Developing Checklists for Purchase Orders

On LinkedIN people were looking for a standard purchase order checklist. The problem with that is no two companies standard purchase order templates are going to be exactly the same. This means that to create a checklist what you need to do is work you’re your lawyer or contract specialist to compare your P.O. template against what needs to be addressed in the P.O. to ensure the combination of the two meets your needs and creates
a checklist that you can use.

Here’s an example of a contract checklist that I have used that lists all the things I traditionally look for in a contract that you could use as a starting point for that review.
The process would then be to identify”
1) What items that are already covered by the template so you don’t need to check for them.
2) What, if anything, do you need to add or can delete?
3) What do you need to manage?

Identity of the parties (correct legal name(s))
Addresses (mailing and notice addresses. (note: you can’t send certified mail to a Post Office Box)
Purpose of the agreement (why the agreement is being made)
Have all underlying assumptions and representations made been documented and included in the agreement?
Have definitions been created and are those defined terms used throughout the agreement?
Date of execution, effective date, (impact on any orders in process)
Duties of supplier – what must they do
Duties of buyer – what obligations do you have other than payment, if any?
What are the remedies for non-performance of other party? Are they likely to drive the desired behavior?
Term of the agreement.
Dates of performance, Lead times, other restrictions on when work can be done.
Prices, agreed adjustments to pricing
Amounts, quantities
Payment terms, what triggers payment obligations?
Control and approval over changes,
Cost formula for future changes
Delivery terms and delivery point
Packing and packaging requirements
Other deliverables, quantities, timing
Required reviews and approvals
Responsibilities for taxes & duties,
Rights of acceptance.
Warranties, warranty term, repair warranties, limitations or exclusions.
Limitations of liability, damages, cap on buyer’s liability.
General indemnification against personal injury or property damage.
Insurance requirements.
Intellectual property indemnification.
Definitions of circumstances that constitute a breach.
Cure period to correct breaches.
Rights and responsibilities for termination for cause.
Rights and responsibilities for termination without cause (or cancel the order).
Governing law, venue of any law suits.
Treatment and or use of information disclosed / confidentiality.
Merger provision stating it represents the entire agreement between the parties.
Provisions that survive the termination or expiration of the agreement (order).
Force majeure provisions.
Order flexibility (cancellation, reschedule).
Other provisions for support, training, maintenance, repair.
Did you incorporate specifications, statement of work, acceptance test, quality, workmanship or other applicable requirements?

Other issues and things to check:
Continuity of supply commitments (guaranteed availability, end of life notices with last time buy options)
Additional terms if outsourcing will be used where 3rd party will purchase e.g. Third Party Beneficiary or rights of enforcement of terms
Signature of Authorized Parties
Define key performance terms such as day, hours, so it’s clear exactly what it means (e.g. calendar versus business, clock hours versus work hours).
If words have multiple meanings which could create a different interpretation, make it a Defined term with the meaning clear.
Check to avoid commonly misused terms – e.g. Assure, Ensure, Insure or Bi- versus Semi such as Bi-monthly = every other month, semimonthly equals twice a month
Carefully check the use of conjunctions (and/ or) to ensure it meets your desired intent.
When providing a list of examples, if other things may apply make sure you aren’t limited to the list by including something like “shall include, but not be limited to…” so its clear that the list isn’t all inclusive.
Check punctuation for proper use and to verify it means what you want to say. Punctuation can change the entire meaning of a sentence or clause.
Use exhibits when necessary to explain things
If words don’t clearly describe it, provide examples of what is meant
Spell out dates instead of date numbering conventions (08/06/2005) so it’s clear to all parties exactly what is meant. In the example depending on where you are from it can mean either August 6, 2005 or June 8, 2005.
When including numbers, spell them out in both words and numbers
When dealing internationally be clear on the currency used. For example, dollars can be U.S., Canadian, Taiwan, Singapore, Hong Kong etc.
Check to make sure that separate documents are properly incorporated by reference. Check the referenced title, date, revision level, number of pages against the actual document so everything matches.
Check for inconsistencies between individual terms and between the agreement and documents incorporated by reference
Have every section numbered, every page numbered and include identifying information on each page just in case pages become separated.
Don’t rely on spell check software. It may be the incorrect word, but as long as it’s a real word the software won’t highlight it
Proof read it!


If you learned from this post, think about how much more you could learn from my book. "Negotiating Procurement Contracts - The Knowledge to Negotiate"
The book is only US$24.95 plus shipping. The hot-link to amazon.com is above the date.

Bargaining Zones - A New Look

In a number of books on negotiation the authors speak about negotiation settlement ranges. The assumption is that both parties have their desired positions and a walk away position. In the Suppliers case they will never go below a certain amount and Buyer will never go above a certain amount. So the premise is the bargaining zone for the negotiation will be where the Buyer's and Supplier's ranges overlap. This iwass a great concept in theory, in practice it’s not very useful as in most negotiations you are not dealing with a single issue such as price alone, you are dealing with many issues that affect the cost of the relationship and your life cycle cost

The simple fact is Buyer’s may be willing to pay more than what they consider to be their worst case price if they see additional value. The may also pay more if they need what the Supplier is selling and simply don’t have an alternative where they can walk away. Similarly, Suppliers have been known to sell for less than their worst case if they see additional value from the sale or they need the business and can’t walk away. This means that depending upon the circumstances of each of the parties at the time of the negotiation and the leverage each party has, their best and worst cases will change and so will the “bargaining zone.”

Even on strict price negotiations who you buy from will impact the bargaining zone. For example if you buy from a Supplier subsidiary their bargaining zone will be impacted by what they had to pay to purchase the product at the transfer price from the Supplier and what overhead and profit they need to make for that subsidiary. If you purchase a product from a distributor their bargaining zone is going to be impacted by the deal they have with the OEM. Most distributor relationships fall into two price models. A common type is the distributor is given a discount off the Suppliers list price, so their worst case selling price be based upon that discount plus what they need to make to cover their overhead and profit. The other distributor model is more of a price protection approach has target selling prices and they get their discounts and margins by staying close to the target selling price, so their bargaining zone may be very small.

As a Buyer going into a negotiation, its important to establish your goals and what your walk away point would be as that sets your own bargaining zone. Its also important to track and consider the impact of each concession on the total cost of the relationship. Where you really get value you may agree to pay more than planned. If the Supplier clearly wants to provide you less under the contract you want to make sure that each time that is proposed you have the expectation that you will pay less as a result.

When should you try to uncover the Supplier’s bargaining zone? Normally I wouldn’t care about the Supplier’s bargaining zone as their responses as part of the negotiation would indicate where it will be. If I felt it appropriate I could include a target price as part of a RFP to serve as an anchor for negotiations. The key is to never head too far down the path with the Supplier (especially if the circumstances could lock you into using them), before you know whether or not the potential deal will be acceptable. I’ve seen too many Buyers have to settle for bad deals simply because they had either invested to much into the relationship to walk away or because they simply did not have the time to start over with another supplier.
 
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In considering the bargaining zone you need to take the concept called “value equivalence into account. Graphically value equivalence looks like this

All value equivalence means there is a relationship between price and value. The more value you get, the more you should be willing to pay. The less value you get, the less you want to pay. To a supplier in selling their goal is to show how the unique features of their product, services or additional services will provide a benefit to you that you will value. If they can do that and they know that their unique features are providing you with value, that may lessen the competition from suppliers whose products or services don’t have the same features or added services. When this occurs they will try to stay closer to their desired price.

If they can’t get you to admit that their unique features will provide you with a benefit that you will value, that forces them compete on price against products that don’t have those features. Value also exists in the contract terms you negotiate as what you agree upon will either add to or reduce your costs and risks in the relationship. Any time a supplier doesn’t want to agree to a term what you need to do is make it clear that they are significantly trying to diminish the value. If you can’t accept the change you make it clear that at those terms the value isn’t there to warrant the purchase. If you can accept the terms, you make it clear that since the value is reduced to you, you need to pay less. Make it clear that changes to what you need won’t be free. There is a cost that will either impact whether you will buy or what you are willing to pay.

The last aspect of value is how much the other party needs or wants your business. If they really need or want your business that will further drive them toward their minimum selling price. Buyers never want to tell suppliers how much they need the supplier as all that will do is provide them with a reason not to lower your price or not agree to your terms.

How does this tie back or relate to the bargaining zone?
 

