German case on Distribution Law

12 May 2005

Alexander Duisberg

The District Court of Stuttgart ("court") has come up with a useful clarification on the nature of exclusive software distribution agreements and structuring related business models under German law (District Court of Stuttgart, non-appealable decision of 26 February 2004 (docket no. 40 O 168/00 KfH)).

The claimant, a German software company, had entered into an exclusive distribution agreement with a German distributor of hardware and software (the "agreement"). In the agreement, the defendant had committed to pay to the claimant from each sale of the claimant's software products (the "software") 50% of the recommended end user list price subject to a minimum payment of €125,000 for the initial 10 months of the agreement, payable in 6 instalments (the "minimum payment"). The delivery of the software was organised so that for each purchase the defendant would ask the claimant to send him a licence key. The defendant would hand it over to the end user, who would then download the software from the claimant's website.

During the initial 10 month period, the defendant achieved only a fraction of the anticipated revenues and did not pay the agreed minimum payment. Shortly after that, the defendant found himself in an inferior market position because the claimant had co-developed a competing product with a third party (to which the claimant had sold off all rights of exploitation). The defendant declared that the agreement had expired. In response, the claimant terminated for cause and for alleged failure to comply with the agreed payment terms. The defendant claimed rights to withhold the payment for several reasons, including:

(i) allegedly incomplete software documentation;
(ii) lack of performance by the claimant. The defendant alleged that the claimant had not granted it a comprehensive copyright licence which could be sub-licensed to end users with the software licence and also alleged that the claimant had not delivered (in advance) a sufficient number of licence keys. Thus, not enough end users were provided with rights of use to meet to the defendant’s overall sales target; and
(iii) the principle of estoppel due to the change in the market in respect of the competing product.

The court awarded the claimant's claim in full. It stated that the payment obligation was de facto an agreed lump-sum payment. Thus, it was due in full, independent of the defendant's lack of success in marketing the software. The court found that the agreement had burdened the defendant with the entire risk of merchantability and market success. In particular, the court rejected the defendant's allegations as to (i) on the basis of lack of evidence. As for (ii), the court made it clear that the defendant, apart from holding a licence for demonstration purposes, did not hold a right of use and exploitation in the software independent of the individual orders by end users which could be sub-licensed. The court confirmed that there was no express contractual provision to that end. The court also took as a strong indication the manner in which the software was delivered and made available to the end users, i.e. the pass-through of the licence key from the claimant to the defendant on to the end user effectively resulting in not more than ad hoc sub-licences. Finally as for (iii), the court decided that no share of risk had been agreed between the parties. It would be normal in any distribution agreement to presume that the distributor was better placed to estimate the marketing opportunities than the producer. The court gave weight to the fact that the claimant had no direct influence on the sales efforts of the defendant. In the court's view, the claimant had wanted to obtain an additional protection by agreeing on minimum revenue targets in exchange for the exclusive distribution right. The court viewed this as independent of the fact that the claimant himself had later assisted in introducing a competing product to the market.

The decision demonstrates that structuring the mode of delivery in a software distributor relationship, in particular in exclusive distribution relationships, is decisive for the allocation of risk and any eventual exclusion of rights to withhold minimum turnover target payments.