Due Diligence Before Signing New Vendor Contracts to Reduce Risk

George Benaur, Benaur Law LLC

Business agreement

While large corporations may have the resources to conduct thorough due diligence before committing to a new contractual relationship with a new vendor, many small businesses do not necessarily have those resources. Many business disputes, however, especially those involving small-to-medium sized businesses (but also at times involving large companies), originate from bad deals reached because businesses did not conduct adequate due diligence before entering into the contract.

Here are some examples from cases:

  • The business partner previously sued their former business partners
  • The company was part of various other corporate entities that seemed to be involved in the same business
  • The alleged factory in China was really a trading company, a middle-man for the factory

These are just a few examples for illustration purposes; there are surely many others that businesses discover too late, after the contract is signed and there is a breach of contract situation. Unless sufficient due diligence is conducted on these issues before entering into the contract, the business risks having little options if there is a litigation, especially if the agreement does not contain sufficient protections to try to mitigate such risks (which is a separate topic and not addressed here).

The time and resources spent on researching prospective new business partners will vary depending on the circumstances, such as the industry, the type of vendor arrangement, the amount of the investment, whether it is domestic or international, and many other factors. Generally speaking, however, some basic degree of due diligence should be required as an internal company policy before proceeding with any new contractual relationship.

Business owners can and should conduct basic due diligence on their own. For example, before entering into a new agreement, a business can conduct online searches and ask for referrals from other businesses or local business administration offices. A basic review should consider how long the new vendor has been in the particular business at issue and what type of prior assignments have they handled, what are their operations like and where are they located (e.g. domestic or foreign), and whether they are reliable and deliver products or services on time and within budget. The circumstances may be different depending on the industry and the type of contract, but these issues should be considered as part of the risk analysis.

When the new contract merits investing into more in depth research, businesses may turn to additional resources, such as specialized databases or investigators, to conduct more in depth background searches on prospective partners. The additional review, for example, can gather information on property records, litigation history, UCC filings, or corporate affiliations. Prior litigations, in particular, can reveal important information about the prospective partner (e.g., the owners were involved and lost in a theft of trade secrets case, failed to deliver products as promised, were previously sued for having a sham corporation, etc.).

Selecting the degrees of due diligence in new vendor agreements depends on various factors and will differ from situation to situation. Before companies enter into contracts with new business partners, however, they should try to mitigate risks by conducting adequate due diligence on their new partner or vendor. Doing so can significantly reduce the risk of a dispute in the future, even if it does require an investment of time and money before proceeding with the new agreement.

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