International contract of supply: Risks and how to reduce them

Mainstream

An international supply contract is not just a template document on the transfer of goods. It is a system for managing commercial and legal risks in a cross-border transaction.

The question is not whether the treaty is signed at all. The question is what happens when something goes wrong: The buyer will not pay, the goods will be delayed at customs, sanctions will work, the currency will collapse or force majeure will occur.

Therefore, effective risk management in international supply begins with three checks:

How the contract distributes these risks between the parties.Where and how you can protect your interests.

If these three issues are not resolved at the contract formulation stage, the company does not manage the transaction. She's hoping for luck.

When international supply risks become a reality

Problems under an international supply contract arise if:

• The foreign buyer delays or refuses to pay
• Goods damaged, lost or not conforming to specification
• delivery time is broken
• Changes in exchange rates or restrictions on transfers
• New sanctions against the counterparty’s country or its bank
• Export restrictions or embargoes have been applied
• Unplanned customs duties and charges
• The contractor interprets force majeure in his favor
• Distributor violates the obligation of exclusivity or minimum volumes
• There was a dispute about the quality and acceptance of goods
• You must return the advance or recover losses from a foreign counterparty

The mistake that most of the participants make

Many companies start their negotiations with the question:

What price and delivery time do we fix?

That's the wrong first question.

The right question is:

What are the critical risks in this transaction and what contractual mechanism minimizes them?

Sometimes the best result is a strong arbitration clause. Sometimes a bank guarantee or letter of credit. Sometimes, transfer of ownership before full payment. Sometimes, hedging currency risks. Sometimes - a detailed specification and mechanism for accepting goods.

International delivery requires not just signing a contract, but building the architecture of the transaction.

Step 1. Select applicable law

Applicable law is the foundation of all rights and obligations of the parties. It defines:

• validity and interpretation of the treaty
• Transition of ownership and risks
• penalty, penalty and interest
• avoidance
• The concept of force majeure and difficulties (hardship)
• limitation-limitation
• possibility of recovering lost profits
• Validity of limitation clauses

Often, parties choose the law of the seller, buyer or neutral law (for example, the English, Swiss or Vienna Convention on Contracts for the International Sale of Goods, 1980). - CISG.

It's important to remember: CISG is applied automatically, unless the parties have excluded its validity and their places of business are located in the countries-parties of the Convention. Many template treaties are silent about this, which creates a field for unexpected interpretations.

Step 2. Harmonize jurisdiction and dispute resolution mechanism

The jurisdiction answers the question: Who and where will decide the dispute.

An international supply contract should include a clearly formulated clause that specifies:

• court of the country
• or international arbitration with the indication of the institution (ICC, LCIA, VIAC, SCC, SIAC, etc.)
• arbitration
• language
• number of arbitrators
• Applicable Procedural Law (lex arbitri)

Blurred wording such as “disputes are resolved in court at the location of the defendant” or “in arbitration of the seller’s country” in practice create chaos and delay the resolution of the conflict.

Step 3. Details to determine the subject of the contract and the quality of the goods

Most disputes arise not from malice, but from a different understanding of what should be put.

Reducing risk is helped by:

• specifications with technical parameters and tolerances
• samples approved by both parties
• references to international standards (ISO, EN, ASTM, GOST)
• certificates of origin and quality
• Pre-shipment inspection conditions (SGS, Bureau Veritas, etc.)
• mechanism for agreeing on changes in the specification
• elimination of defects or replacement of goods

In international disputes, a written specification signed by the parties is often valued more than dozens of commercial letters.

Step 4. Select the right basis for supply of Incoterms

Incoterms are not just three letters in the “terms of delivery” column. It is the allocation of costs and risks between the seller and the buyer.

It is critical to state precisely:

• Incoterms version (preferably relevant, for example, Incoterms 2020)
• specific basis (EXW, FCA, CIP, DAP, etc.)
• geographical location with maximum accuracy (city, terminal, port)

Mistakes in the choice of the basis or its misunderstanding lead to disputes about who bears the risks of destruction of goods, pays freight, customs clearance and insurance. For example, the EXW (French factory) base for international shipment often creates tax and customs risks for the buyer in export clearance.

