Granting Exclusivity

Written by Narda Ben Zvi, Adv., Partner and Head of High tech and IP department at Yaacov Salomon, Lipschutz & Co.

There are many possible pitfalls in commercial agreement, and in this series of articles we will address some of the common ones, starting with the request for Exclusivity.

Exclusivity is a demand frequently made by business partners: Distributors for a particular territory, customers with a large share of the marketplace for a particular product, and even finders who seek investment or facilitate market entry for you.

Exclusivity may be granted for a particular territory or a particular product, may limit you from dealing with competitors or bar you from an entire industry, and is almost invariably bound with a time restriction, to avoid a Catholic wedding. It should always be defined with special care, and its nature, scope and termination provisions in large part determine whether an exclusive deal is viable or not.

Granting exclusivity is always a big deal, a significant concession that should be counter-weighted with a proportionately large reward, and should never be granted without careful consideration of its ramifications and alternatives.

Having said that, exclusivity is not something you need to view as a pure restriction, a huge concession on your part, on the contrary, there may be significant benefits to granting exclusivity. Despite the instinctive recoil from restricting your business activities, an exclusive provision may lead to an incredible success story. For example, it may allow you to receive a much larger contract, to demand fixed or minimum prices for a longer-termed contract, provide you with significant up-front payments, or create a foothold and recognition in new markets – especially if you specifically demand that your distributor invest significant funds in building the market for your product. Exclusivity may even be the tool you need to acquire funding from clients for the development of specific new features or products, or when facing large companies, allow you to soften or exclude some of their other demands.

Sometimes, such provision will be accompanied by a reciprocal undertaking – for example, you will request that your exclusive distributor would not sell competing products, and that your partner to the joint development efforts of a certain product will not cooperate with competitors in their efforts to launch a competing solution.

When debating exclusivity, you need to understand the concern of the party demanding it – frequently, they simply do not want you to deal with their competitors, and on different occasions they have reasonable and legitimate concerned that needs to be addressed such as free riding of their efforts to promote your products. Understanding your partner's needs and motivations is highly important in order to negotiate exclusivity, and succeed in narrowing it down to something that can provide enough protection to your partner without putting too much restriction on your own freedom to do business.

For example, distributors in new markets generally contend that several years of exclusivity are essential to them, as they are required to make intensive investments in order to successfully introduce your products or services to the market. They rightfully claim that they need to verify that others will not harvest the fruits of their investment. They will claim that a few years of exclusivity is a small price to pay in order to achieve a foothold in a new territory and only makes sense if you want a distributor that will really invest its time and resources in your product and will not promote your competitors.

Now, taking into account all those very common claims, you need to narrow down the risks of relying on a single (exclusive) distributor – an exclusive and ineffective distributor may ruin your market, and you cannot afford to remain behind while your competitors achieve significant market presence. Your exclusive distributor may, after building a customer base, proceed to use its acquired experience and knowledge to market a competing product, engage in parallel import, or even attempt to misappropriate your intellectual property.

Indeed, having a single channel of trade means that you have a single failure point, a bottleneck, and you need to have care not to fully entangle your future with your exclusive partner.

So, in granting exclusivity you should map your concerns and address them, one by one: Exclusivity should be tied up to limited territory, limited and predefined period of time, should be dependent on minimum and gradually increasing sales targets.

What may seem like an excellent deal on day one may prove to be a disappointment five years later, and any exclusive contract should include appropriate escape clauses, with easily verifiable qualifiers, careful attention to the protection and use of your intellectual property, and right of audit – since you do not ordinarily have any means to verify the numbers provided by your partner's reports.

While exclusive contracts may provide you with great opportunities, they can also become a trap, as they effectively restrict your business. While you should not discard a proposal merely because it includes a demand for exclusivity, take extra care to weigh the pros and cons of any such offer, and consult with your attorney to negotiate and craft a contract that offers the least restriction for the most rewards. Remember that exclusivity is a tool that can only be used sparingly by its very nature, so get the most you can for the leverage it provides.

Written by Narda Ben Zvi, Adv., Partner and Head of High tech and IP department at Yaacov Salomon, Lipschutz & Co.

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