Legal experts explain the extra clauses you need in a supply contract to keep all parties happy
Supply chain experts are not lawyers. And therein lies a problem. “Why do contracts go wrong?” reflects Emily Sadler, commercial contract expert at law firm Paris Smith. “Good question. Lots of companies write contracts themselves. They use negotiators who are not trained lawyers, who fail to document legally what was agreed, in language that reflects contract law.”
Factor in time pressures, inexperience, and unexpected factors like Brexit and a pandemic, and supply chain and procurement contracts can turn into a nightmare.
For example, look at Serco, which signed a deal to house asylum seekers for the UK government in 2013, but forgot to specify in the contract how many asylum seekers to house. The numbers soared, triggering a loss of £115 million for Serco on a £35-million revenue deal. The chief executive blamed sheer naivety on the part of his company. The company’s negotiators simply didn’t know how to draw up a contact.
So what’s the best way to upgrade supply chain and procurement contracts to ensure they are watertight?
“Make sure you have your governing law specified,” says Duncan Spokes, commercial and strategy manager at YPO, one of the largest public sector buying organisations in the UK. “Is the contract under Scots or English law? Where will a dispute be resolved? I’ve seen contracts not making that clear. We had a contract for a crematoria project which encompassed the Dutch, German and English law. Which one takes precedence? It’s the first thing to get sorted. Really, really important.”
Another tip. “Clarify your dispute resolution procedure,” says Spokes. “At YPO we have very clear dispute resolution clauses and escalation points. They state who has the authority to take action and, if a matter is not resolved, what happens next. We include time constraints to avoid unnecessary costs.”
Contract indemnity is vital too. “You need to make sure damages are proportionate. If I book a hotel room for a business trip, and it is cancelled, can I claim unlimited damages? That would be absurd. The contact should make clear the scale of the damages,” he says.
A common error is to bloat the contract by including non-legal material. James Bousher, director of operational performance at consultancy Ayming UK, says: “Most contracts are formed after a tender or bid process. The tendency then is to include the tender response as an appendix, however more often than not this either doesn’t reflect the final outcome of the tender or contains a lot of unnecessary information.” Cutting out non-legal clutter such as appendices is an essential step.
Bousher believes a balance must be struck on size. Bigger isn’t always better. “The best organisations actually have different contract templates to match what is being procured,” he says. “There is nothing worse than trying to unpick a service contract agreed to using a contract designed for goods. However, even then a template contract that tries to cover every eventuality can be a bit overkill; anybody signing a low-value services contract using the NHS T&Cs for services will know the pain of reading all 112 pages.”
A common source of confusion in contracts is when verbal agreements are made after signing. Are these verbal statements valid in law? It can be hard to say. The solution can be a no-variation clause, argues Mark Rhys-Jones, head of the dispute resolution team at law firm Foot Anstey.
“It’s very common for parties to overlook ‘no-variation’ clauses, which in most commercial contracts will provide that a variation of the contractual terms will only take effect if it meets certain formalities, such as being recorded in writing and signed off by a named representative. After the contract has been signed off, these formalities can be forgotten about in practice, which can result in uncertainty of terms and the risk of disputes arising over what has or has not been agreed,” he says.
Contracts can be enhanced by including measures to help both parties. For example, a requirement to offer demand forecasts. “Forecasting is not often dealt with in a supply contract,” says Sadler of Paris Smith. “But forecasts are really critical to getting a contract that works.”
A sound principle is to specify when forecasts will be issued. “The customer could be contractually required on a quarterly or monthly basis to present non-binding forecasts so the supplier can plan ahead,” she says. “It’s not a commitment to buy, but a collaborative process for both parties to get an idea of what demand might be. It would normally happen informally anyway, but it’s better to have something concrete.”
Termination rights are standard in every contract. However, a mid-contract exit clause can also be included. “In legal terms we say ‘terminate for convenience’,” says Sadler. “There doesn’t need to be anything wrong. It’s just that the contract is no longer serving you, and you want to move onto another supplier, and this is a mechanism to allow you to have flexibility.”
Ultimately, there’s a long shopping list of desirable add-ons to contracts that improve the deal for both parties. However, time constraints may prevent all options being included. So Sadler has practical advice for procurement professionals with limited time or a tight legal budget.
“My top tip is to think of the three things that really matter to you. Maybe its flexibility and the ability to bring a contract to an end without waiting ten years. Maybe it’s the limitation of liability that’s the key for you, because you don’t want to expose yourself unnecessarily. You are unlikely to have a perfect contract in every respect; decide what is important to you and focus on that. You need a bit of commercial reality in there,” she says.
The overarching lesson is that contracts must be the domain of supply and procurement experts. Never assume a contract will cover all aspects. Feel free to question lawyers to make sure there are no woolly assumptions.
Just look at the procurement failure of the European Union on AstraZeneca vaccines. Commissioner Stella Kyriakides believed a “best efforts” clause meant a cast-iron obligation to hit deadlines.
Her exact words: “The view that the company is not obliged to deliver because we signed a ‘best effort’ agreement is neither correct nor is it acceptable.”
Alas, she was wrong. The contract implied no such thing. Even the best resourced professionals can make mistakes.
What is force majeure?
The COVID era put the spotlight on a rarely used legal term: force majeure. Scripted to take into account so-called acts of God, the concept suddenly became of prime importance to suppliers and buyers struggling with crippled logistics.
But what exactly does it cover? “It’s not a precisely defined term,” says Adrian Aston, director of disputes at law firm Naismiths. Put roughly, he says, it’s “a dramatic and unforeseeable event that overrides a party’s contractual obligations”. Earthquakes, wars and pandemics are the usual culprits.
He offers three insights into the legal standing of force majeure. The first is that just because a disaster has struck does not mean force majeure can automatically be claimed. “Not everything stops in a pandemic,” he points out. “It is still possible to work on a construction site, so a builder could still operate.”
Second, claims are hard to establish. “It’s not a free pass,” says Aston. “The fact that a builder can’t buy plaster or cement is merely associated with the pandemic.” The usual requirement is for the contractor to do everything possible to overcome an obstacle. “You can’t just say ‘my supplier can’t deliver’. You must do everything to overcome the delay, short of spending money,” he says.
And third, a lack of clarity can be expensive. When writing contracts, it is vital to be specific about duties and liabilities. “You are never going to capture everything in a contract,” says Aston. “But it is certain that in the future contracts are going to be more explicit about force majeure and how something like a pandemic affects obligations. We are going to see a lot of high-stakes legal battles to see where responsibility lies. A strong contract can avoid that entire scenario.”