The "Most Favored Nation" Clause, and Why it Matters for Your Business
Most small business owners don’t have the luxury of hiring an “in-house” counsel (an attorney who is an employee of the business) to deal with reviewing contracts, keeping track of the terms and conditions, and negotiating contracts. This can put businesses who rely on vendors at a disadvantage. Each vendor your business relies on for its products or components typically means a different contract, with different terms, applies to the purchase of those products or components. The same can be true if your business serves as a vendor for others.
One contract provision that can be buried in the boilerplate of “standard” agreements is called the “most favored nation” clause, and can have significant long-term financial impacts on your business - in addition to being a litigation risk if these contracts are not tracked.
Brief History
Though an issue for vendor-reliant companies, the most favored nation clause has its origins not in business, but international relations. When negotiating any agreement, price is the obvious lynchpin that determines whether two parties have a deal, or go elsewhere for what they want. One common practice in maintaining an international trade advantage is to ensure no other country gets a better deal than you. As a result, if two countries have agreed to a most favored nation clause, they cannot offer a better deal to any other country in the future without offering that same deal to the “most favored” nation.
In fact, for the World Trade Organization, a most favored nation clause is part-and-parcel of joining. For example, if one WTO member nation cuts agricultural tariffs for another member nation by 2%, it must do the same for all WTO member nations.
Use in Business
In form, the most favored nation clause has been adapted into the most favored customer clause in business contracts, and is most commonly deployed in contracts involving the purchase and sale of goods (though there is no reason this clause can’t be adapted for service providers as well). In substance, it operates the same. If ACME, Inc. enters into a contract to sell Beta, LLC widgets at a price of $0.05 per widget, and proceeds to enter into a contract with Zeta Corp. to sell widgets at $0.03 per widget, ACME, Inc. is contractually obligated to begin selling widgets to Beta, LLC at $0.03 per widget.
If you are a vendor/supplier that unknowingly entered into an agreement with a most favored customer clause, one negative implication is obvious. You are contractually obligated to sell certain goods to certain customers at the lowest price you have available, which has a negative impact on gross profits (and ultimately net income). One not-so-obvious implication is the litigation risk posed by these clauses. If you have a most favored customer clause in your contract with Customer A, but began selling the same goods to Customer B at a lower price 2 years ago, Customer A may sue for the difference over the pas 2 years. Depending on the volume of the goods being moved under the contract (and of course the price differential), this can be significant exposure for a vendor/supplier.
Of course, the clause works both ways. If you are a business that relies on vendors/suppliers, a most favored customer clause can work to your advantage, since you will be entitled to lower prices (and, through litigation, potentially the difference between the price you’ve been paying vs. the lowest price they give to any other customer for those goods).
The True Cost of Avoiding Lawyers
When it comes to contract work, many business (particularly growing businesses) tend to avoid using lawyers as intermediaries. The elephant in the room being “cost.” However, what might have cost a few thousand dollars for a lawyer to review and negotiate contracts can cost tens of thousands of dollars in litigation expenses. Contract litigation not only involves the cost of your company’s attorney, but also the value of a judgment your business may be ordered to pay. As if this weren’t enough, many “standard” or form contracts contain attorney’s fees provisions by default. This means if you lose in court, you may be liable to pay for the winner’s attorney’s fees (in addition to court costs). Though some readers may be skeptical (seeing as this is on a business law firm’s website), it really is best practice to spend some money on one lawyer involved in the contracting process than risk paying thousands more on your attorney’s fees, possibly their attorney’s fees, a court-ordered judgment, and court costs.
Make no mistake, the internet has certainly made business-related legal documents far more accessible to small businesses than ever before. If you are considering using these “form” contracts, please keep in mind, the fact that a clause is in the “fine print” or a company’s representative didn’t know what the “legalese” was saying are not defenses to the contract’s enforceability. It’s best to hire a lawyer to level the playing field when it comes to negotiation, and have one draft an agreement that sufficiently addresses individual contract situations. This will help avoid the expense of litigation due to these “landmines,” because you will have the benefit of knowing exactly what terms are in your contracts.