We live in uncertain times. Over the past year, we have seen the UK voting to leave the EU, the depreciation of sterling, interest rates falling to a record low, a controversial US President elected and the BBC losing the Bake Off to Channel 4.
Changing times can put pressure on existing contractual arrangements. Business drivers evolve. The formerly advantageous contract may have become difficult. Perhaps the supplier hasn’t performed what you were expecting them to, is encountering financial difficulties or has become insolvent. Alternatively, one party may be looking to save costs, increase value for money or avoid a contract that no longer meets their business needs.
Understanding your legal rights will help you to best manage, renegotiate or escape contracts in the most advantageous way.
To terminate or to turnaround?
Contracts can take a significant amount of time and effort to negotiate and make successful. Terminating the contract brings it to an end. It is final. As Warren Buffett once said, (in a different context): "It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently."
Before considering termination, there may be other turnaround options which lead to a better outcome. The output of termination tends to be binary. In the right circumstances, turnaround can offer a more dynamic solution.
The first thing is to understand your business drivers. What is the contract designed to achieve? What is it in fact delivering? Where is the shortfall? What is causing it? Once you have that sort of information, you should be better placed to consider a range of options:
- Can you improve service delivery of the supplier through use of key performance indicators or service level provisions? Have you sought to deploy those tools from your contract?
- Is there a dispute resolution provision in the contract allowing you to escalate grievances in potentially a more constructive way than by terminating?
- Are there continuous improvement provisions by exclusivity, benchmarking and/or minimum purchase obligations in the contract that you can make use of to seek savings? Best value clauses tend to be seen in public sector contracts so that they can demonstrably meet best value criteria. Continuous improvement provisions can act as a guarantee to the recipient that the supplier will try to improve the service and its terms without extra charge.
- Is part of the reason for perceived underperformance personality driven? If so, are those involved sufficiently objective and if not, should someone else negotiate and implement any turnaround plan?
- Could you vary the contract by mutual consent? You might not need to vary the whole of the contract. It might be specific terms such as price or scope
- If you get regular payments under the contract, you may want to think carefully before terminating on the grounds of breach. In some cases the right to continuing payments is more valuable than the right to seek damages. In that case you might wish to affirm a contract. If you end the contract, then no further payments would ordinarily fall due, you would have the right to claim damages and must act reasonably to mitigate your loss. If your damages cannot be evidenced or you do not have the time or resource to pursue, then affirmation might be another option
- Finally you might wish to use termination or the threat of termination or partial termination as a way to negotiate better terms.
What if I am concerned about the financial viability of the counterparty?
Non-payment is a common ground for ending a contract. If the counterparty cannot make payment of monies due, then:
- Refresh your financial due diligence to gauge the seriousness of the problem. Keep communication lines open with the counter party. They may agree to supply information that isn't in the public domain (eg their latest management accounts) to evidence their inability to make payment. (This can provide a collateral benefit of broadening your enforcement options). For more about that click here
- Within your business, ensure that you have clear communications strategy to escalate the information you discover to the relevant decision makers
- Ask what it is that will cause the counterparty to pay your organisation ahead of others. There is some truth in the adage "He who shouts loudest…" Speed is essential, especially if the counterparty is close to insolvency. Does your business have anything the counterparty really needs? In appropriate circumstances, a statutory demand might be used to bring the other party to the negotiating table – but long term, that is not conducive to preserving a relationship
- Think carefully before supplying any further goods or services. If you do, ensure that the counterparty is trading on your terms. (If appropriate, include a retention of title clause in respect of your goods)
- Would a lump sum payment be preferable to instalments? If you cannot recover payment of all sums due immediately, consider whether the counterparty might be able to provide some sort of security (eg a charge or guarantee) to support an instalment arrangement
- It is possible for sellers to obtain credit insurance to guard against the risk of defaulting buyers. In each instance, it pays to do a costs versus benefit analysis. Insurers are likely to want to see satisfactory terms of business in force
- It is also possible to have a clause in your contract requiring the buyer to obtain insurance upon receipt of goods and to have the sellers' interest noted on the policy. Whether this is practical will partly depend upon the parties' relative bargaining power
- Whilst you are considering your termination rights and potentially going through a termination process, look at building relationships with other partners and develop a transition plan. If the counterparty is an essential supplier, it might be worthwhile supporting them during this time.
Contractual performance cannot always be turned around successfully and in that case, your business may need to move on. In part 2, we will consider termination strategies.