In the past two years, the international markets have been under severe stress due to a series of exceptional events: the pandemic, raw materials shortage, the war in Ukraine, and the energy crisis. This situation has led to significant problems in the management of supply chains, particularly lack of stocks, delivery delays, and price increases. The consequence is high instability in relationships with suppliers and customers, which makes it challenging to organize the supply chain and international business operations in the medium term.
The supply framework contract is one tool available to mitigate risks and plan supplier relationships: it is a sales or purchase framework agreement whereby the parties define the main terms of a future series of product orders. This agreement is instrumental for setting the price (and the price adjustment mechanisms) that will apply for a certain period, product volumes, and delivery schedules.
What I am talking about in this article:
- What is the supply framework agreement?
- What is the function of the supply framework agreement?
- The difference with the general conditions of sale or purchase
- When to enter a purchase framework agreement?
- When is it beneficial to conclude a sales framework agreement?
- The content of the supply framework agreement
- Price revision clause and hardship
- Delivery terms in the supply framework agreement
- The Force Majeure clause in international sales contracts
- International sales: applicable law and dispute resolution arrangements
What is a framework supply agreement?
It is an agreement that regulates a series of future sales and purchases between two parties (customer and supplier), which will take place over a certain period.
It is therefore referred to as a “framework agreement” because it is an agreement that establishes the rules of a future series of sales and purchase contracts, determining their primary elements (such as the price, the volumes of products to be sold and purchased, the delivery terms of the products, and the duration of the contract).
After concluding the framework agreement, the parties will exchange orders and order confirmations, entering a series of autonomous sales contracts without re-discussing the covenants already defined in the framework agreement.
Depending on one’s point of view, this agreement is also called a sales framework agreement (if the seller/supplier uses it) or a purchasing framework agreement (if the customer proposes it).
What is the function of the framework supply agreement?
It is helpful to arrange a framework agreement in all cases where the parties intend to proceed with a series of purchases/sales of products over time and are interested in giving stability to the commercial agreement by determining its main elements.
In particular, the purchase framework agreement may be helpful to a company that wishes to ensure continuity of supply from one or more suppliers of a specific product that is essential for planning its industrial or commercial activity (raw material, semi-finished product, component).
By concluding the framework agreement, the company can obtain, for example, a commitment from the supplier to supply a particular minimum volume of products, at a specific price, with agreed terms and technical specifications, for a certain period.
This agreement is also beneficial, at the same time, to the seller/supplier, which can plan sales for that period and organize, in turn, the supply chain that enables it to procure the raw materials and components necessary to produce the products.
What is the difference between a purchase or sales framework agreement and the general terms and conditions?
Whereas the framework agreement is an agreement that is used with one or more suppliers for a specific product and a certain time frame, determining the essential elements of future contracts, the general purchase (or sales) conditions are the rules that apply to all the company’s suppliers (or customers).
The first agreement, therefore, is negotiated and defined on a case-by-case basis. At the same time, the general conditions are prepared unilaterally by the company, and the customers or suppliers (depending on whether they are sales or purchase conditions) adhere to and accept that the general conditions apply to the individual order and/or future contracts.
The two agreements might also co-exist: in that case; it is a good idea to specify which contract should prevail in the event of a discrepancy between the different provisions (usually, this hierarchy is envisaged, ranging from the special to the general: order – order confirmation; framework agreement; general terms and conditions of purchase).
When is it important to conclude a purchase framework agreement?
It is beneficial to conclude this agreement when dealing with a mono-supplier or a supplier that would be very difficult to replace if it stopped selling products to the purchasing company.
The risks one aims to avoid or diminish are so-called stock-outs, i.e., supply interruptions due to the supplier’s lack of availability of products or because the products are available, but the parties cannot agree on the delivery time or sales price.
Another result that can be achieved is to bind a strategic supplier for a certain period by agreeing that it will reserve an agreed share of production for the buyer on predetermined terms and conditions and avoid competition with offers from third parties interested in the products for the duration of the agreement.
When is it helpful to conclude a sales framework agreement?
This agreement allows the seller/supplier to plan sales to a particular customer and thus to plan and organize its production and logistical capacity for the agreed period, avoiding extra costs or delays.
Planning sales also makes it possible to correctly manage financial obligations and cash flows with a medium-term vision, harmonizing commitments and investments with the sales to one’s customers.
What is the content of the supply framework agreement?
There is no standard model of this agreement, which originated from business practice to meet the requirements indicated above.
Generally, the agreement provides for a fixed period (e.g., 12 months) in which the parties undertake to conclude a series of purchases and sales of products, determining the price and terms of supply and the main covenants of future sales contracts.
