1. Legal Grounds Governing Distribution Agreements
A distribution agreement is a type of hybrid commercial contract (primarily based on the framework of sale-of-goods transactions combined with commercial services) and is governed by the following legal instruments:
- 2005 Law on Commerce:
- Articles 310 and 311: Suspension of performance of contracts.
- Articles 312, 313, and 314: Suspension and cancellation of contracts.
- Articles 300–307: Remedies for contractual penalties and compensation for damages in commercial activities.
- 2015 Civil Code:
- Article 422: Termination of civil contracts.
- Article 428: Unilateral termination of contract performance.
- 2018 Law on Competition: Governs vertical agreements and ensures that sales targets are not used as a pretext for abusing a dominant market position to restrict the distribution of competitors’ goods.
2. Does Failure to Meet Sales Targets Automatically Constitute a Fundamental Breach Justifying Contract Termination?
2.1. Statutory Grounds for Unilateral Termination (Articles 312 and 314 of the Law on Commerce)
A party may only suspend or cancel a contract in either of the following circumstances:
- A breach occurs that the parties have expressly agreed in the contract shall constitute grounds for suspension or cancellation of the contract;
- One party commits a fundamental breach of its contractual obligations.
A “fundamental breach” is defined as a breach of contract by one party that causes such damage to the other party that the latter is unable to achieve the purpose of entering into the contract (Clause 13, Article 3 of the 2005 Law on Commerce).
2.2. Legal Risks Where the Contract Contains Only Vaguely Defined Sales Targets
- If a distribution agreement merely states that “The Distributor undertakes to achieve monthly sales of VND 1 billion” but does not expressly stipulate that failure to meet the sales target will entitle the other party to terminate the contract, such failure alone will generally be regarded as a failure to meet business expectations rather than automatically being recognized by a dispute resolution body (Court or Arbitral Tribunal) as a fundamental breach.
- In such circumstances, if the manufacturer unilaterally issues a notice stating that it will “immediately revoke the distribution rights”, such action may be determined to constitute unlawful unilateral termination of the contract, potentially giving rise to an obligation to compensate the distributor for damages.
3. Conditions for Lawful Termination of a Distribution Agreement
To ensure that the termination of cooperation due to a partner’s failure to meet sales targets is legally compliant and does not expose the business to counterclaims, the business should satisfy all three of the following groups of conditions:
3.1. The Contract Must Contain a Clear Termination Trigger
The contract should specifically define the level of sales underperformance that triggers the right to terminate. For example:
- Failure to meet sales targets for two or three consecutive assessment periods (monthly or quarterly);
- Actual sales performance falling below a specified percentage of the committed target (e.g., achieving less than 70% of the agreed target);
- Expressly stipulating that such failure entitles the distributor appointing party to unilaterally terminate the contract before its expiry without being liable for compensation.
3.2. Prior Written Notice Must Be Given
- Pursuant to Clause 2, Article 428 of the 2015 Civil Code, a party unilaterally terminating the performance of a contract must promptly notify the other party of the termination. Failure to give notice that results in damage may give rise to an obligation to pay compensation.
- The business must comply with the prior notice period agreed upon in the contract (e.g., giving 30 or 60 days’ prior notice). Any notice purporting to terminate the contract immediately upon issuance may constitute a breach of the agreed notice procedure.
3.3. The Distributor-Appointing Party Must Not Have Breached Its Supply Obligations
- If the distributor fails to meet its sales targets due to circumstances attributable to the distributor-appointing party (e.g., delayed deliveries from the factory, defective goods, insufficient stock during peak seasons, or failure to provide marketing materials as agreed), the distributor may rely on the appointing party’s breach to challenge the termination of the contract.
4. Major Risks of Unlawful Unilateral Termination
- Liability for compensation for infrastructure investment costs: Distributors often incur substantial upfront costs for warehouse rentals, purchasing delivery vehicles, recruiting sales teams, and decorating showrooms in accordance with the distributor-appointing party’s brand identity. If the agreement is unlawfully terminated, the appointing party may face claims for compensation for these depreciated investment costs.
- Disputes over the handling of unsold inventory: Once distribution rights are revoked, the distributor may no longer be able to continue selling the goods in the market, particularly if its authorization to use the brand is withdrawn. If the parties have not clearly agreed on an inventory buyback mechanism, the appointing party may face claims for a refund of the purchase price together with warehousing costs.
- Damage to the reputation of the distribution network: Handling a distribution partner without a clear legal process may trigger negative reactions in the market. The distributor may resort to heavily discounting its inventory to recover capital quickly, thereby disrupting the pricing structure across the entire distribution network.
CONTACT LEGAL CONSULTANT:
TLA Law is a leading law firm with a team of highly experienced lawyers specializing in criminal, civil, corporate, marriage and family law, and more. We are committed to providing comprehensive legal support and answering all your legal questions. If you have any further questions, please do not hesitate to contact us.
1. Lawyer Vu Thi Phuong Thanh, Ha Noi Bar Association
Email: vtpthanh@tlalaw.vn
2. Lawyer Tran My Le, Ha Noi Bar Association
Email: tmle@tlalaw.vn
Nguyen Thuy Duong