Step 5. Establishing secure payment terms

Financial risk is key. International contracts must balance the interests of the seller (getting money) and the buyer (getting the goods).

Tools to reduce the risk of non-payment:

• Prepayment (partial or full)
• Letter of Credit (documentary, confirmed by a first-class bank)
• bank guarantee of return of advance and fulfillment of obligations
• collector
• payment against the provision of shipping documents
• Retention of Title (ROT) until full payment, with due regard to the validity of such reservation in the buyer’s country

The opposite risk for the buyer is the loss of an advance payment when the goods are not delivered. Here, the guarantee of the return of the advance payment, which should be provided by a first-class bank, and not just a promise of the counterparty, is critical.

Step 6. Settlement of liability, penalty and damages

International contracts need to balance a fixed amount of compensation with proof of actual losses, which can be difficult in different jurisdictions.

The contract shall clearly specify:

• penalty for delay in delivery (as a percentage of the value of undelivered goods per day / week)
• penalty
• loss-calculation
• Limitation of total liability (exceptions for intent, gross negligence, death, infringement of intellectual property rights)
• Liquidated damages, especially important in the Anglo-American legal system, where penalties are not allowed.

Step 7. Consider sanctions, currency and export risks

In the current geopolitical realities, this is one of the most important blocks.

The treaty should include:

• Assurances about the absence of parties in the sanctions lists (Sanctions Compliance Clause)
• the right to immediate termination of the contract when imposing sanctions making the execution illegal
• mechanism for searching for a legitimate alternative method of execution (payment route, correspondent bank)
• Distribution of risks of changes in currency regulation and impossibility of currency conversion
• Export/import licenses
• a re-export clause to certain jurisdictions (for example, to Russia or Belarus if the goods are of American or European origin)

Without these reservations, the company risks not only commercial losses, but also administrative or criminal liability for violating sanctions and export control regimes.

Step 8. Adapt Force Majeure and Hardship Clauses

The standard article on “fire and flood” doesn’t work in today’s world of pandemics, supply chain ruptures, Suez Canal closures, and geopolitical conflicts.

A strong force majeure clause should:

• Provide an open but illustrated list of events
• explicitly mention epidemics, government bans, border closures, cyberattacks
• set the time limit for notification of force majeure
• determine the consequences of the obligations of the parties
• grant the right to termination if the force majeure lasts longer than a certain period

In parallel with force majeure, it is worth incorporating a hardship clause, which allows the parties to sit down at the negotiating table and adapt the contractual terms (price, terms) if the execution has become economically ruinous, but legally still possible.

Step 9. Protect intellectual property and privacy

In distribution and licensing agreements associated with the supply, it is important to specify:

• Limits of use of trademarks and commercial designations
• Prohibition of registration of similar designations in the country of the buyer / distributor
• confidentiality of commercial information for the entire period and after termination of the contract
• prohibition of reverse engineering and copying of goods
• auditor

Step 10. Agree on termination terms and post-contract obligations

The final of the contract is no less important than the beginning. Make it clear:

• Termination of a Material Violation (material breach)
• time-limit
• consequences of termination for unfulfilled orders and unpaid consignments of goods
• Fate of warehouse stocks, advertising materials and equipment
• redemption of the balance of the distributor or its return to the manufacturer
• post-contract prohibition of competition (within the limits allowed by local law)
• return of confidential information

Risk minimization strategy: tool-shopping

Common mistakes in the preparation of an international contract of supply

1. A “framework” contract without specifications is valid until the first dispute. The court cannot determine the agreed goods, price and time.
2. Ignoring applicable law, the parties from England and Germany may not suspect that their contract is “by default” applied CISG, which treats penalty and damages differently than their national law.
3. The incorrect name of the institution or outdated regulations make the reservation pathological and force to spend years to determine the competence of the arbitration.
4. EXW without VAT and export realities Foreign buyer cannot physically export goods and export, which leads to disruption of delivery and tax problems for the seller.
5. The confusion of the concepts of “penalty” and “loss” Penalty (penalty) in English law is invalid. Requires a model of liquidated damages.
6. The buyer’s bank blocks the payment, but the seller is obliged to deliver the goods. The contract does not give the seller the right to suspend shipment.
7. The entire contract must contain an “Entire Agreement” clause, which excludes any oral representations and pre-contractual correspondence.

