A common or “boilerplate” provision in commercial contracts is the renewal clause. Typically included in the Term section, this clause dictates if and how the agreement will renew after the initial term ends. When entering an agreement, your position on the renewal provision will likely depend on your role in the relationship (e.g., as either buyer or seller of products/services).
In some agreements, renewal is automatic if neither party opts out in writing. Although automatic renewal terms may be convenient, particularly when your business depends on the seller’s product or license, they may also be costly unless there is a termination for convenience right with a short notice period. Therefore, in this situation, it is important to track the renewal terms closely to avoid missing the deadline to terminate. Otherwise, your business may become stuck in a costly contract without a remedy to terminate until the end of the new term (e.g., a year or longer).
Other contracts require the buyer to proactively renew. In this case, the buyer should track the agreement’s termination date and make an informed decision about renewal before the agreement expires in order to avoid any lapse in service. Even in situations where the product or service is essential and contract renewal is necessary, it may be possible to amend some of contract terms rather than simply renewing the agreement “as is.” In other words, renewal discussions present an opportunity to leverage to your advantage the possibility that you might not renew.
Specifically, buyers/licensees should consider the following 5 issues before deciding whether or not to renew a vendor agreement:
1. What steps are required to renew and when must they be taken?
As stated above, it is important to track the terms of the renewal provision. Missed deadlines can cost your company a significant amount of money, lead to an interruption in service and/or impact your leverage to make any changes in the contract. Therefore, before all else, carefully review the termination clause to determine the deadline by which you must provide notice to either opt out or proactively renew.
2. Does renewal still support your business objectives?
Consider whether the product or service still adds value, as well as if it is still worth the cost (in terms of both cash and opportunity cost associated with not exploring other available options). To make a sound decision, you should examine the deal itself, as well as other external factors such as (a) organizational priorities/budgets and how they may have shifted, (b) management’s goals for the coming period, (c) the marketplace and the potential availability of new competitive options, and finally, (d) new internal capabilities that may enable you to provide the same product or service in-house. For example, even if this function is critical to your company, if you need more customization than an off-the-shelf solution provides, you may decide to terminate the relationship if you have the capability to bring it in-house. For these and other reasons, putting renewal on “auto pilot” may not make sense.
3. Will pricing and/or volume change upon renewal?
Will pricing increase upon renewal? Do you anticipate using the services more or less? Both questions deserve reflection, especially if your business has undergone changes over the course of the contract term. For example, if you have spun off or purchased any affiliates or subsidiaries, it may make sense to renegotiate the price and/or volume. Likewise, if you were acquired or made any acquisitions, find out if the new entity has its own agreement with the same vendor, perhaps at better pricing. You may be able to negotiate a variable or tiered pricing structure that goes up and down with scale based on your volume needs. Finally, adding language to the agreement which allows for a price reduction in the event of declining market prices or a divestiture of affiliate or subsidiary entities will help ensure that the deal remains fair even as your company scales (up or down).
4. How else should the agreement be amended prior to renewal?
If there have been problems or issues with the vendor, consider amending the agreement to specifically address those issues -- such as to add more “teeth” to existing remedies or to include additional remedies. For example, you can try to negotiate credits, additional termination rights, termination for convenience rights, SLAs, etc.
5. Do you have a contract review process in place?
It is good practice to seek input from all relevant stakeholders prior to contract renewal. From business/budget owners to power users and management, solicit feedback on what has and has not worked well with this vendor and ask for suggestions on what might improve the relationship. With this information in hand, you can then review the contract’s core terms to ensure they still make sense for your business. For example, as a new customer, you may have been forced to commit to minimum volume commitments and/or term lengths to lock in pricing. But, as an established customer with a purchase history, you may be able to negotiate a month-to-month renewal option, with no more minimums. Alternatively, you might opt for a longer-term deal to obtain an even lower price, after carefully weighing the pros and cons of doing so and ensuring that the agreement includes the proper exit strategies and termination rights, in the event your needs change.
If you have questions about an agreement’s renewal clause or any other terms in an agreement in general, please contact Stacey Heller at firstname.lastname@example.org or (703) 403-5347 to discuss your company’s specific needs.
Stacey Heller is an experienced transactional attorney and has worked with companies in a variety of industries, including technology, retail, telecom, advertising, hospitality, and real estate and construction. Stacey regularly handles a broad range of work for her clients, from commercial agreements to real estate (commercial leasing and construction), as well as dispute resolution matters. Stacey can be reached at email@example.com or (703) 403-5347.
 Of course, if you change your agreement to a month-to-month term, the vendor may also be able to terminate on those same terms unless you add expressly different termination time frames for the vendor than what you have.