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Jan 20, 2005
Distribution and Agency in Central America, Consequences of Termination and Compromises contained in the Central American Free Trade Agreement (CAFTA)

By Hernán Pacheco O., LL.M.

Introduction

During the late 60's and early 70's most of the Latin American countries adopted special legislation to regulate the relationship between foreign companies and domestic distributors, agents, sales representatives and dealers. Some countries also incorporated within said special legislation provisions to regulate the relationship when both distributor and supplier are local companies.

The proponents of said bodies of rules substantiated the need for adoption of special legislation in the fact that many foreign companies came to the region, hired a sales representative or appointed a dealer, who supposedly invested significant resources in opening the market for the foreign product and once the market matured, the foreign company terminated the distributor without cause and took over the market. In many cases the relationship between the foreign company and the local agent or distributor was not properly documented, leaving the terminated party without recourse.

Like many Latin American and European jurisdictions, the Central American countries enacted legislation aimed at protecting the rights and interests of the local distributor, agent, sales representative or dealer, particularly in cases where the foreign supplier terminated the commercial relationship without just cause. The consequence of termination under those circumstances was the activation of an indemnification mechanism, the characteristics and particularities of which vary from one country to the other.

Most of the adopted laws contained restrictions and limitations to the free will of the parties and in some countries, made it almost impossible for the foreign company or the principal to terminate a commercial relationship of this nature, without being forced to pay a costly indemnification and fulfil other obligations.

With the liberalization of markets and the global economic trends, much pressure has been exerted to abolish these protectionist legislations, some of which have been qualified as "non tariff barriers to free trade and economic development".

The Central American countries reacted in different fashions to these pressures and have amended their respective laws or the interpretations thereof accordingly. During the Central American Free Trade Agreement (CAFTA) negotiations, the existence of this type of restrictive laws in most of the countries was the subject of extensive discussions and finally, the parties agreed to introduce changes in practically all legislations on the subject matter.

This paper reviews the status quo of the distribution laws in the five Central American countries that executed CAFTA and in Panamá, which although not part of CAFTA nor part of the Central American Common Market is undoubtedly a most important economic player for our region. The document also examines the consequences for the parties in case of termination of the commercial relationship and finally, refers to the commitments adopted by each CAFTA subscriber under the Agreement.

 

I. Costa Rica

Costa Rica is one of the few countries in Latin America that still has special legislation to regulate the relationship between local distributors, dealers or agents and foreign companies. This set of rules is contained in Law number 6209, Law for the Protection of Representatives and Distributors of Foreign Companies, of February 24, 1978, and its By-Laws, Executive Decree number 8599 of March 9, 1978.

According to Article 1, Paragraph a) of Law 6209, a foreign company is defined as:

"Foreign companies: Any individual or company domiciled abroad which carries on commercial activities within the country, directly or through branch offices, agents or subsidiaries."

A distributor is further defined as:

"Exclusive Distributor or Co-distributor: Any individual or company, which, by means of an agreement with a foreign company, imports or manufactures in the country, goods for distribution within the national market, acting at its own expense and risk."

A representative or agent is defined as:

"any individual or company which in a continuous and autonomous manner with or without legal representation prepares, promotes, facilitates or accomplishes the sale or distribution of goods or services which foreign companies sell or render in the country."

Law 6209 contains particular features that tend to over-protect the rights and interests of those individuals or entities qualified as representatives or distributors of foreign companies under the definition of Costa Rican Law. The importance of the distinction between distributor and representative or agent lies in the consequences of termination in each case.

The Law has been declared as a Law of Public Order, which means that it is paramount to the free will of the parties. Therefore, the parties cannot include in a distribution or representation contract any term or condition that would conflict with the provisos of said Law, nor could they take exception to any one of them based on their private agreement. As indicated supra, those provisions of the distribution agreement that contradict the scope of Law 6209 are deemed null and void.

For example, there is abundant jurisprudence which in no uncertain terms establish that the existence of a distributorship needs not be documented in a formal written contract. To the contrary, our Courts have interpreted that when Law 6209 makes reference to a contract or agreement, it includes not only a formal written instrument, but an undocumented commercial relationship between the parties suffices. In other words, the mere fact that a commercial relationship between a foreign company and a local individual or entity conducting business in such capacity exists, suffices to construe a distributorship, thus rendering the parties subject to the provisos of law 6209.

Our Courts have been very open in connection with the evidence acceptable to demonstrate the relationship, i.e., correspondence, witnesses, purchase or supply orders etc., have been accepted by our Judges to substantiate such a commercial relationship.

