Latin America: Overview
This is an Insight article, written by a selected partner as part of GCR's co-published content. Read more on Insight
Within professional and academic life, we have observed that there are many issues and cases present in relationships developed between manufacturers and their distributors, all of which must be studied under the specific situation in which they effectively occur, without forgetting that every economic setting is different to any other depending on the way each problem is looked at.
Regarding the matters between manufacturers and distributors, two situations are found: private issues and state issues.
The first of these is focused on the legality of the clauses established for private parties - eg, two merchants - and their development for those two strategic allies.
The second comprises the way in which the vertical scheme between two independent companies is established and its consequences within a relevant market, prohibiting that with a determined scheme the freedom of entry for enterprises that compete with the manufacturer is hampered, as is the freedom of choice of the consumer for a product or service.This article intends to explain the implications of both regulations within the problematic issues that are developed between manufacturers and distributors.
It is of paramount importance to understand the essence of the issues mentioned to describe certain aspects of marketing that are closely bound to the different distribution schemes created by different companies that operate in a specific market.According to marketing rules, a manufacturer must decide if market penetration is to be undergone through a direct plan or an indirect distribution scheme.
It is considered a direct scheme when a particular company carries out the activity of distribution with its own employees. It is an indirect one when a third party that is unconnected to the company - often referred to as an intermediary - executes the distribution.
Under the same concept, indirect distribution can be carried out through a short or long channel. A short channel is when the manufacturer hands over its distribution to a retailer and is in charge of selling to the consumer. A channel is called long when within the logistics chain there is more than one third party as an intermediary, like when a wholesaler supplies to a retailer and then the retailer supplies to the shopkeeper.In the same way, there can be a mixed or joint distribution when the direct channels share distribution with indirect channels - in other words, when the manufacturer competes with its own indirect channels. In such a scenario, the distributor competes with the manufacturer; however, not within the production market cycle, but within the distribution market cycle.
The methods of penetrating the market via indirect distribution, both in its short and long form, are also classified according to their intensity. There can exist distributions that take the form of exclusive, selective or mass production. An indirect distribution is exclusive when there is only one person appointed as an intermediary, either by territory or by product. It is selective when there are a few distributors in a particular area; all of them specialised and competing among themselves without holding exclusivity in the particular territorial area. It is considered mass production when there is no degree of specialty for distributing the product, making it possible for virtually anyone to enter the distribution channel without any requirements whatsoever.
Within our topic, it can be said that companies, for the sale of their products or services, can utilise diverse strategies for market penetration.
The first one can be referred to as ‘pull’ and it is used by a manufacturer who decides to directly publicise the product in a way that it is possible for the objective market (consumers), to get to know the qualities of the product, leaving in the long term memory of the consumers an image that will be remembered at the moment of purchase for choosing the preferred brand name. The information received by the consumer is of such content and length, that after having been transmitted by all the available means of publicity, the product selection made is completely convincing within the consumer’s mind. Under this approach, the distributor does not participate much in the positioning of the product due to the fact that the consumer already has a preconceived choice made.
The other strategy used is called ‘push’, and refers to when the distributor is in charge of convincing the consumer or the client about the goodness of the product to be able to position it within the market. It is the same distributor who captures client fidelity under a brand name, creating a double relationship: the client of a brand name, where the consumer is loyal to that brand; and the client of a vendor, where the shopkeeper is loyal to the retailer who brings to his shop the brand that will be later sold to the public.
Finally, it is necessary to take into account that within a distribution scheme, a task can be placed on the distributor under two different methods: either a passive sale or an active sale.
The sale is a passive one when the seller (distributor) waits for the clientele to approach its business (shop) without leaving the premises. This situation normally presents itself when the pull has been so strong that the interested customers directly call to place purchase orders.The sale is an active one when the seller (distributor) seeks its clientele leaving its place of business, using a push, due to the fact that the distributor is in charge of seeking new markets with new clients.
All of the explained concepts, combined or carried on with certain particularities according to the requirements of the manufacturer, give rise to relationships between the strategic allies (ie, manufacturer/distributor) in different degrees, which in turn carry economic and financial objectives based on market positioning and penetration of a brand name within a market.
