Uncertain Times: Contract check

Posted on: 13/10/2022

Category: For your business

Resilience is a term often banded about as a skill worth developing and the recent few years and events have perhaps tested our resilience levels more than usual. It is also a quality, which businesses need to rely on to face the uncertainty, caused by major global events of recent times.

Part of a business’s resilience is the contracts they have in place to run their business. The certainty of contracts are arguably the foundation of good stable growth, as all parties know where they stand and unknown risk is minimised.

It is always worth taking the time to review key contracts, whether with suppliers or customers. In these difficult times, there are three particular clause worth keeping in mind.

How can the contract be terminated?

Businesses might start to look at their onerous or non-profitable contracts to see if they are worth continuing with. To know if a contract can be terminated it is first important to know whether it is a fixed term contract, when that comes to an end or whether it rolls on indefinitely. Look for notice provisions – what time period needs to be given how to give notice and to who it goes to. Sometimes there are separate clauses, away from the termination clause, to cover this. To end a contract correctly these must be followed.

In certain circumstances, there may be fault based termination rights such as a party being in breach of the contract or fall foul of the insolvency termination rights. If “time is of the essence” for performance then failing to deliver or perform on time may bring about an automatic right to terminate and claim damages. I also use the term “insolvency” loosely as some clauses allow a party to terminate if, in their view, the other is financially unstable. That is a subjective test. Termination for another’s breach usually has to be of substance. Often it is referred to as material breach so that small, minor, one-off indiscretions are excused. Termination for a fault will also need to follow the correct termination procedure set out in the contract.

Sophisticated contracts may also set out the consequences of a termination. It may require action from a party to pay all outstanding invoices, impose an early termination fee, or set out the return of items or transition to a replacement supplier. Therefore, decisions to terminate must consider all consequences of taking that step.

Be alive to any ongoing liabilities surrounding confidentiality, data protection or post termination restrictive covenants; just because the supply part of the contract has ended there may be ongoing legal liabilities.

As a final note contracts must be lawfully terminated. Termination for invalid reasons could lead to a breach of contract claim against you for damages so it must be a considered step looking at more than just the process to end the contract.

Late Payment Protection

The main protection for non-payment of invoices (other than perhaps a termination right) is to charge interest for late payment. Often this is a clause linked to the payment terms and gives an express right to charge interest on late payments. With base rates having been so low for so long it may have been overlooked in recent years. However, with recent and expected base rate rises the use of such clauses may trigger payment and assist with credit control and therefore cash flow of the business.

For businesses without contractual rights to claim, interest there may be the right to claim interest at 8% on qualifying debts under Late Payment of Commercial Debts (Interest) Act 1998.

Force Majeure

Following Covid more business are aware of the term Force Majeure. It is a contractual clause, which seeks to prevent a party being in breach if they cannot perform their part due to an event outside of their control. Often they give additional termination rights when a contract remains in suspense for a period. Typical events are wars and natural disasters but can also include strike action and, if well drafted, events that fall into the ambit more loosely. However, a bad bargain or contract, which has become unprofitable or unsuitable, is unlikely to benefit from the protection of force majeure.

Just as a business conducts regular reviews of sales, turnover and profit it should also keep a check on its contracts so that they can respond to outside forces and build resilience to face the more difficult times.