Monday, December 19, 2011

Termination without cause - Is it better for the Supplier of the Buyer?

The simple answer is that it really depends upon the circumstances of the parties.

There are two types of suppliers. There are supplier that don't have any problems and they are performing well. They may not like termination without cause clauses as they will have to make new sales to backfill the work. There are suppliers that are having major problems performing and are teetering on potential termination for cause. If a supplier feels that they could ever fall into that second category they should welcome it. On the downside they will lose the business. On the up-side it can prevent them from wasting more money trying to perform. If exercised it extinguishes the buyer's right to collect damages. It also usually allows them the right to collect costs of termination which they wouldn't be able to collect if they were terminated for cause. It's that latter situation where the supplier welcomes it as it dramatically will reduce their cost and liability.

As to Buyers, it would all depend upon the reason for the exercise of the termination. If a buyer is exercising the right on a supplier that is performing because their circumstances have changed, clearly that buyer limits the costs on something they no longer may need or want. It does however cost them what they may have already invested and paid for and it costs them the costs of termination they must pay the supplier. There is always a significant costs associated. If the Buyer is exercising the right to terminate without cause because they supplier is simply not performing and they don’t have confidence in them in the future, the only real benefit they get is not having to deal with that supplier and maybe get better assurance that the work will be performed when they use someone else.I've had suppliers that wanted to do their own thing their own way rather than listed to what my company wanted or needed and those I clearly used termination without cause with.The costs to the buyer is what they have paid to date, the costs of termination and whatever it will cost to complete the work. What the prior supplier had done may also have no value and may need to be scrapped.

If the situation is something like switching from one supplier to another by exercising a termination for convenience, the advantage may be to the buyer.In that case the buyer will always need to consider the cost of termination against the benefits they will get from the new supplier to determine if it makes economic sense to switch. Buyers could use the threat of switching as leverage to get price reductions.

In negotiating termination without cause provisions in contracts that don't have firm commitments to purchase such as blanket or master agreements I explain that the termination without cause provision is in their best interest. When they give me that puzzled look I explain that I can effectively do the same thing as terminating the agreement without cause by simply stopping purchasing. The advantage to them is it lets them know that orders won't be forthcoming and that any materials or work that I authorized that they still have will be paid for as part of the termination,.

The Two Step

In Texas the two-step is a dance performed to country music. In negotiation what I call a “two step” is an approach that I like to use when I don’t like the commitment they supplier will accept. I might be able to accept the commitment they want if there was something more to it. That something more is what I call the second step. Let me give you a number of examples of what I mean.

A supplier is unwilling to agree to firm time to perform and will only commitment using reasonable efforts to perform by a specified date or within a period. For example they will only agree to use reasonable commercial efforts to meet your specified delivery date. You want them to try but you are also concerned with the fact that such a commitment doesn’t guarantee if or when when performance will occur. All the supplier has to do is exercise the required efforts. The second step would be to also include a firm commitment as part of their commitment. For example: “Supplier shall use reasonable efforts to delivery the product within thirty days. Supplier shall deliver the product in no greater than forty-five days.”

Your customer wants to include a pay-when-paid payment term. That type of commitment doesn’t guarantee you when you will actually be paid. You don’t want the obligation to make payment be open ended, especially since you don’t control when that will occur. In this case the second step would be to include a firm period. For example: “Prime Co. shall pay Sub Co. within ten (10) Days after receipt of payment from Customer Co, or net ninety days, whichever occurs sooner.

You want a termination for convenience provision and the Supplier wants to be reimbursed their actual and reasonable costs associated with the termination. If you agreed to only that the potential costs could be unlimited. The costs would only need to be actual and reasonable. The second step in this commitment would be to manage and limit those costs. “In the event Buyer terminates this agreement without cause, Buyer shall reimburse Supplier for its actual and reasonable costs associated with the termination. Supplier shall use reasonable efforts to mitigate the cost of the termination and the total cost of the termination shall not exceed the contract Price.”

Your warranty provides for four remedies repair, replace, refund or credit. Your language has you deciding upon which option you can select. The Supplier wants to decide which option they provide because they don’t want you demanding new product when they can repair it or they don’t want you to demand a refund or credit as a way of reducing your inventory. If you provide them with the right the second step is control or manage which options they Supplier can select. “In the event of a warranty defect, Supplier may, at their sole option, repair or replace the Product, Supplier’s option to refund or credit the purchase price shall require buyer’s approval.” That way if you needed the product they couldn’t take the cheap way out and simply refund the price, or worse provide you with a credit that you won’t be using any time soon. If you allow credits, you could either include a second step to that as part the term or include a second step as a condition of your approval. “If buyer makes no purchases within a sixty-day period, Supplier shall immediately refund the full amount of any credits.”

Second steps can also be used to increase the standard of commitment a party has to perform, or the level of effort required which increases their costs or impact. For example: "Supplier shall use commercially reasonable efforts to repair or replace materials under warranty in ten (10) calendar days after receipt". The second step could be "If Supplier is unable to delivery within ten calendar days, Supplier shall use its best efforts to expedite delivery. Supplier shall deliver the repaired or replaced product no later than thirty (30) calendar days.” In this example, commercially reasonable efforts is a low standard which means that if it would cost the supplier more to perform than usual, they don’t have to do it. The repair or replacement would follow their normal process. By including best efforts after 10 days, it would require them to perform the activity irrespective of the cost. By including the firm commitment to thirty days, it changes the standard from only efforts to a firm commitment.

Second steps can be used to make commitments that are not firm, firm. They can be a limiters or qualifiers. Supplier may have reasonable reasons for what they are demanding, but what they want to provide you as a result may not be enough. I use second steps to make sure I get what I need. If a supplier doesn’t want to give you that second step that should be a red flag. If the second step changes the parameters to what should be reasonable and they don’t want to agree I would be concerned their real intent. Second steps are a linking tactic where you are saying that I’ll give you what you want provided I get what I want.