Exclusivity Clause: Everything You Need to Know
An exclusivity clause restricts the signer from buying, selling, or promoting any goods or services from anyone other than the issuing company.11 min read
What Is an Exclusivity Clause?
An exclusivity clause is part of a bigger legal document that restricts the signer from buying, selling, or promoting any goods or services from any person or company other than the issuing company associated with the contract. In other words, the company or individual works exclusively with the issuer of the contract. Many company owners who are excited and eager to get started in business may overlook the clause. It may also be included as part of another legal document or contract.
However, an agreement of this nature should be taken seriously. Make sure you understand the terms and potential risks involved before you sign. Violating an exclusivity clause can come with stiff penalties and fines. It is also very difficult to break this clause of a contract without being held responsible for the penalties listed. The clause is also referred to as an exclusivity agreement form and an exclusivity contract.
An exclusivity clause is an agreement between at least two parties where one party will purchase goods exclusively from another. This ensures that the seller is the only party providing the other with the goods outlined in the agreement. A violation of an exclusivity clause may result in a cancellation of the contract, leaving the signer responsible for any goods or services purchased. But this scenario is likely the best scenario since the contract issuer can take more extreme legal action. In some cases, violators of exclusivity agreements have been restricted from buying other goods or services from competitors.
An exclusivity clause mandates that the parties who have signed are legally restricted to sell or purchase goods to or from a single party. The buyer is restricted from promoting, buying, or using similar products from any other vendor or provider. This clause could apply in several situations, including franchises, distributorships, and business opportunities.
If a business broker or investment banker represents one of the parties, the exclusivity clause would refer to the exclusive engagement between the banker/broker and the seller. But if the broker no longer represents the seller and the company is sold within a specific period of time, this can violate the terms of the exclusivity agreement.
A seller might say it is too hard to determine whether a buyer was involved in the deal when a business broker is involved. But the overall purpose of an exclusivity agreement is to protect the broker from working with a seller who breaks the deal as soon as the seller meets the buyer, thus eliminating the need to pay the broker for their services.
An exclusivity clause will typically state that the seller cannot pursue or consider offers made by other potential buyers once the Letter of Intent (LOI) has been signed. Exclusivity clauses tend to be complex and may lead to issues between the two parties. Some investors believe that companies should never offer or take exclusive deals. But in some cases, an exclusivity agreement can help protect both parties.
Example of an Exclusivity Agreement
One example of a successful exclusivity agreement is one of the top-selling electronics across the globe: the Apple iPhone. When Apple launched the iPhone in 2007, it formed an exclusive partnership with AT&T to sell the phone. It took two years of negotiation to come to this agreement. Prior to 2007, wireless carriers were extremely cautious about the software on mobile phones and had to be able to control the software to maintain a relationship with their customers.
Apple broke the mold in terms of wireless carrier-controlled software by controlling exactly what software was installed on its product. AT&T took a big risk by taking this exclusivity agreement since it lost lots of control over the device's functionality and operation. But the wireless company saw the success of the iPod and decided to give control of the customer experience to Apple. AT&T benefited because any customer who wanted an iPhone would have to sign a two-year service agreement with AT&T.
The original exclusivity clause between Apple and AT&T was rumored to last for five years, but exceptions and "out" clauses allowed Apple to begin selling through other carriers a few years after the release of the first iPhone. The wording and execution of the clause with AT&T also helped Apple create a template for agreements in other countries, where AT&T didn't offer service.
Startup and smaller companies may not have as many opportunities for exclusivity clauses since their buyers aren't often concerned with beating out the competition. However, as the deal gets larger, more executives will push for exclusivity to help their companies win in the market. Winning against competitors may include offering services or products at lower costs and growing revenue faster. Offering an exclusive product or service is one quick way to achieve both goals.
Why Is an Exclusivity Clause Important?
An exclusivity clause can protect both parties involved with a contract. Without the clause, a buyer could opt out of selling or promoting a business partner's goods or services, making it harder for that company to succeed. The exclusivity clause also benefits the buyer because it restricts the seller from making the goods or services available to anyone who is willing to sell or promote them. Limiting exposure is a marketing tool that can increase excitement and anticipation among consumers.
