Effectively Managing Supply Chain Risk: Formal Agreements
3 Oct 2023
In today's increasingly complicated trading landscape, ensuring the resilience of supply chains is absolutely critical to maintaining business continuity and positioning your business to take advantage of market opportunities. From use of emerging technologies and wholly-outsourced operations to purchase of raw materials or critical components, companies are more reliant than ever on third parties delivering their end of the deal.
While verbal agreements and "handshake deals" may have their place in certain settings, when it comes to ensuring critical supply, the importance of putting in place robust, formal terms cannot be overstated. This article looks at importance of formalising such agreements, the key legal elements they should cover, and the risk of carrying on without a formal arrangement.
The Significance of Formal Agreements
Certainty and Clarity: Formal agreements provide certainty and clarity by setting out the roles, responsibilities of, and expectations upon each party. This reduces the chance of misunderstandings or disputes (saving both time and money down the line) and fleshing out any areas of operational uncertainty.
Protection of Interests: Contracts allow businesses to protect their interests by specifying conditions such as pricing, quality standards, and timescales, ensuring that suppliers clearly understand their obligations and giving the customer access to clearly defined remedies if they are not met.
Legally Binding: Formal agreements, when properly drafted and executed, are legally binding and can be enforced much more easily than trying to piece the contract together from various ‘he-said-she-said’ emails and conversations. This means that enforcement is quicker, easier and less expensive.
Key Legal Considerations
While the specifics of an agreement will depend on the nature of the supplier relationship, certain legal components are fundamental across various sectors:
Definition of Goods/Services: Clearly describe what the supplier is to provide. Ambiguities here can lead to disputes and dissatisfaction.
Pricing and Payment Terms: Clearly outline the pricing mechanism, any potential adjustments during the term, and terms of payment to avoid future disagreements.
Term and Termination: Define the duration of the agreement and grounds upon which either party can terminate it (e.g. break clauses or termination for specific breaches).
Intellectual Property: Especially in tech or creative industries, it’s vital to determine who owns IP developed during the relationship.
Confidentiality: Safeguarding sensitive information is paramount. Both parties should commit to keeping certain details confidential.
Liability and Indemnities: Set out exclusions of and limits on liability and circumstances under which one party might indemnify the other against specific losses.
Force Majeure: Address scenarios where obligations might be delayed or prevented due to unforeseen and uncontrollable events, ensuring neither party is unfairly penalised.
Governing Law and Dispute Resolution: Determine which jurisdiction's laws will apply to the agreement and how disputes will be resolved, be it through mediation, arbitration, or court proceedings.
The Dangers of Informality
While formal agreements require effort and often legal expertise to draft, the risks of proceeding without one are significant:
Unenforceability: Without a written agreement, proving the terms of a verbal contract or implied understanding can be arduous. This can make enforcement in the case of a breach challenging.
Duration: Contracts without a clearly defined term/duration are at risk of being terminated for convenience on “reasonable notice”. What is reasonable may not necessarily be what is sufficient to replace a critical supplier at an acceptable price point.
Financial Risks: Without pre-agreed terms, there might be unexpected costs, or suppliers might raise prices arbitrarily.
Operational Disruptions: Absence of clear delivery or quality terms can lead to operational hiccups, affecting the bottom line.
Reputational Risks: Disputes with suppliers, especially if they become public, can damage a company’s reputation and client trust.
Loss of Remedies: Without a formal agreement, a business may find itself without adequate legal remedies if a supplier defaults or causes harm.
The relationship between companies and their key suppliers forms a critical aspect of their business when it comes to operational success, financial performance and, where relevant, attractiveness for investment or sale. While it might be tempting (or easier) to operate on trust or informal understandings, the strategic and operational importance of these relationships means that formalisation is critical. A well-drafted, comprehensive agreement safeguards interests, mitigates risks, and lays the foundation for a fruitful, long-lasting supplier relationship.