The bargaining zone should be a range at a point on the value equivalence line. The bargaining zone could move up or down the value equivalence line as shown with the blue arrows depending upon whether value to the deal is being added or reduced. The supplier’s desired price that is on the high end of the zone is based upon buyer getting maximum value out of the features and service they provide. That increase value is intended to distinguish their product or service from their competitors. The minimum they will accept for the price and terms will depend upon how much they need or want the business.

The buyer’s maximum price will be based upon the value they perceive. The buyer’s desired price can be anything as long as it doesn’t insult or alienate the supplier so they won’t do business with you.

You can use value equivalence to negotiate cost, or push to get greater value. One way to do that is to get prices from competitors that are both higher and lower than the supplier you will be negotiating with. Then compare the features and services that are included with each. Then look at what the price difference is for those features and service to determine if there is sufficient value from those to warranty the cost difference.

If you have a supplier that offers much more at a price that is only slightly more, highlight the differences and tell them that they need to provide more or sell for less because they aren’t offering enough value at their price point. If you have suppliers they don’t have the features who are much cheaper, as long as you haven’t told the supplier that you want or need the product, tell them the added value for the features doesn’t warrant the incremental cost difference. The message is here is what those features or services are worth to me, here is what I can buy another product for that doesn’t have those features. The maximum I want to pay is the sum of the two. The lower price without the features and services and your value for those features and services.

If you don’t need or want those features, let them know that so they know that if they want to make the sale they need to compete on price against companies that don’t have those features.

Just so you understand value equivalence here’s an example. You have Suppliers A, B, C, D who have their price and value plotted on the slide below..

Between A and B the decision should be simple. B offers more value at a lower price. For A to win the business they would either need to provide more value or reduce their price as shown by the red arrows.

Between B and C the difference in value isn’t significant but the price difference is significant. If you wanted to negotiate with C, you use B as the benchmark and only want to pay the reasonable value of the difference in features or services between B and C. You would want to drive C in the direction of the Blue line.

With respect to D, what they are offering at their high price is also the highest potential value, if you value it. There price is consistent with the value. If you valued all they offer you still want to make sure that the incremental price they charge for that is not greater that the combination of the price you were able to drive C to plus the value you place on those incremental features and services as shown by dashed orange line.

Pay when paid.

Pay when paid is a term that prime contractors may try to include in their subcontracts. Instead of having a firm payment period, what pay when paid terms do is make the prime contractor’s responsibility to make payment to a subcontractor contingent upon receiving their payment from the customer. The advantage it provides to the prime customer is cash flow.Instead of having to make payments to their subcontractors and wait until they get paid by the customer, the subcontractors have to wait until the prime gets paid, The prime has no outlay of their own cash or doesn't need to borrow money to pay subcontractors during the project. This reduces the prime contractor's cost. Whether it’s good for the subcontractor will depend upon the circumstances. If the subcontractor was the only subcontractor on the project and they had high confidence that the prime would complete their work in a timely manner without and problems it might be ok as long as prompt payment from the customer could be expected

My of contract terms is you should only take risks that you can control. The greater the number of other subcontractors involved and more work the prime does, the more potential situations where problems caused by someone else would be used to delay or withhold payment, Do you really want to depend upon all the other parties to determine when you will get paid? If you were certain you would get paid in a reasonable period and wanted to take the risk, Further you might be able to include a carrying cost in your price that takes into account the period you are effectively financing the work.

If I had to accept a pay when paid term I would include what I call a safety net.In this the safety net would be the maximum period allowed before you must be paid as long as you met your performance. To me that’s a reasonable request since you have no control over the prime contractors performance or the other subcontractor’s performance. That’s the Prime contractor’s responsibility.

For example:
"Prime Contractors shall pay Subcontractor ten (10) Day after receipt of payment from Customer or net X Days, whichever occurs sooner.

Further to protect against the Prime withholding significant payments for a dispute you might also
want to protect yourself by a term about withholding payment in the event of a dispute which was the topic of a separate post.

Whether a pay when paid clause may be legally enforceable will always depend upon local law. In recent years a number of jurisdictions have enacted laws that are designed to protect smaller contractors against abuses by large contractors.

Retainage.

Retainage is simply the withholding of a portion of the payment due to the supplier until such time as a specific event or milestone occurs. When the event or milestone occurs the agreed portion of the retainage will be released. For example, in a construction contract there could be a provision that ten percent (10%) of the value of each payment will be withheld. There could be a limit on the total amount withheld so that once five percent of the total value of the work has been withheld there will be no withholding on further payments. The defined milestones or events that that will cause a release from the retainage could be that fifty percent of the retained amount will be released upon Substantial Completion of the Work. Substantial Completion would be a term defined in the contract. The remaining fifty percent could be paid at Final Acceptance (another term that would be defined in the agreement). There could also be a provision where some portion of the retainage could be held during the warranty period. Where retainage is handy is when payments are being made based upon the estimated percentage of completion of the work. While you would like those invoices to be as accurate as possible, you have both the amount of retainage and the natural lag between invoice and payment to protect you from paying too much too soon.

Retainage is an alternative to requiring the supplier to provide a performance bond or other guarantee that the work will be performed. This means that the value of the amount being retained needs to be significant enough to serve as leverage to have the supplier complete the work before the retainage is released. The same type of protection may be accomplished by simply structuring a payment schedule where you make sure that they payments aren’t front end loaded (meaning the payment schedule doesn’t pay the supplier too much in early stages) and a significant portion of the contract price will not be paid until a final milestone such as Final Acceptance is complete.

Implied Warranties – What are they and why would a supplier want to disclaim them?

An implied warranty is one that that is not expressly stated in the agreement but is recognized or imposed by law based on the nature of the transaction. For example under the Uniform Commercial Code enacted in the U.S. there are two implied warranties – merchantability, and fitness for a particular purpose. The implied warranty of merchantability is that the item being sold is of merchantable quality. Merchantable quality is quality that is generally acceptable in the specific line of trade. An implied warranty of fitness for a particular purpose means that the item being sold is fit for the purpose for which the buyer is purchasing the item.

If all a supplier wanted to do is not be responsible for quality, they could simply state that the product is being sold on an as-is basis. In doing that they are making no representations as to the quality of the product. Most suppliers are less concerned with the warranty of merchantability than they are with the warranty of fitness for a particular purpose. That’s usually the implied warranty they want to avoid when they want to include a specific disclaimer against implied warranties.

For a supplier to be held to the warranty of fitness for a particular purpose the buyer must have disclosed the specific purpose to the supplier. If they did and the warranty of fitness for a particular purpose applied and the product was not fit for that purpose, the buyer could terminate the contract and sue for breach of the warranty and pursue damages. They could insist on the supplier correcting the problem at the supplier’s expense as an alternative to pursuing breach and damages. They could also keep the product and use the fact that it does not meet the implied warranty to collect damages for the diminished value or simply pay less.

Most suppliers simply want to sell products, they want buyers to determine what they need so that it’s the buyer’s problem if the product doesn’t meet their needs. What they don’t want is their sales to result in claims, lawsuits or damages if it isn’t fit for the buyer’s specific purpose. That’s why they want to include the disclaimer.

There can be a number of purchases where a buyer is definitely relying upon the supplier to provide them with a product or service that does meet a specific requirement or purpose. In those situations you would not rely upon an implied warranty. You would want to either make acceptance conditional upon proving that it does meet those requirement, make it an express warranty or both. In the acceptance and test requirement you would specify both the specific purpose it is required to meet and include acceptance terms that require that the item demonstrates that it does in fact meet that specific purpose. Your obligation to make payment should be conditioned upon that acceptance. That way if it doesn’t meet those requirements you can return the product and not make payment or you can work with the supplier to correct the problem. Including it as a warranty would protect you against the potential that it did meet the requirements at acceptance but later failed to meet those needs.

Without acceptance to prove it works or an implied or express warranty of fitness for a particular the rule “caveat emptor” applies. If there is a problem it’s your problem. What you can do will depend upon what return or restocking rights you have in the agreement or what the supplier decides they will do. With those terms it’s the supplier’s problem.

Incorporation by reference - Obsolete Standards

What happens when an obsolete standard is specified and incorporated by reference into the Agreement?

You can incorporate any document by reference into your agreement. It doesn’t need to be active or current. For example, if you had a previous document with a supplier that you had let expire and you needed to do business with the supplier again, you could incorporate the entire terms of the prior agreement by reference and then add or deleted terms needed for the new agreement.

