The importance of pro-active contract management in an economic downturn

Actively managing business contracts means taking the appropriate steps to ensure compliance – or to vary or exit an unnecessary or underperforming contract – mitigate losses and disruption and help drive business efficiency.

Set-up efficient contract management from the outset

The best way to ensure efficient contract management is to set-up processes and procedures from day one and ensure that all contracts entered into by the business are included as soon as they are signed. An efficient system of recording all contractual relationships, the key terms, rights, obligations, key dates and putting in place a process for regular review and ongoing monitoring will provide a solid foundation. The reality, of course, is that not all businesses will have had the resources or foresight to do this from inception. However, it is never too late to start this process with all new contracts and to undertake regular reviews and ongoing monitoring of existing contracts.

Contract review

Absent an existing contract management process, now is a good time to put one in place, prioritising the most strategic and business critical contracts.

The first task will be identifying all existing live contracts. This may sound easy, but every business relationship will involve many forms of contract and while some will be in the form of stand-alone written agreements or heads of terms, others may be in the form of purchase or service orders and accompanying master services agreements or either party’s standard terms and conditions. Sometimes, there may be nothing more than an exchange of emails.

The starting point for the review of existing live contracts will be to clearly identify and note at least the following:

• The end of the term and whether any automatic renewal provisions apply. If so, what notice is required to prevent auto-renewal and when can (or must) this notice be given? If a fixed term has expired but the parties have nonetheless carried on performing, you may need to seek advice as to the rights of either party to end the contract.

• What are your primary obligations, including any minimum purchase or minimum spend requirements, delivery or payment terms (noting whether time is of the essence) and service level commitments?

• What are your primary rights and the other party’s obligations?

• Are there any express consequences of breach by either party, including any requirement to give a defaulting party a remedy notice period before being able to terminate?

• Are there any dispute resolution provisions requiring the escalation of disputes and/or provision for mediation, arbitration, or other alternative dispute resolution process?

• What is the applicable law and jurisdiction, particularly if not England and Wales?

Relationship review

The next step is to review the contractual relationship. Whether the contract is with a customer or a supplier/service provider, it is important to understand from the individuals who are managing the relationship how things are, in fact, operating. The things to consider here are set out below.

Do the parties actually understand, and are they operating in accordance with, the terms of the contract?

Often the reality of performance between two business teams can differ in a number of ways from what the contracting parties intended. That may or may not present practical problems but if goods are not being delivered or services provided in accordance with the contract terms, your business may be less efficient as a result. For example, if payments are not being made in accordance with the contract terms, this could be having a knock-on effect on cash-flow and your ability to meet payment obligations under other contracts. Taking a close look at this and taking appropriate steps to engage with the other party to get things back on track may be an easy win in terms of business efficiency or cash flow and may help ease pressures elsewhere. Read more in our article “Contractual ways to improve cash flow”.

What are the warning signs that the other party might start failing to meet their contractual obligations?

Current market conditions are likely to cause some businesses to encounter difficulties. These may relate to supplies, logistics and transportation, staffing, cash flow or various other challenges. A troubled supplier/service provider or customer can have the potential to have a knock-on adverse effect on anyone contracting with them. Warning signs that could indicate another party may be having business difficulties which may have an impact on their ability to continue to perform their contractual obligations could include:

• Late or delayed deliveries/service provision or payment without any or any adequate explanation

• Requests for price adjustments outside of agreed contractual terms

• Accelerated or delayed payment term requests outside of terms

• Changes in product or service quality or service levels

• Deteriorating market position

• Delayed or restated audited financial statements

• Removal and replacement of key management roles

• High turnover of staff.

If you start to spot these red flags, you will need to decide whether in the first instance to simply keep a watching brief with continued and closer monitoring of the contract and performance, or whether to start engaging directly with the other party to seek assurances as to their ability to continue to meet their obligations.

If you are the customer and the contract is one of supply of goods or services and is not an exclusive arrangement, consider taking steps to line up an alternative or additional supplier to mitigate and minimise potential disruption to your business and any potential issues with onward contractual obligations you may have with customers. In exclusive arrangements, it may be in both parties’ interests to agree a variation to allow services or supplies to be obtained from elsewhere. Read more in our article contract amendments made in an economic downturn.

If the warning signs turn to failures to meet contractual obligations and potential breaches of contract, consider the points raised below and seek advice.

Is either party underperforming or failing to comply with their obligations?

Not operating in accordance with the contract may actually be a failure by one of the parties to comply with their obligations and be a breach of contract. It is important that any such failure or breach is identified and addressed as soon as possible.

If the failure or potential breach is on your side, consider what steps can be taken to get things back on track to minimise exposure to a possible claim for breach of contract and/or termination by the other party. Taking such pro-active steps may also minimise the loss the other party may suffer as a result, thus reducing your potential liability.

If the other contracting party is failing to comply with their obligations, it is important to consider your options. You may prefer to engage and require future compliance. Alternatively, if the contract is no longer working or there is a risk that the failure will lead to a disruption of your business in the future, you may want to consider if the counterparty’s breach gives rise to a right for you to terminate. Advice should be sought at this stage to ensure any steps taken (or not taken) do not adversely impact your right to terminate or claim damages. You can read more in our article about terminating commercial contracts.

Does the contract remain relevant, appropriate or necessary for the needs of the business?

The needs and requirements of businesses change over time and such changes can be driven by unexpected spikes or steep declines in customer or supplier demand which occur during the term of a contract caused by outside factors such as economic or political turmoil. Being acutely conscious of the term of contracts which are no longer required is important if you wish to end the contract at the earliest opportunity. The first thing to look for would be a termination for convenience clause, enabling one or either of the parties to give notice to bring the contract to an end. Care should be taken when exercising such a clause to ensure that the timing, form, and delivery of the notice all comply with any contractual requirements to minimise the risk of challenge later.

In circumstances where the contract is no longer working for either party, there may be a common need to agree a variation where there is a desire for the relationship to continue to the benefit of both parties. Care needs to be taken when agreeing amendments or variations and this is covered in greater detail in our article, “Are contract amendments made in an economic downturn legally binding?”.

Keep monitoring

Being focused on ongoing monitoring of contract compliance and performance will help identify risks and potential business exposure at the earliest possible stage. A diligent business should always be looking ahead and ready to take positive action in response to any of the warning signs identified above. This can help mitigate or minimise any potential business exposure and thus drive business efficiency and cash flow.

Ongoing contract monitoring is important not just to ensure compliance by your contracting partners but to also ensure that that your own business is keeping up with the performance of its contractual obligations. Other contracting parties may well be monitoring your performance, and some may be looking for a reason to force a renegotiation or termination, or bring a claim for damages against you.

LS Unlock

If we can assist in relation to any commercial contract disputes, we would be very happy to do so and would encourage consideration of our “LS Unlock” initiative setting out the financial possibilities on which we may be able to provide advice. LS Unlock comprises a free initial assessment of significant commercial claims together with a menu of alternative fee arrangements which can reduce and, in certain cases, eliminate the upfront cost of pursuing a claim. This initiative has been designed specifically to assist clients in this uncertain economic climate and is part of our commitment to working with clients to help them survive its effects.