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Termination of supplier contracts can be voluntary or involuntary and may happen for many different reasons. If you have a contractual agreement with a supplier, ending this contract early may present significant financial and operational risks for your business.

Reasons for terminating supplier relationships

Common reasons for ending a contract with a supplier include:

• their failure to meet the terms of the contract - eg supply you with goods or services
• provision of sub-standard or defective products or services
• consistent late delivery issues
• supplier bankruptcy, acquisition or considerable management change
• availability of cheaper (or more reliable) service elsewhere

In most cases, the relationship between a supplier and their customer is contractual, ie based on a commercial agreement. Terminating this deal early and without justifiable cause may open your business up to potential penalties.

Termination of supplier contracts - key considerations

If you're considering terminating a contract with a supplier because of their unsatisfactory performance or excessive costs, it may be worth talking to them first. They may offer to resolve the issues or reduce the price in an effort to keep your custom.

If you are determined to end the relationship, however, it is critical that you:

• document the supplier's failures and shortcomings
• review the contract and the termination provisions
• assess all the possible threats to your business
• consider an exit plan that will minimise the potential for disruption

It is also important to identify a new way of getting the goods or services for your business before you exit the existing supplier relationship. If you do not have a new supplier ready to take over, it may take time to set up new processes, which can lead to operational difficulties.

Termination clauses

Your supplier contract should include a service level agreement (SLA), setting out the expected standards of service, mutual responsibilities as well as conditions for termination.

Exit or termination clauses should clearly describe:

• when ending a contract may be valid
• the length of notice you will need to give
• any penalties that may apply if you end the contract early

Contracts will typically specify the notice period that you must give to terminate the contract. It's vital that you follow the agreed notice procedure. If you fail to give proper and timely notice, you supplier could argue that you have breached the terms of the contract.

In absence of termination clause in the contract, or of the written contract altogether, the law will require you to give 'reasonable' notice. What is meant by 'reasonable' will depend on the specific circumstances of your supplier relationship. For example:

• the length of your relationship
• the formality of the arrangement
• the current market practice
• the duration of negotiations about termination

Early penalties for ending supplier contracts

Exiting a supplier relationship early can cost you a considerable sum. You should check the contract to see if there are exit fees for terminating the deal early, and if the termination clause can reduce what you have to pay. For example, you may be able to rebate service fees due to poor supplier performance.

Beware of signing contracts with excessively high exit fees. Severe penalties may effectively lock you in with that supplier. If their quality and effectiveness decrease, your business may suffer.

How to manage the end of supplier relationship

Have guidelines in place for how you handle the termination of a supplier contract. Following best practice and negotiating a mutually beneficial and cordial end to the relationship can leave open the possibility of working together again the future.

Important things to discuss and agree with the supplier include:

• stock held in their warehouses or distribution centres
• assets or equipment which they or you need to return
• subcontractor arrangements or third-party contracts
• disputed or outstanding payments
• use or return of confidential information
• intellectual property rights

In negotiating the exit, make sure that the existing supplier gives you all the information you need to make the transition smoother. If possible, arrange that they take responsibility for handling the changeover process, including handover of goods, to a new supplier.

Consider seeking legal advice when drawing up important contracts. See how to choose a solicitor for your business.