What Commitments Do Franchise and Distributorship Agreements Entail Before Investing?
Entrance
In pre-investment legal due diligence processes, accurately identifying a company's existing contractual obligations is crucial. Franchise and distributorship agreements, in particular, provide direct information about a company's revenue structure, market position, and growth potential. However, the obligations inherent in these agreements can pose significant risks for potential investors or acquirers. Minimum sales obligations, regional protection clauses, and termination terms are among the most prominent of these risks.
This article will detail how to analyze these clauses in franchise and distributorship agreements, how to integrate them into pre-investment legal risk assessments, and will include theoretical explanations and case studies.
1. Definition and Nature of Franchise and Distributorship Agreements
Franchising and distribution agreements are contracts that allow a business to market its goods or services to third parties through an intermediary, rather than doing so directly.
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The franchise agreement includes details about the brand, business model, training, and monitoring systems;
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Distributorship agreements are primarily structured as wholesale relationships.
Although neither type of contract is explicitly regulated in the Turkish Code of Obligations, they are considered within the scope of general freedom of contract and are shaped in light of legal doctrine and judicial decisions.
2. Why is it examined in the Due Diligence Process?
Franchise and distributorship agreements should be reviewed prior to investment for the following reasons:
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It affects the company's future revenue expectations.
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There may be payment obligations or purchase guarantees tied to turnover.
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Clauses such as non-compete agreements, exclusivity, and territorial protection may involve restrictive risks.
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Aspects such as the duration, termination, and transfer of the contract directly affect investment plans.
3. What Does the Minimum Sales Obligation Mean for an Investor?
When a dealer or distributor is given a specific sales target, quantity sales, or order commitment, this creates both obligations and risks.
Contractual Risk:
Such clauses often state:
"The distributor undertakes to order at least 500,000 units of product annually and deliver them to consumers in the market."
These obligations include:
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If it is not compatible with market competition conditions,
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If sales targets are difficult to achieve,
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If supported by penalty clauses,
This creates a risk of financial compensation for the investor.
4. What Kinds of Risks Do Area 4 Protection Provisions Create?
Territorial protection means granting a distributor or dealer exclusive rights within a specific geographic area. Such provisions are typically expressed as follows:
“The distributor is the sole authorized distributor within the European side of Istanbul, and the manufacturer cannot authorize another seller in this region.”
a) Problems from the Investor's Perspective:
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This agreement could be an obstacle if the company wishes to operate in another region.
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It can make it more difficult for other companies to integrate after a merger/acquisition.
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It may be subject to review by the Competition Board regarding restrictive provisions.
b) Competition Law Aspect:
According to Article 4 of the Law on the Protection of Competition, regional restrictions may be prohibited if they create market dominance or restrict competition.
5. How are termination terms included in the risk analysis?
a) Fixed-Term or Permanent Contract
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In fixed-term contracts, termination is only possible for a justifiable reason.
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In indefinite contracts, either party can terminate the contract with reasonable notice.
However, most contracts include penalty clauses or compensation provisions in case of early termination.
b) Typical Termination Provision:
"If one party terminates the contract without just cause, the other party shall pay compensation equal to 30% of the average annual sales."
Such provisions carry a significant risk of binding obligations on the investor. In particular, the inability to transfer or renegotiate existing contracts could jeopardize post-merger operations.
6. Case Study: Unrecognized Revenue Commitment Before Investment
Case:
A German investment fund initiates a due diligence process to acquire a technology company operating in Turkey. The investigation reveals that one of the distribution agreements includes a minimum annual sales commitment of 10 million TL, a target that has not been met for the past two years, and the manufacturer has issued a notice of termination for the contract.
Assessment:
This information directly influences the investment decision. Requesting a discount on the purchase price or seeking renewal of the contract becomes a necessary condition for the process.
7. Dispute Resolution and Takeover Conditions
Arbitration clauses in contracts, provisions regarding the jurisdiction of local or foreign courts, and transferability clauses must be carefully checked.
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If the contract is non-transferable, the transfer to a new company after the investment may be prevented.
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If arbitration takes place in cities like London or Paris, the process can be both costly and slow.
8. Compliance and GDPR Review
In dealership and distributorship relationships where customer data is shared, explicit consent, information texts, and data processing agreements should be reviewed within the framework of the Turkish Personal Data Protection Law (KVKK).
Otherwise, administrative fines may be imposed due to a post-investment data breach.
9. Legal Checklist for Investors
- Minimum sales obligations and penalty clauses
- Territorial protection and competition restrictions
- Contract duration and early termination conditions
- Dispute resolution method and competent judicial authority,
- Transferability and renegotiation of the contract
- GDPR compliance and customer data processing permissions
- Current status of contractual obligations
Conclusion
Franchise and distributorship agreements are among the areas requiring the most attention during due diligence studies conducted before investment. Minimum turnover targets, geographical restrictions, and binding termination clauses imposed by these agreements can severely limit a company's operational flexibility after the investment. Therefore, every investor should obtain a detailed legal interpretation of the contractual obligations and identify the commercial and legal risks of the undertaken commitments in advance.
Gamze Akbulut, Law Faculty Student
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