Exclusivity clauses are commonly seen in commercial lease agreements. An "anchor tenant" in an office building, shopping center, or other commercial building, whose presence helps attract customers and other tenants, may bring up this type of clause. An exclusivity clause, in this case, might prevent the commercial building owner or management from leasing to the anchor tenant's competitors at the same site.
Reasons to Consider Not Using an Exclusivity Clause
Using an exclusivity clause within a business contract can put the signer under financial strain. If major opportunities come up that would directly violate the clause, the signer cannot take advantage of the compensation and other benefits that may have come from that opportunity. If you are worried about losing out on better opportunities, it is often best not to sign a contract with an exclusivity clause or negotiate the terms so that you have more flexibility.
For example, many bloggers work with companies to promote their goods or services. These agreements might include exclusivity clauses to prevent the blogger from writing about similar products or services within a short time, which may cause confusion among readers and potential customers. Bloggers might negotiate for shorter periods in which they must exclusively promote the brand and then have the freedom to move on to other opportunities.
Potential drawbacks of an exclusivity clause include:
- Limited flexibility and creativity.
- Prolonged time without the option to take other opportunities.
- Financial strain due to losing out on other business opportunities and partnerships.
In the past, exclusivity agreements were sometimes problematic in so-called "zero-hours contracts." A zero-hours contract does not obligate an employer to provide a set number of working hours to a worker, and it does not obligate the worker to accept any offered work. An exclusivity clause in a zero-hours contract could result in a worker missing income-earning opportunities from other companies even if no work is available from the original employer. The Small Business, Enterprise, and Employment Act of 2015 made exclusivity agreements in zero-hours contracts unenforceable.
If an employer tried to take action against a worker under an exclusivity agreement with a zero-hours contract, that employer could be liable for compensation to the employee.
Reasons to Consider Using an Exclusivity Clause
Choosing to use an exclusivity cause can come with a number of benefits. When negotiating this clause, both parties should make sure that it works on both sides. You may want to negotiate for increased compensation because you are limiting future work or opportunities. Some of the reasons to consider using this type of agreement include:
- Limiting who your partners work with to create a competitive advantage.
- Becoming an exclusive provider of services or goods to a business.
- Receiving services or goods exclusively from another party.
Before signing any contract that includes an exclusivity clause, make sure you clearly understand the terms. You can always request to negotiate terms of the clause if you are unhappy with the restrictions. The worst that can happen is the contract issuer can say no. Prior to signing, make sure you fully understand the worst-case scenarios, such as if you break the clause, the company goes out of business, or other issues that could arise. If you understand those and still feel comfortable with the terms, go ahead and sign.
Benefits of an exclusivity clause might include:
- Increased income.
- More brand loyalty.
An exclusivity agreement is rarely unlimited; this term will just about always have an end date. So, while there is no firm deadline, it is important to establish an immediate need for the product or service before offering to a seller. In the iPhone example, Apple did not begin selling the iPhone to other carriers or customers before arranging the exclusivity deal with AT&T. The excitement of the new product in the mobile device industry pushed customers to AT&T, making the deal work for both parties.
What Could Happen When You Use an Exclusivity Clause?
With an exclusivity clause in place, the seller is obligated to only promote, solicit, and sell the agreed upon products or services. The clause restricts the seller from making agreements with other companies that would be considered as competitors. With this agreement in place, the buying party agrees not to solicit the goods provided by the selling party from anyone else as long as it is in effect. Whether you are the seller or the buyer, you can create a competitive advantage for yourself in this case since no one else will have access to the same goods.
What Could Happen When You Do Not Use an Exclusivity Clause?
Without an exclusivity clause in place, the seller may not see the benefit in selling or promoting only the products or services from one company. In the blogging example used above, it might look inauthentic if the blogger posts about similar products and/or services within a short period, causing potential customers to ignore the suggestions. Without an exclusivity clause, the company cannot guarantee loyalty from its partners.
