Are you making the most of your contracts?

Pete Maguire is a partner in the commercial contracts team at Wright Hassall. He specialises in the drafting and negotiation of outsourcing and commercial contracts in the technology, retail, security, logistics, catering and support services sectors.

Are you making the most of your contract in the current climate?

The focus on the far-reaching effects of coronavirus appears to have shifted from healthcare worries to economic woes, with the financial impact creating a period of instability, particularly throughout supply chains.

With more sectors looking to get back to work, including construction, it is hardly surprising that companies in survival mode are looking to protect their interests and reduce risks, with a review of their existing commercial contracts essential.

Few contracts will have been written to mitigate the risks of a global pandemic, with months of lockdown and social distancing, but understanding its impact on commercial relationships and the ability of a business or its suppliers to fulfil their contractual obligations, is currently key.

Businesses have to be close to their suppliers and customers, like never before. They have to understand the pressures everyone is facing in the current climate and the impact a failure by any member of the supply chain would have both commercially and practically.

Key contractual points

The relationship between a service provider and their customer is typically completely different from that defined by a standard supply of goods agreement. Personal interactions are often critical and maintaining the relationship is essential to the success of the service.

From the provider’s perspective, whilst it is critical to ensure that exposure is as limited as possible in the current economic climate, it’s equally as important to ensure the customer does not feel exposed by any new approach to the service provided.

Working hard to mitigate costs and actively coming up with proposals, will stand the relationship in good stead, whilst enhancing the feeling of mutual trust between the parties.

In terms of the contract itself, the first important consideration is whether it contains a force majeure clause and if so, does it extend to the impact of the pandemic?

Whilst a service provider should certainly consider this clause and whether the current circumstances could trigger it, they must ask themselves if it will be in their long-term interests to do so.

The impact of a force majeure clause can sometimes be draconian and can potentially lead to an immediate termination of activity, which presumably, will not be in the interests of either party.

How to address the necessary variations

Instead of jumping straight to the triggering of the force majeure clause, it may be possible to make use of the variation provisions in the contract. This will enable any additional costs incurred to be recovered by the service provider.

If the costs incurred under the contract are driven by people costs and if it’s possible to flex resources, but have additional costs picked up by the customer, this would be a sensible option.

For example, the service provider may be able to recover redundancy costs in some circumstances, if the contract allows it.

Some contracts will have a formal change control procedure which sets out the process to be followed and it would be worth checking to see whether the customer is entitled to withhold its approval of any changes proposed.

The critical point here is to try and find a way of ensuring that a contract remains financially viable. The contract will usually set out how a variation should be documented, but even this can vary.

If the contract is silent in this respect, then the accepted position under English law is that any variations would need to be agreed between both parties, rather than imposed by one or the other.

When variations to the contract are agreed, these should be documented carefully, detailing whether they can be agreed verbally or whether they need to be in writing and signed by both parties.

Mitigating losses and managing relationships

For a service provider, to effectively mitigate their losses, it’s important to understand how their charges are calculated, and whether it’s an open book arrangement or cost plus.

Cost plus is a common form of charging and it may be possible to mitigate costs by making use of this mechanism, particularly if the supply chain costs increase as the costs of materials are impacted by the pandemic.

When it comes to managing ongoing commercial relationships, it’s important to assess both supply contracts and commercial contracts, as there may be flexibility allowing for volume related price reductions.

In any event, if a service provider can reach an agreement with suppliers that enables it to keep costs to the customer down, this can only improve the relationships with customers.

It’s always good to talk…

In May 2020, the government released guidance it hoped would encourage organisations whose contracts have been impacted by the coronavirus crisis to behave fairly and responsibly in relation to performance issues and contractual enforcement.

Whilst the guidance has no legal power, it calls for parties to act proportionately when dealing with disputes and to collaborate to find solutions that are fair to both parties and consider each party’s financial resources and protection of the health of their workers.

The official guidance is keen for contracted parties to talk, rather than automatically trigger a dispute due to impaired performance, when a time extension, different performance or compensation could keep the supply chain going.

When one also considers that the upcoming Corporate Governance and Insolvency Bill will impact the ability of suppliers to suspend services in the event that end customers are in financial difficulties, it is clear that the government is focussed on attempting to maintain contracts when under normal circumstances parties might be seeking to take enforcement action.

The single most important issue for service providers, is not necessarily the contract itself but the ongoing relationship with their customer. And vice versa for the customer; if the supply chain worked before, it can work effectively again, if every business does its bit.

If there is any risk a business might not meet its contractual requirements, the best thing to do is not suffer in silence, but open a dialogue as quickly as possible.

Given a good working relationship and a customer who may also require flexibility, then collaborating to find an equitable outcome, with the contract as the foundations for that relationship, businesses could emerge from the crisis in an improved position.

Wright Hassall is a top-ranked firm of solicitors based in Warwickshire, providing legal services including: corporate law; commercial law; litigation and dispute resolution; employment law and property law. The firm also advises on contentious probate, business immigration, debt recovery, employee incentives, information governance, professional negligence and private client matters. For more information please visit: https://www.wrighthassall.co.uk/

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