The Courts have also interpreted that, even if it was not explicitly provided for in the corresponding agreement, a relationship established with a local representative or distributor, could become of an exclusive nature, if the foreign company keeps contact only with that distributor or representative for an extended period of time. The concept of presumptive exclusivity may have changed upon enactment of the Law for the Promotion of Competition and Consumer Protection (Law 7472 of 20 December, 1994), as said law prohibits any and all type of monopolistic practices. However, the issue of the impact of Law 7472 over Law 6209 has not been tested yet in Court.

The scope of protection of the Law goes as far as restricting the applicable legislation and forcing the parties to submit themselves to the jurisdiction of the Costa Rican Courts. Accordingly, Article 7 of Law 6209 reads:

"The jurisdiction of the Costa Rican Courts and the rights of the representative, distributor or manufacturer by virtue of this Law, cannot be relinquished."

However, the Constitutional Court declared Article 7 partially unconstitutional, thereby changing the position traditionally sustained by the Civil Courts concerning the exclusivity of the Costa Rican courts over the handling of disputes under law 6209. The Court held that said position contravened a number of international conventions and in resolutions number 10352 of 22 November, 2000; 02655-2001 of 4 April 2001 and 12712-2001 of 14 December 2001 allowed the submission of a dispute under a distribution relationship to arbitration, even if the forum for such arbitration is abroad, provided the applicable law is 6209.

The Law under analysis also regulates the causes for termination of a distribution or representation relationship.

Under Article 5 of said Law, the only causes for termination without responsibility for the foreign company are:

"Article 5: The following are deemed as just causes for the termination of the contract of representation, distribution or manufacture, for which the foreign company is not liable:

1. Offenses and misdemeanors against the property and reputation of the foreign company committed by the representative, by the distributor or by the manufacturer.
2. The incompetence or negligence attributable to the representative, distributor or manufacturer, declared by one of the judges of the Civil Court of its domicile, as well as a decrease or a prolonged and substantial stagnation in sales, due to causes attributable to the representative, distributor or manufacturer. The establishment of quotas or official restrictions on the importation or sale of the product or service shall presume the non-existence of the relationship, unless proven otherwise.
3. The violation on the part of the representative, distributor or manufacturer of the trade secret and loyalty due to the foreign company, by the disclosure of facts, knowledge or techniques relative to the organization, the products and the operation of the foreign company, acquired during his commercial relations with the foreign company.
4. Whatever other serious fault on the part of the representative, distributor or manufacturer relative to its contractual or legal duties and obligations with the foreign company."

Termination for any other cause, will render the foreign company liable to pay compensation, which includes re-purchase of the inventory, plus ten per cent to cover finance charges and, if taken to litigation, subject to an importation ban on its products until a guarantee bond is placed to satisfy the court that the obligations will eventually be fulfilled.

The Law also allows the local distributor or representative to rescind the agreement for causes attributable to the foreign company, in which case, the foreign company would be held liable to pay the indemnification, albeit the local distributor or representative terminated the relationship.

Accordingly, Article 4 contains an exhaustive list of instances construed as just causes for termination of the distributorship by the local distributor, representative or manufacturer, for which the foreign company is liable:

1. Offenses and misdemeanors by the company's officials against the property and the reputation of the representative, distributor or manufacturer.
2. The termination of activities of the foreign company, unless it is due to causes beyond their control.
3. The unjustifiable restriction on sales, imposed by the foreign company, which may result in a reduction in the volume of business carried out by the representative, distributor or manufacturer.
4. Lack of payment of commissions or fees earned by the representative, distributor or manufacturer.
5. The appointment of a new representative, distributor or manufacturer, when the affected ones have exercised the representation, distribution or manufacture on an exclusive basis.
6. All unilateral modifications introduced by the foreign company to the contract of representation, distribution or manufacture, which impair the rights and interest of their representative, distributor or manufacturer.
7. Whatever other serious fault committed by the foreign company which impairs the contractual or legal rights and obligations that it maintains with its representative, distributor or manufacturer.

According to Article 3 of Law 6209 if the distribution agreement is terminated, the foreign company shall purchase the inventory of its products from the distributor, at a price including the cost of said products, plus a reasonable percentage for the investment made. This percentage shall be determined by the Ministry of Economy, Industry and Commerce.

The foregoing is further regulated in the By Laws to Law 6209, which, in case of termination establishes the following additional obligations of the foreign company:

1. Pay all outstanding commissions, as well as those that may eventually arise from business in process of formalization at the moment of cancellation of the contract.
2. Purchase the inventory of products, at cost, including direct and local expenses plus taxes, plus ten percent (10%) to cover financial expenses.

