Brief Introduction About Exclusivity Agreement
When two parties are negotiating a business deal, they may agree to negotiate only with each other. This makes it an exclusive negotiation. They can choose to formalize this exclusivity in an agreement known as the exclusivity agreement. Under this, one party agrees to deal only with the other party for as long as the agreement lasts. It is also known as a lock-out or shut-out agreement. It is a legally binding contract between them. Usually, these agreements happen in a buyer/seller relationship. Here, the buyer agrees to purchase goods exclusively from the seller for the duration of the agreement. The seller, on the other hand, agrees to exclusively supply goods/services to the buyer during this period.
Purpose of an Exclusivity Agreement
The main purpose of this agreement is to enable two parties to deal only with each other. It prevents outside parties from interfering in the ongoing business negotiations. Therefore, it strengthens the business relationship between the parties. It gives the buyer enough time to carry out the necessary due diligence of the seller. For the seller, it serves as an assurance that during the term of this agreement, the buyer will exclusively and solely transact with the seller and no one else. Having this agreement in place prevents wastage of time and financial resources of both parties. It helps them finalize negotiations without worrying about their competitors.
Contents of an Exclusivity Agreement
A well-drafted exclusivity agreement must include the following terms:
- Names of the parties
- Date of the agreement
- Exclusivity period: the period of exclusivity to be observed by both parties;
- Conduct during the exclusivity period: which activities are allowed and which are not;
- Notice
- Exclusivity fee
- Obligations of the parties
- Confidentiality of information
- Consequences if either party negotiates with a third party during the exclusivity period
- Termination of agreement
- Dispute settlement
- Governing law
- Signature of the parties
How to Draft an Exclusivity Agreement?
When drafting this agreement, it is important to consider the following points:
- Provide a clear definition of “exclusive.” State precisely what activities are permitted under this agreement, and which are prohibited.
- Mention expressly that neither party can negotiate or transact with any outside party during the exclusivity period.
- Prescribe notice obligations that if either party receives any outside offers during this period, it must notify the other party in writing and furnish all related proof.
- Clearly state the exclusivity fee that is to be paid by the buyer to the seller for entering into the agreement. This clause must also mention when the fees become due, when it is to be paid, and the manner of making the payment. Also, mention the circumstances when such a fee is to be refunded by the seller.
- Mention the obligations of the parties. For example, the seller should provide all the necessary information to the buyer for the transaction and not enter into other transactions with outside buyers. Similarly, the buyer should conduct due diligence of the seller, pay the required fees, and not initiate alternative transactions.
- Both parties will exchange business information with each other. To prevent them from sharing the information with any outside party, include a confidentiality provision.
- It is very important to consider potential antitrust law risks that may arise due to the exclusive relationship conferred by this agreement.
[ Also Read: Exclusive Distribution Agreement ]
Negotiation Strategy
Before signing this agreement, both parties should understand all the terms and the risks that they carry. They will approach the negotiations differently. But the agreement has to be fair to both of them. They should be flexible and accommodate each other’s demands as much as possible. The buyer should negotiate for a long exclusivity period. It should try to convince the seller to end his business discussions with other potential purchasers. Similarly, the seller should negotiate for a short exclusivity period. It should discuss mutual exclusivity with the buyer, where the buyer also refrains from entering into business transactions with other sellers.
Benefits and Drawbacks of an Exclusivity Agreement
Benefits:
- It creates a competitive advantage by not allowing outside interference.
- It makes the seller the exclusive provider of goods and services to a business during the term of this agreement.
- It protects the buyer by restricting the seller from selling its goods and services to any outside buyer during the term of this agreement.
- It helps the buyer to establish itself in the market.
Drawbacks:
- It restricts both parties from entering into business transactions with other entities.
- It may cause both parties to lose out on other attractive business opportunities.
- It may give rise to antitrust and competition law concerns.
What Happens If the Agreement Is Violated?
If there is a dispute under the agreement, it will be settled as per the dispute settlement clause. But if that process fails and the parties choose to sue in court, some of the below-mentioned legal consequences may follow:
- If the buyer violates the agreement(1), then the seller can either terminate this agreement or sue the buyer in the local court and recover damages. It can also ask the buyer to pay for the goods that it had agreed to purchase only from the seller under the agreement.
- If the seller violates the agreement, then the buyer can sue the seller in the local court. It can recover limited damages to cover loss of expenses, or it may get an order restraining the seller from negotiating with the buyer’s competitors. It can also enforce other restrictive measures against the seller, depending on the terms of the agreement.
An exclusivity agreement acts as a safeguard for both parties. It requires the parties to the agreement to negotiate/transact exclusively with each other during this period and prohibits either party to enter into an alternative transaction with a third-party buyer/seller. The agreement not only saves time and financial resources of both parties but also establishes a stable business relationship and promotes competition in the market. However, care must be taken to ensure that the terms and conditions of the agreement do not result in a monopoly(2) or promote anti-competitive practices and polarize the market.