What about standards? If the standard was incorporated by reference into the agreement you would be required to meet it even if the standard was defunct. There would be exceptions to that if country law required that the current standards must be complied with. If the contractor was required by law to meet the new standard, the responsibility for any cost difference would belong to the buyer. The buyer could argue that the contractor either knew or should have known that the new standards were required as a matter of complying with the law and as a result the price should have included the cost for complying with the new standard. In this case the court would look at the entire agreement. If there was language in the agreement that required the supplier to comply with applicable law and the new standard was mandated by law, the buyer might prevail.
If the agreement made no mention of the requirement to comply with that applicable country’s law, the supplier might prevail. That is because in the event of an inconsistency, it will be construed against the party that drafted the document.

If the document that referred to obsolete standards was prepared by a third party such as an architect, engineer or consultant. the owner could potentially file a claim against them. That would be considered an “error or omission.” A claim for errors and omissions could include damages sustained and any cost of re-work to correct the error or omission. It would not include
any areas where the owner received additional value as a result of the new standard. The principles of equity would prevent the owner from financially benefitting from the error or omission.

Termination without cause - Is it better for the Supplier of the Buyer?

The simple answer is that it really depends upon the circumstances of the parties.

There are two types of suppliers. There are supplier that don't have any problems and they are performing well. They may not like termination without cause clauses as they will have to make new sales to backfill the work. There are suppliers that are having major problems performing and are teetering on potential termination for cause. If a supplier feels that they could ever fall into that second category they should welcome it. On the downside they will lose the business. On the up-side it can prevent them from wasting more money trying to perform. If exercised it extinguishes the buyer's right to collect damages. It also usually allows them the right to collect costs of termination which they wouldn't be able to collect if they were terminated for cause. It's that latter situation where the supplier welcomes it as it dramatically will reduce their cost and liability.

As to Buyers, it would all depend upon the reason for the exercise of the termination. If a buyer is exercising the right on a supplier that is performing because their circumstances have changed, clearly that buyer limits the costs on something they no longer may need or want. It does however cost them what they may have already invested and paid for and it costs them the costs of termination they must pay the supplier. There is always a significant costs associated. If the Buyer is exercising the right to terminate without cause because they supplier is simply not performing and they don’t have confidence in them in the future, the only real benefit they get is not having to deal with that supplier and maybe get better assurance that the work will be performed when they use someone else.I've had suppliers that wanted to do their own thing their own way rather than listed to what my company wanted or needed and those I clearly used termination without cause with.The costs to the buyer is what they have paid to date, the costs of termination and whatever it will cost to complete the work. What the prior supplier had done may also have no value and may need to be scrapped.

If the situation is something like switching from one supplier to another by exercising a termination for convenience, the advantage may be to the buyer.In that case the buyer will always need to consider the cost of termination against the benefits they will get from the new supplier to determine if it makes economic sense to switch. Buyers could use the threat of switching as leverage to get price reductions.

In negotiating termination without cause provisions in contracts that don't have firm commitments to purchase such as blanket or master agreements I explain that the termination without cause provision is in their best interest. When they give me that puzzled look I explain that I can effectively do the same thing as terminating the agreement without cause by simply stopping purchasing. The advantage to them is it lets them know that orders won't be forthcoming and that any materials or work that I authorized that they still have will be paid for as part of the termination,.

The Two Step

In Texas the two-step is a dance performed to country music. In negotiation what I call a “two step” is an approach that I like to use when I don’t like the commitment they supplier will accept. I might be able to accept the commitment they want if there was something more to it. That something more is what I call the second step. Let me give you a number of examples of what I mean.

A supplier is unwilling to agree to firm time to perform and will only commitment using reasonable efforts to perform by a specified date or within a period. For example they will only agree to use reasonable commercial efforts to meet your specified delivery date. You want them to try but you are also concerned with the fact that such a commitment doesn’t guarantee if or when when performance will occur. All the supplier has to do is exercise the required efforts. The second step would be to also include a firm commitment as part of their commitment. For example: “Supplier shall use reasonable efforts to delivery the product within thirty days. Supplier shall deliver the product in no greater than forty-five days.”

Your customer wants to include a pay-when-paid payment term. That type of commitment doesn’t guarantee you when you will actually be paid. You don’t want the obligation to make payment be open ended, especially since you don’t control when that will occur. In this case the second step would be to include a firm period. For example: “Prime Co. shall pay Sub Co. within ten (10) Days after receipt of payment from Customer Co, or net ninety days, whichever occurs sooner.

You want a termination for convenience provision and the Supplier wants to be reimbursed their actual and reasonable costs associated with the termination. If you agreed to only that the potential costs could be unlimited. The costs would only need to be actual and reasonable. The second step in this commitment would be to manage and limit those costs. “In the event Buyer terminates this agreement without cause, Buyer shall reimburse Supplier for its actual and reasonable costs associated with the termination. Supplier shall use reasonable efforts to mitigate the cost of the termination and the total cost of the termination shall not exceed the contract Price.”

Your warranty provides for four remedies repair, replace, refund or credit. Your language has you deciding upon which option you can select. The Supplier wants to decide which option they provide because they don’t want you demanding new product when they can repair it or they don’t want you to demand a refund or credit as a way of reducing your inventory. If you provide them with the right the second step is control or manage which options they Supplier can select. “In the event of a warranty defect, Supplier may, at their sole option, repair or replace the Product, Supplier’s option to refund or credit the purchase price shall require buyer’s approval.” That way if you needed the product they couldn’t take the cheap way out and simply refund the price, or worse provide you with a credit that you won’t be using any time soon. If you allow credits, you could either include a second step to that as part the term or include a second step as a condition of your approval. “If buyer makes no purchases within a sixty-day period, Supplier shall immediately refund the full amount of any credits.”

Second steps can also be used to increase the standard of commitment a party has to perform, or the level of effort required which increases their costs or impact. For example: "Supplier shall use commercially reasonable efforts to repair or replace materials under warranty in ten (10) calendar days after receipt". The second step could be "If Supplier is unable to delivery within ten calendar days, Supplier shall use its best efforts to expedite delivery. Supplier shall deliver the repaired or replaced product no later than thirty (30) calendar days.” In this example, commercially reasonable efforts is a low standard which means that if it would cost the supplier more to perform than usual, they don’t have to do it. The repair or replacement would follow their normal process. By including best efforts after 10 days, it would require them to perform the activity irrespective of the cost. By including the firm commitment to thirty days, it changes the standard from only efforts to a firm commitment.

Second steps can be used to make commitments that are not firm, firm. They can be a limiters or qualifiers. Supplier may have reasonable reasons for what they are demanding, but what they want to provide you as a result may not be enough. I use second steps to make sure I get what I need. If a supplier doesn’t want to give you that second step that should be a red flag. If the second step changes the parameters to what should be reasonable and they don’t want to agree I would be concerned their real intent. Second steps are a linking tactic where you are saying that I’ll give you what you want provided I get what I want.

Allocation of Supply.

There are a number of reasons why a supplier may have constrained supply and need to place the availability of that product on allocation. If you negotiate procurement contracts I think its important to understand the dynamics that occur when a supplier goes into allocation There are two natural tendencies that most suppliers will follow when a product is on allocation. First, since there is limited availability they want to allocate supply to where they make the most profit. A moderating factor to that is not wanting to alienate key customers.

To understand where you might stand in this process you need to first consider where you would be from a supplier profitability perspective. Profitability is determine by several major factors. Supplier will normally sell through a number of different sales channels. The profitability by sales channel going from the least profitable to the most profitable in general would be 1) Original Equipment Manufacturers (OEM), 2) Value Added Resellers (VAR), 3) Distribution, and 4) Other direct sales such as internet sales.

Profitability is further managed by what’s called tiering within an individual channel. Within the OEM Channel a Supplier could have three tiers with each tier getting different terms and discounts or pricing based upon their value to the supplier and their volume. A Tier 1 in the OEM channel would get the highest discounts and would represent high volume, valued OEM. Tier 3 in the OEM Channel may get a price that is only slightly better than what they would pay if they bought the product from Distribution. Tier 3 OEM’s would be low volume, non-strategic customer. This means that the combination of the channel and the tier establish the profitability. For example a Tier 2 OEM Customer represent the same level of profitability as a Tier 1 VAR customer.

If the Supplier allocated product on profit alone, the vast majority of product would be sold to other direct sales or distribution where the supplier makes the most profit. The problem with that is they would be alienating their biggest customers, the Tier 1 OEM’s and Tier 1 VAR’s. Many companies also rely heavily on distribution for their sales, so they may not also want to alienate them. This means that left to their own choices, the groups that would get the least allocation would be the lowest tier OEM’s and VAR’s and the Other Sales customers.

