UK: Reading The Fine Print

Last Updated: 18 May 2009
Article by Matthew Gore

Port Strategy, April 2009

An unstable operating environment gives port operators the opportunity to re-visit and in some cases even re-write existing contracts, as Matthew Goreexplains.

In the current economic climate many port users are in survival mode which is putting extreme pressure on operators of ports and terminals to compete on price and service obligations.

Now is the time for these operators to review both supplier and customer relationships. In particular, they should ensure that their commercial contracts protect their interests, facilitate improved cashflow and assist in managing credit risks.

Users facing severe volume and revenue reductions are reviewing important contracts like terminal agreements to see if they can renegotiate terms and/or move to terminals offering lower rates or better service.

In contrast, some operators are looking to strengthen rewarding customer relationships and get out of unprofitable ones while obtaining keener prices and better service levels from underperforming sub-contractors.

As in any negotiation, knowledge is key and understanding strengths and weaknesses is vital. There may be opportunities to save costs, improve service levels, identify angles for renegotiation in scope, terms, price or even to sever a commercial relationship without resorting to dispute resolution.

In some circumstances it may be possible for a party's lawyers to "engineer" a repudiatory breach by the counterparty which would enable termination of the contract for "cause". If faced with the loss of a contract, an operator may seize upon an opportunity for negotiation and settlement in order to avoid the loss of a customer entirely.

A starting point is to establish whether there is a contract in place. Contracts do not need to be in writing. They may be formed by an exchange of emails, a course of dealing between parties or simply based on a rate sheet and general trading terms and conditions. However, without a written contract, relationships are at risk and users and operators alike may be well advised to get a written contract in place with mutually beneficial terms.

Inevitably a sudden request to enter into a formal written contract could send the wrong message and the process needs to be managed effectively.

In the absence of a written contract, the law, as well as custom and trade usage, may imply certain terms into the relationship between trading partners. Operators may wish to seize upon the lack of a formal contract to sever unprofitable arrangements, although a short period of notice should normally be given before ceasing to provide services.

Companies should also be alive to the fact that despite an express written contract, the actions of the parties over the course of time may alter the terms of these. The regular acceptance of payment within 60 days instead of the documented 30 days may alter the written contract terms for example. The regular non-enforcement of contractual "penalties" (technically known as liquidated damages) may also preclude a party from relying on these in the future.

If a contract sets out a specified duration and notice period to terminate in clear and unambiguous language, it is advisable to follow the notice procedure or to apply commercial leverage to terminate by consent or renegotiate terms. Any rights to terminate a contract for breach should be exercised with care as there is the potential for a counterparty to make a claim for wrongful termination.

Where, however, the contract does not provide for a minimum duration, guaranteed throughput or spend commitment or require a minimum notice to terminate, the position in law is quite simple. No claim would succeed for lost profits and wasted costs on the basis of the length of the relationship and a user could be perfectly entitled to terminate the relationship with a short period of notice.

Where, however, a user has entered into a terminal agreement for a fixed duration with no option to terminate earlier, then the user would be liable in damages to the operator if it decided to terminate the agreement prematurely. The operator is required, as a matter of law, to mitigate any losses the operator sustains. The measure of the damages would be the sum necessary to put the operator in the position it would have been in had the user performed its obligations throughout the entire fixed term.

The best case scenario would be that the operator would find a replacement customer, effectively mitigating its loss and substantially or entirely extinguishing the user's liability. In the current economic conditions this could be particularly difficult.

The worst case scenario would be that the operator would be unable to find a replacement customer. In these circumstances the user would be liable to the operator for whatever profit the operator would have made on the sums due under the agreement that they are now relieved from performing, that is the operator's "net loss" for the remaining duration of the agreement.

Subject to any contrary written agreement, the actual sum which the operator would be entitled to recover depends upon their ability to mitigate their loss and the calculation of their profit less their costs of providing the services under the agreement that they are now relieved from performing.

Now more than ever, operators should pay particular attention to the payment terms of their contracts. It is becoming increasingly important to keep a tight rein on credit control to improve cashflow and reduce credit risks. Operators may wish to consider performing credit checks on new customers and asking for payment on account or seeking guarantees from parent companies or banks of suitable standing or taking other appropriate security for credit.

They may also wish to include provisions allowing them to terminate contracts if there are delays in payment or providing for interest on late payments. It should be remembered that there is a UK statutory right in certain circumstances to interest on late payments. Users may however wish to try and negotiate discounts with operators for early or prompt payments. In certain circumstances operators may wish to exercise liens over users' goods to facilitate payment, where this right was included in the contract.

As an increasing number of companies face difficulty in meeting their payment obligations as they fall due some of these may find themselves in administration. If operators fail to manage credit control effectively then there is a greater risk that a number of their trade debts could become unsecured debts of their customers in administration.

If however, the administrators affirm the contract on behalf of the user, any monies owed will be treated as an expense of the administration and be payable in priority to all other claims except those of secured creditors.

Operators should also review their performance and service levels, user expectations and local market developments as they may enhance existing and new business. A service level agreement for example keeps discussions between operators and users on an objective level and gives operators the opportunity to live up to their obligations and then go that extra mile.

There should be specific performance levels identified in order to improve and develop service levels. Users should seek regular reporting from operators and look to include provisions for failure to meet agreed service levels including the right to benefit from any discounts, sums payable or the ability to terminate in the event of default.

The inclusion of continuous improvement provisions in contracts are useful for users to require operators to deliver service or quality improvements along with cost savings. More than ever before, operators need to engage with users, understanding their individual and specific circumstances more closely to improve service levels to meet and even exceed expectations.

A constant open and constructive dialogue is advisable on how to best serve users and to work closely together on projects and initiatives to ensure continuous and incremental improvements in service levels and cost reductions adding to both parties' bottom lines.

Operators need to identify and review existing arrangements with users and suppliers alike. It is now more important than ever that parties are clear which terms apply to their commercial arrangements. No company can afford to ignore the potential to improve their commercial advantage in the current economic climate. This may mean formalising existing arrangements, negotiating new contracts, amending or even terminating current contracts.

As cash remains king, operators should use their commercial contracts to improve cashflow and reduce credit risks, in order to keep one step ahead of the competition. The profitability and success of operators during the global economic downturn will be determined more than ever by users' business and loyalty and the use of clear, written service level agreements provide operators with an objective tool upon which to deliver their services.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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