Monitoring and enforcing framework contracts

Framework contracts rely on a combination of provisions for first, second and third-party monitoring, as well as legal and non-legal sanctioning. A consultant lawyer to German food retailers and manufacturers refers to monitoring as ‘screw drivers’ used to limit variability in performance:

“Framework contracts always include audit monitoring: First-party audits by the company itself, …second-party audits by the retailers, third-party audits by the IFS and then you have the governmental inspections. So you employ a few ‘screw drivers’ to influence compliance” (ID 13).

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The framework contract in Table 8.1 comprehensively captures first party monitoring in Section V. A retailer-label confectionery manufacturer reports 60 audit days per year, with less than half of the days dedicated to third party IFS audits (ID 14) and the remaining days split between first and retailer second party audits. Retailer audits typically happen once annually, without prior notification:

“Retailers reserve the right per contract or GTC to visit the supplier at any day or night time. Retailer audits take less time than the IFS and may last 4-5 hours. They will issue a report with points that the company needs to address over a short period of time. Then they come again, unannounced, to check if we did it” (ID 14).

In addition to the manufacturer’s agreement to first and second party audits, the manufacturer typically accepts responsibility for auditing sub-contractors. For example, Beta requires its manufacturers to:

“address non-compliance with BSCI guidelines at their respective suppliers’ sites. If the manufacturer notices any issues, they must remedy them. Only if the encountered issues are beyond the manufacturer’s power to be rectified must they notify Beta and Beta will consider offering support measures” (Lebensmittelzeitung, August 2013).

In case of incidents exposed to added media or NGO scrutiny, such as ‘palm oil’ production or pesticide use, retailers extend second party audits beyond Germany and sometimes implement local training initiatives to enhance compliance rates with product and process specifications:

“The benefit of introducing local training schemes and checking the products and processes on site, even in distant markets like China, is that you can be sure the products comply with the quality required. … [A major German retailer] told me recently that they want to know the issues happening locally, because once the products are on their way, it is too late” (ID 13).

When second or third-party monitoring reveals non-compliance, retailers and manufacturers activate legal and non-legal sanctioning provisions:

“If you do not sanction non-compliance with measures that were anticipated and known in advance, you deviate from the rules and undermine trust created in this framework” (ID 13).

Sanctions are exercised to penalise non-compliance and enforce future compliance. While legal sanctions exercised by governmental authorities are deemed ineffective due to under- staffed auditing divisions and low fines, retailers and manufacturers draw on a range of non- legal sanctioning provisions such as compensatory payments for damages, fees or (temporary) contract termination. Such non-legal sanctioning provisions are considered ‘customary law’ (‘Gewohnheitsrecht’, ID 14). Even minor deviations from contract terms can

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mobilise non-legal sanctioning provisions, as reported by the former quality manager at a poultry manufacturer:

“We were delivering to [retailer] Gamma and their contract requires a 98% delivery threshold. This means we may never deviate from their ordering volume by more than 2%. But this can happen very quickly! We were once …not able to deliver …they threatened us with draconian penalty payments. …if we were a smaller company … such penalties can break the neck” (ID 14).

Retailer Beta uses a combination of financial sanctions, such as deducting 5-10% of the ordered product value plus a lump-sum payment of 3000 Euro per delivery. In addition, non- legal sanctions involve changes to contract terms (such as increased compensatory payments, more frequent audits) and temporary or finite contract termination:

“It is common practice among retailers to‘block’ a certain manufacturer from further delivery contracts for some time following an incident. Sometimes this is necessary to signal to the media and consumers that the retailer is ‘doing something’ about it. The retailer distances himself for some time and may re- list if the manufacturer promises to play by the retailer’s rules again” (ID 40).

Contract termination or ‘blacklisting’ suppliers in internal databases are the most powerful non-legal sanctions (ID 1). Hence, protecting a company’s reputation and continuity of business relationships is a vital concern for retailers, manufacturers and other suppliers. To achieve this, most framework contracts specify out-of-court dispute resolution provisions, including negotiation and arbitration. A consultant lawyer to German food businesses highlights that:

“no one wants to bother public courts with an issue in your business relationship. In practice, this happens very rarely…. The purpose of framework contracts is not to prepare for or facilitate court settlements, but to facilitate an ongoing relationship with as little recourse to the courts as possible” (ID 13).

This observation is echoed by a senior member of the ‘German Industry Association for Food Law and Science’ who highlights pragmatic reasons for settling disagreements ‘entre nous’:

“ultimately what decides how an issue is settled is very pragmatic: …The bigger companies do not go to court because they do not want to stand in potentially negative limelight even if they have the capital and good chances to win. Smaller companies do not go to court because they do not have the capital and are afraid of catapulting themselves out of business. A lot of things are settled ‘entre nous’ through negotiating, threatening, offering. A court settlement mostly only promises to damage the relationship somehow …An internal agreement is much more cost effective” (ID 12).

Hence, most retailer-manufacturer framework contracts consulted for this research include provisions specifying willingness for mutual negotiation to resolve potential conflict.

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Negotiation and arbitration are important provisions supporting sanctioning non-compliance without reverting to public courts for three reasons: (1) Both take place in a closed environment and remain unknown to media, consumers or competitors; (2) In case of arbitration, companies draw on industry experts specialised in resolving industry specific cases, enhancing speed and fairness; (3) In contrast to public court settlements that typically result in compensatory payments or contract termination, the objective of negotiation and arbitration is the continuity of the agreement.