Why You Need a Long Term Supply Agreement

If you regularly source products from the same suppliers – or if you are a supplier with some regular customers – then it can often be of benefit for both sides, to set up a long-term agreement.

Advantages include:

  • planning ahead is easier
  • providing security of supply, for the buyer, and of orders for the supplier
  • pre-agreed pricing formula – predictable prices
  • the buyer can get a better price in return for the commitment
  • less admin – you don’t have to maintain purchase orders over and over again

This type of agreement can be useful in a wide range of businesses, from supply of raw materials in the construction industry to supply of goods to a retailer.

The milkman always delivers

Milk delivery is typically a long term supply
Image: Keystone View Co (http://hdl.loc.gov/loc.pnp/cph.3b04462) [Public domain], via Wikimedia Commons


Here are some of the basic terms you need to include in your contract.

General Scope

This establishes the basic agreement between the parties for the sale and purchase of products which will probably be defined in a Schedule.

Duration

The start date and initial period of the contract need to be specified.  This might be 12 months with the contract providing for it to be rolled over on a quarterly or longer basis until one side gives notice.  And since a long term contract involves planning ahead, each party should be required to give reasonable notice if it wants to bring the contract to an end: the buyer may need time to find another supplier and the supplier does not want to find he has committed himself to stock than he cannot readily sell elsewhere.

Quality Issues

The quality of the products is, in effect, going to be defined by reference to the specification which will be in a Schedule to the Agreement.  If the quality of any delivery does not meet the specification, the contract should make the Supplier responsible for their replacement.  In the case of some supply contracts, in particular raw materials such as coal or sand, the contract might usefully contain provision for independent testing of the material. And if the supplier is a wholesaler, the contract might require that samples are to be provided in advance if the supplier wants to source goods from a new manufacturer.

Quantities, Forecasts, Orders.

It is common to have terms that provide for the buyer to give regular forecasts of quantities, thereby enabling the supplier to be in a reasonable position to meet purchase orders.  Sometimes this involves an annual forecast which is then refined to a quarterly forecast and followed by monthly purchase orders.

Sometimes there will be agreed minimum and maximum quantities and these may be coupled with a “take or pay” provision.  In such a case, if the buyer fails to take the minimum quantity, he will pay for the shortfall.  Similarly, if the supplier fails to provide the minimum quantity, he may be penalised.

The contract will also deal with the requirements for placing an order, within minimum time periods and provision for delivery dates and a model order form can usefully be included in a schedule.

Pricing

The agreement will usually contain a schedule with details of prices but, since price adjustments in a long term contract are usually going to be necessary, there may also be a formula for price adjustments.  This could, for example, provide for a price adjustment each year by reference to the Retail Price Index published by the government in the supplier’s country.

Alternatively, prices might be adjusted by reference to the supplier’s price list or, if there is no formula, there could be a 3 month period of negotiation and if agreement cannot be reached, either party has the right to terminate the contract.  Sometimes there will be agreed discounts on list prices which may vary depending on the quantities being sold.

Payment

Generally there will either be payment on a monthly basis against invoices or, alternatively, especially in a cross-border deal, the buyer may agree to open a revolving letter of credit which will give the supplier greater security.

Payment dates and interest on late payment should also be covered.  In the UK the supplier may want to claim interest under the Late Payment of Commercial Debts (Interest) Act 1998, which allows interest to be claimed at 8% p.a. above Bank of England base rate. The supplier may also be allowed to suspend deliveries if payments are overdue for more than a specific period.

Deliveries, Risk & Ownership

The agreement will specify where deliveries are to be made and when they are to be made.  Method of transportation (and who bears the cost) can also be covered.  Both ownership and risk in product usually passes from the supplier at the delivery point.  Details of who is responsible for packaging or for the cost of storage if the buyer postpones a delivery date can also be dealt with.

Claims

Depending on the type of products and whether they are to be sold in the retail market by the buyer, there may be a clause dealing with defective product liability claims from third party customers.  In that case the contract is likely to put primary responsibility on the supplier but, if the buyer has modified any products before passing them on, the issues of liability could be complicated.

If the supply is for raw materials, a sampling and testing procedure may be appropriate, with reference to an industry expert if the buyer claims that the products are defective or sub-standard.

Termination

Be sure to include a clause that allows each party to terminate if the other commits a serious breach or becomes insolvent.

Force Majeure

In a long term contract unforeseen circumstances could disrupt the supply arrangements.  It can be useful to include a ‘force majeure’ or unforeseeable events clause so that if this occurs the party affected will not be treated as failing to perform the contract.  Examples of force majeure events can be included in the wording. As well as war and terrorism, fire and flood, there might be contract-specific items to be covered such as closure of a quarry that the supplier is relying on for his supply of rock.  If force majeure goes on for more than x months, either side can terminate the contract.

Limit of Liability

It might be sensible for the contract to limit liability for both parties – if the supplier fails to deliver an agreed quantity of material that is vital for the buyer’s business, he might agree to accept responsibility for paying the extra costs that the buyer incurs with another supplier but exclude liability for any loss of business suffered by the buyer.  Similarly, if the buyer suddenly cancels an order, he might agree to cover the supplier’s loss on that delivery if he has to sell it elsewhere at a lower price, but not pay as much as the full cost of the goods.

Disputes and Law

If a dispute occurs, it can be useful to have a three-stage process for dealing with the problem.  First, direct negotiation between senior executives, secondly, if this does not resolve the matter, the dispute can be referred to mediation.  Only after these processes can a dispute be referred to the courts or arbitration.

The form of contract is best put together with a set of terms and conditions plus a series of schedules dealing with the variable items such as details of the products, specifications, prices, minimum and maximum quantities, delivery point, price adjustment formula and a pro forma order form.

ContractStore has a long term supply contract template at: http://www.contractstore.com/A138-long-term-supply-agreement

We also have a number of contract templates for manufacturing and supply at: http://www.contractstore.com/goods-manufacture-supply

This entry was posted in Business Contracts, Guidance Articles, Running an SME and tagged , , , by Giles. Bookmark the permalink.

About Giles

Giles is the founder and managing director of ContractStore. It was his idea to set up a company selling documents online and he has played a major part in the company's development. He is an English solicitor, with over thirty years' experience of drafting and negotiating commercial and construction contracts in the UK and overseas. Giles has long been convinced that there is a quicker and simpler approach to the delivery and supply of most contracts, and he is an active proponent of the use of plain English in legal documents. He specialises in the drafting of construction and engineering contracts and as well as contributing contracts to the ContractStore website, he is co-author of the JCT Constructing Excellence Contract and of 'Exporting Made Easy' with Simon Bedford.

Leave a Reply

Your email address will not be published. Required fields are marked *

Please prove you are a human being: