Supplier Relationships: Where Breakdowns Occur

20 May 2013 Dashboard Insights Blog

Supplier relationships do not break down overnight. Often the reasons or causes for the breakdowns are not those in the moment, but those that companies do not prepare for. A breakdown with the supplier relationship is often tied to a mistake that takes place days, months or even years before. These mistakes take many forms, but usually fall into one of four categories: (1) pre-contract Mistakes, (2) contracting mistakes, (3) relationship mistakes, and (4) termination mistakes. 

One of the most common pre-contracting mistakes is an inadequate request for quotation or other bid document. Documents soliciting bids should provide the detail necessary for a supplier:

  • The format should be consistent, clear, and easy to understand.
  • All the requirements and qualifications necessary should be set forth. 
  • The buyer should include the terms and conditions according to which the RFQ will be awarded and pursuant to which the supplier will be bound. 

Another common pre-contracting mistake is failing to conduct adequate diligence on any potential supplier. A wealth of public information is available on suppliers. Some of the more common resources include:

  • Dunn & Bradstreet® Credibility Corp.: Credit checks, especially for larger companies. 
  • Experian: Credit checks, especially for smaller companies. 
  • S&P Capital IQ: For both private and public companies.  Includes information about operations, business transactions, financials, competitors and major news.
  • LexisNexis® atVantage: News, business dealings, financials, litigation records and filings.
  • Intelligize: Database of SEC filings.
  • LexisNexis® Courtlink: Searches for court filings from any court with electronic records.
  • Public Records Reports: company snapshot, associated people, corporate filings, liens/judgments, UCC filings, property ownership, and motor vehicle ownership. 
  • IP Portfolio: Multiple databases are available that allow you to determine what patents or trademarks might be owned or affiliated with an entity.

Of course, no due diligence could be complete without reviewing the web sites of your potential suppliers or conducting the most basic internet searches for news, blogs and other publicly available information. 

One of the most common contracting mistakes is the failure to be precise regarding what the final contract is comprised of. The most common contracting mistakes result in the “Battle of the Forms.” This mistake is so common that the Uniform Commercial Code has attempted to resolve the Battle of the Forms. (§ 2-207.) The most common example of this contracting mistake occurs when a buyer issues a Purchase Order with its terms and conditions on the back to a supplier. That Purchase Order is accepted by the issuance of an Invoice by the supplier. Of course, the Invoice has the supplier’s terms and conditions on the back. The terms and conditions of the two documents conflict. Whose will control? More likely than not, those of the supplier’s Invoice. If your contracting processes are not robust, you will not know what your terms are. As a purchaser, make sure that your Purchase Order, RFQ, or other offer document “expressly limits acceptance to the terms of the offer …” Moreover, when the supplier sends their acceptance document, do not neglect to review it for any terms or conditions to which you do not want to agree and object – in writing – as soon as practicable.

Routine relationship mistakes include the failure to monitor performance and resolve problems as they arise. Is your supplier doing a good job? How do you know? Determine at the outset of the relationship the parameters by which you will measure the performance of your supplier. Then, put controls in place so that you can monitor that performance. Make sure that you generate internal reports on your supplier’s performance so that you can routinely address issues in the relationship. Such measuring and monitoring will lead to fewer disputes. And, if you have disputes, they will be resolved more quickly and efficiently.

Few companies are aware of the pitfalls of failing to terminate their contract effectively. The termination is often not the last step in the process – parts must be resourced. Therefore, it can be a mistake not to enter an Exit Agreement of some kind. An Exit Agreement allows you to specifically negotiate and ensure that your tooling and intellectual property are not only returned, but transferred to your new supplier. If the supply at issue is just-in-time, this sort of agreement decreases the likelihood of an interruption in your supply chain. You can reach agreement to buy out the remaining inventory of your old supplier which is in both your interests. Further, you can arrange for your new supplier to buy any left over raw materials from your old supplier. While this might result in some increased costs for this remaining inventory and raw materials in the short term, what it saves the company in transition efficiencies, reduced dispute costs (in money and time), and overall efficiencies will almost certainly be much greater.

A more detailed discussion of these and other common pitfalls in supplier agreements can be found in the attached Practice Note “Sale of Goods Agreement: Common Pitfalls”, authored by Foley & Lardner LLP partner Jeffrey A. Soble and published by the Practical Law Company.

Sale of Goods Agreements Common Pitfalls (5-525-2962)

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