28 April 2020

Covid-19 – Contracts for business survival

Contracts are right at the heart of business infrastructure and survival. The terms that have been negotiated into the key contracts that support your business can be vital to protect your organisation and help you to negotiate unexpected turmoil. Those with bespoke, robust contracts now are likely to be able to negotiate from a position of strength; those whose contracts are ‘cookie-cutter’ or based on ’templates’ and not tailored to address specific business risks will struggle to enforce them or find a compromise with the other party.

As the coronavirus crisis has deepened, businesses everywhere have been dusting off their contracts and checking their terms to see how they might protect themselves, manage risk or seek legal recourse in these challenging times.

We have been asked to advise on several business-to-business contract scenarios, cross-sector, both on the supply and customer side, where businesses are looking over existing contracts, or negotiating fresh contracts, in order to address the challenges of the current crisis and the potential business disruption it is causing.

Overseas supply chains

Companies who rely on the supply of component products from overseas are finding themselves in uncharted territory as manufacturing slows, established import routes become problematic and currency exchange rate fluctuations affect the cost of goods and impact profitability.

Can we switch suppliers because of supply problems?

Customers in the supply chain may be looking for alternative, perhaps more local, suppliers, to alleviate disruption to their operation or to speed up the process. However, if the supplier terms do not allow the customer to source goods from elsewhere in the event of a delay, the customer may find itself facing a bill from its original supplier for goods which arrive late in addition to paying its alternative provider.

What do we need to protect us against higher costs?

Purchasers of imported goods may find their costs increase as a result of recent currency market volatility. A bespoke customer-focussed contract may well provide that the supplier bears the risk of such fluctuations. Agreements between a purchaser of components and its ultimate customer which allow for a price increase of finished goods due to increased costs supply chain materials may well enable the component purchaser to pass on its increased supply chain costs to the end customer.

Minimum Sales Targets/KPIs

We can’t meet the targets – what’s our next step?

A number of businesses have discussed with us their concerns about being able to meet minimum sales targets or KPIs agreed in contracts at a time when the economy and market conditions were in a much healthier state, and they could more confidently project performance.  A contract becoming less profitable for one or other party to perform than initially forecast, or conditions for the business arrangements underlying the contract becoming less financially viable, are unlikely to provide the basis for one party being excused from the targets that were originally agreed, unless the contract terms make specific provision for this (see, also, our section on ‘force majeure’ below in this regard).

Franchisees and service providers affected

We have seen this arising as a concern in various settings, including in franchising arrangements, in which minimum monthly or quarterly sales targets are common, and in contracts for services’ provision across different sectors.

Often, contracts provide for pre-agreed damages (or liquidated damages) to be paid by a party failing to meet agreed targets, or for deductions to be made from fees expected, which can introduce another level of imminent and ongoing cash flow issue when times are already tough.

One way of anticipating the issue in future contracts, or contracts which you are currently renegotiating, is to build in specific assumptions on which minimum targets or KPIs are based; if you are the contract party to be bound by KPIs, consider also adding in a general “risks” section in your contract, which is designed to anticipate risks related to market or sector specific conditions, and provide that there is some leeway in meeting targets or KPIs should one of these risks transpire.  Clearly, this may require some finely balanced negotiations with your counter-party, but it is about creating contracts which aim to take account of real and practical considerations.   

Events

Cancellation, postponement, deposits and bookings

Events industry businesses have particular challenges at present. Social distancing rules have meant that events such as global business conferences, training events or product trade shows, are on hold for the foreseeable future. Many are looking hard at contract terms dealing with cancellation, postponement and return of deposits for their spring and summer bookings (or indeed to establish whether a virtual alternative is a viable option).

Protecting cashflow

To protect cash flow, the preferred route for many such organisations would be to re-schedule their spring and summer events to autumn or winter 2020 when current restrictions may have been lifted or cancel and issue a voucher for use against a future event. However, some are finding their booking terms with customers do not support this approach, for example, allowing customers the right to end the contract and a full refund if they choose not to sign up for the new date.

What to look out for in contract negotiations

At the outset of a commercial relationship, where time is short and there is a strong business drive to get the deal done, it can be tempting to sign the other party’s standard business terms or pick an ‘off-the shelf’ supply agreement that looks the part, but, in practice, suits neither party’s business model, nor the specifics of the commercial deal you have spent time agreeing.

