Costa Rica Attorneys - Lawyers, Lang Asociados Law Firm

General Comments on the Costa Rican Law on the Protection of Representatives of Foreign Companies

Many foreign companies doing business in Costa Rica establish their relationship with local parties either without a written contract or through their standard distribution and/or representation agreements. In most cases, those agreements and the establishment of the local relationship are created and entered into without knowledge and/or full understanding of the existing local law, which establishes a very protectionist regime towards the local company.

The following document’s purpose is to address some of the most important issues in the Costa Rican Law on the Protection of Representatives of Foreign Companies (LPR), with the goal of permitting foreign companies to have a better understanding of it, making more informed decisions as to the establishment of relationships with Costa Rican companies and the most convenient structure for such.

A.- SCOPE OF LPR:

LPR (Law #6209 of March 9, 1978 as amended by Law #6333 of April 30, 1979) and its regulations (Executive Decree #8599-MEIC of May 5, 1978), create a very protectionist regime towards the Distributor and the Representative, establishing a series of protections for this entity, covering expiration of the agreed term, indemnification for termination of the agreement and important guarantees for payment of such indemnification, among others.

Sections 1(b) and 1(c) of LPR indicates the scope of its application, defining "distributor" as any person that by the means of a contract with a foreign company, imports or manufactures goods, in Costa Rica, for their distribution in the local market, acting on his own account and risk; and “representative” as any person that in a continuos and autonomous manner –with or without legal representation- prepares, promotes, facilitates or finishes-up the sale or distribution of goods or services that foreign companies sell or provide in the country (as one may see, the activities under this second definition cover a very broad scope). Only contracts responding to that definition of Distributor and/or Representative will be regulated by such law.

Section 7 of LPR, further states that the jurisdiction of the Costa Rican Courts and the rights of the distributor and/or representative by virtue of such law cannot, in any circumstance, be waived, which means that, even if you have a contract in which the distributor and/or representative accept foreign jurisdiction and laws, LPR will apply. In all cases, Costa Rican distributors and/or representatives would be protected under Costa Rican Law and would be able to recur to our country's Courts to enforce and ensure compliance of their rights granted by such laws.

The distribution and/or representation relationship does not require to be established in writing; the actual relationship between the parties is in most cases considered an agreement which can give basis to a structure falling within the scope of LPR.

B.- TERMINATION OF THE CONTRACT UNDER LPR:

1) Just and Unjust Causes in the LPR:

Section 2 LPR states very clearly that if the distribution or representation contract is terminated or if it is not renewed after its expiration date, due to Unjust Causes, or to causes beyond the control of the Distributor, the foreign company would have to indemnify the local entity for an amount to be calculated on the basis of the equivalent of four months of gross earnings for every year or fraction of a year that the agreement was in force. Such gross income is to be calculated according to the average of such monthly incomes during the last two or four years, depending if the relationship was of distribution or representation.

According to the LPR, gross earnings are to be calculated as the difference between the product's sale price and its cost, and the indemnification may not, in any event, exceed a maximum of 36 months.

Furthermore, such indemnification must be paid in a lump sum full payment, immediately after the termination of the contract or after the final court ruling on the matter.

The Foreign Company, in the event of a legal suit, must render a bond to guarantee the indemnification, which is determined by the Judge. If such bond is not rendered, all importation of its products and the appointment of a new Distributor will be banned.

Distribution Contracts, according to the LPR can terminate under Just Causes or under Unjust Causes. The LPR lists a number of Just Causes that permit the termination of the contract. Those causes are divided in two groups:

i. Cases in which the Foreign Company is liable:
* Crimes committed by the Foreign Company's Representatives against the property and/or name of the Distributor.

* Closure of the Foreign Company (termination of business), unless it is due to force majeure.

* Unjustified restrictions on sales imposed by the Foreign Company, which result in a decrease on the transaction volume of the Distributor.

* Lack of timely payment of moneys owed to the Distributor by the Foreign Company.

* Any unilateral amendment to the contract by the Foreign Company that affects the rights or interests of the Distributor.

* When the Foreign Company changes its domicile or its object, or if it is transformed, subdivided or absorbed by another Company, there is no Just Cause for the termination of the contract. The prevailing Company is responsible for the indemnification if the contract is terminated.

* Any other MAJOR offense or noncompliance by the Foreign Company that damages the contractual or legal rights of the Distributor or its obligations towards it.

ii. Cases in which the Foreign Company is not liable:

* Crimes committed by the Distributor against the property and/or name of the Foreign Company.

* Negligence or ineptitude of the Distributor, declared by a Judge.

* Decrease or prolonged and substantial stagnation of sales, for which the Distributor is responsible (the establishment of quotas or official restrictions to the importation or sale of the article presume the non-existence of fault by the Distributor, unless the contrary is proven).

* Violation by the Distributor of the confidentiality or the secrets of the Foreign Company, revealing facts, know-how or techniques concerning the organization, the products and/or the operation of such Company, which were acquired during their commercial relationship.

* Any other MAJOR offense or noncompliance by the Distributor that damages the contractual or legal rights of the Foreign Company or its obligations towards it.

