Don't leave loose ends in contracts

In the wake of the financial difficulties suffered by large suppliers such as WorldCom and KPNQwest, you would be best advised to...

In the wake of the financial difficulties suffered by large suppliers such as WorldCom and KPNQwest, you would be best advised to check your contracts to see what you can do if your supplier goes to the wall, writes Andrew Lucas.

Most contracts will have provisions that set out the rights of parties in such situations. However they are not that easy to understand.

Examining a standard clause will help to illustrate your rights under contracts you have already signed and introduce some tricks of the trade that will give you better rights in the future.

Typical clause
A typical standard clause on termination of an IT contract might read, "The Agreement may be terminated in writing by either party with immediate effect from the date of service on the other of written notice if a resolution is passed or an order is made for the winding up of the other (other than for the purposes of solvent amalgamation or reconstruction) or the other becomes subject to an administration order or a receiver is appointed to take possession of any of the other's property."

Does it apply to you?
First, always make sure it is clear to which companies the clause relates.

Imagine you have a contract with the UK subsidiary of a US telecoms supplier. The US firm hits stormy financial waters and files for Chapter 11 bankruptcy protection. You would of course be concerned that the UK company is going to go the same way.

Under the suggested wording above, you would not have the right to terminate your agreement with the UK company just because its US parent was in trouble. You would have to wait until the UK company was insolvent or wound up.

As the UK subsidiary could limp on for some time this could lead to months of uncertainty. So seek to have the clause relate to both the company you are dealing with and its associated organisations.

Set a trigger
Be aware that the clause covers specific events such as "a resolution is passed". Companies can be in difficulty a long time before it gets to this stage.

Consider insisting on a more general wording which allows you to terminate in circumstances where the supplier is in financial difficulty and you have good reason to believe that it will not be able to perform its obligations under the contract now or in the future.

Getting a supplier to agree to such wording could be difficult. If so, try to use a more objective test. For example, if the supplier is a public company the right to terminate could be triggered if the supplier's share price drops below a certain level.

It is important to note that, in the absence of a correctly-worded clause, contracts are not necessarily automatically terminated in an insolvency situation. A whole column could be devoted to the ins and outs of the general law on this area alone.

Remember, the reason things are specified in a contract is to create a degree of certainty. So if you want certain things to happen when an event occurs, spell it out in the contract.

Take steps to protect your contracts
Your rights to terminate when a supplier is in financial trouble may not be as clear as you think.
  • Do not rely on the general law - ensure there is a clause in the contract

  • Do not rely on boiler-plate clauses - tailor the clause to your requirements

  • Check that you can terminate for the insolvency of your supplier's parent company

  • Check that your rights to terminate occur on a wide range of events - not just on formal court proceedings.

Andrew Lucas is senior lawyer at Law firm Simmons & Simmons.

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