Detriments of Distribution

[dropcap class=”kp-dropcap”]S[/dropcap]ince January 2018, distributors have played an interesting role in California’s cannabis industry. From a regulation perspective, dealing with a distributor is not optional. However, from the business decision vantage point, they’re not all that necessary. Still, some manufacturing and cultivation licensees opt to utilize distributors for sales and retail relationships with the distributor attempting to act like a brand house (more akin to the liquor model). Whether you have a short- or long-term supply and distribution agreement with a distribution licensees your basic key terms have to be covered in order to avoid disaster on production and sales. If you’re contemplating entering into a more traditional distribution relationship, here are some of the red flag issues.

“From a regulation perspective, dealing with a distributor is not optional. However, from the business decision vantage point, they’re not all that necessary.”

Exclusivity

Bad distribution agreements will obfuscate whether the relationship is exclusive or non-exclusive and especially in regard to certain or various product lines. This is a huge mistake really for both sides, and especially if a distributor is obligated to buy up “all of the product produced by a wholesaler.” One great example is if the wholesaler creates a new product line that isn’t mentioned specifically in the distribution agreement. Without being super specific on exclusivity, disputes are bound to occur.

Relationship with Retail

The relationship with retailers is probably the most valuable asset coming out of the distribution agreement. Routinely, distributors will bar wholesalers from making contact with or selling direct to retailers that are sourced through the distribution agreement. It’s incredibly important then in the agreement (especially in California where distributors don’t have to buy products from wholesalers if wholesalers want to be on retail shelves) to define what retail relationships are included as “off limits” in the contract.

Sales, Marketing, Advertising, Sales Data and Information Rights

Wholesalers can still afford to be picky with distributors in California. As a result, as a wholesaler, if you have specific conditions around the sales of your product (e.g. price, placement, prominence, store selection), you need to negotiate these with the distributor and not necessarily let the distributor take the helm. In addition, wholesalers should not be hesitant to put the onus on distributors to participate in the marketing and advertising of their products (especially in an exclusive relationship) or to at least force the distributor to assist the wholesaler with its marketing and advertising efforts.

Payment Terms

Getting paid from licensee to licensee in California can be a massive challenge, because it’s expensive to run a licensed cannabis business, and margins are typically not great at any volume. A solid distribution agreement will have a very clear payment schedule (and even protocol for disputes specifically related to getting paid). And there’s a big difference between getting paid when the distributor picks up the product versus getting paid when the product actually sells at the retail level. What’s worse is that some distributors may extend credit to retailers, thereby delaying the ultimate pay date for the wholesaler, and if that’s the case the wholesaler should expect to wait a long time to get paid out.

Termination and Effect

This is often one of the biggest areas of problems in these agreements. Sometimes the distributor has a unilateral, “without cause” right to terminate with however many days’ notice to the wholesaler. If you’re a wholesaler, this makes you a sitting duck in that a line of sales could vanish with limited notice, and you’d be powerless to stop it. Plus, the impact unilateral termination can have on existing orders (if not properly determined) can be devastating to a wholesaler that may have changed its entire business and labor force to accommodate the distribution relationship. When the relationship is over, the question will stand as to whether the wholesaler can still pursue relationship with those retail entities, and if there’s a non-circumvent that’s instituted by the distributor for a matter of years, the wholesaler is out of luck.

Product Reps and Warranties

Usually, a distributor isn’t going to have robust product representation and warranties. However, in California, where a distributor can store products, has to have them tested, and can package, label, repackage and relabel flower products, there’s a lot of product handling and interaction going on at a distribution facility. In turn, wholesalers should seek to get at least some reps and warranties around product fitness when in the hands of the distributor (depending on what the distributor will actually do with the product), and indemnification for the same.