Saturday, October 22, 2011

Creating Safety Nets.

Many times a specific term may be unique to a product or service or class of products. For example the warranty against defects in material and workmanship may be different for different products. The tendency may be to point to another document that would establish the specific term. For example the Warranty period for Defects in material and workmanship shall be specified in Appendix A. That approach works well when you follow each commitment to verify that the term has been established. I’ve run into a number of situations where it wasn’t managed.

I’ve run into agreements that point to another document to establish the warranty term only to discover that the document it pointed to never established the warranty term so there was no warranty. I saw a situation where an agreement pointed to another document to establish an epidemic defect rate. When I looked at that document it pointed to another document to establish the rate. When I reviewed the third document, no rate was established. Since there was no threshold rate established to trigger the ability to collect under the Epidemic Defects section, we were unable to collect under the terms of the agreement for what turned out to me a situation where the cost of the defects were in the hundreds of millions of dollars.

To prevent things like this from falling through the cracks, it’s best to include what I call a safety net. Safety nets are created by including language in the original term, which establishes a minimum or standard, but provides the ability to agree to something different.

For example:

“Unless otherwise agreed by the parties in writing in Appendix A, the warranty period against defects in material and workmanship shall be two (2) years.” This creates an automatic 2 year warranty, but allows the parties to agree to something longer or shorter depending upon the circumstances.

“The epidemic defect rate shall be one percent (1%) unless the parties agree in writing in Appendix A to a different epidemic defect rate.” This establishes a default rate of 1% which the parties can change by later agreement.

“Sixty days prior to the term of the Agreement, the parties shall meet to negotiate the price for the next twelve months, which shall not be more than the then current Price.” This guarantees that the price for the extension will be no more that the current price, but allows you to negotiate something better so you aren’t locked into a Supplier with no leverage over what the cost would be.

Here’s an example of another form of safety net. In your negotiation of liability for defects you agree that their maximum liability will be no more than one times the prior years purchases. However during the first year, there will be no prior year’s purchases. Further a problem could occur more than a year after you stopped purchasing. In both cases, relying on the prior years purchases would limit their liability to zero. To prevent that you would include a safety net by also including a fixed amount. For example “Supplier’s liability for _____ shall not exceed one (1) times the prior years purchases by Buyer or one million dollars (US$1,000,000.00), whichever is greater. The Impact of doing this is you would have the minimum amount to rely upon. If sales go up, the limit goes up.

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