Managing risk in commercial supply agreements

In the current economic climate surprises are not often a good thing which is why it’s important to try to create as much certainty as possible. There are several ways in which an organisation can minimise risk in commercial supply agreements, both through contractual clauses and practical operational steps.

How can I minimise risk?

Start with due diligence. Know who your contracting partner is and check key information about them such as their financial health and reputation.

Suppliers should include a retention of title (“RoT”) clause, so that the supplier retains legal ownership of the goods supplied until the customer has paid in full. This clause does not stop the customer from selling the goods on however. To prevent this, include provisions that require the customer to insure the goods and to keep them separate from other supplies – prohibit them from making changes to them and reserve the right to enter their premises to recover the goods. Sometimes, the scope of a RoT clause can extend to title being retained in all goods supplied until the customer no longer owes any money – a so-called ‘all monies’ clause – but this is not always appropriate. Be selective and be mindful that a RoT clause is unlikely to assist in an agreement for the supply of perishable goods.

Often when one party is in financial trouble the other party wants to terminate the contractual relationship alongside their other rights, such as to suspend further supply, to minimise future exposure. This requires a robust termination clause that clearly states this right. Consider including financial distress and change of ownership triggers. Include appropriate transitional provisions in a consequences of termination clause such as payment obligations, co-operation, access to data and whether all “orders” are terminated automatically as well. If pricing has been based on anticipated order volume record that with minimum price or quantity clauses.

Risk does not always come from a failure of a party themselves and it can often be driven by external factors. Suppliers should try to retain the right to adjust their prices and customers need to watch out for these. A common method for doing so is provision for an annual price rise at a specified percentage or the rate of RPI or CPI. Ideally suppliers would seek to include the right to pass off on any cost increases including in respect of component parts and delivery.

Contracts can also limit the liability of a party in the event of a breach, perhaps by excluding a party from claiming certain categories of loss such as consequential and indirect loss, loss of anticipated savings, revenue or data etc, or it may be via hard cap on the amount recoverable. These clauses allow parties to know, and potentially insure against, their exposure from the outset so they can plan ahead. So called “super caps” may be helpful if there are particular areas of concern rather than having an inflated cap for all claims.

If sub-contractors are involved, make sure the relevant terms flow down into their agreements too.

Government policy can also limit risk. The Vertical Agreement Block Exemption Order  provides protection from competition law for organisations that work at different levels of a supply chain. As long as the organisations have market share below 30% and aren’t active in certain product markets, they will not breach the prohibition on restrictions of trade within the UK which can otherwise have serious financial consequences.

Communication is key

Most importantly, parties must recognise that a contract is a live document and due diligence should continue throughout its term. Open and ongoing communication is key to building a relationship and fore-warned is fore-armed should issues arise. Staff should work with shared diaries so key dates for renewal or milestones aren’t missed. Larger organisations may want to adopt a contract playbook to ensure the standardisation of contracts.

Such practices mean that staff can recognise risks both when negotiating contracts and during their term and in many cases early action can avoid losses down the road.

This article was co-authored by Rebecca Quinn and William Hall.