What is an Exclusive Supply Agreement?
An exclusive supply agreement is a contract between a buyer and a seller where the seller commits to supply a product or service only to the buyer. The seller agrees to withhold supply from all others, so long as the buyer continues to purchase the product(s) or service(s). This differs from other types of supply agreements, a non-exclusive supply agreement permits the seller to sell the same product to multiple buyers. While exclusive supply agreements are generally lawful under the Competition Act, 1985 [RSC 1985, c. C-3] , the restrictive nature of such agreements requires caution in their creation and execution.
A fundamental difference between an exclusive supply agreement and a non-exclusive supply agreement is that the former prevents a seller from providing the same product(s) and/or service(s) to more than one buyer. This means that in an exclusive supply agreement, the buyer has "exclusive" rights to the product(s) or service(s). An exclusive supply relationship can be advantageous to a buyer because it prevents competitors from having access to the same products or services. A potential drawback to an exclusive relationship for a buyer is that it may prevent a buyer from seeking out better pricing from alternative suppliers.
Benefits of Exclusive Supply Agreements
The advantages for suppliers and purchasers of an exclusive supply agreement are both clear. Exclusive supply agreements allow a supplier to secure the patronage of a purchaser for a particular product or service. This enables that supplier to generate the maximum possible revenue from its intellectual property and foreseeably gain efficiencies through the commitment of the purchaser.
For the purchaser, the advantages of an exclusive supply agreement are twofold. Firstly, a purchaser enjoys the security of knowing that its supplier has committed to supply it with its products or services for a particular period of time. Secondly, the purchaser may secure itself access to the supplier’s most innovative products and services. This can be particularly important where products and services must be updated or obsolescence is imminent.
In exchange for the commitment of a purchaser, a supplier may in turn require that the purchaser make certain commitments to the supplier in an exclusive supply agreement. This may include requiring that the purchaser solely purchase the supplier’s products or services rather than its competitors’ products or services. The supplier may also require that the purchaser commit to marketing only those products or services of the supplier in a particular territory, thereby ensuring that the supplier’s products or services rank high in the search results of potential customers.
Alternatively, the consideration for the purchaser’s commitment may be receipt of the supplier’s best products and services at fair market prices, or alternatively, at discounted prices, thus providing the purchaser ongoing benefits. Combination arrangements of any of the above are possible as well.
Finally, exclusive supplies may have the added advantage of bolstering the formation of a value chain that can more effectively compete in the marketplace. By committing themselves to key suppliers, purchasers can guarantee their presence in the value chain, thereby increasing their efficiencies, reliability and minimizing the potential for supply shocks.
Typical Elements of an Exclusive Supply Agreement
An exclusive supply agreement typically contains the following elements:
Product specifications: The agreement must define the subject matter, i.e., the type and quantity of products to be delivered. If the products are components of other products, the parties will need to consider how parts will keep pace with advances in technology, or product improvements.
Delivery schedules: The parties should specify delivery requirements such as the time period for delivery, frequency of deliveries, lead time (time between placement of order and request for delivery of ordered goods) and emergency deliveries.
Price: The parties need to address price issues such as price adjustment provisions, discounts for early payment or late delivery, interest on late payments and maximum price increases, among other considerations.
Annual minimum purchases: The parties may specify minimum annual purchases to be made by the exclusive buyer in order to maintain exclusivity under the agreement. This is more common when the products are resold in the form of wholesale or retail.
Termination: The parties should address termination conditions which may include periodic notice requirements and/or reasons for termination.
Potential Issues and Challenges
Because of the potential for serious concerns about restraint of trade and competition, suppliers will generally reserve the right to terminate exclusive supply arrangements on short notice if they identify undesirable outcomes, competitors or other conditions, such as in the QLM Supply Release Terms. However, what are some of the risks that parties should be particularly aware of prior to entering into exclusive supply arrangements? What steps can you take to manage those risks?
As discussed above, the most significant potential issue with supply arrangements is that they might breach competition law in the applicable jurisdiction. For example, a supplier that has a dominant position may find itself subject to substantial penalties (or orders for divestiture) if they engage in an arrangement that results in an anti-competitive outcome, so-called "excluded practices", or if they rely on what may be considered an exclusionary clause in a supply contract.
In addition, the prospect of an arrangement resulting in a competitor being foreclosed from the ability to obtain supplies from the supplier may cause concern . This could occur, for example, if the quantity or quality of supply an existing customer could obtain from the supplier was so much lower than the quantity or quality the same customer would have been able to obtain from the dominant competitor that it was effectively foreclosed from the market; in the QLM Supply Release Terms, GASC has made it clear that it does not intend to broadcast detailed information to domestic mills about the specific reasons why an application is not accepted.
Competition concerns are also far more likely to arise in respect of exclusive arrangements for the supply of inputs to a domestic industry, as these inputs are typically not fungible and are likely to be critical to the operation of the industry. If, for example, a key supplier to a dominant competitor decided to enter into an exclusive supply arrangement, it could provide those inputs to its new exclusive customer at prices substantially below the costs of supply for previously supplied customers, thereby giving rise to an anti-competitive effect (as the competitor’s costs would be significantly higher) and enhancing the relative competitiveness of the dominant company’s product.
However, there is no predetermined threshold at which a share of purchases to one supplier becomes significant enough to raise competitive concerns and therefore, where those arising out of exclusive supply arrangements are a concern, it is always worthwhile seeking the guidance of an experienced antitrust lawyer prior to entering into such arrangements.
Formulating a Strategic Exclusive Supply Agreement
An exclusive supply agreement must be drafted with a clear understanding of the relevant legal requirements and protections. Exclusive supply agreements should generally include: a description of the products or services covered by the agreement; the duration of the agreement; terms and conditions for the performance and delivery of the products or services; pricing, payment, and other relevant terms; the minimum purchase quantities that must be met; any exclusivity requirements for the buyer (i.e. restrictions on competing purchases); necessary licensing requirements (if applicable); quality and minimum operational specifications; the procedures for reporting discrepancies, returns, defects or defects in quantity, or other complaints as warranted.
Depending upon your industry, a more complex business arrangement may be required – such as for products that require sophisticated technologies or regular updates. Various industries may have specific federal and state laws and regulations that carefully regulate exclusive supply relationships and relationships between manufacturers and suppliers. Both parties should have counsel review the proposed agreement to ensure compliance with applicable laws and securities regulations.
Practical Examples and Scenarios
Many industries have adopted exclusive supply agreements as a standard way to do business. Take, for instance, the computer manufacturing industry. A global leader in computer hardware and software regularly enters into exclusive supply agreements with various component suppliers. These agreements give the company a competitive edge. In one case study, a manufacturer of computer memory chips provided chips solely to a leading computer maker under an exclusive supply agreement. The agreement allowed the computer maker to negotiate lower prices based on the guaranteed volume and gave the memory chip supplier a steady stream of business . The computer maker benefitted because it could rely on consistent product availability and always had the latest product offerings from the chip supplier. In a second case, a domestic steel manufacturer entered into an exclusive supply agreement with a major automobile manufacturer. This allowed the steel supplier to gain stability and gain visibility into the auto company’s long term product plans. In many cases, the amount of stability that these agreements provide is sufficient to allow a supplier, if it is of sufficient size and financial resources, to justify investments in new capacity and to extend loan guarantees from banks and other lenders. This can work out well for everybody.