3 Keys to an Evergreen Contract
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An evergreen contract is a mutual agreement which contains an automatic renewal clause. An evergreen contract continues to renew until one party elects to terminate the contract. When the parties sign a contract, the parties involved might give an evergreen option to one of the parties. The renewal period might be different from the initial contract period. To understand how an evergreen clause works, it is important to know when a contract normally ends.
When do contracts end?
Contracts end on the expiration date or the fulfillment of the obligations described in the contract. The absence of a contract period is not definitive evidence that the agreement is an evergreen contract. A contract that specifies delivery of a product or service, for example, might terminate upon delivery.
Contracts that do not have a fixed delivery or explicit expiration date might be classified as indefinite contracts. An indefinite contract is cancelable at will with notice by either party under common law and the Uniform Commercial Code. There are important nuances to this principle.
Indefinite contracts create risk for both parties because it can be difficult to determine what is reasonable notice in the event one party wants to terminate the contract. To address this problem, evergreen contract provisions require explicit notice for termination.
An evergreen contract automatically renews or continues indefinitely. First, the contract might provide that it expires on a certain date with automatic renewal for an indefinite series until one party provides notice of termination as specified in the contract. Second, an evergreen clause might provide that the contract continues indefinitely until one party cancels based on the procedures in the contract.
How does an evergreen contract and an auto-renewal provision differ?
Given this definition, it is helpful to note that an evergreen contract is not the same as an auto-renewal contract. An auto-renewal contract, like its evergreen corollary, renews automatically, but for a specific number of times. An auto-renewing five-year lease, for example, might contain a one-year renewal provision. The two contracts might have a similar duration in fact, but the structures are different.
This provision allows the tenant to stay in the building for an additional year without renegotiating the terms of the lease. At the end of the renewal period, however, the lease expires with or without notice.
In contrast, an evergreen contract continues indefinitely until one party provides notice.
Here is an example of an auto-renewal clause:
This agreement shall have an initial term of two years from the effective date. Upon expiration of the initial term, this agreement shall automatically renew for a period of one year.
Notice how the clause renews automatically but for a fixed period. One year in this case.
Here is an example of an evergreen clause:
This agreement shall continue in force for a period of two years. Upon expiration, this agreement shall continue in force until either party notifies the other party in writing as specified in this agreement of its intent to terminate this agreement in which case it shall terminate 60 days from the date of the notice.
Notice that there is an expiration date (two years after execution). This is an evergreen clause, because the contract continues for an indefinite period after the expiration. One would expect this contract to contain clear notice provisions to allow for either party to terminate the agreement in the future.
What is important to track for evergreen contract provisions?
Beyond the basics of contract management, there are three techniques to improve your management of evergreen agreements and clauses.
1. Set recurring alerts to review the agreement
Evergreen contracts can be filed and forgotten. At the time of signing, it is difficult to imagine forgetting a contract. Organizations can suffer from contract amnesia in several ways. An evergreen contract becomes another contract for organizations that produce a prodigious number of contracts. Staff turnover means that institutional memory of an evergreen contract is lost with the latest departure.
To cure contract amnesia, organizations should leverage contract management software to set recurring alerts. Recurring alerts should include the following:
- A short title to describe the alert at issue,
- Notes that will help remind staff about the main issues in the contract,
- The alert recipients (it’s best to include more than one person),
- The date of the first alert, and
- The frequency of the recurring alert.
The frequency of the recurring alert depends on the purpose. An alert to review a particular evergreen contract in depth might recur every year. An alert to review evergreen contracts throughout the contract portfolio as a group might recur quarterly or monthly.
2. Analyze the role of evergreen contracts in the contract portfolio
One of the most significant contract management shortcomings for organizations is the myopic focus on a single contract. While it is important to negotiate the best bargain for the organization, contract risk management revs up after contract execution. Evergreen clauses can compound this problem, because there is little external reason to reassess them after execution. Unless there is a breach when it is too late to deal with the contract proactively.
The corrective action is to review the contract portfolio holistically on a periodic basis. This requires effective contract management reporting. Collecting evergreen contracts or contracts with an indeterminate duration for analysis can be illuminating. Ask these questions of your contract portfolio:
- What percentage of all contracts are evergreen or indeterminate?
- How long ago was the oldest review of an evergreen contract?
- What is the ratio of evergreen to auto-renewal contracts?
- What types of contracts are evergreen? What departments, divisions, or subsidiaries are producing the most evergreen contracts?
Understanding evergreen contracts in the context of operational units (departments, divisions, etc.) or by type of contract is particularly revealing.
If your legal counsel is concerned about evergreen contracts, then this analysis can focus the renegotiation work on the areas of highest need.
3. Ensure better on-boarding of new evergreen contracts
It is hard to perform the analysis above without proper tagging of contracts with evergreen clauses or absent a clear duration. One of the most common missteps in finance, legal, and contract management departments is to open the spreadsheet list of contracts and leave the Expiration Date column blank on the row with the new contract.
There are two problems with this approach:
- Later it is not clear whether someone just forgot to add the expiration date or there is no expiration date. Now someone has to dig up the contract and review it for the date.
- A blank spreadsheet cell cannot notify you of a recurring review. Of course, spreadsheets do not send notices anyway, but they certainly do not send alerts based on unknown dates.
Instead, configure a contract management solution to classify evergreen contracts as they arrive. There is still no expiration date, but with a strong classification system, you can run the reports and perform the analysis required to prevent evergreen contracts from draining the organization.
Conclusion
Most organizations have evergreen contracts in their contract portfolio. Chances are that no one knows how many, how much money is at stake, and what the consequences are. With three simple steps above you can help your organization master these challenging agreements.