Businesses of all kinds, and all sizes, enter into vendor agreements in the ordinary course of business. And like many third-party vendors, the types of vendors that cater specifically to the technology needs of commodity brokers and traders — those offering services for data streams, instant messaging, front-end software, and audit trails services — frequently contain “auto-renewal” provisions (also sometimes called “evergreen” provisions).
Evergreen provisions have the effect of allowing the contract to continue forever unless the customer gives a timely notice of termination. These provisions, if ignored, can become potentially expensive problems, because most customers have no system for tracking the cancellation deadlines of their agreements.
For example, assume Commodity Broker XYZ wants to enter into a data license agreement with a vendor whereby the vendor will stream market quotes or other data to XYZ. The license agreement is likely to have a provision similar to this:
Sound familiar? Some vendors take a very aggressive approach to these evergreen provisions, and claim that the language must be construed literally. (In particular, we have seen brokerage and trading firms struggling to modify or cancel contracts with providers of financial data and instant messaging terminals.)
For example, assume the expiration of the original term of the vendor’s agreement is December 31. If notice to terminate should have been given, say, October 1 (90 days before year-end) but instead is actually given by XYZ on December 1 (30 days before year-end), then the vendor refuses to cancel the agreement because notice was untimely. The vendor then threatens collection if XYZ does not pay for the full amount of the agreement through the end of the following year. Obviously, this would be a very expensive result if XYZ no longer needs the service that is seeking to terminate.
Two questions arise: First, is an evergreen provision enforceable? Second, if it is, can losses be mitigated?
Generally speaking, evergreen provisions may be enforceable, but some states have created hurdles to make it more difficult for vendors to enforce them. In New York, for example, a vendor must give written notice to the customer at least 15 days and no more than 30 days before the time when the customer must provide notice of its desire to cancel the contract. The failure to do so invalidates the evergreen clause. However, the New York law does not apply to every type of contract.
Other states take different approaches. For example, in Illinois, the “Automatic Contract Renewal Act” provides limited protections to the customer, but the customer must be a “consumer,” and by its express terms the Illinois law does not apply to business-to-business agreements.
At least one state (Wisconsin), for business-to-business agreements for the lease of business equipment, requires the vendor to give certain notice to the customer about the evergreen provision, and also requires the provision to be separately initialed in the agreement.
Brokers and traders should consult with their attorneys to carefully check the law in the applicable state. In summary, however, it is accurate to say that in a business-to-business context, evergreen provisions are often enforceable, although some states make them easier to enforce than other states.
So how can you avoid this problem? First, and stating the obvious, read the agreement and negotiate the provision out of the agreement at the inception of the relationship. If you can’t outright eliminate it, then look for other ways to mitigate its harsh effects. For example, you might shorten the notice period, so that the cutoff for giving notice is 10 days before the end of the term, not 90 days. Another solution might be to negotiate a cap on the penalty, so that instead of being forced into a full year extension, the rollover is limited to a much shorter time.
Finally, if you find yourself on the hook for an expensive contract extension for a service you no longer need, consider giving immediate notice and then defending any ensuing collection case to enforce the contract. A reasonable argument in defense can be made that the damages resulting from the breach should be the actual loss suffered by the vendor as a result of the late notice, not the loss of the relationship. Put another way, the fact that the contract renews by its own terms for a year does not necessarily mean there are damages incurred by the vendor equal to one year of service*.
Rick Reibman is a co-chair of Thompson Coburn's Corporate and Securities group and leads the practice in Chicago.
*See, e.g., RGJ Associates, Inc. v. Stainsafe, Inc., 300 F. Supp. 2d 250, 253-54 (D. Mass. 2004) (“Furthermore, any such damages must result from the inadequate notice of termination as opposed to the loss of the business due to the termination itself.”); Mood v. Kronos Products, Inc., 245 S.W.3d 8, 12 (Tex. App. 2007); Kham & Nates Shoes No. 2 v. First Bank of Whiting, 908 F.2d 1351, 1359 (7th Cir. 1990) (if borrower received less than contractually agreed-upon notice from lender, “then an award would be in order for the loss attributable to the inadequate notice”).