Such listing of Just Causes is not a limited one. The Law is clear when it states that any other MAJOR offense or noncompliance can be a cause to terminate the contract without liability by the Foreign Company.

One option is to let the Courts determine which contractual obligations would imply major offenses or noncompliance. The other, which is the one we suggest to use, is to indicate in the agreement itself, the specific obligations that, if not performed, would imply major offenses or major noncompliance that would lead to its termination by Company with just cause.

2) Inventories:

Unlike the indemnification for the termination of the agreement which are owed only when the termination or not renewal were done without Just Cause, the Foreign Company, when terminating the contract, according to the LPR, has to purchase the Distributor's inventories, at a price that includes the costs of those products plus the "reasonable percentage of the investment made by the Distributor". Such percentage includes taxes, transportation, payments to employees, warehouse costs, among others, and has normally been calculated at 10%.

According to our Courts' criteria, this purchase of inventories is an option for the Distributor and an obligation for the Foreign Company, for both the cases of terminations with and without Just Cause.

3) Other issues related to the termination of the agreement:

According to Costa Rican Law, the rights and obligations originated in the LPR are extinguished if they are not claimed within two years after the occurrence of the fact that would have motivated the claim.

In the event of termination or not renewal, the indemnification would be determined taking into account the moment the parties initiated their relationship.

C.- WHAT CAN BE DONE TO MINIMIZE RISKS AND STRUCTURE A BETTER REPRESENTATION AND/OR DISTRIBUTION RELATIONSHIP VIS-A-VIS LPR?

There are ways to structure the relationship with the local entity which, although would not eliminate all risks and applicability of the protectionist regime established by LPR, would give the foreign company more weapons to permit it, in the case of a dispute, to reach a more favorable settlement or take a stronger position in Court. As follows, we will try to outline some of them:

1) Always have a contract:

As we indicated above, the distribution and/or representation relationship does not need to be created by the means of a contract; and the mere factual relationship between the parties is good enough proof, before a Costa Rican Court, to claim the protection of LPR.

If the contract is structured properly, it can help the foreign company establish specific obligations whose non-compliance leads to termination, as well as mechanisms of proof for most aspects of the relationship.

We suggest the contract to be signed in Spanish (or in another language but with a signed Spanish translation) and to create documentation and wording that decreases risk for it being considered an adhesion contract.

2) Renew the contract periodically:

This practice would permit to amend the distribution and/or representation relationship in a manner that would allow the foreign company to keep up with changes in the actual relationship, as well as to establish additional requirements and obligations, sales quotas, acceptance of previous term’s performance by the foreign company, etc.

3) Major non-compliance:

Label the breach of most contractual obligations of the local party as major non-compliance of the agreement, as per the provisions of LPR. This would permit the foreign company to argue, in case of a dispute, an agreement between the parties on the nature of the breach, leaving the judge less margin for interpretation in favor of the local entity.

4) Establish obligations for yearly reports:

Formal yearly reporting is a very important manner to show non-performance by the local entity. Documenting such reporting (made, in most cases, when the local party is not expecting a breach or a dispute) can help proof performance problems.

Additionally, the non-compliance with this reporting requirement may be a cause for termination of the agreement with just cause by the foreign company, if it can be presented as a case of major breach with the contract.

5) Cut the foreign element from the contract:

LPR only applies to distributors or representatives of foreign companies. If a local subsidiary can be open, with a real local presence (office, employees, etc.) and such entity is the signatory of the contracts, LPR does not apply. The presence must be real (the creation of a local corporate entity is not sufficient) but does not need to be at a large scale.

6) Cut the local element from the contract:

LPR only applies to local distributors or representatives. A common practice is to grant the contract to a foreign subsidiary of the local entity. In this case, it is crucial that all sales activities follow this structure (i.e. shipping may be done to Costa Rica but to the name of the foreign subsidiary; correspondence and invoices must be made to the foreign subsidiary, etc.).

7) Prepare and instruct the sales staff:

All the measures taken to decrease risks under LPR may be worthless if the foreign company’s staff does not maintain practices that are congruent with the distribution and/or representation policies, guidelines and safeguards. All documentation issues by such staff and all actions taken by them shall bear in mind the master guidelines.

8) Keep documents:

All documented communications to and from the distributor and/or representative should be systematically filed and stored. These items may become crucial proof in the case of a dispute.

9) Establish periodical minimum sales:

The non-compliance with such minimums (which must have been mutually agreed) may be considered a major breach by the local entity.

10) Non exclusivity:

Contractually state that the representation and/or distribution relationship is non-exclusive. This would permit you to appoint additional representatives and/or distributors in case of dispute and/or need and would facilitate dealing with problems with one or more of such.

11) Limit to certain products:

If possible, grant representation and/or distribution solely for certain lines and/or products, leaving margin for other relationships on other lines and/or products.

The knowledge, intelligent structuring and coordination of a foreign company’s Costa Rican distribution and/or representation channels, before the existence of any disputes, is a very effective manner to counteract the protectionist spirit of LPR. Our experience has shown that it is possible to drastically decrease the risks of a local operation if safeguards are taken. We hope these guidelines are a starting point for such task.