Tuesday, January 21, 2014

Should you put limitations on the Suppliers right to cure a breach?

If you were negotiating contracts for on-going product or service delivery one of the worst things that can happen to you is to have a supplier that is constantly breaching on-time delivery obligations and curing that breach within the allowable cure period. In a production setting that type of unpredictable delivery performance forces you to either have stock-outs or carry additional inventory at a significant cost.

While a supplier may have a valid reason for not shipping on time such as a production problem, many times the reason for a late shipment may not be valid. For example, the volumes intended for you get sold to another customer that is willing to pay more. For example, a major customer of the supplier hasn’t planned their demand and the supplier uses the product intended for you to meet that other customer’s need. These aren’t remote events, they can and do happen frequently.

One way to protect against continuing breach-cure, breach-cure is to put limitations on the number of times the supplier can cure. For example just like in baseball where it’s three strikes and you are out, you can limit the number of times a supplier can “cure” a breach. You do that to trigger an additional requirement, such as having the supplier stock and maintain inventory at your location at their cost. Alternatively you could use it to provide you the right to terminate the agreement.

The key in writing and negotiating a limit on the right of the supplier to cure breaches to on-time delivery requirements is to determine what constitutes a “strike”. For example with late delivery breaches you have several variables to consider:
1. The quantity involved.
2. How late the deliveries were.
3. The frequency of the late deliveries.
4. The total volume involved.
5. The number of strikes allowed.
An order of one unit that is one day late hardly warrants being considered a strike. If you have daily or weekly deliveries the potential to miss a delivery significantly increases. My preference is to always look at performance as a snapshot over a specific period of time such as any thirty-day period and use that to measure performance.

For example if more than half the volume ordered within that thirty-day period is delivered more than 10 days late, that’s a strike. Any individual order of more than X quantity that’s thirty or more days late is a strike. These are just examples as you need to identify the performance levels that will cause you significant pain, and have those constitute a strike.

In determining the number of strikes that trigger your rights, the key is to consider the impact the measurement period will have. For example if you selected three strikes within a 12 month period, you could have two months in a row with terrible performance and not have any rights until that third strike occurred. My preference is to have multiple measurements that can trigger rights. For example, 2 strikes within any ninety-day period or 4 strikes within any 12 months. These combined measurements allow the supplier no more than 1 strike in each 90 day period.

Why would you go through this process? First, as long as the supplier cures within the allowable cure period there is no breach for which you can collect damages unless you specifically included Liquidated damages for late delivery. If they feel no pain, they won’t correct the problem and you will continue to have the problem.

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