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The best agreements align interests: relationship agreements are based on win-win.

Lawyers make three kinds of mistakes in drafting supply chain contracts. They fail to remember that an agreement in a supply chain is a "relationship agreement"; they approach a supply chain agreement from the point of view of "rights and remedies" instead of considering the confluence of interests and alignment of parties; and they manage risk on the assumption that Chicken Little was right - the sky is definitely going to fall - Instead of understanding that when things go wrong the cause is more likely to be death by a thousand cuts.

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Relationship agreement

Any agreement with a member of your supply chain is a relationship agreement. They can be as simple as agreements for the continuous supply of product under pre-agreed terms and conditions, or as complex as inter-supplier agreements among a buyer and multiple sellers.

Supply chain agreements are not "pay-and-walk-away" real-estate-type transactions where the better one party does, the worse for the other. As soon as you sign a supply chain agreement, your future and that (if your supply chain co-party are bound by function and business interest. Your attitude in a supply chain relationship has to be different from your attitude in an agreement where there's no ongoing relationship.

By entering into an agreement with a member of your supply chain, you've formed a relationship that functions like a living, breathing organism. Like all organisms, it has to be flexible and deal creatively with change.

But a "legalistic" approach to change, whether bad or good, may not work. Rights and remedies have to do with default and blame, damages and compensation, termination of agreements and elimination of business relationships. Rights and remedies are what's left behind when the relationship is nothing but a bitter memory.

For example, a natural health products start-up recently entered into a highly legalistic agreement with a contract manufacturer. Sadly, the contract was drawn as a "zero-sum game" rather than a relationship agreement. Things went well for a while, but after a year or so it became apparent the contract put the parties at odds.

The buyer's counsel, who created the agreement, urged the buyer to terminate to get leverage. What she didn't know was that the contract, as drawn, had become financially untenable for the supplier, who welcomed the termination. If there had been better alignment, the parties would have responded effectively to the challenges of change and would not have thrown their money away on subsequent litigation. Ironically, the lawyers were mutually aligned in the process of litigation, the continuance of which produced good fees.

Win-win

Alignment of interests works like a charm. If you can draft a relationship agreement that ensures that if I act in my own best interests, you win, and that if you act in your own best interests, I win - then you've got alignment.

We see alignment all the time. Take how wise parents make kids share. If there's apiece of cake to be shared between two kids, one cuts and the other gets to choose her piece first. After the kids have finished with the protractor and ruler, there are no complaints because the one who cuts makes sure both pieces of the cake are exactly the same. That's perfect alignment. Let them eat cake indeed.

Wise lawyers will think carefully about the actual needs of the particular supply chain relationship and opportunities of mutual interest. They will draft a relationship agreement that achieves alignment and ensures parties work for, not against, one another.

A wise lawyer will ensure there are provisions in the agreement that always promote the relationship, even when there are errors and bad luck. Those provisions will include communications protocols, governance committees, alignment committees, informal dispute resolution, executive review and encouragement of joint activities of all kinds. In short, all the "organs" that the body of the relationship needs to not only stay alive, but also thrive.

Chicken Little was right

The rights and remedies sections of supply chain agreements are often drafted in a way that takes into consideration bankruptcy, major breaches, infidelity, earthquakes and alien invasion. In many cases, however, they ignore the far more likely events that plague business relationships, such as competitive interference; customer preferences; changes in laws, technology and costs; adverse publicity; bad middle managers; slowness; or bad production quality. As a result, these agreements address unlikely events, but not the things most likely to happen.

This is often the result of a lawyer using a "precedent" - a template that's an amalgam of previous work. While the use of precedents and templates makes sure you don't miss anything, it's no substitute for considering the best way to achieve alignment,

Donald B. Johnston is a partner at the law firm of Aird & Berlis LLP in Toronto.
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Title Annotation:Supply chain contracts
Author:Johnston, Donald B.
Publication:CMA Magazine (Mississauga)
Geographic Code:1CANA
Date:May 1, 2011
Words:791
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