Something Wicked This Way Comes: Exclusivity Clauses

It’s the Devil’s Own Contract Clauses, the Sequel! This time, we’ll learn about exclusivity clauses.

So, does this mean we are exclusive?

Exclusivity in contracts is pretty much the same as exclusivity in dating.  It’s saying to one another: “so long as you are with me, you can’t be with anyone else”.   This could be a service provider telling their customer that they aren’t allowed to buy similar services from anyone else during the contract. Alternatively, it could be a purchaser telling a supplier that they aren’t allowed to sell a certain product or service to anyone else so long as the contract is going on.

My rule of thumb? Exclusivity is paid for.  Full stop.  No payment=no exclusivity. Just say no. Have that clause removed.

But here’s the thing….  If you do as I’ve suggested here and you read your contracts before signing them, you will run across LOTS of contracts with exclusivity terms. As in, exclusivity that no one is offering to pay for.  Placement agencies want that positions be given solely to them.  SaaS service providers will demand that they be the sole provider of whatever service they provide.  Your larger clients will require that if you sell to them that you not sell to their competitors.  And so on and so forth.  Lawyers love to stick these in, hoping that silly companies that don’t read their terms will blindly sign on the dotted line and get stuck. In my experience, however, most of the time, this is nothing more than old-fashioned greed.  The clause is there in an attempt to lock up the market and help themselves; there’s no product or service-related reason.

In rare cases, there is a genuine business reason for having this in place.  In that case, it needs to be paid for.  Furthermore, the terms of the contract need to be set up in such a way so as to take into account the impact of that exclusivity clause on your business.

What sort of impact?

Here are some examples to illustrate the potential downside of exclusivity.  

  • If you are limited in your ability to sell a product or product line to other companies, when this contract ends, you’ll find yourself with a giant hole in your income…and scrambling to fill it because you have no client base (you weren’t allowed to sell). For a cautionary tale, see here.
  • If a service provider isn’t doing a good job, you have no real recourse. You can’t move to another service provider.   If it’s a really restrictive clause, you might not even be able to bring the activity in-house. This can have significant consequences on your business, anything from not being able to fill a key position (if exclusivity is given to an placement agency) to your mobile app not functioning properly (if exclusivity is given to a company providing mobile app support) to projects not getting done on time or not being done well (if exclusivity is given to a consultant or other service provider).
  • If a revenue partner isn’t succeeding or isn’t as productive as they should be, you’ll be stuck, and your revenues will be stuck with you. You might not even be able to bring the activity in-house. Potential consequences? If you’ve signed with an exclusive distributor of your product or service in a region…that region may remain under-developed and under-performing until the end of the contract period, at which point you’ll have to start from scratch with a new distributor and with an anemic existing customer base.  If you’ve signed an exclusive contract with an ad network, you are now stuck with whatever ads and whatever CPM they send to your site, as opposed to having multiple networks and allowing them to bid against one another. If you’ve signed an exclusive contract with a sales platform (e.g. Amazon), you’ll be effectively blocked off from all territories or populations which that platform doesn’t serve or in which that platform is less effective.

In short, exclusivity can hobble and damage your business.

What about where exclusivity makes sense?

There will be times in which exclusivity does make business sense.  In this case, you’ll want to ensure that the exclusivity is limited to the extent that is needed to address your specific business goals.  In addition, you’ll want to ensure that the contract includes terms which offset some of the risks that exclusivity brings with it.  For example….

  • If you are limited in your ability to sell your products to competitors, the exclusivity should be as narrow as possible and the compensation you are receiving in this contract should include an element for the exclusivity (that is, to compensate you for the sales you could otherwise be making) and the contract should have a longer notice period so as to provide you with enough time to find new clients if this client doesn’t renew.
  • If you are limited in your ability to use other service providers, the contract should include stronger warranties (promises) on the part of the product or service provider. The contract should also answer an important question: what are they paying for the privilege? What additional quality or service levels are you getting in exchange for giving them exclusive status?  Exclusivity can also be limited for a set amount of time for each project. For example, a placement agency might have sole rights to fill positions for two weeks, after which you can send it to all and sundry.  Alternatively, or in addition, you may choose to incorporate easier exit terms.  If I know that I can get out of a contract relatively quickly—say 1-3 months, I may be a bit more willing to take a chance on giving exclusivity. If the partner doesn’t perform, I can cancel, and off they go!
  • If you are limited in your ability to use other revenue partners (e.g. distributors, resellers, platforms), you’ll want a combination of the above. You may demand a minimum fill rate or minimum guaranteed sales revenues. You might limit the exclusivity by geography, scope, time or some other factor.  For example, you might give up the right to outsource sales to other distributors but retain the right to sell in-house; this will allow you some flexibility if needed. You may link exclusivity to milestones or performance where you can get out of the exclusivity clauses if the partner isn’t performing as agreed. Here as well, easier exit terms can help, as it allows you to address underperforming sales results faster, before they turn into massive holes in your revenues and your cash flows.
  • In all of the above cases, you’ll want to ensure that you have a provision stating that in the event you terminate the Agreement for breach, the exclusivity provision and related terms (e.g. a non-compete provision) terminate immediately.

An ounce of prevention is worth a pound of cure

Above all, the key to managing exclusivity arrangements is knowing who you are getting into bed with—their pluses and minuses, their advantages and limitations.  You can then draft your contract in general and any exclusivity clauses in particular with these in mind.  In short, do your homework and be creative.  For example, if you are selling on a sales platform which demands exclusivity but doesn’t cover all of your target areas, look into how you can offset this.  Perhaps the contract can be amended so that exclusivity only covers certain regions.  Or you might elect to modify and divide your product line between distributors or platforms (e.g. the English version of the book is sold off of Amazon but other languages are sold off of other local sites). If you are a smaller company, you might not have sufficient bargaining power to request changes to contracts, but a shorter-term contract (even at a higher cost) might be an effective solution.  You deal with limitations to start but ensure you have an opening to get changes as you grow.

The above are, of course, only examples.  If you are going to include exclusivity in a deal, it’s a good idea to touch base with legal counsel (as always—give them full details of what you are trying to do). They can review and make sure you are taking the relevant risks into account and that your contract includes adequate protections.

Thank you (yet again!) to Sharon Herman Hezroni of SHH Law Offices for her help with this article.