Contracts with suppliers: are you leaving money on the table?

From office supplies to IT infrastructure and essential components, businesses of all sizes enter contracts to purchase goods and services.

For each business a small number of these will be key strategic relationships, and the contracts with these suppliers will likely receive attention from the executive team or the board. The majority of purchases, however, will be non-strategic and/ or low value in nature. Resource constraints mean that standard terms and conditions presented with the supplier’s quote will often be overlooked, and a contract entered into with neither review nor negotiation. This can lead to unpleasant surprises when the business wants to exit the contract, resist a price increase or claim compensation for poor performance.

Examples of contractual provisions that can cause revenue leakage if not checked include:

Payment terms:

• Suppliers’ standard terms often include short payment terms. Can your accounts payable processes meet their requirements? If not, you risk being late in paying. Can you extend the payment terms to improve your cashflow?
• What is the interest rate on late payment? If the contract does not specify, the law provides a default of 8% above base rate. It is common for purchasers to request a lower rate.
• Does the contract entitle you to set off amounts owed by the supplier against payments for the contract goods or services?
• Is there a mechanism for changing the price? Does this require both parties’ agreement, or is it automatic (e.g. an annual upwards ratchet?)

Performance management:

• Are there clear timescales for delivery of goods and services, and remedies for delays?
• In longer-term contracts for services, chronic underperformance is a material risk. Including service levels and service credits can incentivise performance and provide a straightforward financial remedy for non-compliance.
• Where a supplier is supporting the purchaser to deliver innovative or improved outcomes, “pain-share/ gain-share” mechanisms can be included in the contract to allocate financial risks and make payment conditional on delivery.

Termination rights:

• How can you exit the contract if performance is poor or you want to switch supplier?
• Are there key dates or deadlines for giving notice? Standard terms and conditions often roll over automatically, locking in the purchaser for another fixed period.

Liability and indemnities:

• What are your liabilities? In simple contracts, a purchaser’s only enforceable obligation may be to pay the purchase price. In more complex relationships there may be additional obligations regarding use of the supplier’s tools, know-how or brand name.
• Even contracts for low-value items can include disproportionate liabilities for the purchaser. These should be identified and, where appropriate challenged.

Action Points for Purchasers

While there can be no “one-size fits all” approach to a business’s purchasing contracts, the following process steps can improve oversight and management of this important cost area.

1. Map your suppliers: A classic procurement model segments suppliers along two axes: the value of the contract (low/high) and the number of available suppliers (few/ many). This is a useful starting point for a risk-based allocation of management and legal resources.
2. Implement rules for review: Low value commodity contracts may require only a check of four or five key clauses to secure “quick wins” and avoid traps. Long-term, strategic or partnership type arrangements will likely merit a more bespoke contract and detailed negotiation.  
3. Track key dates: including price reviews, deadlines for notice of termination or renewal, contract expiry dates.
4. Monitor performance: Pro-actively enforce the contract, including service credits or other financial remedies.

How Boardside can help

Boardside Law’s commercial lawyers have significant in-house experience working with businesses to optimise their purchasing arrangements and minimise supply chain risk. Our support services include reviewing third party terms, preparing bespoke purchase contract templates and training management and operational teams on contracting processes.