A contract for the manufacture of goods has recently expired, but what happens if to continue to receive orders?
Manufacturing contracts are often entered into for a fixed period of time (often referred to as the “term” of the agreement). Whilst it helps to deal with what happens after the term of the contract, for example either automatically extending the contract into a “run-off” period, or even a provision that states the parties will review the situation, it is not always the case. Sometimes there is only a fixed term (and the presumption is the contract has expired after that fixed term).
This leads to the situation where the term of the contract has lapsed and both parties have forgotten about the contract expiring, this is particularly possible in industries that have volatile supply and demand.
So in such a case, what terms do the parties contract on? That will depend on:
- what the parties have said and done about extending the contract to date (if anything); and
- the extent to which behaviour is consistent with the terms of the elapsed contract.
Such issues are only really examined when a court looks at them. As such, it will depend on the facts as to what could actually happen in practice. For example, it could be that:
- A new contract has been entered into between the manufacturer and the customer. A contract does not necessarily need to be in writing and may be based on actions of the parties.
- The existing contract has been extended, on the same terms or on slightly modified terms. Just as a contract may be created by actions, it can be modified without writing too. Terms of the contract restricting variations unless in writing can also be deemed not to apply.
- No formal term of contract is agreed, but only a one off purchase occurs. This will be subject to the implied terms of statues such as the Sale of Goods Act 1979, Supply of Goods and Services Act 1982 and Unfair Contract Terms Act 1977.
Word and actions of the parties
In judging what in fact has happened, a court will look at the parties’ actions and communications, taking the test of what a reasonable person would have understood the parties' intentions to be, rather than what they may (each) have subjectively intended.
In the Scottish case of SJD Group Ltd v KJM (Scotland) Ltd , the court found that a reasonable observer (detached from the knowledge of the parties) would almost inevitably have assumed that the parties were continuing to do business, so far as possible, on the terms of their expired franchise contract. This was found on the basis of an absence of discussions (and written agreement) between the parties.
Considering the existing contract
If the parties to a manufacturing and supply contract continue to forecast, supply and pay under the terms of the existing contract (even though the contract has expired), this will support an argument that their relationship is still dictated by its terms.
However, whether a court will hold that view (or whether it takes the view that the contract has been amended) will depend on the facts; for example, if the manufacturer has been extending credit to the customer to entice continued orders, but the contract states payment in advance (or on relatively short payment terms), it is likely that the extended terms of credit will prevail.
In cases where terms of the expired arrangement do not make commercial sense when compared with the parties' current dealings, then it is more likely that the parties have a new contract, based on the new terms adhered to. It is also possible that there is no ‘amended’ contract and the parties are only contracting on implied terms (from statutes such as the Sale of Goods Act 1979 and common law, i.e. case law).
Ending the relationship – what happens next?
If there is no contract, then of course neither party is obliged to continue dealing with the other. This may pose a risk if the customer is out of contract with its manufacturer and needs assurances around capacity and availability. For a manufacturer, depending on circumstances, this can mean a position of greater bargaining strength.
If the original contract has been extended (or there is a new contract on the same terms) then the termination provisions from the original contract may apply, insofar as possible, and to the extent consistent with the parties’ other words and behaviour. However, given that the original term has expired, the most likely outcome is that the court will imply a term that the contract will be deemed to continue on a rolling basis, subject to a right to terminate on reasonable notice.
“Termination upon reasonable notice” will of course depend on the individual circumstances of each case. Typically speaking, the following are key factors as to what is ‘reasonable’:
- the length of the original contract term, together with the type of contract (for example, if it was an exclusive contract or there were minimum volume levels, the notice period is likely to be longer);
- the time needed by the terminated party to replace the lost business represented by the contract (which might be significant if the manufacturer is exclusively producing goods for the customer or a small pool of customers);
- the degree of financial dependence of the party being subject to the termination (see 2. above);
- the common intention of the parties at the time when they entered into the original contract; and
- the commitments of the parties which exist at the date of notice to terminate (for example, if the manufacturer is producing, labelling, packing and shipping the products, the notice period is likely to be longer).
Whilst it is not always possible to do so, towards the end of a contract the parties should meet to discuss either expressly extending or varying a contract before its expiry. Doing so will avoid uncertainty about the nature of the parties' relationship going forward.
To avoid issues generally in drafting contracts, it is often preferable to have a fixed “initial term” which then automatically extends, either for fixed renewal periods or for an open ended duration (with the flexibility for either party to terminate on notice).