The relationships between manufacturer and distributor are also treated with care from an economic point of view. The private relationships between them can transcend and affect an economy, especially when their relationships place at risk the freedom of choice that a consumer has and the capacity of a competitor to join the market, creating certain distortions that, according to economic science, are not appropriate.The aforementioned issue can be better understood when we bring in the economic concept of elasticity of demand within an economy. Elasticity of demand presents itself when in a market there are different alternatives of products or brands. The purpose of such a concept is to illustrate that if a market is not in economic dependence, it is because product substitutes exist, which in practice gives the option of choice to the consumer. If there is a price rise on a particular brand, it will also be possible to migrate to another brand without being forced to accept the new higher price.
With regards to the capacity of a competitor to join the market, it must be said that if the new competitor is able to become part of it, that will normally help the consumer have more options and obtain a better price. That is why economic science describes the creation of markets without elasticity of demand as ‘undesirable’, which can also be damaging if that comes together with barriers for the entry of new competitors.
Therefore, the issues analysed so far that describe the liaisons between manufacturer and distributor must take into account economic rules, which constitute principles of superior rank.Let us also not forget that a relevant market is generally not only limited to a specific country. A market can be referred to as a specific zone within a country, a state or region, a city, a part of city or even a neighbourhood.
Within continental law, there are different regulations for studying the problematic issues between manufacturers and distributors. The ones we will point out in this article are:
- antitrust regime;
- competition law; and
- contracts (typical and atypical)1
- Restrictive agreements: It is important to explain that in most countries that apply continental law, indirect distribution starts with a prohibited market distribution. Every channel of distribution must defend its legality when confronting the law or else it will be understood as a vertical cartelisation.
- Restrictive acts of competition: These are unilateral behaviours in which the following is sanctioned:
- denial to sell; and
- price imposition.
- Abuse of market dominant position: After establishing that a company is dominant in a market, it is then necessary to have in mind that the company is prohibited to:
- utilise tied conditions; and
- to create barriers of entry within the channel in a relevant market.
- Business integration: It is necessary to define if the duties included in a distribution channel generate control from one company to the other. If it is so, a case of business integration will take place according to competition law, generating the obligation for such integration to be reported to the competent authorities.
- clientele deviation;
- enterprise disorganization;
- induction to contractual breach;
- secret violation; and
- unfair agreements of exclusivity
- commercial agency;
- trademark license;
- purchase agreement;
- use of patents; and
- The figure of typical and atypical contracts within continental law refers to contracts that are regulated specifically by the law (typical), and contracts that are created and agreed by the parties that are not specifically regulated by the law but which are bound by the provisions stated in general contract law (atypical).
There can be more regulations that apply to the relationship discussed; however, for the purposes of this article, only these three will be taken into account.
Under antitrust provisions, what is looked after is relevant market health as an important item in an economy. In this sense, we are talking about a public legally protected right, not a private one. Through its supervision and control entities, the state (government) exercises a task of economic intervention to protect that right.
As a consequence, in case of wrongdoings, the state authorities impose sanctions and fines and prohibit such behaviours, all of which are regulated under an administrative scope.
However, what has been said does not imply that the conducts mentioned above should only be analysed under an administrative lens, due to the fact that such wrongdoings can cause pecuniary damage to private entities, which in turn obtain the right to legal actions in order to seek indemnity for their loss.
We can therefore observe that in a legal relationship such as the one described in this article there is, according to continental law, a legal connection between a conduct and the damage that was caused by that conduct. The conduct is a commercial restrictive practice (antitrust provision); therefore, we must conclude that the affected party has course of legal action towards the originator of such conduct.
Having stated that a commercial restrictive practice can be the origin of damage for a private entity, it is now mandatory to be able to identify the factual assumptions of commercial restrictive practices applicable to the issues between manufacturers and distributors.There are four classes of factual assumptions with regard to restrictive commercial practices that in our opinion must be taken into account within the issues involving manufacturers and distributors.
In general, competition law provisions cover issues regarding contractual liability and extra contractual liability (tort) where a third party causes damage to the competitiveness of a company in the market.