If the foreign company terminates the agreement for reasons not contemplated in the list of just causes for termination listed in Law 6209, based on Article 2 of said law the local company is entitled to sue, and claim damages based on the method of calculation of indemnification referred to above.

For many years, the Costa Rican Courts interpreted that a provision establishing a definitive term of an agreement covered by the scope of Law 6209 was null and void, and the compensation procedure applicable in all instances where the relationship was terminated for causes other than those comprised in the law or not renewed for causes beyond the will of the local distributor. Accordingly, the Civil Courts upheld that if a distributorship or representation agreement was not renewed for reasons not attributable to the local distributor or sales representative, this was construed as breach of contract with liability to the foreign company.

However, a recent landmark Supreme Court of Justice ruling (Periódicos Internacionales, S. A. v. UPS Worldwide Forwarding Inc., Ruling 62-F-04, Supreme Court of Justice (January 30, 2004)) changed previous interpretations by stating that the initial point of the analysis of a distribution relation must be the terms and conditions of the agreement executed by the parties -their free will- which would determine the existence or not of conditions adverse to Law 6209 and its application.

Should a foreign company decides to terminate a distributorship unilaterally without cause, Law 6209 contemplates a mechanism of indemnification in favor of the local distributor, based on average gross profit over a period of time.

In this regard Article 2 of Law 6209 states that:

"Article 2: If the representation, distribution or manufacturing contract is revoked due to causes contrary to the will of the representative, the distributor or the manufacturer, or when the contract has reached its term of expiration and is not extended for reasons beyond their will, the foreign company must indemnify them with an amount that shall be calculated on the basis of the equivalent to four months of gross profit for each year or fraction thereof of time served. The amount of the indemnification shall not, in any case be calculated for a term exceeding nine years of service. In order to establish the gross profit for each month, the monthly average earned during the last four years or fraction thereof of the term of the contract will be determined, in the case of representative and manufacturers, and the average of the last two years or fraction thereof in the case of distributors."

The By-Laws to Law 6209, in their Article 1, further set the guidelines to calculate the compensation in favor of the local representative or distributor:

"Article 1: The amount of the indemnities referred to in Article 2 of Law 6209 shall be determined:

1. For the Representative of Foreign Companies, by adding up the commissions received during the last four years of the duration of the contract, or fraction thereof, including the corresponding commissions covering pending orders. The aforementioned total shall be divided by the number of months which constitute the period of calculation to establish the monthly average of the gross profit, which shall then be multiplied by the number of years of the duration of the contract or fraction thereof; the result of which shall be multiplied by four.
2. For distributors or co-distributors, by adding up the gross profit received during the last two years or fraction thereof of the duration of the contract, whose final result shall be divided by the number of months which constitute the period of calculation in order to determine the monthly average of the gross profit, which shall be multiplied by the number of years or fraction thereof of the duration of the contract, and the result shall be multiplied by four.
3. For manufacturers, by adding up the gross profit received during the last four years or fraction thereof of the duration of the contract. The aforesaid total shall be divided by the number of months which constitute the period of calculation in order to determine the monthly average of the gross profit. The aforesaid average shall be multiplied by the number of years or fraction thereof of the duration of the contract and the result shall be multiplied by four.
4. For the Representative of Foreign Companies who also is a distributor, co-distributor or manufacturer, by adding up all the results of each of the calculations, indicated within the clauses a), b) and c)."

Further, Articles 2 and 3 of the By Laws to Law 6209, refer to the indemnification procedures as follows:

• According to Article 2 the gross profit in case of distributors and manufacturers consists of the difference between the sale price of the product and its cost .
• Article 3 establishes that the amounts paid for indemnification under the law shall not exceed 36 months of compensation.

Article 9 of Law 6209 refers to the rules for payment of the indemnification and establishes that the indemnities contemplated in this law must be paid in one lump sum, immediately after the termination of the contract or as the case may be, upon the final judgment. In case a dispute under Law 6209 is brought to Court, the foreign company is normally required to render a guarantee covering the total amount of the indemnities claimed by the representative, distributor or manufacturer, which amount shall be determined by the judge. Should the company fails to do so, the Ministry of the Treasury shall suspend, upon request of the plaintiff, the importation of all types of products of the aforementioned foreign company.

 

CAFTA

Costa Rica and the United States are signatories to the Central America Free Trade Agreement (CAFTA), which includes Annex 11.13. This Annex establishes the specific compromises of Costa Rica and the other Central American countries to promote trans-border commercialization or trade of services.

