Friday, April 19, 2013

Evergreen versus self-extending contracts

An evergreen contract (meaning a contract with no end date) is not legal in many countries. Those locations require contracts be of a specific term. A self-extending or self-renewing contract is a contract that has a specific term, but may automatically extend unless one of the parties provides a notice to the other party that they do not want to have the agreement extend.

As contracts and procurement people are constantly being asked to do more with less people, one of the things you need to do is look for activities that you can eliminate. Many times you may be doing business with the same supplier for many years. When you have a specific term, it forces you to do an amendment each time to extend the agreement. If the extension does not happen before the end of the term of the contract the first thing you lose is contract coverage on purchases made after the expiration date. Once a contract has expired, it no longer legally exists so it can’t just be amended. You would need to do a new document to incorporate the terms of the expired document and would also need to make that new document retroactive to the termination date to get contract protection during the interim period. More important from a buyer's side, it open it up to having a new document that needs to be reviewed and approved. You may not have the same leverage you had when you negotiated the original contract and may now be dependent upon the supplier. What I also found was many times on a supplier side if an amendment to extend the agreement was required, you frequently will have the supplier's legal people or others that want to re-negotiate many of the terms. What you don't want is to be forced into accepting new terms simply because you need the supply.

A self-extending or renewing contact will allow either party to provide notice to not have the agreement self extend. If neither provides notice the contract extends for another year without the need for an amendment. The notice period needs to be long enough to allow you to take steps to ensure you do not have an interruption of supply on your side and allow the supplier time to backfill your business with another customer. On a production purchase you would need to take into account a products lead time and possibly the time required to qualify another supplier and product. If you use self-extending contracts you always want to provide for periodic price negotiations so you can adjust pricing. Self-extending contracts work well in situations where there are no firm commitments to purchase specific quantities. That way if there is a problem with the supplier or their pricing, you can simply not buy from them and then send the notice to not extend the contract. As situations and needs can change, if there are contracts that have firm purchase commitments, I would never have a renewal period be more than one year. The reason for that is simple. The cost to terminate a one year commitment will always be less than a multiple year commitment. The real advantage of self-renewing versus fixed term agreements is you avoid having to do amendments each year. Many companies I’ve worked for had contracts on a calendar year term which meant that most contracts would need to be amendment in that one period and that caused contracts to lapse and not have coverage. Not having to do amendments to extend the period is simple and time saving. All you really need to do from a Buyer’s side is to have a planning calendar which many contract systems have the functionality to provide key dates so you are reminded well in advance of the notice date that you may need to take action if you do not want that contract to be extended.

Tips in drafting self-extending contracts:

Include clear language disavowing any firm obligation to purchase goods or services under the contract. For example:
“Buyer is under no obligation to purchase any Products or Services, except as ordered in Purchase Orders”

Include a clear description and mechanism of how goods or services will purchased (i.e. purchase order, master purchase order with calls, service order, work order, etc.).For example:
“All purchase will be made by Purchase Order in either electronic or tangible form and shall be Supplier’s authorization to conduct transactions under this Agreement.”

Include a clear description of what, if any, terms can be modified by the subsequent purchase document. For example:
“Any additional or differing terms or conditions on Buyer’s Purchase Order or Supplier’s acceptance shall be void unless accepted in writing by both parties.”

Include a description of how pricing may be changed. For example:
“One-hundred and twenty (120) days prior to the end of the current term, the parties shall meet to negotiate pricing for the next term. If the parties are unable to reach agreement by ninety-days prior to the end of the current term, the current pricing shall be extended for ninety-days into the new term. After ninety days of the new term have elapsed, either party may terminate this agreement without liability if new pricing has not been mutually agreed.

An example of a self-renewing clause:
The term of this Agreement shall be for two (2) years from the Effective Date and thereafter shall extend for successive one-year terms until either party provides notice of intention to terminate. Any notice of intention to terminate must be given at least _____ months prior to the end of the then current term.