However, the term ‘unfair competition’ is wrongly denominated, due to the fact that for its operation there is no requirement for the existence of competition between parties that confront each other within a legal action. That is to say, the fair competition regime does not safeguard competition between competitors; what it preserves as a legally protected right is the safeguarding of competitiveness for a company in a market, caused by conducts of third parties - understanding third parties to mean competitors - but also including other participants on the market that are not competitors.
The competitiveness of a company, understood as its participation or concurrence, can be affected on a legitimate or illegitimate way. What should be achieved under this context is that the relationships of participation within a market are enshrined within the principles of good faith, sanctioning the faults to the duties of clarity, information and transparency.
It can occur that in case such duties are not followed, the relationship between manufacturers and distributors can be affected.
At this point, the reader can observe how important the marketing preliminaries included in this article are to be able to project the different possibilities that can be presented within the context of unfair competition, all of which can be studied and analysed thoroughly. For example, if the duty of utmost good faith is not carried out properly, the possibility of the following can be present in a relationship between the parties:
The last pivotal point we must not forget is that within legal actions for unfairness there are actions for damages and also for threat or menace.
Within continental law, as mentioned above, there are different types of contracts, all of which can be grouped as typical and atypical.The first ones carry essential elements that permit differentiations among them. They can also be filled with accidental elements through which the parties design and create the setting of their contractual relationship.
Atypical contracts do not carry essential elements; they have characteristics that inhibit their main provisions to be understood as factual assumptions already codified under the continental rule of law as typical contracts. Hence, it is invalid for a provision that is already stated in the law to be considered atypical.
To determine if a given atypical contract’s provisions are valid within a given country’s legislation, it is mandatory to confront it with the legal system in each country that contains the stated limits to the freedom of celebrating private agreements; these may include public policy and morality. If they are not followed, the contract may become void.
Contracts of intermediation can take (depending on what has been explained) the form of typical or atypical contracts. To be able to observe its application within antitrust and competition law, we must undergo a study to establish if the provisions in a particular contract specifically exclude the application of both law regimes. At this point it is important to note that atypical contracts do not exclude the application of either antitrust or competition law. This is because there is no specific provision in the law that excludes it or that states to the contrary.
As a listed example of the legal figures that exist, we can name:
All of these figures must be studied with the purpose of clarifying the true relation that exists between a manufacturer and its distributor(s). The important issue is not to observe a contractual template on its own; the true task is to analyse the real-life development of the covenants, through evidence that can only be effectively reflected via financial statements (balance sheets or profit and loss accounts), marketing plans, budgets, comparisons with others, strategic plans and other documents that make clear what really went on within the relationship. That is the real agreement, which constitutes the contract.
Finally, it is worth mentioning cases of abuse of contractual dominant position. In contractual relationships, it is common to have a strong party and a weak party in a business negotiation. Such a relationship does not depend on the existence of a contract of adhesion because, notwithstanding its inexistence, dominance within a contractual relationship can be present anyhow. From our point of view, there exists a position of contractual dominance when one of the parties is economically dependant on that contract; such as when it is not possible for that party, either in theory or in practice, to initiate re-sales in other product markets, or when the clauses have been imposed or modified unilaterally even with the consent of the weak party. In this case, a dominant relationship can be clearly observed that is not on its own illegal; on the contrary, it has been consented by the other party. That is why we must follow the initial premise that the clause is valid and not abusive when the clause is disputed within legal proceedings (for abuse of contractual dominant position). What will be contested is the way in which it has been interpreted by the dominant party. Normally this is done on that party’s favour, in prejudice to what was originally agreed in the original negotiation, acting against the weak party in the relation, acting with bad faith.
Therefore, the abuse of a contractual dominant position is based on the principle of utmost good faith, which in case it is not followed at the moment of interpreting the contract, would result in the stronger party always prevailing.
The purpose of this article was to explain the problems that concur on a typical continental law regime between manufacturers and distributors, and to express that such issues should be studied within a competition and antitrust law framework. This is not to forget that its practical application depends on the type of contract chosen, which in turn depends on the ‘real’ relationship that underwent between the parties, observing consent, but punishing the overflow of power from the strong party in the relationship; which is usually strengthened by a valid clause with abuse of power in its application causing damage to its associate in business, the distributor.