What it costs to end a Colombian distribution agreement

Colombia is the market where European companies most often assume their contract protects them and find that it does not. The two provisions that do the damage are short, old and well known to every Colombian commercial lawyer, and almost unknown outside the country.

Article 1324: the formula

Where the relationship is a commercial agency, the Codigo de Comercio provides that on termination the agent is entitled to a payment equivalent to one twelfth of the average commission, royalty or profit received in the last three years, for each year the contract ran.

The three-year base is the detail European companies get wrong, and it works against them. Averaging over the whole life of the contract would flatter a relationship that grew; the statute averages over the final three years, which for a distributor worth terminating is usually the best three.

That is a floor, not a ceiling. The same article provides that where the principal terminates without just cause, or where the agent terminates for the principal's fault, the agent is additionally entitled to an equitable indemnity determined by experts, taking into account the extent to which the agent developed the goodwill of the business.

A ten-year relationship therefore carries a base entitlement of roughly ten twelfths of the average of the last three years' earnings, before any equitable indemnity. On a growing account that is close to ten months of recent earnings. It is a number you can and should model before you sign.

Article 1328: your governing law clause does not survive

This is the one that surprises people. The Codigo de Comercio provides that contracts of agency performed in Colombia are subject to Colombian law, and that any stipulation to the contrary is without effect.

So the standard European drafting, Danish law and arbitration in Stockholm, does not remove the Colombian regime for a genuine agency performed in Colombia. An arbitral tribunal applying Colombian law will apply articles 1324 and 1328; a tribunal applying Danish law risks an award that Colombian courts will not enforce against Colombian assets.

Mexico is the useful contrast. It has no equivalent statutory indemnity at all and no mandatory law provision of this kind, which we cover in ending a distributor agreement in Mexico. Two neighbouring markets, opposite answers, and the same contract template used for both is how the exposure gets created.

The real risk is re-characterisation

Everything above applies to agency. A true distributor, who buys goods for its own account, takes title, bears the inventory risk and resells at its own price, is not an agent, and articles 1324 and 1328 do not apply.

The problem is that you do not decide which one you are by what the contract is called. Colombian courts and the Superintendencia de Sociedades look at the substance of the relationship, and a "distribution" agreement can be re-characterised as agency where the facts point that way. The factors that push a relationship towards agency include:

• the supplier controlling resale prices rather than the distributor setting them,
• the distributor being remunerated in substance on a commission basis, including through guaranteed margins or systematic rebates that function as commission,
• the supplier bearing the commercial risk on unsold stock through return or buy-back rights,
• the distributor promoting the supplier's business in the supplier's name rather than building its own,
• tight control over the distributor's customers, territory and conduct.

None of these is fatal alone. Together they are the picture of an agent.

What to do about it

Decide which relationship you actually want, and then be consistent. If you want distribution, let the distributor take title, set its own resale prices, carry its own inventory risk, and build its own customer relationships. If you want the control that comes with agency, accept that you are in the article 1324 regime and price the exit into the deal from the start.

The version that costs the most is wanting agency-level control while calling it distribution and hoping.

Model the exit at the outset. One twelfth per year, on a three-year average, is arithmetic. Run it over five and ten years at your expected volumes and put the number in the business case.

Use a fixed term with express renewal. A term that expires is a cleaner end than a termination, though it does not by itself extinguish an article 1324 entitlement where the relationship is agency.

Document just cause as you go. The equitable indemnity turns on terminating without just cause. If performance is the problem, record it contemporaneously with targets, warnings and responses. A file assembled after the decision is worth much less than one built over two years.

Keep the registration out of it. The regulatory hold is a separate lever and it compounds this one: see your distributor holds the INVIMA registration.

Common questions

Does Colombia require compensation when a distributor is terminated?

For a commercial agency, yes: article 1324 of the Codigo de Comercio provides one twelfth of the average annual commission for each year of the contract, plus an equitable indemnity if termination was without just cause. For a genuine distributor who buys and resells for its own account, those provisions do not apply.

Can a Colombian distribution contract be governed by foreign law?

For a genuine distribution relationship, generally yes. For agency performed in Colombia, article 1328 subjects the contract to Colombian law and voids any stipulation to the contrary, so a foreign governing law clause does not remove the statutory entitlements.

What is the difference between agency and distribution in Colombia?

Agency means promoting or concluding business on the principal's behalf, typically for commission. Distribution means buying for your own account and reselling at your own price and risk. Colombian courts look at the substance rather than the label, so a contract called distribution can be treated as agency.

How is the Colombian agency indemnity calculated?

The base is one twelfth of the average commission, royalty or profit the agent received in the last three years, multiplied by the number of years the contract ran. Where termination was without just cause, an additional equitable indemnity is determined by experts, taking account of the goodwill the agent built.