The phone rings: a client, a buyer for a retailer, wants a supply agreement drafting quickly.

"Keep it short, two pages max and do not spend too much time on it".

"Fine", I say, "How long is it to run?"

"Initially three years", comes the response, "The FD's got a great rate and we need to tie the supplier down".

"In that case it is not going to be two pages long but we can still produce one quickly".

Why?

Most long term supply agreements are an anathema to the buyer. They want to dictate the commercial terms, they want flexibility and it is about buy it when it sells and stop when it does not. Long term commitments may have the attractiveness of security and incidentally give the FD the financial base to project forward, but as a buyer who wants to buy something that the market no longer wants, what happens when the price, which seemed attractive at first, no longer fits the margin? If you are a supplier then you would love a long term minimum volume commitment with RPI indexed annual pricing. It makes your long term planning more effective, allows for investment and guarantees returns over a decent period.

Such contracts can therefore be valuable but they can also turn out to be onerous.

The best supply agreement is one that is signed, put in a drawer, and never sees the light of day. That is because the parties are able to deal with each other in a flexible manner reacting to the market on product and price.

We would all like to second-guess where the market will be in three years time, but sure as eggs are oeufs it won’t be where it is now.

If you want a long-term supply agreement then you will need to give careful thought to what might happen to alter the commercial balance set out in that agreement. If the parties are free to react to each others requirements because they are not tied in then that can often produce the right result, otherwise you part company, but if the buyer wants more for its money where is the incentive on the supplier to provide it? The longer the term, the lengthier the agreement. You will need change control clauses, volume change clauses, product development clauses, obligations for marketing and advertising requirements, consideration of exclusivity and non-compete obligations, price variations both up and down - all will have to be factored in.

From a legal perspective I have seen the effect on companies where previous managers have tied the hands of the new management. There is no buy-in to the old contract by the new management, and little flexibility unless it is carefully drafted. Most buying departments are not geared to monitoring and managing such arrangements. They are not set up to do this, as often they are traders relying on quick turnaround to make the returns. If the worst comes to the worst and the arrangement is just not working then the longer the term the more expensive it will be to exit.

So I say, "of course you can have a two page agreement just as long as you can bring it to an end on short notice". In that case either it works from the start, or you negotiate changes on a commercial basis as you go along, failing which you can give notice quickly and start with someone else.

Long term supply agreements do have their uses but careful thought needs to be given on what should go in them and inevitably that will result in a lengthier and probably more expensive-to-produce agreement. That has to be factored against the long term benefits that might have been negotiated by the finance director!