Key Provisions for Supply Chain Contracts

01 November 2017 Manufacturing Industry Advisor Blog
Author(s): Nicholas J. Ellis

In the manufacturing industry, a company’s supply chain can be a source of both risk and value. By paying careful attention to the terms of its supply chain contracts, a company can help to mitigate its risks while at the same time maximizing the value of its supply chain. While no provision in a contract should be overlooked, the six areas discussed below generally are the most critical points to consider when it comes to drafting a supply chain agreement.

1. Critical Commercial Terms – The first step for any supply chain contract is to ensure that the agreement captures all of the necessary commercial terms.  Although seemingly obvious at first glance, it is not uncommon for parties to find that the written document they signed does not address a particular issue.  It may be that the issue never came up during negotiations.  It may be that the parties reached an agreement, but failed to document that agreement. Regardless of the reason, failure to properly document the key commercial terms of the parties’ agreement often leads to future disputes over what the contract requires. Furthermore, the lack of agreement could result in an unenforceable contract.  Failure to reach agreement on a particular issue other than quantity is not automatically fatal.  However, if the lack of agreement on commercial terms is sufficiently pronounced, a court may find that there “never was a meeting of the minds” to form any contract at all.

2. Quantity – The most critical term in any contract for the sale of goods is the quantity term. Under the UCC, a quantity term is the only term that must appear in a contract for the sale of goods.  Absent a written quantity term, any contract for the sale of goods (over $1,000) will be unenforceable.  A quantity term does not need to be expressed as a number.  For example, a requirements contract can determine the quantity by reference to the buyer’s actual requirements for its business.  However, the quantity term must be in writing and it must be signed by the party against whom it is sought to be enforced.

3. Duration – With the exception of “spot buys” and other one-time purchases, a supply chain agreement should clearly state how long the parties intend for it to last. Absent an agreed duration, a contract may be terminated by either party upon reasonable notice.  While such an arrangement can bring flexibility, it also creates a lack of stability in the supply chain.  In industries where securing an alternative source of supply is an expensive and time-consuming process, most notably the automotive industry, the ability of a supplier to “opt out” of a contract by giving reasonable notice creates a significant risk for the buyer.  Similarly, a seller does not want to make a significant investment of capital and resources to supply a product only to have the buyer turn elsewhere.

4. Early Termination – If parties desire flexibility as to the duration of their contract (and have the bargaining power to obtain it), the best approach is to negotiate an agreed clause that allows one party (or both) to terminate the agreement under certain circumstances.  In many cases, a termination provision only requires that a party provide sufficient advanced notice.  Other examples include provisions that allow a party to terminate a contract upon a change in control or the meeting (or failing to meet) of certain performance milestones.  In some industries, such as the automotive industry, it is not uncommon for a party with significantly greater bargaining power (almost always the buyer) to insist on a contractual right to terminate the contract at any time for nothing more than convenience.

5. Warranties And Disclaimers – Warranties are the promises a seller makes regarding goods or services being provided to the buyer. Supply chain contracts typically include express warranties.  In addition, the UCC may supply a number of implied warranties that will be considered part of the contract, unless they are disclaimed.  The most well-known examples of implied warranties are: the implied warranty of fitness for a particular purpose and the implied warranty of merchantability under the UCC.  Depending on the subject matter of the contract and the governing law, other implied warranties also may apply.

6. Limitation Of Remedies And Damages – Under the UCC, parties to a contract for the sale of goods are permitted to limit both the potential damages and the remedies that may be available in the event of a breach.  A limitation of remedy limits the types of remedies that are available to a non-breaching party.  For example, the most common limitation is a provision limiting a buyer’s remedy to “repair or replacement” of any defective goods. A seller that wishes to include such a limitation in its contracts must ensure that the seller is willing and able to stand by its offered remedy.  Otherwise, the remedy may be deemed to have “failed of its essential purpose” and will be deemed unenforceable.  A limitation of damages limits the damages that a party that may be awarded in the event of a breach, either by capping the damages or by eliminating certain categories of damages all together.  For example, a limitation of damages might state the maximum damages that a buyer can recover are limited to the amount that the buyer paid seller under the contract.  Alternatively, a limitation of damages might provide that a party is not entitled to recover lost profits.

A more detailed discussion of these issues can be found here.

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