Evergreen Contracts: Everything You Need to Know
Evergreen contracts are legal agreements that automatically renew after the expiry date.3 min read
Evergreen contracts are legal agreements that automatically renew after the expiry date.
What Is an Evergreen Contract Provision?
One of the common terms of a contract is the length or duration of the contract. The duration for which the parties remain in contractual obligation varies from contract to contract.
An evergreen contract gets renewed periodically until a party defaults or terminates the contract. An evergreen contract usually contains a renewal period during which a party can choose to terminate the contract. This period varies from 30 to 60 days before the contract renews itself automatically.
In some cases, a party is allowed to terminate the contract just by giving a written notification to the other party. Some contracts may require the terminating party to pay a cancellation fee during the renewal period.
When a contract spells out the procedure for its termination, it usually overrides the local laws.
Some contracts may have an evergreen or automatic renewal clause. If none of the parties terminate the contract after the contract duration comes to an end, the contract gets renewed for another period of similar duration.
A wide variety of contracts may contain an evergreen clause, including the following:
- Employee stock options
- Dividend reinvestment plans
- Lease agreements
- Guaranteed investment certificates
- Insurance policies
- Product distribution agreements
- Revolving loans
Employee Stock Options
Sometimes, an employee stock option plan contains an evergreen clause to automatically include additional shares in the plan every year. The idea is to offer an incentive to employees to grow the company's net worth for shareholders.
The evergreen option renews annually on its own unless the company's board of directors terminates it.
Dividend Reinvestment Plans
Another example is a dividend reinvestment plan wherein shareholders get an option to use the dividends to buy company shares. Instead of paying cash dividends, the company credits the accounts of the shareholders exercising this option with additional shares.
Shareholders exercising this option enjoy an evergreen election that continues to apply to their dividends until the company or the shareholders terminate the plan.
A lease agreement may contain an evergreen clause so as to provide for its automatic renewal when the lease period comes to an end. The lease may be made to renew for a similar duration or on a monthly basis.
For example, you may enter into an evergreen lease agreement with your landlord for a year, after which the lease keeps extending indefinitely on a month-to-month basis. You or your landlord may cancel the lease agreement anytime during the monthly auto-renewal period.
Guaranteed Investment Certificates (GICs)
A GIC guarantees a certain rate of return on your investment for a specified period of time. At the end of the investment period, if you do not expressly instruct the company not to renew the investment, it gets renewed automatically for another period.
Let's say, for instance, you have invested $1,500 in a four-year non-redeemable GIC. On maturity, it automatically renews for another four years. If you choose not to renew the investment, you must expressly instruct the company.
Several insurance policies contain evergreen clauses. For instance, when you buy a car insurance policy for a year, the insurer automatically renews the policy at the end of the term, for yet another year. This is done through a clause that says the policy would be renewed by the insurance company unless the insured does not cancel the plan.
Product Distribution Agreements
When a coal miner agrees to supply coal every quarter to a power distribution company, he may continue to supply the coal even after the end of the contractual period. However, either party may decide to discontinue the supply agreement.
A revolving loan borrower can use the loan amount, repay it, and use it again. Banks grant these loans only to borrowers who meet the specified criteria. They review the status every year.
As a borrower, you continue to have access to the sanctioned funds unless the bank decides otherwise. The lending bank may choose to cancel the loan at the end of the load period.
Pros and Cons of an Evergreen Contract
An evergreen clause offers the convenience of not having to renegotiate the terms upon expiry of the contract. However, you may find yourself stuck with the contract in the event that you are not satisfied with its performance.
If you are dissatisfied with the contract and forget to terminate it on its expiry, you may have to bear with it for yet another period.
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