To protect against having a situations where supply could completely dry up because of allocation, a company may seek to negotiate an allocation of supply provision. The concept of an allocation of supply provision is simple. As an on-going customer you want the supplier to commit to you that you will get your fair share of the available supply. Most of these clauses seek a pro-rata share of the available supply based upon your past purchase history in comparison to the total market for the product. If you purchased two percent of the products before it went into allocation, you want to be provided two percent of the available amount.

If a supplier values your business they should have no problem with committing to giving you a commitment to provide you with your reasonable share of the allocated amount. If they won’t, I would expect that if an allocation were to occur that supplier would focus on what’s best for them. I would never single source that kind of a supplier as I would know that I couldn’t depend upon them for supply.

Adjusted Basis

In yesterday’s post about the cheap way out I mentioned the use of the words "adjusted basis" as
another thing that provides the supplier with cheap way out. Today I want to explain what that means.

The term “adjusted basis” is something that suppliers may seek to insert into a term where the Supplier is obligated to refund the buyer the purchase price. For example, if the Supplier was unable to get a license in the event of an infringement of a third party’s intellectual property rights, they may be obligated to refund the price. If a product failed to meet agreed performance specifications and that could not be corrected, they may be obligated to refund the purchase price.When they attempt to insert language that says that the refund will be on an adjusted basis, what they are saying is that the refund will not be what you paid, it will be less taking into account depreciation, wear and tear, damage to the product or other things that reduce the asset’s value.

The important thing for you to consider is what will be the impact to you of not being able to use the product in the future. For example if you licensed software and you could no longer use that software what would be the impact? If it was used on a stand alone basis and you can simply use another program the impact is small and maybe getting a refund on an adjusted basis may be reasonable. What if you wrote a large amount of code that was linked to using that program which you will no longer be able to use? How would you then fee about getting back less than you paid?
What if you paid to have a piece of capital equipment delivered, and rigged to the site of use and now you’ll have to have that removed, Do you really want to get back only a portion of what you paid?

Those other costs you incurred you may not be able to recover as they would probably be considered as incidental damages and may be precluded by the limitation of liability. The one thing you can control is the amount they will refund. If I was going to incur all those other costs without any ability to recover them,I know that I wouldn’t want the refund to be on an adjusted basis.While you did have the use of the product for a certain period, you also incurred all those other costs that you will not be able to get full value on those investments because of a problem the supplier caused.Using "adjusted basis" in a commitment to provide a refund is just another cheap way out of a problem that the supplier caused.

The “cheap way out”

One of the most important things you need to do in contracting is never allow a supplier a cheap way out in the event of a problem, especially where doing so would leave you with a greater burden.

For example, do you give the supplier the right to terminate the contract for convenience. That may be the cheapest way out of the contract for them, but where will it leave you? If you sourced and invested in qualifying a supplier, can they refuse to accept orders? If they can you’re probably giving them the cheap way out of having to deliver what they promised at the price they promised.If a contract term has a number of alternative remedies, who decides which remedy will be provided. If it’s the supplier, you are offering them a cheap way out.

For example:
If under warranty redemption you allow repair, replace, credit of the purchase price or refund of the purchase price and you leave the total choice of which to do to the supplier, you are offering they a cheap way out. What if you really need the product repaired or replaced and they elected to provide you with a credit? You may need to allow them the ability to choose whether they want to repair or replace the item, but I would want to approve any refund or credit. That way if I needed it the would have the option to just refund the money which may be the cheapest solution for them, they would need to provide repair or replacement.

For example another common area where there may be multiple remedies in when there is a claim of infringement and the supplier has to indemnify the buyer. If the supplier contract or change to your contract said:
“In the event of a claim of infringement against the product Supplier shall either:
1. Procure and pay for a license to use the product.
2. Modify the product so that it is non-infringing
3. Provide a new product that is non-infringing, or
4. Refund the purchase price to the Buyer on an adjusted basis”

What this would be doing is potentially setting the supplier up to have the cheap way out. In reviewing this, the buyer would first consider what is the financial impact to the buyer for each of the options. If they are not all cost neutral to the buyer, you don’t want to allow the supplier to pick which one they want to provide as they would normally pick the one that is cheapest for them. That could be the most expensive for you. To avoid that establish a priority in which those remedies must be provided where the next remedy is available only if the prior remedy is not capable of being done. For example

In the event of a claim of infringement against the product Supplier shall perform the first of the following remedies that is practicable. (capable of being done):
1. Procure and pay for a license to use the product, or
2. Modify the product so that it is non-infringing, or
3. Provide a new product that is non-infringing, or
4. Refund the purchase price to the Buyer on an adjusted basis

If there is a remedy you don’t want, such as you may not want #4, don’t include it on the list.
In doing that, if they failed to do items 1,2, or 3 they have breached the agreement and would be subject to damages. The damages you incur would be more than just a refund. If you included #4 on the list, and they are able to exercise that remedy, that would be all you would be able to collect for the problem. You’ve accepted an agreed remedy. If a supplier wants to pay a refund on an adjusted basis they are seeking an even cheaper way out of a problem.

Estoppel

Individuals In procurement need to understand the concept of estoppel. Estoppel is a theory that exists primarily under equity principles although some jurisdictions may provide for estoppel under law. The primary use of estoppel under equity principles is to prevent what is called “unjust enrichment” by one of the parties. Unjust enrichment is simply getting more at the other party’s expense where the basis for getting more simply is not warranted. Estoppel precludes or “stops” a person from asserting a fact or a right or prevents a party from denying a fact. Acts that may create a situation where estoppel may apply is when one party’s actions, conduct, statements, admissions, or failure to act prejudices the other party. For example if you had apparent authority to tell a supplier to start to do the work and they did, you could later deny them payment arguing that there was no contract or order. Estoppel would prevent you from denying that fact because you received the value of the work and to not pay for the work performed would prejudice the supplier

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There are several types of estoppel. The ones that would apply most to procurement are:

Equitable estoppel .This occurs where one party is barred from asserting a fact or right because they made false representations or concealed the facts. This is called equitable estoppel). For example, if a supplier made a representation in a contract that a certain thing about the product was true or concealed facts knowing that it wasn’t true, they would be prevented from arguing that its wasn’t true or the buyer shouldn’t have relied on the representation.

Estoppel by latches. This occurs where a party is barred from asserting a fact or right because they failed to act until the other party was prejudiced by the delay. For example, if a painting company arrived at your house and started to paint your house in error and you knew that they were doing it and took no action to stop it, in a claim by that company for payment you could estopped or prevented from asserting that you had no contract with the supplier or failed to authorize the work.

For procurement the key is your actions, statements, admissions or failure to act, if they prejudice the supplier, may prevent you from asserting or denying certain facts. In dealing with a supplier, rather than rely upon their actions, statements, or admissions make sure they become part of the agreement so you don’t have to rely upon estoppel. Rather than rely upon the supplier’s inaction, make your agreement clear as to what is required and what occurs if there is a failure to act. A good example of that is supplier claims. The fact that a supplier has not submitted a claim does not mean that there are no claims. If you want to manage supplier claims so they must be brought within a specific time period so that extinguishes their ability to make claims after that point, make sure that’s clear in the agreement.

Contracts versus Agreements

I continue to be amazed at some of the posts that I see on LinkedIN. One topic asked what was the difference between a contract and an agreement. Some of the responses said that agreements weren’t enforceable, but contracts were. That’s simply wrong. The simple fact is what you call a document has no impact on whether it will be enforceable or not, its whether the document meets all the requirements for it to be a legally binding in accordance with contract law.

Contract law requires six things for an enforceable agreement between the parties 1) an offer, 2) an acceptance, 3) legal purpose and objective 4) a meeting of the minds of the parties, 5) consideration and 6) competent parties. (See post Contract – legal requirements for a contract). The laws of different jurisdictions may further require other things to make it enforceable. For example, countries that have a "statute of frauds" law require a writing for certain transactions to be enforceable. Other locations may require documents to be sealed, or notorized or include a tax stamp to enforce them.

The simple fact is you can call the document that represents a transaction between two parties almost anything. It can be a contract, an agreement, a lease, a license, a non-disclosure agreement, or virtually anything else. Purchase Orders aren’t called contracts but under the law of contracts they become an enforceable contract when they meet the six requirements to form a contract. Even documents called Memorandums of Understanding and Letters of Intent can be legally enforceable contracts. All that has to occur is for the content to meet the requirements to form a contract and be signed by both of the parties. Calling a document something different than a contract does not protect you from the other party enforcing it if the document itself meets the requirements to form a contract.

