Terminating supply contracts

It has now been over a year since the Rana Plaza garment factory disaster in Dhaka, Bangladesh, which lead many businesses to initiate a careful audit of their supply chains.  Retailers increasingly recognise the importance of working collaboratively with their suppliers, as well as the advantages of limiting their supply base to fewer, stronger suppliers with which they can maintain a close relationship.  Now, more than ever, it is important for businesses to be able to make the termination process as fast and painless as possible where there are good reasons to bring the relationship to an end.

Terminating the contract

In accordance with the express terms of the contract

In most common law jurisdictions, priority is given to the principle of freedom of contract and, by extension, the parties' rights to terminate a contract in accordance with its terms.  Courts will generally respect the express terms of the contract between the parties, so that, if a contract is terminated in accordance with its terms and its notice provisions, the courts will very rarely intervene.  Where there is no formal contract or the contract does not contain clear termination provisions, however, it will be important to obtain legal advice.

Where the supplier is in a foreign jurisdiction to the buyer, it is important to obtain local law advice before taking steps to terminate a contract even if the contract contains clear termination provisions and is stated to be governed by English law.  This is because the supplier may benefit from certain protections under local law that will override the contractual terms on termination to protect the supplier's position, especially if the supplier may be said not to be on an equal commercial footing with the buyer.

"Reasonable" notice to terminate

Under French law, for example, buyers can be liable for terminating a supply contract without giving sufficient written notice, irrespective of whether the buyer has complied with the contractual notice period.  In other jurisdictions, like Germany and Italy, reasonable notice periods are dictated by law and range from 1 to 6 months depending on the length of the relationship.

In England, however, only where no notice period is specified will courts infer a duty to provide "reasonable notice", taking into account the circumstances of the case.  In a recent High Court case, Hamsard 3147 Ltd (T/a Mini Mode Childrenswear) v Boots UK Ltd [2013] EWHC 3251 (Pat), Mr Justice Norris confirmed that, when the contract is silent, what is "reasonable" will depend on the particular facts involved, at the time the notice is given.  This is now relatively settled law; however, this case provided guidance on the factors that are relevant when calculating a reasonable notice period.

An implied duty of "good faith"

The role of good faith in contractual relations governed by English law attracted considerable interest last year, after the High Court implied a duty of good faith into a Distribution Agreement in Yam Seng Pte Ltd v International Trade Corp Ltd [2013] EWHC 111 (QB).  As noted in an earlier post, that decision was decided very much on its own facts, and is unlikely to herald a significant change in the approach of the courts.  The general view remains that, in keeping with the principles of freedom of contract and the binding force of contracts, in English contract law there is no legal principle of good faith of general application.

The Yam Seng decision highlighted the difference between the approach under English law and those of a number of other jurisdictions.  The Court noted Bingham L.J.'s famous observation (in Interfoto Picture Library Ltd v Stilletto Visual Programmes Ltd [1989] 1 Q.B. 433, 439):

“In many civil law systems, and perhaps in most legal systems outside the common law world, the law of obligations recognises and enforces an overriding principle that in making and carrying out contracts parties should act in good faith.  This does not simply mean that they should not deceive each other, a principle which any legal system must recognise; its effect is perhaps most aptly conveyed by such metaphorical colloquialisms as ‘playing fair', ‘coming clean' or ‘putting one's cards face upwards on the table.'  It is in essence a principle of fair open dealing … English law has, characteristically, committed itself to no such overriding principle but has developed piecemeal solutions in response to demonstrated problems of unfairness."

In many civil law systems, good faith may provide the addition of “supplementary” obligations to those expressly provided either by the parties or by legislation and the control of unfair contract terms to afford additional protections on termination of a supply contract to a supplier where, for example, it may not have the opportunity to recoup its investment or is solely reliant on the relevant arrangements for its livelihood.

The European Commission's proposal for a Common European Sales Law (see post) included provisions that would protect small and medium-sized enterprises in a business-to-business contract, including against unfair contract terms.  In its response, the UK Government concluded that the proposed concept of "good faith and fair dealing" was problematic and risked interference with a business being able to manage its risk with any certainty.

As illustrated by the subsequent High Court decision in TSG Building Services PLC v South Anglia Housing Limited [2013] EWHC 1151 (see post), where a contract contains an express right of termination, it remains the case that the English courts will be unwilling to imply a requirement that the termination right is to be subject to a requirement of good faith or may not be exercised unreasonably or vexatiously.

Contract negotiation

As outlined above, it will generally be much harder for a supplier to argue wrongful termination of contract if the termination was in accordance with the express terms of the contract.  Businesses will therefore reap long-term benefits from ensuring that their supply contracts contain clear termination provisions.  However, when the supplier is in a different jurisdiction in particular, it will be important to obtain local law advice in drafting the termination provisions.

Key provisions that businesses should set out clearly in their supply contracts include:

• what will amount to a breach of contract;
• when a breach of a particular term will give rise to a termination right.  For example, the contract might state that the supplier will be in breach of contract if it fails an independent assessment of its compliance with the relevant workplace standards; that the buyer shall send the supplier a formal warning letter requiring the supplier to remedy such breach; and that the buyer shall have the right to terminate the contract if the supplier fails to remedy the breach as required within a certain timeframe;
• a specified period of notice which must be given in order to terminate the contract, which must be reasonable;
• a speedy and internationally focused forum for resolving disputes.

Businesses may also wish to set out in their contracts how the parties are to collaborate post-termination to deal with issues of handover of supply and information.

Conclusion

Having clear, express termination provisions in a contract will always be advantageous, not least because such provisions will help suppliers understand what is expected from the relationship and leave less scope for disagreement if the contract is terminated in accordance with its terms.  Given the different approaches to the termination of supply contracts, however, it is important to obtain legal advice at the contract negotiation stage as well as before any termination decision is made.  Although taking such steps will hopefully assist businesses in avoiding formal disputes with their suppliers, businesses are also advised to provide in their contracts for a dispute resolution mechanism which will allow for speedy resolution of disputes if they do arise.  In a later post, we will look at the options available to businesses for speedy resolution of cross-border disputes.

For more information, please contact Nicholas Peacock, Partner, Naomi Lisney, Associate or your usual Herbert Smith Freehills contact.