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Legal Pitfalls of Distribution and Fulfillment Contracts

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Whether you have used a distributor or fulfillment house for years, or are newly exploring the possibility, as a publisher you should be aware of legal and financial pitfalls lurking inside these contracts.

The terms of a distribution or fulfillment agreement should be spelled out in detail in a written contract and signed by both parties. Ideally, that contract will be drafted by an experienced attorney. But sometimes distributors or fulfillment houses draft their own contracts without attorney input, often creating ambiguities that can strain the relationship when the parties interpret a provision differently.

Either way, the distributor or fulfillment agent generally presents you with its form contract. As publisher, you should be on the lookout for troublesome provisions in the contract before you sign and for instances when your agent does not fulfill its promises after you sign.

The relationship between a publisher and distributor or fulfillment company is an agency agreement that designates the distributor or fulfillment house as the publisher’s financial agent. The agreement often authorizes the agent to collect money for books you have sold and remit payment to you. It also specifies that the agent may deduct its service fees from your collections before remitting the balance to you. Your agent is allowed to keep sale proceeds it has collected on your behalf only when and in the amounts that you specifically authorize.

The following are some of the more frequent pitfalls I have seen in the distribution and fulfillment contracts I have reviewed as counsel for publishers.

Undisclosed charges. These are line-item charges that appear on your invoice but not in your contract. My clients have been surprised by noncontractual charges for everything from Barnes & Noble freight chargebacks, the Baker & Taylor rebate program, and shipping charges the distributor said it would pay, to 1.5 percent late fee penalties, and an $80 fee for correcting one numeral in database entries. Hidden charges may appear under the heading “Miscellaneous” on your agent’s invoices.

Other undisclosed charges may apply when you terminate the agency relationship, such as hundreds of dollars in fees for picking and packing cartons of your books, labeling the cartons, and palletizing the cartons. Your contract may list only a flat fee for termination and not these hidden costs. So ask about all costs you might incur when terminating the relationship before entering into a new or renewal contract.

By far the largest hidden charge can cost publishers up to thousands of dollars a month. I have never seen a contract that authorizes this practice. But many companies handling fulfillment as agents force their publisher-customers to bankroll them—essentially give them a line of credit as a bank would—when book wholesalers return the publisher’s books.

For example, when a wholesaler, such as Ingram or Baker & Taylor, orders your books in May, your fulfillment agent adds the discounted purchase price of your books to a master invoice it sends to the wholesaler. That master invoice also lists books that the wholesaler ordered that month from your agent’s other publisher-customers. The invoice does not mention you or any other individual publisher. The wholesaler just gets an invoice in the agent’s name for a total sum.

The wholesaler may not have to pay your agent’s May invoice until September or later under the terms of its contract with the fulfillment agent. But the wholesaler may return some of your books in June that it ordered in May, books whose costs appear on your agent’s May invoice. The wholesaler then pays your agent less in June because it has deducted the cost of the returned books. When September rolls around, the wholesaler will still pay for all of your books ordered in May even though some of them were returned in June.

Rather than carry the June cash-flow shortfall itself from June to September, your agent charges you for it in June by deducting the shortfall from the amount of collections it remits to you. The result is that you end up lending the money the wholesaler owes your agent (and you) for your books until the wholesaler pays the agent’s May invoice in September. In effect, you buy your own books for a few months.

To avoid these and other unpleasant surprises, ask that your contract list all possible types of charges you might ever see on your agent’s invoice (even if some of them appear unlikely), and the potential amounts. Request this charge sheet before you initially enter into or renew a distributor or fulfillment house contract. Then if you see a charge that is not in the contract, demand that it be taken off your invoice. You do not want to pay a fee you did not agree to pay simply because you did not assert your legal rights.

Return reserves. Fulfillment agents also force publishers to bankroll them with “return reserves.” For example, one contract I reviewed states expressly that the distributor/fulfillment agent will remit to the publisher only 70 percent of book sale proceeds it collects each month, keeping the other 30 percent for a rolling nine months as a reserve against book returns. After nine months, the 30 percent withholds more than nine months old begin to be paid to the publisher on a rolling monthly basis. The reserves over a period of nine months can total thousands of dollars.

Other fulfillment agents may selectively withhold collections for a month at a time as a return reserve.

I have yet to see a contract that permits either practice. If your fulfillment agent withholds your funds as a return reserve, check to see whether your contract gave it the right to do that. If not, keeping those funds from you is illegal.

Insurance charges. Some distributors or fulfillment houses give you the option of insuring your books stored in their warehouse, either through your own insurance agent or through them. Insurance is a must, as hundreds of warehoused books have been known to disappear at a time.

If you choose to insure through the distributor or fulfillment house, make sure it is authorized under state law to sell insurance by checking the state department of insurance’s Web site. Otherwise, it is collecting your insurance premium payments illegally. I know of one large distributor currently under investigation for insurance fraud for this reason. To be sure, ask the distributor or fulfillment agent for a copy of the Certificate of Insurance issued by a bona fide insurance company showing your company as a named insured on the policy.

Percentage of orders service charges. Most companies performing fulfillment duties charge a percentage of the dollar amount of book sales invoiced to buyers each month as their service fee. The charge can be as low as 14 percent to 30 percent or more, depending on whether your agent also does marketing for you.

Many distributors and fulfillment houses also assess a variety of add-ons to the percentage fee. For example, one distributor/fulfillment agent I know charges an 18 percent monthly fee plus piece rates for every step of fulfillment, including answering the phone, creating labels, and using its computer or fax to receive an order. Another distributor/fulfillment agent charges the higher of a percentage of sales or a flat rate. Still others say they will remit to the publisher a percentage of the retail or wholesale price of books sold.

Read your contract carefully to determine what you have agreed to pay for services your agent renders. Then analyze your monthly invoices to confirm that only contractual charges are being deducted from your payments.

Annual fee increases. Some distribution and fulfillment agents unilaterally increase their service fees and/or add-on charges every year without negotiating an increase with you. If your contract does not expressly allow fee increases to be imposed on you, the new rates are not legally binding. You must agree to any change in the terms of your contract for it to be enforceable.

If you point this out and your agent asks you to sign a contract amendment that allows fee increases, demand something of value in return for the amendment. A contract, including an amendment, must have “legal consideration” to support it. In this context, consideration means something of value to the publisher in return for the fee increase. For example, you might negotiate that the new fees be locked in for five years, or that another fee be reduced, or that return reserves be paid over to you immediately, or that some other contract term be changed in your favor before you sign the amendment.

Other trouble spots. As you look through your distribution or fulfillment contract to spot the issues outlined above, look for these other pitfalls as well:

● Can the distributor change the discounts given to wholesalers or retailers without your permission, reducing your income as a result?

● Are you responsible for book buyers’ bad debts?

● Is a “shrinkage” percentage specified, allowing your agent to lose or damage a percentage of your books without paying you for them?

● What are the penalties for late payment of your agent’s invoice (for instance, can it refuse to accept book orders until you pay)?

● What do you have to do to get out of the contract (such as give so many days advance notice), and does your agent have to continue its duties during the notice period?

With a little cooperation from both sides, publishers and distributors or fulfillment houses can amicably negotiate and navigate the relationship of trust they both expect.

Nanci L. Danison, J.D., is an attorney with 35 years experience and an author of three books and 20 CDs/DVDs. She can be reached at NDanison@sbcglobal.net.

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