Requirements Contract: Everything You Need to Know
A requirements contract is an agreement in which the exact amount of items exchanged isn't specifically determined. The amount that will be sold depends on how much the buyer requires. 3 min read
2. Output Contracts and Requirements Contracts
3. Legal Issues
Updated November 2, 2020:
A requirements contract is an agreement in which the exact amount of items exchanged isn't specifically determined. The amount that will be sold depends on how much the buyer requires. Requirements contracts are common when the buyer's needs fluctuate, such as in seasonal farming operations.
About Requirements Contracts
For a specified period of time, a buyer is contractually obligated to purchase all of a particular set of goods that it requires from the seller. An essential element in these agreements is exclusivity. Any agreement that doesn't expressly obligate a buyer to purchase a specific quantity of particular materials or goods isn't a requirements contract.
Buyers and sellers share risk in a requirements contract. The seller assumes the risk of a buyer's business changing in such a way that the cost of fulfilling the requirements becomes unduly costly. The buyer runs the risk of changes in its financial situation. Unexpected price fluctuations may drive these risks.
The benefits for the parties include a predictable demand for sellers and a steady supply for buyers.
Output Contracts and Requirements Contracts
An output contract is the opposite of a requirements contract. In an output agreement, the buyer agrees to buy the full amount that a seller can produce in a certain season or time period. Buyers may start by purchasing a sample batch to make sure it's good quality.
The Uniform Commercial Code, which governs commercial transactions, provides that contractual parties must act in good faith. While the UCC doesn't explicitly say that output and requirements contracts are enforceable, the validity of these agreements is implied.
An agreement between a buyer and seller where the buyer will purchase all goods it requires from the seller, may be interpreted that the buyer has a choice whether it requires any goods at all. Likewise, an agreement in which a seller agrees to sell all of its output to a buyer may be interpreted that the seller is free to control its output.
If you read these agreements this way, it seems to leave one of the parties free to fulfill its obligations or not.
There are valid commercial reasons for these contracts, and courts have found ways to uphold both requirements and output contracts if the only objection to their validity is that they're too indefinite.
When parties try to increase or decrease requirements, this usually results in disputes that go to court. Courts may resolve these disputes with the UCC's "unreasonably disproportionate" test that is used in conjunction with the good faith requirement.
The UCC also provides that a valid agreement involving an exclusive dealing in goods obligates sellers to do their best to supply goods and buyers to do their best to purchase them. This is an application of the doctrine of good faith.
The legality of requirements, output, or other exclusive dealing agreements depends on the application of state or federal antitrust acts, which protect trade and commerce from illegal restraints, price fixing, and price discrimination. According to the UCC, lawful agreements are the only ones that may be enforced.
The biggest concern with requirements contracts is that the amount of goods isn't specified before entering into the agreement. This calls for a level of trust between the parties.
The seller has to trust that the buyer won't back out if demand falls. The buyer has to trust that the seller will continue to supply its needs without a set quantity being listed.
To prevent violations, contract breaches, and other abuses, the following concepts are a major part of these agreements:
- Good faith: Neither party should exercise fraud or intentionally misuse the other party. Each should perform its duties, therefore, in good faith.
- Prior dealings: The requested quantity of goods should be about the same quantity that's been previously requested in prior agreements, if applicable. Major deviations by parties who've had dealings in the past may be viewed as unreasonable.
Contracts are best when each party benefits in some way. Because contract law can be complicated, you may wish to consult with a legal professional before signing one. You want to fully understand the contract's terms so that you know exactly what you're agreeing to.
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