Updated: Jan 7, 2020
Today, we start a special feature on the blog: Behind The Lines. In these posts, we will explore common parts of contracts, and do a deep dive on their impact on you and your business. We'll get behind the lines of language in your agreements.
Every contract has language about its term--the period of time that the contract is valid for. If it is a one-time purchase order, the term is immediate (even if the contract doesn't say it). You sign, you pay, you get what's listed on the document. If it is a service contract, it may be for a one-time service, or may be ongoing for years. Being conscious of the term of your agreements is one of the most critical steps in contract review.
Note that under Illinois law, if a contract has a term that extends beyond a year, the contract must be in writing in order to be fully enforceable. My recommendation is to always reduce your contracts to writing, for the benefit of all parties.
When you get to thinking about contract term, you need to evaluate what benefits you and your business. There are no silver bullet answers that are right for all circumstances. The questions to consider include:
How long do I intend for this agreement to be in place?
Do I benefit from having the contract continue past the initially planned period?
If it does extend, will pricing change?
If it does extend, do I need to have an "out"?
A contract that specifies a term will usually give a time period (e.g. "this contract shall remain in full force and effect for a period of one year following its execution.") This is one of the first things we look for in reviewing the agreement.
The next thing we look for is any extension language. Does the contract give either party the ability to extend it? Does it automatically extend? Automatic extension language usually looks something like this: "This contract shall thereafter automatically renew for successive one-year periods unless cancelled by Customer with the provision of not less than sixty days notice prior to the current termination date." What does that somewhat dense language say? It says that the contract will go on forever, unless you terminate it within a specific window. We call this sort of language an "evergreen clause", because just like an evergreen tree, it keeps the contract fresh indefinitely, until you cut it off.
Let's say your contract is based on a calendar year, and has the evergreen clause above in it. You get to July and you're working on your budget for next year...and you decide you want to terminate this contract at the end of the year. You fire off a letter to the vendor, indicating that you want to terminate the agreement as of December 31. All good, right? Not So Fast... If you sent that notice in July, it is not within sixty days of the current termination date (December 31), so your notice is not effective. Imagine your surprise when you get to January and continue getting invoiced.
These kinds of issues make a lot of people wary of evergreen clauses, but they can be really useful tools for business. An evergreen clause can preserve a long-term and necessary business relationship, without forcing you to go through contract review each year. You develop one good agreement, and you can use it indefinitely. In circumstances such as this, you'll want to include some language that protects your interests. That might include:
Price Adjustments: As seller or buyer, you likely want language covering how price adjustments work. The agreement can limit price adjustments with a fixed adjustment factor (e.g. no more than 3% per calendar year) or it can be based on an index (e.g. based off of the Consumer Price Index to account for inflation). Another flexible tool is to indicate that the rates can change if the seller provides notice of the changes (e.g. the seller will provide not less than 60 days notice of new rates). Rate change language can be really effective when combined with language giving the customer a potential "out" if they don't like the new rates.
Termination: You don't want a contract that goes on forever, so there has to be termination language in there. From either the buyer or seller's perspective, if market forces change, you need the ability to get out of the agreement. Termination language can give you the right to terminate for cause (i.e. if the other party breaches the agreement) or for convenience (for any reason). It can give you the right to terminate at the end of the current term, or at any time during the term.
There are many more considerations that you have to balance. Part of my job is working with you to ensure you understand the legal ramifications of your agreements. However, another critical part of my job (that many attorneys miss) is to ensure that we have thought about your strategic interests, to ensure that your contract serves your business goals. We want to build a set of language that protects you and your customers, and provides a solid foundation for a continuing relationship.
There are a lot of companies that drive towards a contract with traps. The 'end of contract 60 day notice of termination' language example above is a great example of the traps that some businesses set for their clients. From a policy perspective, I'm happy to talk with you about why setting traps like this is not in your strategic interest, and why it will hurt your client relationships and reputation. But at the end of the day, you as the client drive the decisions.
A final thought. There are times when a client of mine will get a contract with language that they don't like--such as the 'end of contract 60 day notice' type provision. But from time to time, we need a service from a company that has language of this nature, and we can't change it. The final step that I take with my clients is to give them practical pointers on how to manage and live with their contracts, to ensure their success. There are simple, practical steps you can take to protect your business against forced evergreen renewals, and I can help you establish better contract management processes.
Contact me today to learn more! 630/292-4023 or email@example.com