Most favored? Think again

Updated Jan 6, 2010

Q: What is the source of “most favored nations” clauses in contracts? We are negotiating a contract with a shipper who insists these clauses are typical and must be agreed to if we want their business.

A: The term “most favored nations” is obviously a misnomer when applied to a transportation contract. The concept has its origin in procurement contract law and refers to international free trade agreements in which a country agrees to give a trading partner nation preferential treatment, agreeing that no other nation will enjoy more favorable importation tariffs or fees.

When applied in a transportation contract, “most favored nations” treatment means you have set a ceiling for the price you can charge, but not necessarily a floor. Usually the language says that you must offer the contracting carrier the same lower rate that you might agree to with another customer on the same or similar traffic.

One can understand that if a shipper is going to enter a long-term dedicated contract with you, it wants some assurance that it has negotiated the best rate, but frequently “most favored nations” status is demanded by shippers and brokers who really are promising you no guarantee of business.

A clause of this type may have a justification in other contexts that are not relevant to a transportation service agreement. I can understand that if a retailer is going to sell a manufacturer’s sweaters, it wants some assurance its competitor cannot undercut its retail price by purchasing the same sweater from the same manufacturer at a cheaper price. But the same dynamics do not seem to justify imposition of these contract provisions in a typical transportation contract.

During the days of regulation, contract carrier service applied to a dedicated or specialized service that was priced independently of everyday “call on demand” service. Following deregulation, the dominance of spot market pricing and depressed economic conditions has placed downward pressure on rates that shippers and brokers exploit. In this context, a “most favored nations” clause can be seen as one way to negotiate a price without making a commitment.

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Another contract provision to watch for is one that says if a bona fide offer of lower rates is received, the carrier must reduce its rates likewise or lose the business. This kind of language can be troubling for a small carrier that is asked to make a comparatively substantial investment to serve a large shipper on a continuing basis only to find its rate undercut by after-the-fact bargain hunting.

In sum, “most favored nations” clauses and “meet it or lose it” provisions are two contractual terms that adversely affect the enforceability of long-term contracts, but that are executed all too frequently without proper risk assessment.

– Henry Seaton is a transportation lawyer who represents carriers.