Monday, March 21, 2011

"Flow-downs” and “back to back” contracts

A flow-down clause is a requirement placed on Seller by the Buyer that obligates Seller to include certain language in their agreements with their Suppliers for the goods or services they procure in support of sale to the Buyer. Flow downs are commonly used in Government contracting where the Government requires a supplier or contractor to place the same or similar obligations on their subcontractors that will be performing work as part of that activity or project. Flow downs are also be used in commercial contracting where the goal of the flow down is to ensure that all obligations that the Supplier assumes with their customer are passed down to their subcontractors and suppliers.

A slightly different form of flow downs is referred to as “back to back” contract. In a back-to-back contract situation the agreements are linked so that all liability, obligations, and rights incurred by the Seller in their agreement with the Customer are mirrored in Seller’s agreement with their suppliers and subcontractors.

A slightly different form of back to back term exists in most confidentiality agreements in which the recipient is given the right to disclose the information to a third party. Those type of flow-downs would require that the recipient enter into a separate confidentiality agreement with the third party where the third party agrees to assume the same duty of confidentiality equal to the recipient before the recipient can divulge information to the third party.

Suppliers may, as part of there agreements with Buyers require flow downs to the Buyer’s end customer for a product or service or, terms within the agreement could require the Buyer to include certain terms in their Customer agreement to flow down the requirement as protection. For example, if a Buyer agreed to indemnify a Supplier if their product was sold in high-risk applications, the Buyer may want a similar term in their agreement with their Customer.

The goal of both flow-down and back-to-back approaches is to ensure that there is no gap in contract coverage between the commitments that the Seller makes to the Customer and what the Seller gets from their Suppliers or Subcontractors thereby reducing the risk. If you fail to do that, you can have uncovered costs and risks that you are responsible to cover with your Customer. That either requires you to carry contingencies (which may make you non-competitive) or it will cut into your profits or cause you to lose money on the contract if a problem occurs.  Flow-down and back-to-back approaches do not eliminate the risk. There is always the risk if the Buyer is unable to recover damages or costs from their Supplier or Subcontractor. A good example of that is when the Supplier doesn’t have sufficient assets to cover the damages or costs.

If a Customer has specified a specific supplier that that they want you to use and you are unable to negotiate complete flow down or back-to-back provisions with that supplier always highlight that to the Project team. If they were prepared for that situation in the sales terms they may have included what is called a “nominated subcontractor” provision that excuses certain liability for customer specified suppliers. If they didn’t they will need to either carry a contingency or get the Customer to accept the risk.

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