Jonathan Tardif
- In an economic downturn, some companies attempt to cut costs by changing suppliers. What are the most common situations when this will occur?
- What are the early warning signs that one party may be trying to extract themselves from an agreed contract?
- If a company fears the other party are trying to pull out of a contract, what should they do?
In an economic downturn, some companies attempt to cut costs by changing suppliers. What are the most common situations when this will occur?
The most common situations when one party will try to terminate an existing contract are when the existing agreement is costing them money, or isn't producing the financial return they hoped it would. In other situations, one party may discover they can get the same service cheaper from another supplier.
Occasionally, suppliers to large public companies will make "opportunistic" claims against them for alleged breach of contracts, in the hope that the PLC will pay them to go away. On the other hand, it may make financial sense for a major PLC to spend ?1 million in legal fees to extract themselves from an uncompetitive contract, if it is likely this strategy will subsequently save it ?3 million in supplier costs.
What are the early warning signs that one party may be trying to extract themselves from an agreed contract?
One obvious sign is if one party suddenly begins to behave very "contractually", especially if they haven't done so before. If one party suddenly insists that all deadlines are adhered to, or procedures are strictly followed, it often can feel like they are trying to "trip up" the other side - because they are.
Alternatively, one party may change the way it corresponds with the other side. Instead discussing the matter casually on the phone, they will begin to insist that all issues are addressed in writing, or dealt with in face-to-face meetings. Conversely, they may stop corresponding with the other side altogether.
If a company fears the other party are trying to pull out of a contract, what should they do?
If a company believes another party is trying to pull out of a contract, they must do two things. Firstly, they must grade the risk of this happening according to its importance. There are some suppliers that most companies rely on in order to function - such as IT. By contrast, if a company's vending machine supplier chooses to stop working with it, that's a less serious problem.
Once the company has carried out a risk assessment, they must then carry out an honest assessment of their performance of the contract. Are they falling short on any area? One of our clients recently came to us, asking us to perform a contract audit. They wanted us to assess whether or not they were complying with their contractual obligations, because they did not want to give the other side any excuse to claim they were in breach. Our clients knew the other side were watching their performance like a hawk. Such assignments are becoming more common.
Occasionally, companies attempt to terminate a contract because their existing supplier is caused them "reputational damage". What are the legal ramifications of such damage?
Increasingly, clients are asking potential suppliers to adopt certain policies - for example in relation to workplace diversity or corporate social responsibility - as a condition of doing business with them. But these "reputational" considerations are not just important when the business has been awarded; they are also important during the initial tender stage. Potential suppliers need to address them, in order to even be considered during the selection process.
But, in general, I haven't noticed these conditions being written into the subsequent supply contracts that often. As a result, the decision on whether or not to terminate a supplier that is causing a company reputational damage remains largely a commercial decision. A client may decide it is better to lose money in terminating a supply contract - even if the supplier is not in breach of any conditions - rather than continue to suffer reputational damage by association. It can take many years to build a brand's reputation, but much less time to destroy it.
When one party decides termination is desirable, what processes are involved?
They should look for evidence of material breaches where possible and, if they believe such breaches have occurred, begin the process of termination. This can be a significant threshold to cross. If a client claims the supplier has breached their contract, and this is not true, the supplier may bring a claim for wrongful termination.
Today, termination clauses are very important to get right because they prevent one side from terminating an agreement too quickly. Where there is an issue which divides the two parties, a termination clause often provides for a series of meetings between the two parties. It is hoped that these meetings will be able to solve the dispute amicably.
In my opinion, contracts that include the requirement for binding mediation are often misguided. When some parties fall out, there is often no point in taking the matter to mediation too early, before the issues are mature - it just becomes a box ticking exercise.
One advantage of taking a dispute to court is that it requires both parties to disclose all relevant information - that's not always the case during mediation. The more information that is exchanged, the more obvious it is to the court which side is at fault.
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