open/close

Logistics contract negotiation

Insights in the industry of transport and logistic services by our experts.

logistieke-contract-onderhandelingen

The negotiation of a logistics services contract is a process that sometimes requires ample patience and attention to detail. Especially in the case of warehouse services the contract duration and exit clauses force the logistics service provider and the shipper to work together for a long time.

When starting negotiations it is wise to be pragmatic and start with the question: “Are there clauses that are nonnegotiable?” At least this way a show stopper is detected early in the process. For the other clauses usually goes that reasonable argumented objections to a clause can be settled by giving and taking. A contract where one party takes all has a weak basis and refusing to give away anything will mostly lead to the other party walking away. The majority of contracts therefore are a result of a balanced compromising process.

This edition of Expert Insights will cover a number of standard contract clauses for warehousing logistics that especially require your attention. An open dialogue and understanding of the impact of these clauses on both sides of the table will hopefully prevent them becoming hot potatoes during your negotiations.

We will cover the following clauses:

  1. Scope of the agreement
  2. Exclusivity and/or Minimum volumes
  3. Liability for direct and indirect damages
  4. KPIs and bonus-malus
  5. Terms and conditions
  6. Contract term and termination clause
  7. Price indexation
  8. Choice of law and venue
  9. Lien and retention rights

1. Scope of the agreement

Description

The scope of a logistics agreement refers to the processes included in the contract and results that characterize the service.  For logistics contracts this means a detailed process description of the services covered in the contract. 

Why is this an important clause? 

It is often not clearly described which services are included in the scope of the contract.  This leads to ambiguity of numerous following clauses. As an example; Often the shipper will believe ‘Warehousing’ to include the entire range of services from arrival of the goods to the warehouse up to the moment the goods leave the warehouse. In contrast, from a Logistics Service Provider’s perspective ‘Warehousing’ could refer to storage only. Hence in case the contract does not clearly specify the service included in ‘Warehousing’, clauses on KPI’s and liability can be interpreted in various ways. 

Considerations while negotiating

To avoid misunderstandings in the future, make a clear description which services will be rendered under the agreement and avoid ambiguities. Well known examples of grey areas include loading, stowing and unloading under a contract of carriage (always check whether the agreed Incoterm under the sales contract corresponds with obligations of the carrier with regard to loading or unloading). It can be helpful to commence the agreement with a preamble. A preamble states the overall objective of the agreement and it recites facts and circumstances preceding the agreement that are of relevance to one or both of the parties. A preamble will help to interpret the clauses of the agreement in case of a dispute.

2. Exclusivity and/or minimum volumes

Description

In logistics warehousing contracts exclusivity and minimum volumes are usually expressed as a number of pallets in storage as well as inbound and outbound movements. When distribution is included it will also include the number of shipments. Exclusivity refers to the right of a Logistics Service Provider to the total volume of a shipper.

Why is this an important clause?

The single most important influencing factor on logistics cost is volume. Logistics by nature is a volume driven industry. As volumes are also the most important bargaining tool for shippers in order to obtain discounts, there is a short-term advantage in presenting the most favorable volume scenario. Nevertheless, substantial mismatches in volumes once the contract is started will in almost any case re-open discussion on rates.

Considerations while negotiating

On one hand it is in many cases difficult to precisely predict volume developments. On the other hand, less volume for the Logistics Service Provider means the contract is less profitable or even loss making. It is also important to realize that exclusivity makes shippers more vulnerable in case of underperformance of the logistics service provider with limited possibilities to quickly react to underperformance. Cost/rates and volumes are communicating vessels. Even if exclusivity and volumes are not explicitly mentioned in the wording of a contract, in reality this does not necessarily mean a shipper can freely change the nature and volume of the business as described in the tender documentation. It is good practice to clearly describe the implication of substantial drops or increases in volumes and its effects on the negotiated tariffs.

