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.

What does “Time is of the Essence” mean and when would you use it?

In contracts you can have minor or major breaches. A minor breach provides only money damages. A major or material breach provides additional remedies and may include the right to terminate the agreement for cause. When you say that "time is of the essence", you are saying that delivery by a specific date goes to the heart of the agreement. For example there is a festival being held on May 15, 2014. You are purchasing goods for sale at that are unique for that festival. You order them and specify that they must be delivered on May 12, 2014. As part of the delivery language you include language that says that time of delivery is “of the essence” of this agreement. You do that to notify them that on-time delivery is critical. Collecting damages or liquidated damages is not adequate because if they are delivered late, you cannot sell them at the Festival and they have little of no value to you.

In drafting time of the essence language you want to make it clear. For example:

Supplier shall delivery the Product to X Location on or before May 12, 2014 ("On-Time Delivery"). On-Time Delivery is of the essence of this contract. Failure to make On-Time Deliver is not subject to cure under Section 12. Buyer shall have the right to reject delivery of and shall not me obligated to pay for any Product attempted to be delivered after the On-Time Delivery period. Supplier’s failure to meet the On-Time Delivery date shall be a major breach of this Agreement and in addition to Buyer’s rights specified in this section Buyer may terminate this agreement for cause."

In that:
•The use of the defined term Product identifies specifically the product that must be delivered.
•You have provided the acceptable window for delivery where On-Time Delivery has been established.
•You have established that On-Time Delivery is of the essence of the agreement.
•You have eliminated the right to cure the breach of the requirement for On-Time Delivery.
•You have made it clear that if On-Time Delivery is not made:
oYou can reject delivery of the goods
oYou do not have the obligation to pay for those goods.
•The failure to meet the On-Time Delivery requirement provides you cause where you may terminate the agreement and claim damages.

You have the right, not the obligation to terminate. If they were delivered to late to sell them, you could refuse to accept delivery of the goods and not pay for those goods because of the breach. If they delivered after the specified date but before the festival you may waive your right to terminate and still accept and sell them. If you decide to terminate, depending upon what your limitation of liability says, you could potentially claim other damages for the breach of that required delivery date. In most agreements the damages you could claim for breach would be limited to direct damages. Direct damage includes the excess cost of re-procurement (the cost of “cover”) if you were able to procure what you need from an alternative source.

Where damages or liquidated damages for delays are adequate you would never use time is of the essence. You use time is of the essence when those damages or liquidated damages are totally inadequate.