Mitigating the Risks Involved With Ending a Business Relationship

11 April 2018 Manufacturing Industry Advisor Blog
Authors: Nicholas J. Ellis

All good things must come to an end. So it is in life, and so it is in business. Eventually all business relationships, including manufacturing relationships, will come to an end. Some relationships end with nary more than a whimper, as both parties are content to move on and deploy their resources elsewhere. More often, the end of a business relationship is an acrimonious affair in which one (or both parties) feels it has been wronged or treated unfairly.

The end of a business relationship is an inflection point that can create a significant risk for manufacturers if not properly managed.  The termination itself may be viewed as improper.  Even if the non-terminating party grudgingly accepts that the relationship is ending, there are likely to be other claims.  Disputes that otherwise might have been resolved by negotiating future business terms, or suppressed because the benefit of the relationship outweighed the claim, can erupt into litigation when parties no longer are concerned with preserving the relationship.  In the case of relationships involving significant amounts of intellectual property, the termination of a relationship often leads to a fight over who owns which parts of the intellectual property pie.  In the manufacturing world, the end of a relationship can prompt claims by the supplier seeking reimbursement for unamortized capital expenses and payment for its work in process.

There exists risk in ending a business relationship no matter what stage the parties are in.  A prospective relationship that falls apart before the parties reach an agreement on all of the necessary terms can be just as likely to result in litigation as the end of a seven-year supply agreement.

The risks that exist in ending a business relationship are as numerous and varied as the relationships themselves.  However, there are steps that a manufacturer can take to mitigate the risks created by terminating a business relationship.

Set the Ground Rules Up Front

Perhaps the single most important step that a manufacturer can take to mitigate the risks involved in ending a business relationship is to agree, in writing, on the ground rules of the relationship.  Parties wishing to enter into a business relationship, whether it is a supply agreement, a distribution agreement, or a joint development relationship should make sure they are in agreement on the terms of the relationship and then document those terms in the contract.  For example, the parties should agree at the outset on how long they want the contract to last.  Will there be automatic renewals?  Will one party or both parties have the right to terminate the contract early?  On what conditions?  If the contract is terminated early, what are the parties’ respective rights and responsibilities?

Follow the Contract

The starting point for any manufacturer that is thinking about ending a business relationship should be to review the existing contracts between the parties to ensure that it is complying with all contractual requirements.  As a threshold matter, does the contract allow for the termination?  Even if the contract allows for the termination, what requirements apply? What form must the notice of termination take and where must it be sent?  If the termination is being made in response to a material breach, does the contract require notice and an opportunity to cure the alleged breach? Even in cases where a manufacturer simply intends not to renew a contract when it expires, it is important to review the contract to avoid potential pitfalls.  For example, some contracts will automatically renew unless notice is given sufficiently far in advance that a party does not want to renew the contract.

Be Aware of Applicable Statutes

In some industries or circumstances, most notably in the case of franchise or distribution agreements, manufacturers must consider whether there are any statutes or other governmental rules that impact their ability to terminate a relationship.  The impact of these statutory schemes can run the gamut from merely imposing certain notice requirements to prohibiting termination or non-renewal without cause.  In some cases, statutes can be used to the benefit of the party seeking to end a contract.  For example, in the case of contracts for the sale of goods, the Uniform Commercial Code, which has been adopted in all 50 states, permits a party that has grounds to be concerned whether the other side will perform, to request “adequate assurances” of performance and, unless such assurances are provided, to exit the contract without having to wait for an actual breach by the other side.

Clearly Articulate All Legitimate Grounds for the Termination

In cases where a manufacturer wishes to cancel or terminate a contract based on a breach by the other party, or concerns about the other side’s ability to perform, it is important to document the manufacturer’s concerns and give notice of the alleged breach.  Even when a manufacturer believes that it has the right to terminate “for convenience,” or based on written notice, a party that believes it has a claim for an alleged breach should identify the breach as further grounds for canceling the contract.  Such notices generally should include all good faith grounds for claiming breach.  In some cases, a party that fails to give notice of an alleged breach may be limited by law, or by the contract itself, from relying on the breach as grounds for termination.  The reverse also is true.  A manufacturer that seeks to cancel a contract in response to a breach should not forgo reliance on provisions that allow early termination on other grounds.  Even if a contract does not require written notice, any notices related to the end of a relationship or an alleged breach should be given in writing.

Ending a business relationship, of any duration, involves risks.  However, by following these basic strategies and planning ahead, manufacturers can avoid, or at least mitigate, many of these risks.

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