3. Liability for direct and indirect damages

dsv-expert-insights-logistics-contract-negotiations-damages 

Definition

Direct and indirect damages are damages that occur due to an error on the part of the service provider or shipper, or due to another breach of one or more contract obligations by either party. It is natural that the shipper should want the service provider to accept liability for damage of any kind. On the other hand, the shipper expects the service provider to offer competitive rates, yet these rates will have to include an insurance premium to cover the risk of any damage. Furthermore, service providers should take care not to leave themselves liable for potentially substantial secondary damages such as indirect damages and/or consequential losses.

Why this is an important clause?

With a logistics contract, shippers obviously want to make sure that the logistics service provider is taking good care of their products. A penalty in case of damage to the product is a good incentive for the products to be handled with care and the utmost to be done to avoid any damage. However, what about damages that occur because of damage to, or loss of, a product? Examples include a missed/cancelled order or a missed flight, or a delay in the product’s delivery. Logically, the latter two examples of loss happen because the product was damaged/ late through the direct or indirect fault of the logistics service provider. The discussion about the inclusion of a liability for the logistics service provider is extremely complex and often has more affinity with insuring against business risk than the initial goal of the liability, namely ensuring that the products are handled with care.

Considerations while negotiating

From a logistics service provider’s perspective, the liability for damage to products is a way for the shipper to ensure that the service provider will be doing its utmost to handle the products with care so they will be delivered to customers in pristine condition. From a shipper’s perspective, the liability cover for product damages in logistics contracts is sometimes considered full cover for all possible damages in the supply chain.

It might be considered a natural impulse to allocate damage or loss to the party in physical possession of the goods. In trade and commerce, however, it has become common practice to limit the amount or extent of logistics service providers’ liability. For some types of contract, liability is limited by an industry standard or even mandatorily limited by law (e.g. CMR). Notably, this is the case for contracts of carriage, where liability is commonly limited to a certain amount per kilogram of gross weight, depending on the mode of transportation. Be aware, though, that this limitation only applies to the main obligations of the carrier. Other obligations undertaken by the logistics provider that are not subject to a contract of carriage nor an industry standard of liability can be arranged for by contract. If a 3PL accepts a higher liability for the goods, this will affect the rates as this increased liability needs to be re-insured with an external insurance company.

The logistics provider usually agrees to be liable for direct damages to the products up to a certain amount per kilogram and/or incident in line with the industry standards. Liability for damages exceeding this amount can only be covered by a separate insurance policy arranged either by the shipper or by the logistics provider on the shipper’s behalf. Since it is virtually impossible to insure against indirect damages and/or consequential losses, logistics providers cannot accept liability for these.

4. KPIs and bonus-malus

dsv-expert-insights-logistics-contract-negotiations-kpi 

Description

Key Performance Indicators (KPIs) are the metrics used to measure service quality. As an example in a distribution contract, a typical KPI would be the percentage of on-time deliveries. Bonus-malus is a system that allows a shipper to withhold part of its payment for the services in case of underperformance, and it allows the 3PL to charge extra when it has exceeded the agreed KPIs.

Why is this an important clause?

Quality usually comes at a cost. In particular, quality levels that go beyond the regular quality level for a logistics operation require extra handling, thus incurring additional costs. Shippers obviously want the very best level of service; 3PLs need to balance these expectations against the associated cost level.

Considerations while negotiating

KPIs are a useful tool to measure the carrier’s performance and also to clearly outline the shipper’s expectations in this regard. Shippers should carefully consider which objectives need to be met in a Service Level Agreement (SLA). If an SLA is meant to merely serve as a performance monitor, it would be sufficient to include it in the periodic performance review. However, if the SLA is meant to secure the quality levels, then the consequences of failing to do so should be clearly stated in the SLA. Such consequences usually include a contractual fine, and a maximum time to realise the required service improvements. If these improvements are not realised, this ultimately leads to cancellation of the agreement. Additional to the contractual fine, a bonus could be agreed in case of outperformance, thus giving the service provider a stimulus for improvement. A reasonable bonusmalus system should be a double-edged sword: it can be very motivating for 3PLs. The level of KPIs should make it realistically possible for the 3PL to exceed the targets.