One example in recent legal history was a case between JPL Livery Services, Inc. and the Rhode Island Department of Administration. The state of Rhode Island negotiated a contract with JPL Livery Services, Inc. to transport dead bodies to the medical examiner's office. When the medical examiner's office was seeking to cut costs, it assigned some of its employees to pick up the bodies. JPL Livery Services, Inc. filed a suit against the medical examiner's office, claiming that the contract was exclusive. But without the clause in place, the state Supreme Court ruled against JPL Livery Services, Inc.
Breaking an Exclusivity Clause
If you break the terms of an exclusivity clause and sell for or purchase goods from another vendor, the penalties could be extremely harsh. At best, the company you have signed the agreement with could cancel the terms and require that you pay for the products you have agreed to purchase. The other party also has the legal right to sue you. This could result in limitations around purchasing products from any other sources. Often, parties will choose this course of action to prevent the other party from buying goods from a competitor.
You could also be limited from purchasing or selling goods for a period of time, depending on the terms of the agreement. The exclusivity agreements between franchisors and franchisees are often more stringent than those between other parties. Before you sign anything, negotiate the terms until you feel comfortable with what you will be getting yourself into by signing the agreement.
Frequently Asked Questions
How Long Does an Exclusivity Clause Last?
The duration of an exclusivity clause depends on what is written into the contract. It can be as short as a few months or as long as several years. Most do not extend beyond 5-10 years, but it depends on the parties involved.
Do I Have to Sign an Exclusivity Clause?
No, although failing to do so could impact your opportunity to partner or work with the company issuing the contract. Most companies are open to negotiation, so if you are unhappy with the terms, try going back to change them before declining the contract.
Steps to File
When crafting an exclusivity clause, the contract issuer should focus on:
- The amount of time the exclusivity clause will be in effect.
- Whether the company wants to name competitors to narrow down the playing field.
- Whether the company wants to name an industry (or industries) to narrow down the playing field.
- Whether the company wants to limit the geography to narrow down the playing field.
In exchange for an exclusivity agreement, the company should seek:
- Long-term and larger contracts.
- An agreement from the signer that the company will be committed to the success of the product or service. Commitments might include case studies, press releases, or reference calls to boost sales and raise awareness.
Make sure the clause is specific about exclusivity. Leaving the terminology too broad could cause confusion and upset both parties involved.
Sample Exclusivity Clause
An exclusivity agreement can include a variety of details, depending on the terms and conditions needed by each party. However, most will follow a similar outline. Include the first and last name of each involved party as well as the agreement creation date. Clearly state that both parties have elected to enter into the agreement based on their interest and free will. Then, outline the terms upon which both parties agree.
The next section should cover which party will provide goods or services exclusively to the other. Mention that during the period of the agreement, the seller is not allowed to promote, sell, or solicit the product to any other parties. Additionally, outline the fact that the buyer is not allowed to purchase the product from any other vendor.
Go over what goods or services are included within the terms of the agreement. Include the minimum recommended sales price for all goods or services listed in the clause. The buyer must be willing to pay that price for the product during the agreement's term.
Next, the agreement should outline the standards of the products being offered exclusively to one party. The buyer should not be forced to purchase a subpar product just because of an exclusivity clause. If they receive something that does not meet the description outlined in the standards section of the agreement, the seller should have the opportunity to correct the issue by replacing the product or refunding the money paid.
Discuss the payment terms of the agreement, including any discounts, deposits, and taxes required or given. Go over how the seller will provide invoices to the buyer as well as late fees or payment options. You may choose to include a section that covers the required action if one party terminates the agreement. The seller may require the buyer to purchase a set number of units at a set price.
Delivery is an important aspect of an exclusivity clause, so talk about how goods or services will be delivered. Include details about any product delays and how those will be handled. Expedited shipping options may be included, if the seller offers them. Outline which party is responsible to pay taxes on the goods, including local, federal, and state taxes.
Most exclusivity clauses will include some type of warranty on the product. If the seller provides a product that is not in the condition outlined, they must either provide a new product or a full refund for any defective items. The buyer in an exclusivity agreement should have the opportunity to inspect all products at the time of receipt.
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