Friday, September 14, 2012

Partial Terminations?

In another forum some asked whether the reduction of a portion of the scope of work was a termination for convenience. Like everything else when you have a question about the rights or obligations of a party, the first thing to do is to read the contract. Normally the concept of termination for convenience applies to the entire agreement and would also require compensation if exercised. The right to remove certain portions of the scope of work or add work is usually addressed a different section of the agreement called “changes” or “variations” provision. You could also have a termination for convenience section that provides for both full and partial terminations.

A good buyer contract should have both clauses so that the buyer has the option of either eliminative a portion of the work or ending all of the work. For a buyer your primary focus in negotiating both of those provisions is to have the flexibility to do what is best for your company. Having that flexibility will also have a cost associated with it as there may be work in process, materials that we ordered that are non-cancellable, etc. As such, the buyer’s goal in a negotiation of these is to make the supplier whole for these costs, but to not pay any more than that. Suppliers on the other hand will always concerned about the unscrupulous buyer or owner that may simply want to remove portions of the work or terminating the contract for convenience simply as a way to award the work to another company who may be cheaper in price.

Can you protect each party’s interests in negotiating both of these terms? I think that a supplier would reluctantly agree that if the buyer really doesn’t need the work, they shouldn’t profit from that. I think that buyers might reluctantly agree that the supplier should be able to collect some damages if the work is simply taken away to be given to another company. A possible solution would be to structure the rights as combination of the payment of costs and damages. In all instances the supplier would be reimbursed their actual costs incurred by either the reduction in scope or the termination for convenience. Whether the damages would be applied would depend upon the circumstances. For example it could be written in a manner where if within a specific period the buyer contracted another party or parties to complete the work, then a damages amount would be paid. If the buyer took no such action within the agreed time frame, then there would be no damages for the reduction in scope or termination for convenience. All the supplier would get would be their actual and reasonable expenses they had incurred at the point the termination or reduction in scope occurred.

The key from a supplier's perspective is to make sure that the damages are sufficient enough to deter the buyer from simply replacing them one with another supplier. For the buyer in doing something like this, if the reduction of scope was for a real need and the balance of the work won’t be completed at any time soon, it eliminates having to pay damages. The establishing damages amount for termination for convenience or major reductions in scope needs a simple tool to determine what’s the best approach. Suppliers also would know that most of the time if the buyer needs the work, they will not wait the time to avoid the payment of damages. As changes these type of changes may occur at any time during the course of the work, as a buyer you would want them to not be a fixed amount. Instead a percentage of the remaining value of the work cancelled would reduce the actual amount that a Buyer could be liable for as work progresses.

I’m sure that there are some suppliers or contractors that would argue that once awarded, the buyer should not have a right to terminate the agreement for convenience or reduce a significant portion of the scope. That’s not a realistic expectation to have as in business change is constant and companies need to be able to respond to the change. I’ve had some suppliers or contractors argue that these rights should be mutual. What that would do is have every supplier that made a bad deal would want to use it to walk away from their commitment. What that could also do is make any investments the buyer made to qualify and use the supplier’s product useless. What that could do in a production setting would be to eliminate a source of supply and not be able to produce until you could source and qualify alternative source. The impact to the buyer could be huge and the damages the supplier would need to pay to have that right would also be huge.

Have I ever used a termination for convenience provision simply to replace a supplier? The answer to that is yes, I have. I’ve done it when it was clear the two companies were simply not on the same page over the work or our requirements. I’ve also done it when it was clear that the work was clearly over the supplier’s capability or the capability of their team assigned. No supplier likes to be terminated for convenience but many times they may also know that if they continue they may breach the agreement and then not be able to recover their costs and may be required to pay damages.

Have I ever used a reduction in scope simply to give the work to another supplier or have the work performed by internal resources? Absolutely. It was always when the supplier in question was a problem, like wanting to make huge profits on new or changed work or simply wasn’t being responsive. When a supplier is a problem sometimes it’s worth paying to get rid of them. No supplier likes to have the scope of the work reduced, but most love it when the scope of the work is increased. I tell them two things. You need to take the good with the bad. As a customer I feel that a supplier need to continue to earn my business and my future business ever day. The best way to do that is do good work and maintain a good relationship. If they work with me and help me they shouldn’t have anything to be concerned about.