The most important clauses are:
- the identification of products and technical specifications (often identified in an annex)
- the minimum/maximum volume of supplies
- the possible obligation to purchase/sell a minimum/maximum volume of products
- the schedule of supplies
- the delivery times
- the determination of the price and the conditions for its possible modification (see also the next paragraph)
- impediments to performance (Force Majeure)
- cases of Hardship
- penalties for delay or non-performance or for failure to achieve the agreed volumes
- the hierarchy between the framework agreement and the orders and any other contracts between the parties
- applicable law and dispute resolution (especially in international agreements)
How to handle price revision in a supply contract?
A crucial clause, especially in times of strong fluctuations in the prices of raw materials, transport, and energy, is the price revision clause.
In the absence of an agreement on this issue, the parties bear the risk of a price increase by undertaking to respect the conditions initially agreed upon; except in exceptional cases (where the fluctuation is strong, affects a short period, and is caused by unforeseeable events), it isn’t straightforward to invoke the supervening excessive onerousness, which allows renegotiating the price, or the contract to be terminated.
To avoid the uncertainty generated by price fluctuations, it is advisable to agree in the contract on the mechanisms for revising the price (e.g., automatic indexing following the quotation of raw materials). The so-called Hardship or Excessive Onerousness clause establishes what price fluctuation limits are accepted by the parties and what happens if the variations go beyond these limits, providing for the obligation to renegotiate the price or the termination of the contract if no agreement is reached within a certain period.
How to manage delivery terms in a supply agreement?
Another fundamental pact in a medium to long-term supply relationship concerns delivery terms. In this case, it is necessary to reconcile the purchaser’s interest in respecting the agreed dates with the supplier’s interest in avoiding claims for damages in the event of a delay, especially in the case of sales requiring intercontinental transport.
The first thing to be clarified in this regard concerns the nature of delivery deadlines: are they essential or indicative? In the first case, the party affected has the right to terminate (i.e., wind up) the agreement in the event of non-compliance with the term; in the second case, due diligence, information, and timely notification of delays may be required, whereas termination is not a remedy that may be automatically invoked in the event of a delay.
A useful instrument in this regard is the penalty clause: with this covenant, it is established that for each day/week/month of delay, a sum of money is due by way of damages in favor of the party harmed by the delay.
If quantified correctly and not excessively, the penalty is helpful for both parties because it makes it possible to predict the damages that may be claimed for the delay, quantifying them in a fair and determined sum. Consequently, the seller is not exposed to claims for damages related to factors beyond his control. At the same time, the buyer can easily calculate the compensation for the delay without the need for further proof.
The same mechanism, among other things, may be adopted to govern the buyer’s delay in accepting delivery of the goods.
Finally, it is a good idea to specify the limit of the penalty (e.g.,10 percent of the price of the goods) and a maximum period of grace for the delay, beyond which the party concerned is entitled to terminate the contract by retaining the penalty.
The Force Majeure clause in international sales contracts
A situation that is often confused with excessive onerousness, but is, in fact, quite different, is that of Force Majeure, i.e., the supervening impossibility of performance of the contractual obligation due to any event beyond the reasonable control of the party affected, which could not have been reasonably foreseen and the effects of which cannot be overcome by reasonable efforts.
The function of this clause is to set forth clearly when the parties consider that Force Majeure may be invoked, what specific events are included (e.g., a lock-down of the production plant by order of the authority), and what are the consequences for the parties’ obligations (e.g., suspension of the obligation for a certain period, as long as the cause of impossibility of performance lasts, after which the party affected by performance may declare its intention to dissolve the contract).
If the wording of this clause is general (as is often the case), the risk is that it will be of little use; it is also advisable to check that the regulation of force majeure complies with the law applicable to the contract (here an in-depth analysis indicating the regime provided for by 42 national laws).
Applicable law and dispute resolution clauses
Suppose the customer or supplier is based abroad. In that case, several significant differences must be borne in mind: the first is the agreement’s language, which must be intelligible to the foreign party, therefore usually in English or another language familiar to the parties, possibly also in two languages with parallel text.
The second issue concerns the applicable law, which should be expressly indicated in the agreement. This subject matter is vast, and here we can say that the decision on the applicable law must be made on a case-by-case basis, intentionally: in fact, it is not always convenient to recall the application of the law of one’s own country.
In most international sales contracts, the 1980 Vienna Convention on the International Sale of Goods (“CISG”) applies, a uniform law that is balanced, clear, and easy to understand. Therefore, it is not advisable to exclude it.
Finally, in a supply framework agreement with an international supplier, it is important to identify the method of dispute resolution: no solution fits all. Choosing a country’s jurisdiction is not always the right decision (indeed, it can often prove counterproductive).