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In an ideal world contracts would not be necessary, but in the real world not having them can be disastrous. Joe Kafrouni explains why customer and supplier contracts are good business.

Long-term suppliers to a supermarket chain, potato growers were shocked to discover the company would not be purchasing the particular potato in which the company had ‘encouraged’ them to invest plant, seed, and machinery as part of a 9000-tonne annual supply to the supermarket chain for the coming year.

The news that the supermarket chain would not be making a commitment to buy any more stock came at a catastrophic time for the growers, many of whom, on the eve of planting season, had also leased land to service the anticipated demand. Approximately 4,500 tonnes of potato awaits the sale that is not to be in cold storage, and costly legal action is anticipated.

Similar scenarios are familiar to many businesses, though the scale and products vary. Misunderstandings with suppliers and disputes with customers are universal headaches of businesses and are especially devastating where the business is dependent on a few or single suppliers or customers.

Perhaps the most unfortunate aspect of the superfluous spuds is that the losses could have been prevented if an effective Supply Contract or, on the part of the supermarket, an appropriate Customer Contract was in existence.


The Deal

The supply contract and the customer contract are two sides of the same coin. The contract between the potato growers and the supermarket is a customer contract in the hands of the growers, and a supply contract in the hands of the supermarket. Therefore, the issues to be addressed are the same.

The negotiation of these contracts is crucial to the success of the deal. If negotiations do not consider the risks faced by each party, determine who is willing to accept those risks and what benefit is required from the other party to accept those risks, then the business relationship may suffer or one of the parties may be left unsatisfied with the final outcome. A ‘no surprises’ policy to negotiations is preferred. It is better to get everything out on the table, even if it is adverse to your position, and deal with it satisfactorily. The other alternative is to remain silent, leaving the potential for unresolvable conflict should the concealed issue arise.

All contracts should be kept simple, be in writing and signed by the supplier and the customer, otherwise difficulty will arise in proving the terms of the agreement. A business owner should not shy away from the requirement of a written contract. Customers or suppliers should also not be surprised by such a requirement. Unfortunately, the good old days of ‘my word is my bond’ no longer stand in today’s commercial world and if another party is not willing to enter into a written contract, you may need to question their intentions.


The Risks

The common risks that such contracts should address include time and method of delivery. From the question of who pays the delivery costs to the agreed back order policy, the time and method of delivery of products is important, particularly if stock is managed on a ‘just-in-time purchasing’ method. Late deliveries, stock shortages, and mistakes on the part of your supplier will more often than not cost money, both in the lost sales and in the goodwill lost through inability to meet obligations.

If time is an important factor to either party, then it should be stated in the contract. It is a good idea to include a schedule for deliveries both parties can refer to, and enforce. A term may also be agreed upon where if the supplier can’t provide a product or service when due, the customer may obtain it from another source. This will prevent the possibility of the customer waiting unnecessarily or receiving a double dose when the original supplier fills the first request on back order months later.

After determining the creditworthiness of a customer, it is important to establish at the outset the expectations for payment. Issues you should consider include:

• mode and schedule of payments,

• deposit requirements,

• security over the customer’s business or other assets for payment, and

• whether the supplier is still required to deliver products or services if payment is late.

Agreement can also be reached that ownership of any goods can be retained by the supplier until payment is received in full. This allows the supplier to repossess the goods should payment not be made, even if the customer becomes insolvent. Such a term would also set out the method of collecting such goods, for example the right to enter the customer’s premises.

To protect the customer and prevent compromising the quality of a business’ own product or service, stipulated levels of quality can be adopted. If measures such as a right to inspect goods upon delivery, refunds or warranty are required or excluded, they can be enforced by their inclusion in the contract.


You should also consider change of ownership when writing up a contract. Clauses should include whether or not the agreement is to continue if either the customer’s or the supplier’s business is sold. Purchasing a business without suppliers is not appealing to most buyers, nor is purchasing one without any clients. Also, you may have entered into a special deal because of your relationship with the particular customer or supplier that you don’t want transferred, so you need to consider this.

A default on the agreement by the other party will inevitably cost money and possibly goodwill. Default clauses must outline a number of remedies for these contingencies. Examples include payment of interest on outstanding amounts, payment of costs incurred in collecting debt, a percentage of sales lost by the default, and the option to discontinue supply of the product or service.

Consideration should also be given to mandatory dispute resolution clauses. These are generally cost effective, faster, and more likely to result in a win/win outcome and a continuing relationship.

Limitation of liability in the case of default must also be considered. If applicable, this will reduce or eliminate a party’s responsibility to pay damages in the situation of default.

You should always include cancellation and termination arrangements. However indefinite an arrangement may seem, there is a need to plan for its conclusion. The contract may be for a defined period or require a set amount of notice to cancel the contract. In addition, obligations that will continue after the deal, such as confidentiality and restraint of trade, should be set out clearly.

Preparing and executing a clear and proactive supply or customer contract tailored for everyday transactions is one of the preventive measures business owners can implement to protect their customer relations and ensure supply of the materials that are required to operate. Most importantly, they avert confusion and prevent your goods from becoming the ‘hot potato’ that nobody wants.

* Joseph Kafrouni is the owner of Kafrouni Lawyers business law firm and can be contacted at joe@klaw.com.au 

This article contains the opinion of the writer only, and does not constitute legal advice. Only a consideration of your individual needs can determine the best legal solution for your business.

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