In the commercial setting, one type of contract that requires particular attention and input from the client is the so-called “requirements contract,” under which a supplier obligates itself to produce all of a particular buyer’s requirements for a given product during the term of the contract. A “pure” requirements contract thus sets no quantity limits on the expected production of the supplier. There are obvious risks to this approach for a supplier.
To mitigate those risks, requirements contracts are regulated under the “good faith” requirements of the Uniform Commercial Code (UCC), which states that the demand for product under such a contract consists of the “actual . . . requirement as may occur in good faith, except that no quantity unreasonably disproportionate to any stated estimate or (absent an estimate) to any normal or otherwise comparable prior output” may be demanded. The UCC thus attempts to tie future requirements to estimates reviewed by the supplier or, absent that, to past practice.
This protection may be helpful if the buyer’s requirements sky-rocket, but a judge’s or jury’s concept of “good faith” and “unreasonably disproportionate” may not provide the protection that the supplier is looking for or needs. The judge or jury might decide that a supplier should be stuck with fulfilling an increased requirement; the supplier could have said “no” to the contract or could have negotiated limits, after all.
However, a less obvious risk is the opposite scenario: what if the buyer’s requirements go to zero after the supplier has spent significant money in tooling up and otherwise preparing to perform under the contract? Is this “unreasonably disproportionate” to an estimate or past usage? It is difficult to imagine a court ordering a buyer to make purchases that it does not want or to award damages to a supplier whose goods are no longer needed. In fact, there appears to be only one such instance of this in Pennsylvania courts. That case involved a road builder who had a requirements contract for fine stone, but switched from using stone to using (less expensive) sand in the construction of its roadbeds. Despite that change in business practice, the Court ordered the road builder to honor its previously entered requirements contract with a local supplier for stone. General Crushed Stone v. Trimpey. Obviously a decision like this should not be relied upon for planning purposes. The case is only a trial court decision, with no real binding authority outside of Monroe County (if even there); and it is very old, pre-dating by years the adoption of the UCC provision that relates to requirements contracts.
The better way for a supplier to handle these risks is to not rely on old cases, or on any cases. The better approach is to negotiate protections into the agreement to militate against the effects of a steeply risen or dramatically decreased requirement from the Buyer. Here are some suggestions:
- Simply put minimum and maximum limits into the Agreement. For the minimum, require that a periodic quantity of product be ordered that will at least cover the suppliers fixed costs in taking on the project (such as tooling costs). For the maximum, some sort of estimate should be made as to what point of production would require additional costs and manpower. If no firm maximum limit is obtainable, a graduated cost schedule may provide some protection.
- Get a solid estimate of what the buyer expects its requirement to be. This should alert you to what is expected, and it should provide some potential protection, if the requirement level radically changes.
- Get a representation, preferably in the Agreement, that the buyer has no potential plans to improve or change its products such that the product the supplier supplies becomes obsolete (and unordered).
- Get a representation that your client is not going to move its operations. Proximity can be important and if your client moves in mid-contract, it may seek a supplier closer to its new location.
- Try to be the exclusive supplier of the product. In many cases this is a fair trade-off to be made in exchange for meeting the buyer’s requirements. “Exclusive dealing arrangements” do get additional scrutiny under antitrust laws, but for a normal size supplier who seeks an exclusive arrangement for reasonable business reasons, the risk is relatively small and likely to be worth it.
Of course, several of the above items are more easily stated than they are obtained, but care should be taken and these limitations should be considered before you promise that your output will match your customer’s requirements.
— Rod Fluck