant court precedents invoking culpa in contrahendo regarding information obligations when concluding Distribution Agreements.

Are there any specific pitfalls which need to be borne in mind when concluding Distribution Agreements?

Our statements to Agency Agreements apply respectively.

In addition, the Chinese peculiarity of so-called foreign trade rights should be taken into account. Under PRC law, PRC companies and individuals are only entitled to conclude contracts for the purchase and sale of goods from and to abroad if they have so-called foreign trade rights. Foreign-invested entities have these foreign trade rights automatically. Nowadays, any PRC company and any PRC individual can apply for foreign trade rights at the competent Authority of Commerce. If the PRC Distributor does not have foreign trade rights, a so-called import agent must be engaged for importing the goods into the PRC and remitting the purchase price abroad.

Scope of Distributor's instruction

Are the parties free to agree on the scope of the Distribution Agreement?

There are statutory limits to the Principal's and the Distributor's freedom to agree on the scope of the Distribution Agreement (mainly based on the PRC Competition Law).

In particular when it comes to limiting the geographic region in which the Distributor may (or may not) sell the products and the customers to which it may (or may not) sell them, such limitations are admissible only under specific requirements which need to be assessed in the individual case.

Furthermore, also agreements with respect to the amounts of products the Distributor must source from the Principal are subject to PRC competition law.

Non-compete obligations may be agreed. For the time being, there is no limitation on the period. However, since the Chinese competition law is evolving rapidly, it is advisable to review this issue from time to time.

The Principal is generally not allowed to influence the Distributor's resale price of the products. The Principal may send a list with price recommendations to the Distributor. Principals should take great care when performing any activities which could be construed as an attempt (even an indirect) to influence the Distributor's freedom to determine the resale price.

What are the primary obligations of the Distributor and the Principal?

Generally, the Distributor has the following primary obligations:

  • to pay the purchase price of the goods;
  • to distribute the products;
  • PRC law does not provide for a statutory obligation of the Distributor to maintain confidentiality. This should be specifically be agreed in the respective Distribution Agreement; and
  • PRC law does not provide for statutory non-compete obligations during the contractual term. This should be specifically be agreed in the respective Distribution Agreement.

Generally, it is assumed that the Principal has the following primary obligations:

  • to deliver the products ordered by the Distributor in time to the agreed place and free of defects;
  • other issues as agreed between the parties.

We strongly recommend setting out in the Distribution Agreement the obligations of the Distributor and the Principal. As no specific statutory law on Distributors exists, this is important to avoid disadvantages.

How is the Distributor paid?

Generally, the Distributor is not entitled to a specific remuneration for its distribution activities. The remuneration of the Distributor consists in the profit it generates in purchasing the Principal's product with a rebate and selling them to its customers at a higher price. The parties may, however, following the principle of freedom of contract, agree on additional remunerations such as minimum monthly payments, etc.

Term and Termination of Distribution Agreement

Term of the Distribution Agreement

There are no statutory rules on the term of Distribution Agreements. The parties are thus, generally, free to set out the parameters of the contractual term, for example in agreeing on a fixed term or an indefinite term or a combination.

If the parties agree on a fixed term and, after the expiry of the fixed term, continue to perform the Distribution Agreements, the Distribution Agreements may be considered to have been tacitly renewed for an indefinite term.

In accordance with Articles 91 et seq. of the PRC Contract Law, the Distribution Agreements ends upon expiry of its agreed term, by mutual cancellation of the agreement or by termination.

It is advisable to expressly stipulate the contract term in the Distribution Agreement. In the absence of such a stipulation and if no contract term can be determined by interpretation of the contract or trade customs, the contract shall be deemed to be concluded for an indefinite period.

Termination of the Distribution Agreement and contractual right to terminate unilaterally

If the Distribution Agreement is deemed to be concluded for an indefinite period, the Distribution Agreement can only be terminated extraordinarily or upon mutual agreement between the parties.

Extraordinary termination

According to Article 94 of the PRC Contract Law, a contracting party may terminate the contract without prior notice period, inter alia, due to a material breach of contract by the other contracting party which has not been remedied within a reasonable period of time after having received a reminder or if the purpose of the contract cannot be achieved due to force majeure. In this case, the terminating party shall not be liable for damages due to such termination.

Pursuant to Article 93 para. 2 of the PRC Contract Law, the parties may agree in the contract on further conditions for an extraordinary termination of the contract.

A Distribution Agreement should expressly stipulate the reasons for an extraordinary termination in order to prevent disputes about the existence of a reason for termination. For example, the law does not define the period within which a defaulting contractual partner has the right to remedy a breach of contract in order to avert the termination. It is therefore advisable to define such time period. In addition, payment delays of a certain duration, an event of force majeure of a certain duration or the failure of a certain minimum turnover of the Distributor are often agreed as extraordinary grounds for termination.

No statutory indemnification or compensation claim as consequence of the Distribution Agreement's termination

Under PRC law, there is no statutory indemnification or compensation in case of a termination of a Distribution Agreement. I.e. unless specifically agreed otherwise by the parties, there is no automatic obligation to pay compensation to the Distributor if the Distribution Agreement is terminated. However, the Distributor may have claims against the Principal for damages occurring due to a breach of contract in relation to the termination or if the Distribution Agreement is terminated due to a breach of contract by the Principal. It also cannot be completely excluded that under exceptional circumstances, a court or arbitration institution may uphold a claim for compensation of the Distributor in case of termination of a Distribution Agreement due to general principles of fairness.

Other consequences of the Distribution Agreement's termination

Statutory PRC law does not provide for a post-contractual non-compete clause and PRC competition law is silent on post-contractual non-compete clauses. Such a clause shall be assessed in the individual case. Generally, the market shares of the Principal and the Distributor in their relevant market(s), the duration of the period, the financial compensation, etc. shall be considered in the assessment.

The Distributor under certain conditions may request that the Principal purchases back goods it has in stock upon the Distribution Agreement's end. To avoid discussions in this regard, the Distribution Agreement should address this matter.

Other than the above, our statements to Agency Agreements apply respectively.

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Portrait ofUlrike Glueck
Dr. Ulrike Glueck
Managing Partner
Shanghai