5. Terms and conditions

dsv-expert-insights-logistics-contract-negotiations-terms 

Description

Terms and conditions are part of a logistics contract because of their general nature. They will cover all areas that are not specific to one contract but rather apply to the company as a whole. Matters that cover the performance of the logistics service provider on certain parts of the operation are not incorporated in the terms and conditions.

Why is this an important clause?

Terms and conditions can be helpful when drafting a contract because they contain many standard provisions, so that the contract itself can remain lean and hence more transparent. The problem with terms and conditions, however, lies in the fact that they are commonly drafted for the benefit of one party only. Any contractual balance reflecting the interests of both parties to the agreement could easily be distorted by applying one-sided terms and conditions.

Considerations while negotiating

Another problem with terms and conditions is the well-known battle of the forms, with the purchasing party applying purchase terms and the performing party applying conflicting delivery terms. In practice, purchase terms and conditions often are drafted to be applied to a contract for sale of goods or for the supply of services in general. As such, these purchase conditions are usually less suitable to be applied to a logistics contract, especially contracts of carriage. An extra dimension to this problem is that, in international or cross-border service supply, the solution as prescribed by law or jurisprudence varies per state. Therefore, it may be especially important to consider the choice of law (and court). In general, logistics terms and conditions that cover the interests of both parties are important to address all issues not directly stipulated in the contract. However it is advisable to be very cautious when including contractual terms and conditions that differ significantly from the general terms and conditions.

For some modes of transport, a solution to both the battle of forms and to the onesided nature of terms and conditions lies in branch terms and conditions that are drafted by (representatives of) both purchasers and service providers. A good example for a Dutch situation is the General Conditions of Transport 2002 (AVC 2002) for road transport, drafted by the Dutch Shippers’ Council (EVO) and road carriers association (TLN) within a joint committee (Stichting Vervoeradres; SVa).

6. Contract term and termination clause 

Description

The contract term is the duration of the logistics contract. The termination clause outlines the reasons/events during the contract period that will justify an early termination of the contract by the shipper.

Why this can lead to discussions

For obvious reasons, the logistics service provider benefits by maximising the duration of the logistics contract. Some logistics service providers stipulate a minimum contract duration. The length will depend on the effort and other investments that are involved in starting up and implementing the contract. From a shipper’s perspective, a shorter contract duration will enable a more frequent renegotiation of contract terms with the aim of reducing tariffs. Common negotiation points include the exact date that the contract is started, the period during which a prolonged contract needs to be agreed upon, and the notice period and prolongation period. Termination clauses are a ‘hot potato’ because shippers regard them as an ‘escape route’ in case of severe problems. For the logistics service provider, termination of the contract will almost certainly mean a large financial loss because the investments involved in setting up the operation cannot be recuperated.

Considerations while negotiating

First of all, it is always advisable to agree to a contract term and/ or a term of notice for cancellation. Avoid a legal no man’s land by stipulating clear and unambiguous termination clauses, a termination date and a notice term. In the absence of an agreement, a reasonable term of notice would have to be established by the court. The court’s interpretation of ‘reasonable’ does not always conform with the views of either party. When choosing the term of the contract, also pay attention to the question of whether the contract stipulates minimum order quantities (guaranteed volumes) and exclusivity. If so, the shipper must be sure that it can fulfil both these clauses for the entire contract term. However, even if no guarantees on volumes are included in the contract, the carrier will still in many cases be entitled to a certain volume that was generated in the preceding period under the contract terms. In other words, even if no minimum order quantity was agreed to, the logistics service provider will often still be able to demand at least a ‘sustained’ order quantity.

Although contracts often arrange for both topics in the same clauses, shippers must bear in mind that there is an important difference between expiration of a contract and cancellations during the contract term. The latter is typically a consequence of grave shortcomings on the part of the logistics service provider. It is advisable to state in advance in the contract which shortcomings always qualify as ‘grave’ and thus as grounds for cancellation. This is especially important in combination with exclusivity.

7. Price indexation

Description

Price indexation is an annual exercise to adjust logistics tariffs by means of a price index in order to maintain the value of the contract after inflation and market-level price fluctuations.

Why is this an important clause?