Costa Rica undertakes to enact a new legal regime for protection applicable to distribution and agency agreements based on the general principles of contractual law, the free will of the parties and equity, consistent with the obligations set forth by CAFTA. The commitment specifically repeals articles 2 and 9 of Law 6209 (mathematical formula for calculation of the indemnification in case of unilateral termination and the obligation of the foreign company to provide a guaranty to secure the payment of an indemnification, respectively).

However, the acquired rights of the local distributor or agent (those granted before CAFTA comes into force) shall be safeguarded.

 

II. Honduras

A. Applicable Laws

Honduras has a specific set of rules to regulate distributorship under Supreme Decree 549, ?Law of Agents, Distributors and Representatives of National and Foreign Companies?.

Under said set of rules, the supplier cannot refuse to renew or unilaterally terminate the contract without just cause. If it does, it is subject to pay a significant pecuniary compensation to the local dealer or agent. Hence, under Honduran Law the unilateral termination or refusal to renew an agreement of this type by the foreign or local supplier without just cause is not allowed, unless indemnification to the Distributor is awarded.

The just causes for termination are established as follows:

1. Distributor's failure to abide by the essential obligations of the contract;
2. Fraud or abuse of trust in the fulfillment of the agent?s (distributor's) obligations;
3. Negligence of the agent/distributor resulting in the loss of market share;
4. Refusal by the distributor to provide reports and accounts or to exercise liquidation pertaining to the business within the time frame and fashion agreed upon
5. Disclosure of confidential information without authority;
6. Bankruptcy, insolvency, inability to make payments or any other legal disablement according to normal business practices;
7. Any action initiated by the distributor that jeopardizes the business or level of sales.

Honduran Courts have traditionally upheld that the parties cannot submit the resolution of their controversies to foreign tribunals nor to any ADR mechanism. Any stipulation to the contrary shall be considered null and void.

 

B. Consequences of Termination

If the foreign company terminates the agreement without just cause, it may be forced to pay an indemnification to the distributor pursuant to article 14 thereof. Such indemnification includes the following components:

•  All expenses made by the local distributor that cannot be recovered due to the modification, non-renewal or termination of the agreement;
• The value of the investments made to the benefit of the foreign company, as long as the Agent or Distributor is not able to use them, in accordance to the depreciation schedules used for the payment of income tax for machinery;
• The value of the merchandise and spare parts in stock that will not be used as a result of the termination or non-renewal; and
• The amount of the annual gross profits obtained by the distributor, agent or representative during the last five years of the distributorship, agency or representation agreement, and if the agreement has a shorter term; five times the amount of the annual gross profits for the number of years the agreement has been in force;

 

C. CAFTA

Annex 11.13 of CAFTA establishes that Honduras shall:

• Consider a just cause for termination the expiration or non-renewal of the term of the agreement;
• Allow for the application of an indemnification (in case of termination without just cause) based on general contractual tenet; and
• If the indemnification is not established in the agreement, allow the parties to recur to arbitration under the general contractual tenet.

 

III. Guatemala

A. Applicable Laws

Guatemala repealed Decree 78-71 that formerly regulated agency, distribution and license agreements. These commercial relationships are now regulated by the Commerce Code and the corresponding agreements can be negotiated and executed in accordance to the free will of the parties.

 

B. Consequences of Termination

The mechanisms of termination of agency or distribution agreements (with or without just cause) are now regulated in article 290 of the Commerce Code. Therefore, depending on the termination scenario, different outcomes and consequences can be considered.

Termination may take place by mutual written consent of the parties or by expiration of the term (only applicable to agreements with definitive term).

In case the commercial relationship is terminated by the distributor or agent, it has to notify the principal with at least three months in advance. At the principal's request, the agent or distributor is obligated to render accounts information and reimbursement of goods/merchandise at CIF price.

Termination under the foregoing scenarios does not trigger any responsibility or liability for any party and neither of them incurs in any severance/indemnification obligation.

Principal's termination decision:

In case the principal decides to terminate the relationship, it becomes liable for all damages and losses caused to the agent, unless a just cause for termination exists. No requirement of prior notice exists if the principal wants to terminate the agreement.

Just cause for termination:

The party responsible for termination without just cause is liable for damages caused to the other party.

For such effect, it is regarded as just cause for termination:

1. For any of the parties:
   1. Lack of fulfillment or infringement by the other party, of the duties agreed upon;
   2. Crimes against the property or person of one of the parties by the other; and,
   3. Refusal to issue the reports and accounts relative to the business, in the time and manner agreed upon.
2. For the principal:
   1. Unauthorized disclosure to third parties of any fact, data, password or formula classified as confidential; and,
   2. Unjustified decreases in the agreed sales average.
3. For the agent, distributor or representative:
   1. Whenever the principal carries out acts that directly or indirectly prevent, or tend to prevent, the agent from fulfilling or complying with the agreement.
4. If the indemnification is not established in the corresponding agreement, the local distributor can request damages (that include promotion costs, non-recoverable investments, stock, labor obligations, etc.

