What is Evergreen (Contract Provision)
Evergreen is a contract provision that automatically renews an agreement after the expiry date. The contract would roll over periodically until one of the parties defaults or gives notice to terminate the contract.
BREAKING DOWN Evergreen (Contract Provision)
When two or more parties enter into a contract, one of the terms they sign off on is how long each party would be bound by the contract. The duration of contracts varies widely and all parties are required to fulfill their obligations for as long as the contract remains in force. However, some contracts have an automatic renewal clause or evergreen clause, which means if neither party terminates it on the expiry date, all parties will be held to abide by the contract policy for another similar duration.
Evergreen clauses can be used in many types of contracts including employee stock option schemes, dividend reinvestment plans (DRIPs), lease agreements, GICs, health care plans, insurance coverage policies, magazine subscriptions, revolving loans, and commodity distribution and supply agreements, etc. Let’s examine some of these examples below.
- Some employee stock option plans provide an evergreen option where additional shares are automatically included in the plan annually. These plans are set to attract and retain great employees who would be incentivized to grow the company to the delight of shareholders. The evergreen options get renewed every year and will remain active unless the board of directors decide to terminate it.
- A dividend reinvestment plan (DRIP) is an option given to shareholders to use dividend payments to buy additional shares in the company. This way, the investor is credited with shares to his account on dividend payment day, instead of cash. An investor who elects this option, in effect, would have an evergreen election which would continue to apply to his dividends until either party cancels the plan.
- A lease term can be structured as an evergreen lease where the lease is automatically renewed at the end of the lease term and rolled over to another term with a similar period, or activated to a month-to-month basis. For example, an individual that enters into an evergreen lease with her landlord would have to use the leased property for a year, after which the contract becomes an indefinite month-to-month live-in arrangement. Of course, during the monthly auto-renewal period, either she or her landlord can break the agreement.
- A Guaranteed Investment Certificate (GIC) is an investment vehicle that locks in an investment for a period of time at a guaranteed rate of return. However, at the end of the term period, if the account holder does not provide the financial institution with instructions to not renew the contract, the institution will automatically renew and lock the funds for a similar period. For example, if an account holder invests $2,000 into a three year non-redeemable GIC, this amount will automatically be renewed for another three years after it matures on its set date.
- Many insurance contracts have evergreen clauses. When a policy holder takes out a car or home insurance policy, the insurer will typically renew the policy for another year, unless explicit information not to do so has been communicated. If any terms of the policy are set to change in the new term, the provider would notify the insured. If the insured does not object or cancel the plan, it will be renewed by the insurance company.
- A coal miner that enters into a contract with a power distribution company to deliver coal every quarter, may do so continuously, through the end of the agreed time period. The contract may be renewed, as with all supply chain vendors, unless either party decides not to continue with the business relationship.
- A borrower with a revolving loan can use up the funds, pay it back, and use it all over again. Only borrowers that meet certain criteria are approved for these loans which are annually reviewed by the lending institution. The borrowers will indefinitely have access to the loan amounts unless they fall out of good standing with the bank. If this occurs, the bank may opt to withdraw the loan at the end of the contract period.
These examples are by no means an exhaustive list of evergreen contracts.
While an evergreen clause provides convenience for either party because they don’t have to renegotiate the terms of the contract on expiry date, one can find himself stuck with these types of contractual agreements if s/he is not satisfied with the dealings. In a case where a dissatisfied party forgets to cancel the agreement when it expires, they may find themselves or their investments locked in for another period of time. For example, an investor with some money in a 2% investment vehicle may have plans on the maturity date to roll over the invested funds into another vehicle with a different company offering 5%. If he fails to give termination notice within the reasonable amount of time stipulated in the policy, he may see his funds automatically renewed with the same fund company for the lower 2% rate. For this reason, due diligence should be carried out by all parties involved to know how and when to dissolve an evergreen contract.