The global financial crisis has seen an increasing number of customers failing to perform under contracts for the supply of goods. These interruptions to international trade serve as a reminder to all suppliers of the need to carefully manage counterparty performance risk.
Two reasons for customer defaults are:
- an inability to obtain credit or other forms of financial security from banks and lending institutions to pay for goods, and
- a decrease in consumer confidence and spending.
Both of these factors are having a direct impact on the cash flow of customers’ businesses and therefore their ability to take and pay for goods.
If faced with a defaulting customer, it is essential for the supplier to determine what its rights are under its contract with the customer and at law. It is very important for a supplier to obtain legal advice in the early stages of, and ideally before, any discussions with the customer to ensure that its rights are preserved under the contract and at law.
In addition to identifying and protecting its legal position, in the case of key customers who remain solvent, the supplier will need to appropriately manage the situation in order to preserve the commercial relationship.
Of course, every cloud has a silver lining. If managed correctly, the situation could lead to unexpected added benefits going forward for a supplier.
Protecting your legal position
Key factors to consider are:
- What are the rights and obligations of the parties following a breach or default?
- Is there a retention of title clause?
- Is there a dispute resolution procedure?
Contracts will often include an express right for a non-defaulting party to terminate the contract in the event of default by the counterparty. However, exercising this right to end the contractual relationship will not always be the most desirable outcome for a supplier.
As all contracts will be different, there will be no guaranteed outcome. So, each contract will need to be considered on a case by case basis.
The silver lining – using the situation to strengthen contractual position
Depending on the circumstances, a customer’s failure to perform under a contract may provide an opportunity for a supplier to review the contract and renegotiate its terms. It may make more commercial sense for a supplier to try to negotiate variations to the contract rather than enforcing its rights in relation to the breach.
Again, any variations will be specific to the nature of the contract and the relationship of the parties, and will require the customer’s agreement. It is vital that all agreed variations are recorded in writing.
A recent example
A supplier had entered into a long-term contract with an overseas customer. When the customer failed to perform its obligations under the contract, the supplier immediately sought legal advice.
It was standard practice for the supplier to attach its general terms and conditions to the agreed commercial terms—both parts forming the entire contract. For this contract, however, it turned out that the supplier had inadvertently omitted to attach its T&Cs.
As a result, if the supplier were to enforce its rights, the law of the customer’s country would apply and not the supplier’s home country governing law specified in the T&Cs.
In the interests of continuing business with its customer, the supplier was able to agree on a payment plan with the customer, and also agreed not to charge interest on the basis that the contract was to be amended to include, among other things, the supplier’s T&Cs.
This article was written by Simon Taskunas, Partner, and Rebecca Crosby, Solicitor, Singapore.
More information
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