 

C. CAFTA

The most relevant commitment for Guatemala under CAFTA is that it shall promote the use of arbitration for resolving contractual disputes.

 

IV. El Salvador

A. Applicable Laws

While El Salvador does not have a specific law that regulates distributorship or agency agreements, it has incorporated provisions in its Commerce Code to regulate said commercial relationship. Articles 394 to 399 contain specific rules that establish just causes for termination, method of calculation of the indemnification, payment of commissions if there is no written agreement, and other relevant aspects of the commercial relationship between a distributor or sales agent and its supplier or principal.

In general terms the law establishes that the parties may freely negotiate the terms and conditions of their contractual relationship. However, the law contains certain provisions that tend to protect the distributor or agent.

For example, Article 395 states that in lieu of specific agreement, the agent or distributor is entitled to receive a commission in proportion to the magnitude of the business made through its intervention.

If a business is not completed for reasons attributable to the principal, the agent or distributor will still be entitled to the full commission. Further, if the agent or distributor has exclusive rights in an specific territory, it will be entitled to receive a commission for any and all businesses made by the principal in said territory, regardless of whether or not the agent participated directly in the business.

Pursuant to Article 399 A, disputes generated from the application of these provisions will be handled through summarial proceedings at the competent courts of the domicile of the agent or distributor.

If the principal is a foreign company and it is sentenced to pay compensation to a local distributor or agent for breach of contract, it will be banned to do business in the country until it pays the indemnification or until it places a guarantee in court to secure payment thereof.

 

B. Consequences of Termination

Article 397 established that either party may terminate the contractual relationship through written notification thereof to the other three months in advance.

However, if the principal does not terminate the agreement based on the just causes for termination listed in article 398 of the Commerce Code or if the principal unilaterally modifies or does not renew the term of the agreement without just cause, the distributor can request damages, which includes components such as recovery of promotion costs, non-recoverable investments, re-purchase of stock, labor obligations, payment of accounts receivables and payment of gross profits during the last three years or fraction thereof.

Article 398 lists the just causes of termination without liability to the principal, as follows:

1. Default by the agent or distributor of contractual obligations.
2. Fraud by the agent or distributor.
3. Gross negligence on the part of the distributor or agent.
4. Continued decrease in sales levels for reasons attributable to the agent or distributor.
5. Unauthorized disclosure of confidential information.

Article 399 further establishes that the distributor or agent is entitled to terminate the commercial relationship, with liability to the principal, in case the latter unilaterally modifies the agreement in detriment of distributor's or agent's rights and interests. In such case, the distributor or agent is entitled to the same indemnification and compensation established in Article 397.

 

C. CAFTA

Annex 11.13 of CAFTA establishes the following compromises for El Salvador :

• It shall not apply articles 394 to 399 of the Commerce Code to any distribution agreement executed after CAFTA is in force by any person of the United States of America;
• If the distribution agreement contains an specific clause with respect to indemnifications, including a provision of no-indemnification, then article 397 (components of the indemnification) shall not apply to the agreement; and
• It must promote that the agreements entered into after CAFTA is in force contain provisions for arbitration.

 

V. Nicaragua

A. Applicable Laws

Nicaragua regulates distribution and agency agreements in the general provisions contained in its Commerce Code. It has no special law to regulate this type of commercial relationship.

 

B. Consequences of Termination

The consequences for the parties in case of termination are those established in the corresponding agreements and, in lieu thereof, the possibility of applying the indemnification for damages contemplated in the Code of Commerce in case the termination infringes contractual obligations.

 

C. CAFTA

Nicaragua has not acquired any compromises under Annex 11.13. of CAFTA.

 

VI. Panama

A. Applicable Laws

Panama does not have specific legislation to regulate distributorship and agency. The terms and conditions of such commercial relationship are left to the free will of the parties as negotiated in the corresponding agreement. In lieu of contractual provisions, the relationship is governed by the provisions contained in its Commerce Code.

 

B. Consequences of Termination

The consequences for the parties in case of termination are those established in the corresponding agreements and, in lieu thereof, the possibility of applying the indemnification for damages contemplated in the law in case the termination infringes contractual obligations.

 

C. CAFTA

Panama is not part of CAFTA.