Sunday, January 30, 2011

Parent / Company Guarantee

The terms in your agreement may have limited value if the entity that you are contracting with doesn’t have the assets or resources to stand behind their commitments. Sales Subsidiaries of Suppliers may be risky to contract with or purchase through if they do not have the appropriate assets or resources on their own. With the exception of tort liability, a Parent Company isn’t liable for sales by their Subsidiary unless they specifically agree to be liable.  Even if you had both the Supplier and their Subsidiary sign your agreement, the Supplier would not be liable for the actions of the Subsidiary or purchases made through the Subsidiary unless the agreement stated that they were jointly and severally liable. In that case either or both would be liable.

There are a number of reasons why a Parent Company may want to have Buyer's purchase from their Subsidiary:
  1. Avoidance if liability on those sales (except for potential product tort liability).
  2. The parent company may not want to conduct business directly in specific locations for tax reason. They may also want to avoid needing to be registered to do business in those locations or become subject to the laws of those locations.
  3. The parent may also want to protect their price and profit as purchases through a subsidiary have the price partially controlled by the Transfer Price (the Price the Parent sells the product or service to the subsidiary)

Parent companies may also not want to be liable for their Subsidiaries as not all subsidiaries are wholly owned, nor would they want to be responsible for what the Subsidiary promises in their agreement.

If the Supplier tries to push you into buying from their Subsidiary, you can qualify the Subsidiary to determine if the Subsidiary has the assets and resources to perform on its own. If they do, you can contract with them. If they don't have the necessary assets and resources, there are several ways to manage against that risk:
  • The Parent Company can become a party to the agreement where both the Parent and the Subsidiary agree to be jointly and severally liable.
  • You could have the agreement be with the Parent and have them designate the Subsidiary as an agent to transact business through. As long as the agent acts within the limits of their agency the Supplier would remain liable.
  • You can have the Parent execute what is called a company or parent guarantee.

There are several ways to create a company or parent guarantee.
  1. If you contract with the parent you could include the guarantee in that agreement.
  2. You could have the parent company sign a separate guarantee letter or as part of the contract. 
  3. You could add an additional signature block to the Subsidiary agreement with the parent company’s commitment such as:

What does a parent guarantee look like? Below is an example where “Supplier” would be the Subsidiary and XCorp the parent company.

“If Supplier defaults in performance of its obligations under the Agreement (as such Agreement may be modified by Supplier and Buyer) XCorp shall pay to Buyer all damages, costs and expenses that Buyer is entitled to recover from Supplier by reason of such default.  This obligation shall continue in force until all obligations of Supplier under the Agreement have been completely discharged or any claim by Buyer against Supplier remains outstanding, whichever is longer."

Suppliers, especially those that sell through Subsidiaries that aren't wholly owned, will be reluctant to assume potential liability for all of a Subsidiary's potential defaults. If you were to run into that problem my recommendation would be to work with you legal team to identify what liabilities the parent has control over and as a minimum look for parent guarantees for those.  For example a Subsidiary that is simply reselling the Parent Company's product has no control over the design of the product or how that product is manufactured. All contract terms that relate to that should be guaranteed by the Parent such as intellectual property infringement indemnities,  indemnities against personal injury or property damage claims caused by defective products and product warranties. 

The reason why this is important is many time a supplier subsidiary may be only a sales company with minimal assets and resources. If you look only to that subsidiary for protection in many cases they simply won't have the assets to resources to stand behind the commitment. Even if you had an agreement directly with the Supplier, you couldn't collect from the Supplier as those transactions were not made under that agreement, they would have been made under the agreement with the Subsidiary. If you can't collect from the subsidiary, and the parent isn't responsible, you would be assuming all of the cost of the problem.

Parent / Company guarantees are usually done in one of two manners. The parent can be added as a signatory to the agreement with the guarantee before their signature. If you use a separate guarantee 
letter for the parent company to sign, you should include a form of preamble paragraph that describes the relationship and the fact that they are providing the letter so their subsidiary will be awarded the
contract so it shows that they are getting consideration for making the guarantee. 

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