(This is not legal advise nor does it create an attorney-client relationship. This is just a blog post. It cannot address the many different issues for individual cases.)

Introduction:
Good distribution agreements make a world of difference. Distribution agreements are vital agreements for driving sales of a product. Few companies can manufacture and distribute their own products. The creator of a product more likely will need to find a distributor to give the product proper market exposure and drive sales. For the distributor, it may want a larger product line to sell and already have the connections to rapidly grow market share. In some industries the customer are very loyal to distributor and will easily try new products based on their recommendations. The agreement between these two parties is a delicate balance, however, because both sides want to maximize their profits and yet need each other also. There are also other possibilities such as using sales representatives, supply agreements, or selling on consignment which can be more flexible but not create as much dedication to the supplier’s product.

A distributor normally carries an inventory of the product and maintains title (ownership). This is the key difference between consignment where title does not change and a sales representative who has neither title nor possession. However, sometimes the supplier will want to retain title until full payment is made. The distribution agreement needs to cover many items because it not just a sales contract but defines the supplier-distributor relationship and their competing interests. The following are some typical terms included in a distribution agreement.
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INTRODUCTION

The power to impose tariffs come from clause 1 (taxing power) and clause 3 (commerce power) of article 1, section 8 of the constitution. Initially tariffs were used to raise revenue but today they are really used to regulate imports. The mission to enforce the customs laws and regulation falls on the U.S. Customs Service, now called Customs and Border Protection. The responsibilities include
- inspection and clearance of carriers, persons and merchandise;
- classification and valuation of imported merchandise;
- assessment and collection of duties on imported merchandise;
- detection and prevention of smuggling; and
- enforcement of import quotas and other restrictions.

The Customs Modernization Act of 1993 (Title VI of NAFTA, PL 103-182)) dramatically changed how CBP treats importers. The Customs Modernization Act placed the legal responsibility on the importer to declare value, assign classifications and determine rate of duty on the goods. The cornerstone of the act is the concept of ‘informed compliance’ which sets a standard of reasonable care for how the importer handles its legal responsibilities. Informed compliance requires the importer to use “reasonable care” in fulfilling CBP requirements. Informed compliance does shift much of the burden to the importer but it can help the importer achieve speedier clearance especially when the importer has a history of voluntary compliance. In addition, after September 11, 2001, the Customs Service merged with Border Protection Service into Customs and Border Protection, security regulations dramatically increased often creating delays. Therefore, the importer is now obliged to follow CBP laws and regulations of face harsh penalties.
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Out fast moving connected world make international alliances and acquisitions more popular than ever. Increasing such deals are being done that would have been unthinkable in the past. Just recently Panasonic sold its home-appliance division to China’s Haier group and Budweiser is now a Belgium company. These are headline grabbing deals, but the same motivations exist for small business. A clothing distributor might make contact with a designer in Brazil or Vietnam establish a distribution deal directly. Small business in the United States need to understand that the U.S. is not leading the way in many trends. The use of smartphones, interactive television, and mobile e- currency further developed outside the U.S. Trends in various industries are tested first abroad. Likewise, many small businesses abroad would like to have a U.S. partner. A business connected, even informally, with a foreign partner may have a unique insight into future trends, technology and potential customers.

Some common motivations for business alliances are the following:

funding: a need to fund research and development for a new product or technology or to fund the marketing phase of a new product. It is great to develop a new product or technology but unless it is “insanely great” significant resources will be needed to gain market acceptance

risk sharing: perhaps the flip side of needing funding is risk sharing. The resources might be there but the risk is too high to bear alone. It is dangerous to bet the farm on one product. This often happens where investment costs are high in such industries as biotechnology. However, the same motivation may exist for a designer looking to start a new clothing line but can’t risk their life savings on a new style.

access to expertise: sometimes money is not exactly the issue but expertise is needed. A company may have a product it designed in a lab, but manufacturing it for consumers is a whole different set of expertise. Or a company may understand the U.S. consumer but not the Chinese consumer.

access to distribution channels: similar to needing outside expertise, a more basic need is distribution. You may be a U.S. company who know the U.S. market but getting your product into Walmart is not easy.

validation- sometimes you have a great product but potential customers are nervous because you are new. A new tablet computer from a startup in Brazil is going to have a hard time being accepted in the U.S. market no matter how much money they have. Now if they are being distributed by ATT then maybe.

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The past two weeks I have introduced the basic structures for forming a business- sole proprietorships, partnerships, corporations and limited liability corporations. Here I will summarize the key differences to consider when choosing a business structure.

Limited Liability

The biggest concern most people have when starting a business is how they can limit their personal liability from business related issues. For example, a workplace accident may result in a lawsuit against the business. A person’s personal assets could be at risk if the business was not using a structure that legally limits liability to the business assets. There is no such limitation on liability for a sole proprietor, a general partnership or the general partner of a limited partnership. Liability is limited to the investment contributed to the business for limited partnerships’ limited partners, LLC, S corporations and C corporations.

