Although many companies are already revisiting contractual provisions relating to nonperformance, like force majeure clauses, as the coronavirus (COVID-19) pandemic continues to wreak havoc on public health and the economy, other proactive (but less publicized) contractual measures can facilitate early discovery and mitigation of potential nonperformance.
As part of third-party vendor management or sourcing procedures, it is common practice for many companies to vet their vendors prior to contract signing for financial viability and wherewithal. In some cases, like contracts for critical products or services or larger vendor relationships, companies include contractual provisions that provide for regular information sharing regarding a vendor’s financial status and specific rights, including step-in and termination, if the financial status materially adversely changes. While these types of provisions are not new, in light of the impact of COVID-19 on supply and demand for certain products and services and the corresponding potential impact on certain critical or strategic vendors, they are gaining more attention from third-party vendor management and sourcing organizations. Companies, which previously looked to rights and remedies such as non-exclusivity and early termination without penalty as sufficient to address the potential risk, increasingly are focused on financial viability provisions to allow for early warning of a potential problem and early action, if necessary, to avoid disruption.
Issues to consider when drafting financial viability provisions include:
- What is the appropriate metric to include in the agreement? Examples may include debt to cash ratios or third-party ratings (such as D&B or Moody rating above a certain level).
- What type of information can/should be shared? If information is not public, is it possible to get an officer or outside auditor certification?
- How often should the information be shared? Quarterly? Upon the occurrence of a certain event or trigger?
- What are the potential remedies? Assurances of delivery or performance? Termination without penalty? Some type of deposit or bond? Step-in rights with cost of cover liability if certain events or triggers occur?
- What would need to occur to restore the vendor to “green” status?
Financial viability reporting provisions and associated remedies should be appropriately tailored to the relevant risk of non-delivery or nonperformance. This typically involves an assessment of the type of products and services at issue, a criticality ranking or assessment of the vendor, and alternative sources if the vendor cannot perform.
Depending upon the state of the economy or the uncertainty of the supply and demand of critical products and services, it is likely that financial viability provisions gain more attention and become a more common topic of discussion (and negotiation).
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