One of the most important elements of a contract is the “term” – that is, the length of time the contract is scheduled to remain in place. Sometimes the parties to a contract heavily negotiate the length of the contract. But many times, they don’t give enough consideration to it when negotiating this important contract provision and end up surprised when they discover they’re stuck with a longer-term contract than they originally intended or desired. Unfortunately, this occurs frequently when businesses sign “evergreen” contracts.
Contracts that contain automatic renewal provisions are commonly referred to as “evergreen” contracts. This is because the term of the contract remains alive, potentially indefinitely, if neither party terminates it. “Evergreen” sounds good, but often it isn’t.
To terminate an evergreen contract, one of the parties must give notice of termination or non-renewal to the other party within a specified time period before the contract renews. If neither party gives the required notice of non-renewal, the contract rolls over for another term. The duration of the renewal term can vary. The renewal term might be identical to the initial term, or it might run indefinitely until one of the parties terminates the contract by giving the required notice of termination or non-renewal. Or, the parties might have negotiated a shorter renewal term – for example, one that continues on a year-to-year or month-to-month basis as is the case in many commercial leases.
Automatic renewal provisions, or evergreen terms, are commonly found in commercial agreements such as supply agreements, purchase agreements, software license agreements, consulting agreements, equipment rental agreements, and office leases.
An automatic renewal provision might read something like this: “The initial term of this contract is one year. After the initial term, the term of this contract will automatically renew for successive additional periods of one year each unless one party gives written notice to the other party at least 90 days before the end of the then-current term that it does not wish to renew the contract.”
Benefits and Risks of Evergreen Contracts
Evergreen contracts have their benefits. The primary benefits of an evergreen contract are convenience and predictability. The contracting parties aren’t required to renegotiate the contract when the initial term expires. They can have longer-term certainty on commercial terms like price and continuity in the supply of routine products and services, for example, yet have the flexibility to discontinue the arrangement if their needs or circumstances change during the contract period.
Evergreen contracts have their risks, though, so a company shouldn’t agree to one unless there’s a strong business case for it. What might have been a favorable commercial term at the beginning of the contract may not be so favorable as time goes on. A party risks being stuck with an undesirable contract if the term automatically renews because the company wasn’t aware that its contract included an automatic renewal provision or because it didn’t strictly comply with the requirements for exercising its option to not renew. An automatic renewal provision can be particularly dangerous when the contract includes an exclusivity provision in favor of the other side that might be overlooked and mistakenly renewed for another exclusive term.
Given the pitfalls, consider adopting a delegation of authority policy for your company that gives only those employees with appropriate business experience authority to approve evergreen contracts. In smaller companies, this authority might even rest exclusively with the CEO. Also, there’s something to be said for consulting your business lawyer before signing an evergreen contract, to confirm the evergreen provision is legally enforceable if you’re the party requesting it and to assist in drafting a renewal provision that you agree with. Taking these steps will help ensure that senior management and the company’s professional advisors have fully considered the risks and rewards of agreeing to an evergreen contract.
If you decide an evergreen contract term is desirable for your company after weighing the pros and cons, make sure you have procedures in place to manage the contract. Schedule recurring reminders to multiple individuals of the deadline for giving the required non-renewal notice. Issue the reminders far enough in advance to give the business teams ample time to evaluate whether the contract should be renewed under its current provisions, renegotiated, or terminated, before needing to provide notice of non-renewal.
There may be valid business reasons for signing a contract with an automatic renewal provision, but be sure to consider these key take-aways before you do:
- Don’t unknowingly agree to an evergreen contract
- Assess the business risks and rewards and make an informed decision
- Be extra-cautious when it comes to automatic renewal terms that are lengthy or exclusive
- Implement policies and procedures to manage evergreen contract approvals and non-renewals
- Seek legal advice on enforceability and contract drafting