Evergreen Contract Clauses Explained
Evergreen Contract Clauses are provisions that are found in a variety of commercial contracts, and their inclusion can have a massive impact on your relationship with your co-contracting party. There are many types of contract clauses that are referred to as "evergreen" clauses. For the purposes of this article, we will be discussing the type of evergreen clause that allows for the automatic renewal of the contract term on its expiration. An evergreen contract is one that automatically renews upon the expiry of the contract term. An evergreen contract clause is one that states that the term of the contract will be automatically renewed unless one of the parties to the contract provides the other party with advance written notice of their intent to terminate the contract. An evergreen contract clause will typically require a certain amount of notice, for example, 60 days prior to the contractual termination date, that a party intends to terminate the contract as of the contract expiration date . If such notice is not provided, then the contract comes to a natural end and will automatically continue upon the same terms as the expired contract. It is important to note that in order for this type of evergreen clause to function properly, it must unequivocally state that unless otherwise terminated in writing, the contract will automatically continue in force after the expiration of the initial term. The contract should clearly state that the only mechanism by which a party can prevent the automatic renewal of the contract into the next term is by providing the other party with proper advance written notice to terminate. Failure to provide proper written notice, in accordance with the contract terms, would mean that the evergreen contract clause has been effectively triggered. In such a case, the contract continues on the same terms and conditions as those under the expired contract. In order to prevent the automatic renewal of the contract for any unwanted reason, it is essential to ensure that proper notice is provided in accordance with the exact requirements of the evergreen clause.
The Advantages of Evergreen Contract Clauses
Historically, most contracts have included clauses with defined beginning and ending dates for how long the parties will be bound. However, some contracts are still ongoing and thus do not have a definitive end date. For example, a monthly service contract that is renewed on a monthly basis will have a natural ending date at the end of the agreed term unless otherwise agreed to. If you are ever in a contract that is not meant to terminate at any specific time in the future, you should look closely at whether your contract contains an evergreen clause or should include one for your benefit. Evergreen clauses can be very beneficial for commercial contracts for several reasons.
First, evergreen clauses provide continuity and avoid interruptions and down time. Consider whether performance and/or satisfaction could be interrupted if the contract were ever required to be reviewed again. This is particularly relevant in a trade or distribution agreement between a long-time supplier and purchaser/distributor or between a supplier and its employees. For instance, if a trade partner ever needed to reapply to continue to distribute certain products it might have the potential to interrupt the product’s availability if there was ever a lapse between contracts or the contract was under review. Contracts for the sale, purchase or lease of real property may contain similar issues when the parties intend to commence the contract terms immediately and often rely on that date being confirmed in writing.
Second, evergreen clauses can reduce administrative effort by avoiding the need to constantly revisit the issue of renewing contracts. Consider a situation in which the parties agree to review the contract terms every year and thus they need to spend time every year reading and reviewing the terms and conditions that exist or negotiating changes to those terms. It is even more burdensome if all or part of the parties cannot agree to renew the contract at the end of some period of time. If the parties have performed the contract many times, however, why is it necessary for them to continue assessing the terms of the contract and negotiating changes? Evergreen clauses avoid this by being self renewing and allowing the parties to focus on acquiring knowledge about the performance of the contract and the relationship between the parties rather than on the contract terms.
Third, in addition to the continuity and administrative aspects, evergreen clauses may be beneficial because they assure the parties that their relationship will be ongoing and thus give them additional certainty about the relationship. For example, if the price of raw materials has decreased, but the evergreen clause provides for an increase in payments, both parties are assured that the other party will take the contract seriously and that there are repercussions for one party if the terms of the contract are not followed.
Finally, evergreen clauses can aid the parties in their litigation. For example, evergreen clauses may provide evidence to the court that the parties intended to be bound forever, particularly if the party arguing otherwise has been previously found to be a "bad actor" under the contract terms or other agreements. Having evidence of a history of the parties abiding by the agreement for several years may bolster arguments for enforcing the contract terms against another agreeing party or awarding attorneys’ fees and other costs to a party that had the right to receive payments for contract terms that were ongoing.