In many contracts the term agreement is made a defined term. This is done so that every time that defined term is used it has the meaning that is set forth in the defined term. For example, you could have a purchase contract, a statement of work, specifications, other documents and could be issuing purchase orders ordering the product or service. When defined to include all of those documents as making up the complete agreement by the parties, when you use the defined term it would include all the requirements of those documents and it would be interpreted in accordance with the order of precedence you establish.

The internet is a great tool and social media sites can also help you learn. Just remember not all the items posted may be correct or accurate. With my blog, if someone feels a post is inaccurate please leave a comment, I want readers to get accurate knowledge.


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Withholding Payment for Disputes

Many people confuse withholding payments in the event of a dispute with set-off. Set-off is
Is a common law right where accounts payable may be offset against accounts receivable. The common law right of set-off does not apply in the event of a dispute. A dispute is a claim, it is not an account receivable. Buyers may want to withhold payments for a number of reasons, some of which may be reasonable while others may not. Suppliers that don’t want buyers to withhold payments may try to include language in the agreement to the effect that in the event of a dispute, the buyer must still make all payments in accordance with the payment terms. What this will do is not prevent the buyer from withholding payments, but it would subject the buyer to damages for the breach of that commitment and would require the supplier to pursue the issue in court or arbitration to get an enforceable award.

The key for the Suppliers in withholding is you simply do not want the unscrupulous buyer from withholding amounts that are much larger than the item in dispute and you don’t want them unreasonably delaying the coming to agreement where they would have free use of your money in the interim. The key for the Buyer is if you have a problem you don’t want to pay the supplier all the money and then have to chase or sue them to collect.

This is clearly a situation where you want the contract term to drive the desired behavior. A potential solution should limit the amount being withheld to only what would be a reasonable value for what is under dispute. Second you want the terms to drive closure of the dispute as fast as possible.

Here is an example of what I mean by using terms to drive behavior: *

1. “In the event of a dispute Buyer may withhold only the reasonable value of the amount under dispute”. This prevents them from withholding the complete payment and limits it to only the value of the dispute. It also requires reasonableness in establishing the value.

2. “The parties will immediately make authorized personnel available to meet and make good faith attempts to resolve the dispute”. This would prevent the parties from delaying the settlement. It also requires that they act in good faith.

3. “If within thirty calendar days the dispute is not resolved, either party may request binding arbitration. If the parties cannot agree upon an arbitrator they will ask the ___________ Arbitration
Association to appoint an independent arbitrator. “ You want to avoid delay.

4. The cost of arbitration shall be shared on a pro-rata basis based upon the percentage of the claim amount awarded.” This would drive both parties to be more reasonable in their discussions as they know if it went to arbitration and they were wrong they would also have the cost of the arbitration to pay.

5. “For monies retained by Buyer, any amount in excess of the amount the parties agreed or arbitrator agreed, Buyer shall pay Supplier interest at the rate of ____ percent commencing from the date the payment should have been made.” This would drive the Buyer to both be reasonable in what they withhold and to settle sooner as its no longer free money to them.

6. “Payment of monies due Supplier based upon agreement of the parties or the decision of the arbitrator plus interest shall be paid within ten calendar days after the date of such agreement or arbitrator decision.” As the customer is already late in paying, you wouldn’t want the normal payment terms to apply.

There may be times when a customer simply feels that the supplier won’t bother to sue them or when the Supplier may not want to use arbitration. In that case think about what behavior the following would drive:

“In the event of a dispute, Buyer may withhold only the reasonable value of the amount under dispute. The parties will immediately make authorized personnel available to meet and make good faith attempts to resolve the dispute. If within thirty calendar days the dispute is not resolved, Supplier may commence an action for breach of the agreement. The reasonable legal fees of both parties shall be shared on a pro-rata basis based upon the court’s determination of the amount due. For example, if the court found the customer to have wrongfully withheld the complete payment, customer would be responsible for payment of their, and the Supplier’s legal fees. If the court found that customer wrongfully withheld half of the payment, each party would be responsible to pay half. For monies retained by Buyer any amount in excess of the amount the parties agreed or the court awarded, Buyer shall pay Supplier interest at the rate of ____ percent commencing from the date the payment should have been made. Payment of monies due Supplier based upon agreement of the parties or the court award plus applicable attorney’s fees plus interest shall be paid within ten calendar days after the date of such agreement or arbitrator decision. ”*

In the example the cost of not being reasonable and coming to agreement goes up dramatically and that should drive the parties to behave more reasonably in trying to settle the dispute.

While this can manage the impact, it doesn’t avoid disputes.

* Note: Language provided is always an example. Always check with your local contracts or legal personnel to make sure that language will be enforceable in your jurisdiction.


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Set-Off

Set-off, which is also referred to as offset, is a common law right to deduct any receivables from any payables. Whether a party has the right to perform set-off will depend upon several things. The most important is the law that applies to the contract. If that jurisdiction follows English common law you may have that right. In locations that don’t follow English common law, it would depend upon what the law of that jurisdiction allows. The next thing to check is whether your agreement has what's called a "merger provision". That's a statement that the agreement represents the entire understanding between the parties. The next thing to check is whether there is a limitation on remedies to only what is spelled out in the agreement. If you have a merger provision and the contract limits the parties to only have the remedies in the agreement a party may not have the right to perform set-off.

Why would you want to have set-off? While it’s a process that significantly complicates accounting for transactions, it does provide some protection in situations where both parties could be owing the other and may be use to manage credit. For example if you had a supplier that you needed to sell products to rather than consign, it would allow you to deduct any payments the supplier owes you from the payments you need to make to the supplier. This could be especially important if you were dealing with significant amounts and the supplier had a poor credit rating where you didn't want to allow them to increase the amount of payables to you. The reverse could be true for a supplier wanting to manage the amount of credit they are extending to a buyer that may not have a great credit rating. Rather than having to extend the additional amount of credit while you wait for payment, offset provides an immediate action. For offset to have significant value in a contract, the amounts involved would need to be significant as it does create a accounting complexity in tracking transactions.
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If you feel that you need to have the right of set-off, rather that rely upon common law or statutory law I whould specify that right in the Agreement. If you don’t want to have set-off apply you should specifically disclaim any right to set off.Being silent in an agreement doesn't protect you from having a set-off if set-off is allowed by law,

If you spelled out that neither party had the right of set-off, that would extinguish the common law right.Courts would look firth to the intent of the parties that is expressed in the agreement.
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The right of set-off only applies to the same legal entities involved. Just like a parent company isn't liable for a subsidiary unless they sign a parent or company guarantee, other entities of the buyer or supplier aren't liable for the payments for their other company legal entities unless they specifically agree to that in writing.For example If you sold product to Supplier Parent and had purchases from Supplier Subsidiary neither the Buyer or the Supplier would have the right of offset as the receivables and payables were not with the same legal entity.

Most companies will be very reluctant to do cross company set-off and that is especially true internationally. That’s not just because of the accounting problems it creates. It would also involve inter-company transfers of funds that can cause tax issues, It would also potentially involve currency losses or gains as the two companies settle accounts between them.


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Mitigation of costs.

A commitment to mitigate costs requires a party to take reasonable steps to reduce the damages, injury or cost, and to prevent them from getting worse. You could potentially look for a requirement to mitigate costs if there is an injury caused by another party’s negligence, in a breach of contract of a contract but most commonly it is included as a requirement when you cancel orders or terminate an agreement. For example, if you require a supplier to mitigate costs associated with a cancellation or termination, they would be required to take reasonable steps to try to keep those costs to a minimum. In mitigating a cost, reasonable steps could include canceling their orders with their supplier, rescheduling work, selling the product to other parties, etc.

In mitigation language the key is in the use of the appropriate standard for the commitment to mitigate costs. For example if a supplier wants the standard for mitigating that they will use “commercially reasonable” efforts to mitigate the cost, what that would mean is if it would cost them more money to do it, they don’t have to do that. That negates the goal of having a mitigation obligation.

