Strategic partnerships: issues to consider and how to address them in your contracts

In our current uncertain world, there is a significant shift towards businesses exploring other ways of working with their supply chains that go beyond the traditional customer/supplier model. Factors such as a lack of suitable incumbent suppliers, shortages in raw materials, energy uncertainties and bottlenecks in the supply of key components such as semiconductors means that a new agility is required. Moreover, the need to invest heavily in new technologies, particularly in industries that tend to take a generational approach to new technology or discoveries, creates additional incentives for joint efforts. There are many examples of this. One being in the telecoms industry, where network collaborations in relation to 5G technology have been common. Similarly, the longer periods between drug discovery and commercialisation in the pharmaceuticals space are driving a greater reliance on contractual joint ventures and co-operation structures.

For businesses to overcome these and other challenges to ensure a robust supply chain, it is important to explore a more cooperative approach. Customers and suppliers are effectively in it together; unless they can work together to find a way around the challenging environment in which they are operating, they will flounder. There is a need to form partnerships to ensure success on both sides, and by forming a strategic partnership that explores non-equity structures, customers can continue to operate with a reliable supply chain supporting them.

How do you go about drafting a commercial contract to support a successful non-equity cooperation/strategic partnership?

Before you start drafting, think about the arrangement from start to finish. By mapping out each stage of the relationship and doing your best to provide for the likely scenarios that might emerge during it – for example, how the parties work together if there is a supply shortage – you will start off on the right foot. Thinking about each stage in the lifecycle of the partnership is important; how will it be initiated, managed during the duration and wound down if the intention is for it to be time-limited? A trite phrase that can nevertheless be a good guide is the concept of ‘gainshare and painshare’. If the collaboration is to be between two parties with truly aligned interests, then both parties should share the entire gain if the overall venture is successful, and both should share the pain of a shortfall. While this need not always be an even split, mechanisms that transparently capture the total profit or loss for the combined venture help in creating this alignment and shared interest.

It is also useful to bear in mind the things that an equity cooperation would have to consider when being set up. Consider all the things that come for free with an equity cooperation, such as management/decision-making processes, escalation procedures, termination rights and how events of default will be dealt with. The benefit of working within a non-equity structure is that you have more freedom and can be creative around how you structure the arrangement as you are effectively starting from a blank sheet of paper.

Thinking carefully about what could trigger termination rights from the perspective of both/all parties is important and requires a lot of thought from the outset of the drafting process. Different termination rights may need to be given to different parties. For instance, if one participant but not the other in a collaboration will be making heavy investments at an initial stage of the collaboration, then the investing party may need to be able to recover those investments, which in turn may require more limited termination rights for the participant that does not invest. Alternatively, the non-investing party might be required to pay some form of compensatory termination payment in any termination scenario, including one involving breach by the investing party.

Another element that also requires careful forethought is how intellectual property rights (IPRs) such as patents, trade marks and copyright will be dealt with under the arrangement. One party may have a valuable portfolio of patents, for example. Auditing the IPRs that each party is bringing to the table from the outset is helpful, and it may be necessary to include some kind of compensation mechanism if one party is bringing more IPRs than the other(s) to the table.

A key question also arises as you consider who will own any IPRs generated under the arrangement. Under the laws of many jurisdictions, IPRs created as part of a commercial arrangement will automatically be treated as jointly owned by the parties unless the contract states otherwise. It can be extremely cumbersome to have to get the agreement of each owner of the IPRs to do something with them each time one party wants to use them. Including a mechanism whereby ownership of a particular type of IPR is assigned to one party only and then licensed to the other party or parties to the contract on ‘ownership equivalent’ terms with the perpetual right to use, exploit and sublicence them to allow them to use the IPRs can overcome such difficulty.

What approach should you take when preparing and negotiating the commercial contract that will govern the arrangement?

Working with the other party or parties to the contract to create a bespoke and balanced set of terms is essential. Unlike with the traditional customer/supplier model, it is counterproductive for one party to seek to impose their standard terms of the other(s) and the parties really need to work together to make the arrangement work. In contrast to the traditional approach, adopting a ‘win-win’ rather than ‘win-lose’ mindset in collaboration with suppliers is key. For instance, in a collaboration in an industrial setting where each participant is to supply components to the other, it may make sense to apply reciprocal supply terms to ensure and maintain a balance between the two participants.

In terms of other practical pointers, you need a clear view from the outset as to what both sides are bringing to the party and how the arrangement will generate commercial benefit to both parties. Thinking about how risk and loss should be sensibly allocated between the parties is necessary, as is considering the possible different levels of ambition of the parties and their desired goals for the arrangement. In addition, taking into account the respective potential outlay of the parties in relation to each clause of the contract is crucial. Unless the potential cost/risk analysis for each party is understood in relation to each obligation under the agreement, it can be impossible to reach agreement smoothly and amicably.

Applying an even-handed rather than combative approach is important, but of equal importance is the need to be creative and agile as to how the contract will operate. The more potential scenarios that can but envisaged and dealt with in the contract covering a non-equity cooperation, the greater the chance of the arrangement being a success.

For further discussion of this topic please listen to our podcast: ‘Successful Contracts for Non-Equity Cooperations’ that forms part of our International Commercial Contracts team’s Better Contracts Podcast Series.