Circular contracting? Choose the right form of contract for your business model!

One form of circular business is the marketing of products suitable for reuse. Such products are put on the market to change hands over time. Products are also repaired rather than thrown away. This is to prevent environmental stress and resource depletion. How does a circular business owner ensure that the product comes back to him? Or that the next owner actually reuses the product? Or that the user handles the product carefully (sustainably)?

In this article, we discuss four contract forms that enable circular business with respect to movable property. Regarding real estate in the circular economy, see this article by Eline Holtland - van der Zwaag.

Contract form is customized

Drafting a contract is customized. This means that the provisions in a contract must be carefully tailored to the business model and product group. Especially in the circular economy, a one size fits all approach does not work. This is partly because circular business is relatively new and the product groups are diverse.

In practice, people sometimes work with Anglo-Saxon contract models such as lease contracts. These usually have to be tested against Dutch law. As will be shown below, the dividing line can be wafer-thin between contracts that see, for example, lease/goods credit and lease/service. Also, the product group may give reason to deliberately choose to buy with buy-back guarantee or, on the contrary, to buy and resell.

1. Lease

Leasing is a great example of a form of contract that can be applied to circular business. Think of rental bikes or shared scooters. Payment is made periodically with a fixed amount or per ride via pay-per-use.

Operational and financial lease

Typically, a distinction is made between two types of lease: operational lease and financial lease. Operational lease focuses on use of the product and financial lease focuses on financing the product. Operational leasing is generally a more circular way of contracting, as the owner is obligated to the user to maintain the product, giving the product a more sustainable use.

With financial leasing, the idea is that the person leasing ultimately becomes the (unconditional) owner of the product. This form of contracting is considered less circular because only the user has an incentive to maintain the product for more sustainable use. This would be different, for example, if a buy-back guarantee is included in the lease contract.

Lease Purchase

Depending on the form and execution of the lease contract, the legal general provisions regarding rent or goods credit (also known as installment plan) may apply. Rent is when an object is given into use and the other party provides consideration for it. The operating lease model is most closely aligned with this. There is debate about which legal provisions are most closely related to the model of financial lease, but in case law financial lease is often qualified as a credit for goods. This is then a reservation of title purchase. This means that the buyer does not become the owner until he has paid a certain amount in redemption.

Clarity in advance

It is important to contract in such a way that it is clear in advance which legal provisions apply. For example, if financial leasing qualifies as rent, the lessor will have to provide the rental enjoyment that the lessee is entitled to expect Also, payments to the lessor may not qualify as repayment for the product put into use, but entirely as rent. However, the legal provisions regarding rent of movable property and goods credit are not of mandatory law for professional parties. Therefore, by deviating from the legal provisions with proper contractual provisions, you can ensure that your contract is properly applied.

2. Service Contract

A service contract is useful for relationships in which the element of service is central. If a product (think washing machine, for example) is offered as a service(PaaS: product as a service), it quickly qualifies as a rental.

Product service systems

However, if a service provider wants to avoid the application of the rental provisions, it will have to use product service systems. These are products that are linked (permanently or not) to services provided by the service provider, making the service central. An example: there are companies that offer products such as washing machines, dryers or dishwashers as a service. In principle, the use of these products is central and will therefore be rental, but installing software can change this. For example, software may allow the service provider to bill periodically and the customer to view his own usage data. Possibly even the software itself will become central as a service(SaaS: software as a service).

If the service element is not sufficiently central and rental provisions apply, the service provider (or landlord, as the case may be) may not be able to impose certain obligations on a tenant. Consider a prohibition against giving the product in use to third parties; this could be an unlawful restriction of the tenant's enjoyment. Drawing up a thorough service contract can help ensure that renting does not inadvertently occur after all.

Pure service contract

In a pure service contract, the customer pays only for the service itself. This implies that the customer does not become the owner of the product through the service contract. As a service provider, it may therefore be wise to include provisions in the service contract that oblige the customer to handle the product as carefully as possible. For example, a service contract (which does not qualify as a rental) may well include a prohibition on giving the product in use to third parties. This is because a service provider will want to avoid the product being subject to depreciation due to careless use.

In this context, the service provider can also, for example, require the customer to use the product only in accordance with the instructions for use. Or to ensure that the product can be taken back undamaged, it is also an option to ask the customer for a deposit.

3. Buy with buy-back guarantee

Buy-and-buy is a form of contract that often occurs with products that can be renewed. Think of electronics or machines which can then be sold again as refurbished .

In the construction of buy-back, the customer first becomes the owner of the product, yet the buyer and seller remain in relation to each other. In fact, it is possible to include a buy-back guarantee in the purchase contract. If you, as business owner , want to issue this guarantee, it may be wise to attach conditions to it. For example, conditions that mean that the buy-back guarantee only applies when certain requirements are met. Consider, for example, the lifespan, condition and maintenance or residual value of the product. Another variation on the buy-back guarantee is the buy-back option. This does not require the seller to repurchase the product, but merely obtains the option to do so.

4. Purchase and resale

Buy-and-sell aligns with the idea of converting trash to treasure. Product groups that often qualify for this are materials that as waste are amenable to recycling such as paper or plastic. For example, consider an office supply manufacturer that supplies an administrative office. The administration office can no longer do anything with the full notebooks, but the third party that converts paper back into newspapers can. In this example, the office supplies manufacturer could make an advance contract with the newspaper manufacturer so that the administrative office knows where to dispose of its paper.

Buy-and-sell is thus the contractual route where a third contractual party enters the picture, in that instead of the seller, only the third party can still do something with the product. Note that the customer retains ownership of the product. If the administrative office does not want to pass on its full notebooks to the third party - for example, because the notebooks contain confidential information - then the third party can waive this option. For this reason, one could speak of a "resale guarantee" from the seller that the buyer may or may not be able to invoke.

In this type of arrangement, potentially every party wins; the seller generates more sales through the contract with the third party, the customer can easily, sustainably and/or even lucratively get rid of its used products, and the third party has an advantageous supply of raw materials. 

In conclusion

Perhaps your circular business model will not fit seamlessly with any of the preceding contractual options. In our practice, we often find that contracts contain elements of multiple contract forms. For example, in addition to the product, software can also be provided as a service. Think of an application that gives the customer insight into his own behavior. As a result, a contract can change color. In each case, which legal rules apply depends on the form and execution of a contract. What form is most appropriate depends, among other things, on your business model and the product group.

Therefore, drafting a contract is always customized and depends on a careful (legal) analysis. Would you like advice on circular contracting? Please contact Lisa Witten for tenancy law questions and Valerie Lipman for questions regarding commercial (software) contracts.