Supply Agreement

A supply agreement governs a continuing flow of goods: raw materials, components, packaging, or private-label products made to the buyer's specifications. The parties agree the legal and commercial terms once; the buyer then issues purchase orders under them.

It differs from neighbouring agreements:

• A distribution agreement also moves goods, but the buyer resells them, so it adds territory, resale and marketing terms.
• A master services agreement covers services rather than goods; Ontario's Sale of Goods Act does not govern pure services.

The master terms should also settle the battle of the forms. Purchase orders, acknowledgments and invoices often carry conflicting pre-printed terms, so the agreement should say that only quantity, price, delivery date and location are taken from those documents. Our guide to business agreements covers the other contracts a company needs.

The usual volume tools are:

• Rolling forecasts. The buyer updates a forecast regularly, such as monthly for the next 6 to 12 months, and the agreement says which part binds (a firm window, such as the first four weeks) and which is only an estimate.
• Minimum purchase commitments. The buyer commits to an annual volume or spend, sometimes with a shortfall payment if it buys less (take-or-pay).
• Capacity and allocation. The supplier holds capacity or safety stock for the buyer and, in a shortage, allocates output by an agreed formula.
• Exclusivity. The buyer may agree to buy all its requirements from the supplier, or the supplier may agree not to sell a custom product to the buyer's competitors.

Pair each commitment with an exit. A buyer that commits to minimums needs a way out if the supplier repeatedly misses delivery dates; a supplier that holds stock needs the buyer to pay for buyer-specific materials if forecasts collapse.

The Sale of Goods Act distinguishes two kinds of terms. Breach of a condition lets the buyer reject the goods and treat the contract as repudiated. A warranty is collateral to the main purpose of the contract, and its breach gives only a claim for damages. Under section 12, whether a term is a condition depends on the construction of the contract, a term can be a condition even if called a warranty, and once a buyer has accepted goods under a contract that is not severable, a breach of condition can generally be treated only as a breach of warranty.

Sections 13 to 16 imply these terms:

No fitness condition applies to a specified article bought under its patent or trade name, and, if the buyer has examined the goods, merchantable quality does not cover defects that the examination ought to have revealed.

Section 53 lets any implied right, duty or liability be negatived or varied by express agreement, course of dealing or binding usage. Supply agreements therefore commonly replace the implied terms with an express warranty, such as conformity to specifications for 12 months, and a defined remedy: repair, replacement, credit or refund. The exclusion should name implied conditions as well as warranties, and the Act itself. In consumer agreements, section 9 of the Consumer Protection Act, 2002 makes such exclusions void.

The CISG applies to contracts for the sale of goods between parties whose places of business are in different Contracting States. It has been in force for Canada since May 1, 1992; the United States, Mexico and China are also Contracting States, but the United Kingdom is not. Under Article 1(1)(b), it can also apply when conflict-of-laws rules lead to the law of a Contracting State, such as Ontario, even if the other party's country is not one. In Ontario, the Convention has the force of law under the International Sale of Goods Act.

The Convention does not cover goods bought for personal, family or household use, or contracts in which the preponderant part of the supplier's obligations is labour or other services. Where it applies, several rules change:

• There is no condition and warranty split. The buyer can avoid (terminate) the contract for a fundamental breach, one that substantially deprives it of what it was entitled to expect, or, for non-delivery, if the seller misses an additional delivery period the buyer has fixed.
• The buyer must examine goods promptly and give notice of a lack of conformity within a reasonable time, and at the latest within two years of handover unless a contractual guarantee period says otherwise, or lose the right to rely on it.
• A party is not liable in damages for a failure caused by an impediment beyond its control that it could not reasonably have taken into account, avoided or overcome.

Section 6 of Ontario's Act recognizes exclusion by expressly providing in the contract that the Convention does not apply. Because the Convention is part of Ontario law, a clause that simply chooses the laws of Ontario is not a reliable exclusion. Neither regime is always better; choose deliberately.

Price adjustment. A common model fixes the first-year price, then adjusts it against a published index for a key input such as resin, steel or energy. Tariffs and other duties imposed or increased after signing need their own clause: who absorbs them, whether they pass through at documented cost, and whether the buyer can terminate above a threshold. If the contract adopts the ICC's Incoterms rules, they allocate the import burden: under DDP (delivered duty paid) the seller pays import duties, while under DAP (delivered at place) the buyer clears the goods and pays them.

Title and risk. Under section 21 of the Sale of Goods Act, risk passes with ownership unless otherwise agreed, so the agreement should state when each passes. A supplier that keeps title until paid holds a security interest under the Personal Property Security Act, which applies to conditional sales whatever they are called; without PPSA registration, it can lose out to other secured creditors or a trustee in bankruptcy.

Delivery remedies. Late delivery can carry a liquidated damages clause setting a pre-estimated amount per day or per order. Events outside both parties' control belong in a force majeure clause, drafted to work alongside the CISG exemption where the Convention applies.

Termination. Provide for termination for convenience on long notice, for breach after a cure period, and for insolvency or change of control. Then plan the exit: last-time buys, payment for buyer-specific finished goods and work in progress, return of buyer-owned tooling and moulds, and transition support to a new supplier.

Harjit Gill owns Peel Fresh Foods Inc., a Brampton maker of ready-to-eat meals. Peel Fresh signs a three-year agreement for printed pouches with Lakeshore Flexible Packaging LLC of Ohio, managed by Elena Rossi. Peel Fresh gives a 12-week rolling forecast, with the first four weeks binding, and commits to 2.4 million pouches a year at US$0.21 each, delivered duty paid to Brampton and adjusted quarterly against a resin index. New or increased duties pass through at documented cost, and Peel Fresh may terminate on 60 days' notice if a pass-through raises the landed price by more than 8%. The agreement chooses Ontario law, expressly excludes the CISG, and replaces the Sale of Goods Act's implied terms with a 12-month warranty of conformity to specifications, with Lakeshore liable for documented direct costs up to the value of 12 months' purchases.

In year two, a new duty raises the landed price by 6%. Lakeshore passes it through with customs documents; it is under the threshold, so Peel Fresh pays and starts qualifying a second supplier. Later, 400,000 pouches fail seal-strength testing. Peel Fresh gives written notice within the 10-day inspection window, and Lakeshore replaces the lot, worth US$84,000, and pays C$46,000 for spoiled meals and labour, well inside the cap. Nothing is litigated.