Potential Pitfalls
While evergreen contract clauses can offer significant benefits, there are also a number of potential risks and drawbacks you should look out for:
Parties may forget the contract is active due to automatic renewal. An automatic renewal period could occur in an off-peak season for your business or when no active business efforts are being put forth. If you don’t have your radar up for the contract at the point of renewal, you might miss it and wind up stuck with an unwanted relationship.
An evergreen clause gives both parties less leverage for negotiation. If your supplier has the opportunity to automatically renew under the terms that have already demonstrated an advantage for them, they may be less likely to negotiate on circumstances that would improve the terms for you.
Parties get stuck on auto-pilot. Sometimes evergreen clauses just keep running on, and no effort is made to review the terms at the end of a period. Either the default period is so long that the parties don’t feel it’s pressing to renegotiate or a party with more leverage uses that leverage to avoid renegotiation.
Evergreen clauses can go unnoticed in a merger/acquisition. In the event of a merger/acquisition, the acquirer may not realize until it’s too late that one or more of the acquired contracts are automatically renewing and cannot be easily terminated.
Problems can occur with periods of automatic renewal. Say your contract with a third party has a maximum period of renewal. And your party reviews the contract every five years but fails to refresh it at each five year mark. If automatic renewal was for five years max, then that contract could extend up to 10 years and you could be stuck.
Common Applications
Evergreen clauses tend to be used in types of contracts that have a need for an ongoing relationship. Some common use cases are service agreements, supply contracts and subscriptions. Let’s take a look how each of these might work.
In the context of services, an evergreen clause could be applied to an agreement for providing software development work to a company. This would provide assurances to the service provider that they could continue to provide their services to the company, unless the company decided to terminate the contract. On the other side of the coin, an evergreen clause could provide the company with a "guaranteed" number of hours of development work each month or year as long as they provide the services. For example, "Service Provider agrees to provide the Company with not less than 200 developer hours per month for the duration of this agreement. If a work order is not provided for such work, it is agreed that such developer hours will not roll over for future use in a given month or quarter." Here, the evergreen clause is used in the context of a minimum and a maximum arrangement.
Evergreen provisions can also be used to ensure a continuous supply of products. For example, a company agrees to provide the Evergreen Company with 1,000 electric motors every month for 36 months, as needed. The contract provides that that the parties will review the price of the motors every year to determine if there has been any change in the marketplace, and adjust the price accordingly. In this context, the evergreen clause provides for guidance as to how and when the contract will be reviewed and modified.
Another example may be in the context of a subscription agreement. For example, when an artist provides their music via a third-party platform (like Spotify), the terms of that relationship are governed generally by both parties’ user agreements. The parties’ relationship may be governed by contract, but renewal and termination timelines may be governed by the individual parties’ relationships with the third-party platform.
A potential complication with evergreen clauses is that the default duration depends on the jurisdiction. So it is best to make sure that you state the desired term explicitly rather than rely on the default provisions. For example, in New York, the default duration is one year. In California, the default duration is five years. Not every jurisdiction has the same default duration, so you should do your homework if you vary the default term.
Legal Implications and Compliance Issues
When considering the use of evergreen contract clauses, there are some specific legal considerations but also practical considerations that need to be considered.
From a legal perspective, the most important consideration is that the termination terms are set out clearly in the evergreen clause. Otherwise, it may end up being "all about the timing". Will the term automatically renew any number of times or is the evergreen clause limited to a certain time as of the effective date of the evergreen clause? In this regard, it is important to specify the length of the renewal period, and whether that period automatically renews each time. The notice requirements are also important to notice to terminate under the evergreen clause. Are the required notice periods clear? Are there any prescribed form or method of delivery for notice?
Another legal consideration is to limit the ability to terminate under the evergreen clause . While commercially, renegotiation may be appropriate after a certain period of time, limiting the ability to terminate a renewable clause can ensure that the relationship continues so that benefits of the evergreen clause can be maximized. But, what if your client’s business change requires a change to the commercial relationship with the vendor? Being able to terminate without penalty at the end of the renewal period can provide some flexibility.