As a Buyer, to get a mitigation commitment that helps you reduce costs, you want to include a the standard or reasonableness. Meeting a reasonableness standard may require the supplier to spend money to mitigate the costs. That means that mitigation language should also include an obligation to reimburse the supplier for those costs of mitigation. To control those potential costs you would also want to place three requirements as conditions of your paying those mitigation costs. First, you want to pay actual costs. Second, you want those costs to be reasonable. Lastly, you also should include a statement to the effect that the total cost, including the cost of mitigation shall not exceed the purchase price. In a cancellation or termination you don’t want to pay more than what it would have cost if the work was completed..

Always check with your lawyer in drafting terms, but a mitigation clause could be something as simple as this:

“In the event of Buyer’s cancellation of an order or Buyer’s termination of this Agreement without cause, Supplier shall use reasonable efforts to mitigate any damages or costs. Buyer shall reimburse Supplier’s actual and reasonable costs required for Mitigation. The total cost to Buyer including the costs of mitigation shall not exceed the Price.”


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Estoppel

Estoppel is a theory that exists primarily under equity principles although some jurisdictions may provide for estoppel under law. People need to understand the concept of estoppel.

The primary use of estoppel under equity principles where the goal is to prevent unjust enrichment by one of the parties. Estoppel precludes or "stops" a person from asserting a fact or a right or prevents a party from denying a fact. Situations where and estoppel may apply is when a party’s actions, statements, statements conduct or failure to act prejudices the other party. There are several types of estoppel.

Equitable estoppel .In an equitable estoppel a party is barred from asserting a fact or right because they made false representations or concealed the facts.For example, if a supplier made a representation in a contract that a certain thing about the product was true or concealed facts knowing that it wasn’t true, they would be prevented from arguing that its wasn’t true or the buyer shouldn’t have relied on the representation.

Estoppel by latches. This occurs where a party is barred from asserting a fact or right because they failed to act until the other party was prejudiced by the delay.For example, if a painting company arrived at your house and started to paint your house in error and you knew that they were doing it and took no action to stop it, in a claim by that company for payment you could estopped from asserting that you had no contract with the supplier or failed to authorize the work. You had the

Collateral estoppel. Collateral estoppel occurs when there is a court ruling against that party on the same matter in a different case.

The goal in equity is to make sure that the parties are treated equitably and that negative actions or failures to act are not rewarded at the expense of the other party. This differs from the responsibility to mitigate damages. The responsibility to mitigate damages requires the use of reasonable care and diligence to minimize or avoid injury. Using the house painting example if the painting company became aware that it was the wrong house being painted, they could not simply continue and expect to be paid. They would need to take reasonable steps to avoid continuing

What this means to procurement people is if they are seeing a supplier do work that they know the supplier is not authorized to do,they can't simply do nothing and expect to get it for free. They need to act to prevent the supplier from incurring further damages.If they don't in a claim for the cost of the work they may be prevented or estopped from making the assertion that it wasn't authorized.


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Divestitures, Acquisitions and Mergers - Procurements role

When you think of divestitures, acquisitions and mergers people seldom think about the role procurement can or should play in those activities. In all of these activities there will normally be a Merger & Acquisition team that leads the negotiations. There will also be a number of functional teams from all the affected disciplines that perform a number of activities in support of the transaction.

In these types of transactions one of the key activities is being able to establish the value of the transaction. These transactions are normally data intense and if you are a buyer you want to do due diligence to ensure that that data that represents accurately represents the business. If you are the seller you need to collect and prepare information for the prospective buyer’s review. If you are merging you want to see where there is synergy or disconnects between the business and areas of opportunity. Virtually all of these should involve procurement.

If you are selling a business or portion of a business, Procurement is involved in the collection of all procurement and procurement contract information to be included in a data room. In the past a secure room would be set aside where prospective buyers could view the information. Today much of the data is loaded onto a secure site on-line where the information is available for viewing but not copying. As the price of the business will be impacted by future sales of that business, with many divestitures there may be on-going commitments to purchase products or services from the acquiring company. Procurement needs to negotiate those commitments. Most divestitures will also require that all contracts that are applicable to the business being divested must be transferred to the acquiring company. This requires procurement to identifying all the contract documents that apply and then determine how they will meet that obligation. If procurement will no longer have a need for that supplier and contract, the contracts get assigned if they are assignable. If procurement determines that they will need to continue using the supplier and the contract, they can’t assign it as it would leave them without a contract. The would need to either partially assign the agrement, or go through the process of working with the supplier to create a duplicate agreement between the Supplier and the Buyer. It’s important for procurement to have terms in their agreement that will allow assignment in the event of a sale of the business that is a major user of the contract. If you don’t have the right to assign the agreement, you would need to get the supplier’s agreement or not be able to assign the agreement which could be a problem for the buyer. It’s also important to remember that in an assignment, the assigning company will remain secondarily liable under the agreement. To avoid that potential future liability you would either need to do an assignment, assumption and novation or create a duplicate agreement where you are not a party.

When procurement pulls all the information for inclusion in the data room for prospective buyers to review, procurement needs to do a number of things. First they need to review the agreements to determine whether the information is subject to confidentiality restrictions. If the document is confidential, procurement would either need to get agreement that the information can be shared, or would need to include a non-confidential summary. For agreements that can be shared, procurement needs to perform what is called “redacting” which means striking out confidential or sensitive information from what is shared. This prevents prospective buyers from using the acquisition process as a “fishing trip” to uncover information and then not follow through with the purchase.

If you are in an acquisition where you are buying a business, the procurement team plays the opposite role of being the ones that should be reviewing and analyzing all the documentation included in the data room to get a better understanding of the operation, who they do business with, what they buy, what contracts they have and how good those contracts are. You use this information to both understand where there are synergies, identify areas where there will be significant disconnect, substantial work or problems and costs. In this role any major problems or opportunities that you find need to be shared with the project team for their use in negotiating the final price to buy the business. If you do wind up buying the business, Procurement then has the significant role of making sure that all the contracts, licenses, etc. that they need to operate the business are transferred to them. They also need to assimilate all those agreements into their process, load them into their systems. They decide which agreements they want to retain or cancel. They consider which suppliers they will retain or replace with their existing suppliers. They will look at systems and information that they acquired and determine what gets retained, what is retired and what gets converted to their existing systems or whether they convert things to the systems of the company they acquired. Throughout all of this procurement needs to look at where in this combined enterprise they can cut costs, improve performance, leverage suppliers etc. If people were included as part of the acquisition, they will also organizationally look at what staffing is require for the business going forward, and where they need staff. They will look at the resources of both organizations to determine what the best team is going forward.

One of the cornerstones in being able to do a divestiture is you must have an excellent contract system. You need immediate access to information that is accurate and current. You also need all other systems to allow you to identify all things that apply to the affected business and individuals. For example, what computer hardware and what software programs do they have and can those licenses be transferred. That information needs to be stored electronically and be available by the procurement team lead to be able to pull from the system, redact and make available in the team room for review. If you don’t have those systems and discipline it makes doing a divestiture much longer, more complex. It also requires a number of additional people to be involved in the process that can have a number of potential negative impacts.

When you are considering doing a divestiture, buying a business or company. or merging with another company you want a minimal number of people involved and they need to manage the activity under strict non-disclosure requirements. The simple fact is not all potential deals come to fruition. In the interim you want everyone to behave like its business as usual and not have the fact that you are considering a transaction to become public. You don’t want customers making different buying decisions. You don’t want employees responding negatively or in fear of their job, as it may never happen. You also don’t want potential information leaked to the investment community where it would impact the purchase price.

In mergers what procurement may or may not do will depend upon the type of merger that’s involved. In a friendly merger the seller may provide all financial information and not provide other due diligence information until the financial due diligence is acceptable. Once the price and terms of the purchase are agreed, they will then involve procurement to perform their portion of due diligence in evaluating the selling entity. Unlike a divestiture or sale of a business, when there is a merger the existing company becomes part of the acquiring company so things like assigning agreements isn’t necessary. The acquiring company picks up all rights and liabilities under those agreements. The primary role of procurement in the acquiring company is to assimilate all those agreements into their process. They decide which agreements they want to retain or cancel. They consider which suppliers they will retain or replace with their existing suppliers. They will look at systems and information that they acquired and determine what gets retained, what is retired and what gets converted to their existing systems or whether they convert things to the systems of the company they acquired. Throughout all of this procurement needs to look at where in this combined enterprise they can cut costs, improve performance, leverage suppliers etc. They will also organizationally look at what staffing is require, where they need staff, etc. They will look at the resources of both organizations to determine what the best team is going forward.