Before signing an international contract, answer 15 questions:

1. Are the parties (name, address, registration number) accurately identified?
2. Is the signatory the proper person according to the trade register?
3. Have we ruled out CISG if it is in line with our strategy?
4. Is the applicable law chosen and is the jurisdiction neutral?
5. Is the arbitration clause enforceable and self-sufficient?
6. Is the exact basis and Incoterms version with a geographical point specified?
7. Is there a mechanism for fixing and changing prices during currency fluctuations?
8. Are payment schedules and security instruments in place?
9. Is the technical specification integrated into the contract?
10. Is a current Privacy and Data Protection Clause (GDPR) included?
11. Is there a time frame and mechanism for quality claims?
12. Does a Force Majeure Clause give the right to avoid long-term events?
13. Is there an automatic right to suspend execution under sanctions restrictions?
14. What are the consequences of termination for goods in transit and warehouse stocks?
15. Where are the assets of the counterparty in case it comes to enforcement?

A strong strategy is usually built on four levels:

1. Doctrinal structuring The choice of the optimal transaction structure (distribution, agency contract, commission, direct delivery). Tax liabilities, the right to deduct VAT and customs risks depend on this.

2. Contractual documentation: The development of a contract, specifications, guarantees and security documents where each risk is identified and covered by the appropriate legal mechanism.

3. Compliance and due diligence Check of the counterparty and its beneficiaries, the product, end-use and destination country for sanctions and export restrictions before signing.

4. Dispute Resolution Strategy Pre-planned conflict action plan: A ready-made package of evidence, an understanding of where to seize, and the presence of an “asymmetrical” clause that allows the creditor to apply to any convenient court if assets are there.

Without the fourth level, the first three are only theoretical defenses.

Can I use the International Chamber of Commerce (ICC) Model Contract?

Yes, ICC Model Contracts (for example, for international sales) are a great basis, but they always require customization for a specific transaction, product, jurisdiction of the parties and logistics.

More importantly: Incoterms or ownership?

Both aspects are critical and lie in different planes. Incoterms distributes the costs and risk of loss of goods during transportation. Applicable law determines the time of transfer of ownership. They may not coincide in time.

How to protect yourself from a sharp fall in the currency?

It is necessary to include a currency clause that allows you to revise the price or link it to a basket of currencies, as well as consider financial hedging instruments.

Is CISG a good or a bad thing?

Different. CISG facilitates negotiations for parties from different legal systems, but contains a number of provisions (e.g., proportionate penalty or right to specification) that may be disadvantageous to the seller. We always recommend an informed choice: to leave the Convention or explicitly exclude its application.

Can the contract be terminated if the counterparty is sanctioned?

It is possible and necessary if the right to immediate termination is expressly provided for in the contract. Without such a clause, the termination may be contested as a breach by the initiator and the performance of the contract may become unlawful.

What to do if the force majeure lasts for a year?

A strong contract must have a maximum force majeure period (e.g., 3-6 months) after which either party is entitled to withdraw from the contract without mutual compensation (except for the refund of the advance).

Related services

• International trade, distribution and cross-border transactions
• International Arbitration, Commercial Disputes and Cross-Border Litigation
• Commercial contracts
• Sanctions, export controls and international compliance
• International regulatory risks and strategic advice

Related material

• How to check a foreign counterparty before concluding a contract
• How to choose an arbitration clause for an international treaty
• Asset tracing: How to find the debtor’s assets before the dispute Enforcement of foreign court and arbitral awards
• Sanctions and international debt collection
• International arbitration: When it is more effective than the court Legal aspects of foreign economic activity: What is important to know about exporters
• How to protect a company from non-payment for international delivery

Conclusion

An international supply agreement is not a formality, but a strategic asset or a colossal threat to business.

A strong contract is not built on trust, but on a detailed analysis of the supply chain, anticipating points of failure and implementing legal mechanisms that will protect the company before, during and after the execution of the transaction.

In cross-border transactions, the winner is not the one who signs the contract faster. The winner is the one who understands where problems will start at the project stage and has already built a system for solving them into the contract.