Governing law of course will be important in confirming that the evergreen clause is enforceable. If the parties are subject to Canadian law, then the governing law provision should be Canadian law, and if there is another country involved, then a careful assessment of the law of that country should be done.
How to Write An Evergreen Clause
A good expression of intent all starts with clear and precise drafting. The courts ultimately look to the actual language used by the parties to determine what they have agreed to; accordingly, using clear and unambiguous language in the evergreen clause will aid in ensuring that the clause is found to be enforceable.
In order to ensure that the clause is clear and unambiguous, the initial term should be a specific period. There is a marked difference between an evergreen clause that provides, for example, for 3, 6 or 12 month renewals, as opposed to an evergreen clause that provides for "regularly" scheduled renewals. The evergreen clause should clearly articulate when the period of renewal for the contract will be triggered, and how renewal may occur. Where the trigger is the end date of the current term, the parties will need to articulate what needs to happen for the evergreen clause to be triggered and (for a renewal) whether notice is required from either party. Another consideration is whether specific words are used to describe the renewal or extension. The use of precise language means that the parties have a common understanding of when an evergreen provision will be triggered. It is important that parties ensure that the termination or expiry of the evergreen clause, and the consequences of its termination, are clearly articulated in the evergreen clause. In PT 2 Fitness Centres (VIC) Pty Ltd v Competition Training Group Pty Ltd [2011] VSC 566, the clause was vague in its wording, and structured in a way that lent itself to different interpretations. The parties ultimately decided that the clause did not operate on the facts.
The parties also need to be very clear about what will happen if the parties fail to provide the prescribed notice. Should the evergreen clause renew without further communication? Should the evergreen clause remain in place but on different terms? Will an indemnity be available in relation to damages caused by the evergreen clause? The above issues are not exhaustive, but clearly list some of the issues that need to be considered and dealt with when implementing an evergreen clause in a contract. An effective evergreen clause should have a mechanism for exercising a right to terminate, as well as the consequences of the termination. In the absence of clear articulation of these issues, it is possible that the clause could be found to be oppressive, and as such void in a liquidated sum under s 247 of the Australian Consumer Law (and the equivalent State legislation, such as the Sale of Goods Act 1954 (Qld)). The parties should ensure that the clause is drafted such that each party is given a reasonable opportunity to respond to the notice of termination, and a reasonable opportunity to comply with the process prescribed by the contract for termination of the evergreen clause. Clarity is key.
When to Consider Alternative Terms
Although evergreen clauses can offer certain benefits, such as avoiding the work involved in renegotiating contracts before they expire, there are alternatives that should be considered. One alternative to evergreen clauses is the fixed-term contract, which envisages a specified period of time for performance. The benefit of this approach is the parties are able to expressly address how contractual obligations will be addressed upon the contract’s expiration. Because a fixed-term contract is significantly shorter than static (evergreen) obligations then its advantage is that any business uncertainty can be accounted for more readily and with fading memories, issues are fresh and not forgotten or "revised" by later comment, explanation or "straightening out the past". Another alternative to evergreen clauses is a contract with an express renewal process or mechanism (as opposed to the automatic renewal of an evergreen clause, which is considered to be a "silent renewal"). The express renewal process may fall within the rubric of the fixed-term contract if the renewal process is tied to a specific date (e.g. , requiring the other party to provide notice at least 30 days prior to June 1, of option year three of four after which the contract terminates on July 31). However, the express renewal process may also be akin to a pure evergreen clause if there is no definitive expiration date and simply waiting until one party takes the initiative to renew or negotiate is contemplated by the contract. In addition, the parties may also consider defining fixed renewal periods of indefinitely recurring renewal processes (with defined time-frames for renewing the contract) to predetermine, rather than postpone the evaluation of the question of whether to continue their contract. Thus, while an evergreen clause (or clauses) may be beneficial, having a flat out expiration date is not the only alternative to protect the contracting parties from the uncertainties associated with an induced renewal of a contract when either party no longer wishes to remain bound by the agreement.