In a friendly merger situation there will normally be a significant damages agreed if one company refuses to complete the merger. As long as the financials upon which the merger was based are correct, a party cannot back away from completing the merger without paying those damages. This means that once the price and the terms of the purchase are agreed, the information that is shared is usually not redacted.

In a hostile takeover, no information is shared and the acquiring company’s due diligence must be performed without the cooperation or the target company. In a hostile takeover, procurements only role would be if they were successful in the takeover the acquiring company’s procurement team would need to do the same things as would be required after the completion of a friendly merger.


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Injunction Clause

In response to one of my posts, an individual suggested that a better approach would be to use an injunction clause so I thought I should write about that.

An injunction is an order by a court ordering a party to stop doing a specific act. You might want to have a clause that allowed you the right to get an injunction in a number of situations. For example, if you had a confidential disclosure agreement and there was a breach by the receiving party of the confidentiality obligation you might want an injunction preventing further disclosure. If you had licensed intellectual property rights to another party and they were breaching their obligations under the license grant, you might want an injunction preventing further use of those licensed IP rights.

Injunctions are a remedy under the principles of equity that would require a court to find that there would be irreparable harm being caused by the breach and money damages alone would not be adequate. This means that while a contract may include an “injunction clause”, getting an injunction from the court is not automatic. The decision is still up to the judge in the court where the request is made.

Most confidentiality agreements are silent as to damages or remedies. When you are silent as to damages and remedies the types of damages that you may claim are not limited. You can also pursue any remedies available to you under law or equity. The two primary rights available under equity are injunctive relief and specific performance.

Where you have an agreement that grants the use of IP rights, there may be a limitation of liability provision that may limit the types of damages and the types of remedies. It is in this setting that you would want to address the rights to an injunction. It could be done by adding a statement in the license grant that discusses rights in conjunction with a breach of that clause by saying something like: “for any breach of this license grant licensor shall have all remedies available at law or in equity”. It could also be done as a specific clause where the specific causes for seeking an injunction are defined with the right of the licensor to claim injunctive relief if any of those causes occur. That type of clause might also include a right to stop selling items that the licensee might need to further use the intellectual property rights. If it included that, the licensee would probably also want rights under equity so they could look for an order of specific performance if they felt they had not breached the license grant.

The key thing to remember is if you are involved in an activity where you might need equitable relief in the form of an injunction, make sure that the contract doesn’t limit your remedies to only those spelled out in the contract or those available at law. Make if clear that you have the right to seek injunctive relief.


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Secretary's Certificates

A contract is voidable if the individual that signed the contract did not have the authority. Officers of a corporation have implied authority to sign agreements because of their position as an officer.They may also have authority that the company has delegated to them. What about other individuals in the company or individuals that may not even work for the company? How do you check their authority?

The best way is to ask for what is called a "Secretary's Certificate". A “Secretary's Certificate” is a document that is signed and sealed by the Secretary of the Corporation that states that the Board of Directors has voted to delegate authority to a specific individual or group and whether they have the right to further delegate that authority. The Secretary's Certificate would need to be stamped with their seal or whatever is required by that jurisdiction for it to be an official corporate document.

If you have a sealed Secretary's Certificate stating that they have delegated authority to that individual any contract signed by that individual would be binding. If you had a statement that a specific individual is authorized to delegate authority for certain actions, you would also want a signed statement from that individual that documents the delegation. Without proof of the delegation and/or the right to delegate, the company could simply void the bid or contract saying that the person didn't have the authority.For example, a corporation could delegate authority to their general counsel to sign documents and allow the general counsel to further delegate that authority to outside law firms where that delegation would be subject to specific parameters.
Creating an agent that can bind the corporation would also require a delegation of authority by someone in the corporation that both has has been granted the authority and has the right to further delegate it.

In most companies the head of procurement is granted authority by the Board of Directors to sign procurement contracts and they are given the right to further delegate signing authority down to lower levels in procurement. That grant only applies to the legal entity they received their delegation of authority from. For example a CPO of a Parent Company would not have the right to delegate authority to a procurement manager in a subsidiary unless that subsidiary gave them the right to have both authority to sign for that subsidiary and the right to further delegate it to individuals within that subsidiary.


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Cloud computing

I came across a post about cloud computing where a supplier was unwilling to agree where the data will be held. All they wanted to provide was a statement that they abide by the Safe Harbors Program. As purchasing of cloud computing services may be something many companies may be considering, I wanted to share a few thoughts. As with anything new my first advise is talk with your lawyer and then carefully consider what information you may want to have in the “Cloud”.

The simple fact is if you take in personal data or receive another party’s confidential information, no mater where you store information your company or institution would still be liable for any disclosure. Highly confidential company data is something you need to protect to prevent unauthorized disclosures. This means that it’s important to have control over where any of that information will be held. I recently read a good article that talks about that issue:

http://www.francoisegilbert.com/2011/04/cloud-computing-legal-issues-data-location/

Aside from location, another important aspect of any type of cloud agreement is whether the service provider will indemnify you against claims from third parties if there is a disclosure. Do they also have the assets to stand behind those commitments?

A supplier may want to say that they abide by the Safe Harbors program, but what does that mean? It means that the country where they are storing the data meets the EEU privacy standards for personal data. It doesn’t limit where the data can be stored to only EEU countries. That would be a restraint of trade. The supplier could hold the information anywhere as long as the country they hold it in meets those same standards for personal data protection. It wouldn't protect you against government orders to access that data. The Safe Harbors program also does not protect confidential business data. It only protects personal data.

From a contracts perspective I would want to specify where the data will be held. If you must go with a safe harbors commitment in the agreement it shouldn’t be a simple statement, it should be a warranty. With a warranty, if you have a breach you can claim damages and terminate the agreement. If you included a warranty you would also need to look at what your limitation of liability says in the agreement. Most limitations of liability limit damages to only direct damages. You would need to carve third party claims for breach of that warranty out of the limitation of liability. You would also need to carve any indemnities the supplier gives for third party claims for breach of that warranty out of the limitation of liability.

Cloud computing is an exciting new technology with lots of potential and many companies rushing in to sell cloud hosting services. As with anything new its important to do your homework and understand the potential risks.


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Warranty against defects in material and workmanship

What affects the warranty against defects in material and workmanship?

1. For the supplier it’s the product’s reliability. As a buyer there should be a relationship between the warranty period and the stated reliability of the product. If the supplier is pushing for a short warranty when they promise a long reliability period that should make you suspicious. If they are confident in the reliability of the product, the cost of a longer warranty period should be minimal.

2. When does the warranty start? Does it start when the supplier ships the product? If it does you need a longer warranty period to take into account the in transit time and the length of time before the product is used.

3. What's covered by warranty? Does it include parts only, when the real cost of correcting the problem will be the labor?

4. Where will the warranty correction be performed? Will the supplier come to your location to provide the service or does it require return to a supplier location.? If the warranty requires the buyer to return the product to a supplier location, which party is paying the cost to ship it in both directions? If you are paying for any of that, in addition to your cost of handling, that’s adding those costs to the relationship.

5. Are you losing the time you don’t have the product while it is being repaired or replaced? Should the time that you don’t have use of it be added to the period? For any repaired or replaced product do you have a minimum period of time that it will be warranted?

6. For a defective product what inspection or test does the supplier want you to perform prior to sending the product back to them? If you have to perform any inspection or test, that is adding to your costs. If the supplier wants to charge a fee for no defect found or no problem found, tell them that you expected them to ship good product so if they want to pay you the same fee for every time they ship you bad product you’ll consider that. I’ve yet to find a supplier that will agree to that.

7. Product Changes. Unless every change is backward compatible with the prior product, you can run into situations where you may not be able to repair a defective product and you cannot use a current product to replace it.

8. Exclusions. Most warranty exclusions proposed by suppliers are far too broad. Exclusions prevent you from enforcing the warranty so exclusions can significantly add to your cost. If you allow broad exclusions your options are to either try to have the product repaired out of warranty for an additional charge or purchase a replacement at full price.There are three separate posts on warranty exclusions.

What warranty affects

1. Life cycle cost / profit. If the supplier’s warranty is less than the warranty you offer your customers on your product sales that includes the supplier’s product that is an uncovered risk. If the product fails after the supplier’s warranty has expired but before your warranty has expired you will bear the full cost of repairing or replacing that item.

2. Product or spare parts inventory. The period of time that you give a supplier to repair of replace a product means one of two things. Either you do not have use of the item during that period, or you need to carry an inventory of products or spare parts to correct the problem immediately while you wait for the return of the repaired or replaced item. The longer that period is, the larger the inventory you may have. It can also affect product shipments and revenue if you need to pull from manufacturing inventory for use with a customer warranty.