The price index is the easy part, since indexation is calculated on a macro level by governmental institutions. An often-heard argument is that indexation should only apply to costs that are subject to inflation. Furthermore it is sometimes used as bargaining leverage in discussions on continuous improvement. Indexation on the basis of ‘market price levels’ is the subject of even more debate. Given the long-term nature of most logistics contracts and the volatility in the market, logistics service providers state that it is impossible to predict the cost of transport, for example, in two years’ time. Indexation of labour and rental costs on an annual basis is a common approach in longterm contracts.

Considerations while negotiating

Consider which index will be used for calculation carefully. The chosen index must match the actual subject of the contract as closely as possible. Some components of the remuneration are usually indexed separately, notably fuel costs. If a separate fuel clause is included in the contract, ensure that it works both ways, i.e. that the purchaser will be compensated when fuel costs decrease and that the carrier will be entitled to apply a surcharge when fuel prices rise. Moreover, avoid double indexation by ensuring that the price indexation clause does not also include price indexation for fuel.

Sometimes shippers want to trade off the price indexation against continuous improvement. However, it is best to keep continuous improvement separate from the indexation discussion and include it instead in a separate clause. In terms of ‘market price level’ indexation, specifically transport services that have little or no consolidation synergy (like Full Truck Loads, Part Loads or Container Transport) fluctuate heavily on demand. As these services are almost completely subcontracted, it is not usually possible to guarantee a fixed price for periods longer than one year, and sometimes even less. Own-operated services or services with high volume consolidation synergies are less sensitive to sudden price-level fluctuations.

8. Choice of law and venue

dsv-expert-insights-logistics-contract-negotiations-choice-of-law-venue 

Definition

This part of the logistics contract describes under which law any future disputes will be settled and the location of the court that will be the venue for any lawsuits.

Why this sometimes leads to discussions?

When the shipper, the logistics service provider and the future logistics operation are all in the same country, this clause is hardly an issue. It gets more complicated when the shipper’s head office is in Country A and the future logistics operation is in Country B (sometimes even on another continent). In case of large contracts, there is the added complexity of the location of the logistics service provider’s head office where its legal department resides. Needless to say, all parties will prefer their own country’s law and a court as close to their home turf as possible.

Considerations while negotiating

The choice of law and venue can be decisive in the outcome of a case, even when uniform law from international treaties applies like in the European Union. Courts in different member states can arrive at diametrically opposing interpretations! One particular example of a difference in interpretation is noted when determining whether damages were caused by the service provider’s wilful misconduct. The qualification of an act of wilful misconduct can be important, since it deprives the carrier of its right to limit liability.

From a practical perspective, the logical approach is to use the law applicable to the country where the majority of the activities are being executed.

9. Lien and retention rights

dsv-expert-insights-logistics-contract-negotiations-retention-rights 

Description

Lien and retention rights refer to the right of the logistics service provider to withhold the shipper’s goods, or even to sell these goods in case of unpaid bills.

Why this sometimes leads to discussions

Obviously, the prospect of not being able to access one’s goods is not very reassuring from a shipper’s perspective. There is also concern on the shipper’s part that the rule could be used as leverage during possible conflicts about invoices. From the service provider’s viewpoint, however, these rights offer some degree of security that it will receive payment for its services.

Considerations while negotiating

Problems with lien and retention rights rarely arise directly in relation to the goods that are actually in the custody of the logistics service provider. Instead, lien and retention rights are typically exercised to enforce settlement of unpaid bills with regard to previous shipments or consignments. More importantly, retention rights are sometimes not invoked between a shipper and its service provider, but rather somewhere in the chain of subcontractors. It is sometimes difficult to prevent this from happening, but if goods represent a certain value or if there is a particular interest in on-time delivery and corresponding contractual fines in the sales or supply contract, the shipper should carefully consider the risks accruing from lien and retention rights being invoked somewhere in the logistics chain. A financially stable logistics service provider orchestrating the various steps in the supply chain, centrally managing the subcontractors, is an important prerequisite to avoiding lien and retention rights being exercise.

Get a quote