When Good Term Contracts Go Bad – Lessons Learned

June 7, 2016 By

June 6, 2016

by Michael W. Bloch, with contributions from David Bulfin and David Wilshin

Stillwater recently worked with several clients and their attorneys to resolve term contract disputes that led to litigation or arbitration. These disputes were grounded in the poor structure and understanding of the terms and conditions of the contracts. Often, the parties to the contract cannot anticipate all the various ways that contract terms can be interpreted or applied to situations they may not foresee. Through its experience working with a large number of clients with a variety of different contract types and situations, Stillwater Associates has experience identifying most of these potential problem areas before they arise. Some of the key lessons learned from working on these cases are as follows:

Conditions Precedent (“CP”) not clearly defined or satisfied.

A condition precedent is an event or state of affairs that is required before something else will occur. In contract law, a condition precedent is an event which must occur, unless its non-occurrence is excused, before performance under a contract becomes due, i.e., before any contractual duty exists. For example, one party’s obligation to pay money may be expressly conditioned upon the other party’s actual delivery of the agreed upon product within specifications at the agreed location and on time.

If there is a CP, its rationale should be clearly understood and the CP rationale and details should be stated in the contract.

The date of fulfillment of the CP should be stated and there should be provisions establishing how its fulfillment will be verified.

If the CP is not fulfilled, then there should be provisions stating what the parties can or should do.

If non-fulfillment of the CP provides for renegotiation of the contract and renegotiation is not successful by a specified deadline, it may be appropriate for the contract to go into phase-out followed by termination.

Ambiguous or Conflicting Provisions can lead to various interpretations causing disputes.

Examples of ambiguity include:

Volume tolerance by Seller or Buyer. If one party can exercise an option, is its exercise subject to operational feasibility on the part of the other party?

Seller may elect a 5% upward tolerance on cargo volume, but loading is subject to Buyer’s vessel draft restriction.

Buyer may elect a 5% upward tolerance, but the Seller does not have the supply.

Tolerances need to be in synch with commercial or operational necessity.

Is volume tolerance on a delivery-by-delivery basis, or over a delivery period i.e., a calendar quarter or year?

Is price escalation/de-escalation based on cumulative volume over time, or calendar periods of time?

Are product specifications clearly defined using identified, accepted industry test methods?

Use of unique terms or contract structure not generally used within industry can lead to a misunderstanding of what to do because the parties do not have a common frame of reference.

Time line of activity or required documentation needs to be in synch with commercial or operational requirements.

Example: Delivery and offtake nominations under the contract need to be consistent with industry practice to acquire transportation (tankers, trains, trucks) or pipeline delivery and offtake.

Contract Re-openers.

Potential conditions for either party to re-open need to be clearly defined.

If one party re-opens, the allowed period for renegotiation must provide a cut-off date for failure to agree leading to phase-out and termination such that both parties can realistically pursue alternatives.

Force Majeure (“FM”) Clause, required notices, and duty to mitigate should be clear.

When these terms are not clear, it can lead to a potential ineffective declaration of FM and request for excused performance due to commercial adversity rather than real events beyond the party’s ability to control.

Where appropriate, if there is a named specific source of supply, FM should be limited to events that disrupt that source of supply. Alternatively, if there is a named specific outlet, FM should be limited to events that disrupt delivery to that outlet.

Parties should give prompt notice of any FM, its nature, expected duration, and their planned actions to mitigate the FM impact or rectify it.

Internal Contract Owner.

Each party should have an internal owner of the Contract who understands the party’s rationale for entering into the Contract. The Contract Owner is responsible for maintaining the relationship with the counter-party.

This may make resolution of what might be small misunderstandings or disputes easier to resolve because the original intent can be recalled.

The internal owner can manage contract performance and authoritatively answer internal questions minimizing inter-departmental conflicts without bothering the counter-party.

Contract Summary.

When a contract will be operated over a long period of time such that the individuals operating and administering it will change, then there should be a succinct summary of the major terms and conditions, and in particular, any unique features of the contract. If the contract document is lengthy, the summary can be particularly useful to operations and administrative staff to understand what they need to do on a day-to-day basis without referring to a lengthy document.

Application and Operation of the Specific Terms should be clear relative to the General Terms (GT&Cs).

It may not be sufficient to simply say “where the specific terms are in conflict with the general terms, the specific terms will prevail.”

It may be better to specifically exclude provisions of the General Terms that might be in conflict with the Specific Terms when the parties want the Specific Terms to prevail.

Full functional review should be undertaken prior to contract execution.

Negotiator may not understand what their organization’s exposures are. Review by other functions, (Law. Treasury, Controllers, Audit, Operations. etc.), may reveal exposures that negotiation of the contract terms or internal procedures should address.

PLEASE NOTE: Stillwater Associates cannot and does not draft contracts or otherwise provide legal advice. However, we believe our extensive experience in the industry and as expert witnesses in litigation of disputes could prove invaluable to you and your legal counsel in spotting issues and suggesting solutions as you negotiate and draft your own contracts.