Taxation

Another major issue is the tax treatment of profits and losses- will it be retained by the business or ‘pass through’ to the owner. If profits are retained by the business they may be subject to double taxation upon distribution to the owners as was explained in the post of corporations. A ‘pass through’ tax structure allows profits and losses to be reported directed on the owners personal taxes. There is no ‘pass through’ of profits and losses for LLC (election possible), LLP (election possible), or C corporations. There is pass-through treatment for sole proprietorship, general partnership, limited partnership. LLC and S corporations.

Management

Sometimes it is important to have a division of management and investors. Often this relates to taxation issues because an investor may be taxed differently depending on whether they have a managerial role. There is a division between management and investors for LP, LLC, S corporations and C corporations.

Lifespan

A business entity may continue to exist even after an investor dies or terminates their investment. A sole proprietorship and general partnership, however, will cease to exist on the death of the sole proprietor or general partner. A business can exist for perpetuity if it is a limited partnership, LLC, S corporation or C corporation.

Stock Issuance

The issuance of stock is the primary way business attract investors, but not every business structure can issue stock. In fact, only the S corporation and C corporation can issue stock. This is a key advantage for a business needing to attract outside investors.

Size Limit

Some business structures are limited in size- either by minimums or maximums. A S corporation is limited to 75 shareholders, a sole proprietorship can only be one person, a general partnership must be two or more partners, and in some states a LLC must have at least two members.

Limited Liability Company

In 1994 New York created a new type of corporation called the Limited Liability Company (‘LLC’). The Limited Liability Company is like a new hybrid created by combining the best of the corporate structure and the partnership structure. Limited Liability Company laws do vary significantly in certain states. This discussion will focus on New York. The New York law is much more comprehensive than most other states. The New York Department of State has a good page on LLCs (here) and is among the resource links at the end of this post.

A LLC is formed by 1- preparing the articles of organization, 2- properly executing such articles and 3- properly filing such articles. (NY LLCL 203) The LLC filing and notice requirements are similar to a LP. A LLC is required to have a written operating agreement. The operating agreement is akin to a shareholder agreement and by-laws combined. If any issue is not covered by the operating agreement it will be governed by NY LLCL. New York claims it is a LLC friendly state and helpful information, including model forms on its website www.dos.ny.us.

The Limited Liability Company has certain advantages to partnerships or corporations. All members of a LLC are protected from full personal liability. At the same time the LLC can be treated as a taw conduit just like a partnership for tax purposes. There are no minimum requirements for number of shareholders or members (unlike s-corporations) Members may also fully engage in management activities without jeopardizing their limited liability. All members have a right to manage the Limited Liability Company unless the articles of organization provide for management by a manager. Unless there is a manager every member is an agent of the LLC.

This combination of limited liability and being a tax conduit makes the Limited Liability Company very appealing with very few disadvantages. One big disadvantage is that if it does business in a state with different LLC laws or in countries without LLC laws it will probably not be treated as a LLC. LLC laws do vary significantly between states and many countries do not recognize a LLC. Also, the expenses to create a LLC are significantly higher and more complicated.

Prior to 1997, for a LLC to be tax as a partnership the LLC had to prove it did not have corporate characteristics. This created a lot of uncertainty. However, starting in 1997 the IRS adopted a ‘check box rule’ for non-publicly traded LLC businesses with two or more members. The rule treats LLCs as partnership for tax purposes by default unless the Limited Liability Company elects to be taxed as corporation. New York has adopted the same system. (Treas Reg 301.7701-3(a) and NY Tax Law 658) If there is only one member of the Limited Liability Company it is not treated as a separate tax entity.

Fees: The fee schedule is at NY LLCL 1101 although some fees are listed elsewhere, primarily Executive Law 96. New York requires an annual fee of $50 per member with a minimum fee of $325. This fee changes often! There is also a 4% Unincorporated business tax on any New York sourced income and possible rent tax.

Conclusion:

A LLC offers many of the advantages of the corporation, providing limited liability for the owners while offering the tax advantages of a partnership without the restrictions of the limited partnership where there must be at least one general partner who has full unlimited liability. The limited liability company also provides advantages that are preferable to an s-corporation, as the LLC is not subject to the restrictions relating to the number and type of shareholders in an S-corporation.

LLC still retains advantages over s-corporations. LLC has no limitations on its organization as do s-corporations. For example, s-corporations have limits on who can be a shareholder and how many shareholders exist. S-corporations have one class of stock resulting in all distributions being made pro-rata. A LLC may have different classes of members with different allocations for income and loss and be based on something other than capital contributions. LLC members can include certain LLC debt in the tax basis of their LLC membership interest. This results in less amount of distributions being considered taxable gains and allow larger amounts of losses to be used for deductions.

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Resources:

New York Office of the Attorney General memo on corporations and limited liability companies

IRS Publication 542 IRS Corporation

IRS Publication 541 IRS Partnerships

New York State Publication 16 New York Tax Status of Limited Liability Companies and Limited Liability Partnerships

New York State Publication 20 New York State Tax Guide for New Businesses

New York State Publication 35 New York Tax Treatment of S Corporations and Shareholders

IRS S Corporation Requirements and forms

New York State Taxation S Corporation Rules and Forms