3. Competitiveness of service or maintenance charges. When a service organization knows what they have under warranty and for how long, they can take that into account in pricing their service or maintenance charges. Once the warranty expires, unless they sell “labor only” service or maintenance contracts they would need to include the cost to repair items out of warranty or replace defective items with replacements.One of the keys in service or maintenance is understanding how long they can count on the supplier to provide spare parts our out of warranty repairs that may be needed. Once you get to the point where the supplier will no longer provide the parts or service, the service organization may need to stop offering service or maintenance to its customers or charge the customers substantially more and get what they need from any source including cannibalizing and using parts from products they take in trade for new sales.

What’s most important?
Having a good warranty against defects is not a replacement for having high quality and reliability.A good warranty against defects helps manage against only a portion of the costs you will incur with a defective product. Collecting more of those costs usually requires negotiating an epidemic defects provision. Even that will not cover all your costs. Mort important defective products cause customer satisfaction issues. When a customer buys your product and it fails, they don’t care that it was the supplier’s product that failed. All they know is that they purchased the product from you.


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Joint and several liabilities.

If as a buyer you had a supplier parent company and a supplier subsidiary both sign an agreement, what do you have? The answer is you have a situation where each company is liable for their own performance and their own actions, Neither is liable for the other company’s performance or actions. As those two companies are legally separate, you would need to determine if the supplier subsidiary could meet all the obligations under the agreement on their own. If they can’t, you need to make sure that the parent company also is responsible for their performance and actions..

If they parent company was not a party to the agreement, the way you make them responsible to require them to provide a parent or company guarantee (which is discussed in another post).Since they are also a party to the agreement, you can do that by simply including a statement that the supplier parent and supplier subsidiary are jointly and severally liable under the agreement. By including a statement that they are jointly and severally liable what that means is both may be held individually liable for their own performance or actions. It also means that both would also be liable for the performance or actions of the other company. You might want a subsidiary to be severally liable for a parent company so you could bring an action in the location of the subsidiary rather than the location of the parent company. You want the parent company to be responsible for the performance and actions of the subsidiary as the parent company will have greater assets and resources to stand behind the contract commitments.

Do you always need to have the parties be jointly and severally liable? The answer to that would be the same as do you need to require a parent or company guarantee. If you are dealing with a subsidiary of substantial size with substantial assets where they should be reasonable able to cover any potential damages, you probably don’t need it. Many subsidiaries are just sales or sales and service companies with few assets.If you were going to conduct significant business through them you probably should have it.

A key point to remember is just because a company may be a subsidiary or have a supplier’s company name as part of their name, when you buy from that company and not the supplier parent, you do not have any privity of contract with the supplier. You cannot make any contract claims against the supplier unless you either get them to sign the agreement and they agree to be jointly and severally liable, or you get them to provide a parent or company guarantee.


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Joint Drafting

In many jurisdictions, how a court interprets a contract will follow what is referred to as the rules of contract construction. One of the most common rules is that in the event of an inconsistency in the contract, that inconsistency will be held against the drafter of the agreement.

What happens when an agreement is heavily negotiated with both parties having drafted sections of the agreement? When someone else is also doing the drafting, you don’t want to have any inconsistencies in their language be held against you. To deal with this people include what is called a Joint Drafting provision.

A joint drafting provision is a very brief statement of intent by the parties. It will say that the agreement was jointly drafted by the parties and in the event of a dispute you do not want the court to follow the rule that inconsistencies will be held against the drafter. By inserting such a provision the court would follow the intent of the parties. Rather than find against the drafter, they would determine the intent of the parties and would interpret the contract and any inconsistencies in the contract according to that intent.


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Jury trials

Why do companies include a waiver of jury trials in their contract terms?

In many jurisdictions a legal dispute that is taken to court will allow for a jury trial. The jury will decide upon both the fate of the parties and any damages that must be paid. When a company
includes a term in their agreement that has both parties waive their right to request a jury trial they are doing that for a reason. They want both the decision and the damages allowed to be based upon the facts and the law, not the potential emotions or prejudices of the potential jurors. For example in a suit between a small company and a large company, a jury or individual juror may emotionally want to side with the small business just like jurors like to side with injured individuals in suits against large insurance companies. They may relate more to the small business or even be an owner of a small business. They could have been laid-off or made redundant after a large business acquired the small company the work for.

While judges may have their own prejudices they still have to make the decision based upon the facts of the case and the law. Once the facts are established they need to apply the law in making their ruling. They know that if they make a wrong ruling based upon the law, the case will be appealed and the finding could be overturned. They also know that they should follow precedent in any award of damages.

Should you agree to a waiver of jury trials in your agreement? That’s something your legal people should tell you. In my years of negotiating contracts I only encountered one supplier that simply refused to agree to a waiver of a jury trial and that was at the direction of their president who was also the founder of the company. He felt that if he could testify before a jury he could convince them that his company was right and the other company was wrong.Whether he was right or not I don’t know. What I do know is that trials with juries traditionally take longer and cost more in legal fees.


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Confidential Disclosure Agreements and Indemnities

Can there be an indemnity clause in a Confidential Disclosure Agrement that includes indirect losses.That was a question that was posed on LinkedIN

The first question to ask is whose information is being disclosed? A Non-disclosure Agreement (NDA) or Confidential Disclosure Agreement (CDA) could be for disclosures between the supplier and the customer,.It could also cover the disclosure of a third party’s confidential information that the supplier is authorized to further disclose. To disclose another party’s information the CDA or NDA needs to allow you to share that confidential information. If it doesn't you have no right to share that information even if you were to disclose it under a CDA or NDA. If the party allows further disclosures, it will require that you have an CDA with that Customer that protects the third party's rights in their confidential information.

For information between the customer and the supplier there would be no indemnity used.Indemnities only apply to third party claims. A breach of the CDA or NDA would result in damages that are allowed in the CDA. For third party confidential information that the supplier has that they want to share with the customer,you would include an indemnification in the CDA or NDA with the customer. You want the customer to indemnify you if they breach the CDA from claims by the third party that the breach by thee customer will also be a breach of your agreement with the third party.

One suggestion is to always keep confidentiality obligations separate from any purchase agreement so that the limitation of liability and the damages can be different and so the term of the responsibility to protect the information can be different.The key in establishing limitations of liability is what types of losses will you sustain from the breach and what is reasonable. While in a purchase agreement limiting certain breaches to only direct damages may be reasonable, most of the time you don’t want to limit liability based upon third party claims as you can’t control what those third party claims may be.For a breach of confidentiality obligation the question would be what types of damages would be claimed. Any direct damages would be very small. The major damages that would be claimed would be loss of revenue, loss of profit and any consequential damages such as costs to stop any infringements or actions to enjoin the use of or further disclosure of the information. In confidentiality agreements you don’t want to limit liability for breach of the obligations. You want the information held and protected in a manner where there will not be a disclosure.

With third party information there are multiple options to manage it. You could have a separate agreement with the customer and have the indemnification included in that CDA or NDA. You could have a three way agreement, Lastly you could have a separate CDA or NDA be created between the customer and the third party. Each approach has its own benefits and risks,The separate agreement with the indemnification approach may have the advantage of not having to involve the third party in the discussion or negotiations. When you do a CDA with an indemnity you are still liable to the third party. The customer would has to indemnify you. If they don't or don't have the assets to cover the damages, you would still be liable to the third party. A three-way agreement works provided that the agreement is clear that there is no joint liability and each party is severally liable for their own breaches. That way if the customer breached the CDA or NDA the third party would need to proceed only against the customer and the supplier would not be liable for the customer’s breach. Establishing a separate CDA or NDA between the customer and the third party eliminates the supplier as a party to that transaction. Since they are not a party they would not be liable and they would not need an indemnity as the third party would need to go directly after the customer.

There may be times where you may not want to involve the third party because of the sensitive nature of the discussions between the supplier and the customer. In those cases you want no limits on liability, the indemnity, and you want to make sure that the customer has the assets and resources to stand behind that indemnity. For all other situations I would suggest avoiding the indemnity approach and have a separate agreement between the discloser and the third party.
Indemnities don't absolve you of liability and they are only as good as the company that is making the indemnity commitment,


If you learned from this post, think about how much more you could learn from the book.
The book is only US$24.95 plus shipping. The hot-link to amazon.com is above the date.