Setting aside time and resource to craft a bespoke agreement which reflects the terms of the deal and endeavours to look ahead and provide for possible issues which might arise, could prove to be well-spent if you head into choppy waters.  This is especially important in the case of higher value deals or arrangements that are going to span a longer duration.

The important terms in an agreement will always depend on the specific details of what is being provided/paid for and by whom – the value of one term or another will almost always vary according to who is the supplier and who is the customer. Plus, the relative bargaining power of the parties will affect their ability to influence the inclusion of, or the specific drafting of, a particular clause. We set out here some key provisions to think about when entering into contracts going forward:

  • Termination/ cancellation
    • Whether the contract is for a one-off supply of goods or services or an on-going arrangement, what does it say about how the agreement can be cancelled or come to an end?
    • Is it for a fixed term or does it require one party to serve notice to terminate?
    • Does it allow for early termination or cancellation for reasons other than a party being at fault or getting into financial difficulty?
    • How well defined are such fault-based termination rights?
    • It is a good idea to give thought to what types of default are serious enough to allow the other party to bring the contract to an end (often labelled as a “material” breach). Specifying particular obligations which, if not met, would trigger the right to terminate can avoid arguments later about whether a particular breach of contract could be interpreted as material or not.

Particularly where the agreement is for a lengthy period (we would say, certainly, for any contract of a 3+ year duration), think about including a right to terminate without the need to establish default by the other party. A right to terminate at any time, on notice, for convenience or due to a force majeure event persisting for a prolonged period (see further below on “force majeure”) may allow you to walk away if the contract becomes more difficult or expensive to perform in the future.

  • Price adjustment – if current events have taught us anything it is that you can never predict the future. What can seem a fantastic deal on the day the agreement is signed can change overnight if market conditions change. If you are a supplier of goods (particularly where you are reliant on foreign imports), contracts which do not allow for price adjustment, even where due to increased costs of raw materials, could make it extremely difficult to negotiate a higher price when scarcity of supply or adverse currency fluctuations make the contract more expensive to perform.
  • Force majeure – clauses in contracts which deal with what happens if a party is prevented from performing due to an event outside its control have received a lot of attention recently. There is no implied right in English law to absolve a party of liability if its ability to comply with its contractual obligations is delayed or made more difficult by external events. English courts will very rarely step in to discharge parties’ freely negotiated agreements even where this may seem just in light of unforeseen circumstances.

Where you are a supplier or service provider, a well-drafted force majeure clause which covers delay or failure due to epidemic, pandemic and government action, as well as the customary fire, flood, acts of God and other events outside the parties’ reasonable control, could prove invaluable. That said, we would not advise entering into a contract you know you cannot perform at the outset – even the most comprehensive force majeure clause will only kick in where events are not reasonably foreseeable.

It is worth noting that the fact of a contractual arrangement becoming less profitable or simply less financially viable due to changes in market conditions will be very unlikely, in and of itself, to provide a trigger enabling a contract party to rely on a force majeure clause for suspension of, or delay in meeting, its contractual obligations.

  • Dispute resolution – at times like these, businesses want quick, practical solutions to tricky commercial issues. Parties to a contract will always have recourse to courts to resolve issues between them, but having contractually binding alternative dispute resolution clauses built in to your agreement could save time and money, as well as enhancing the chances of preserving the commercial relationship between the parties in the long run.

Tom Williams, from our Dispute Resolution Team, comments: “Going to court can be a costly and time consuming process at the best of times, and current restrictions mean that backlogs are increasing.

“The delays arising from court proceedings may be fatal, given the cash flow issues which businesses are experiencing at present. It may be that getting a quick ‘rough and ready’ resolution is better for both parties than a forensic but delayed one. Whilst no-one wishes to enter a contract thinking that there will be a dispute, it makes sense to look, from the start, at creative ways to resolve any disputes which could arise, whether specifying a mechanism for a binding expert determination, mandating settlement negotiations or a mediation (by video link if necessary) before court proceedings can be issued.”

 

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About the Author
Rajeshree Bhojnani, Partner

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