Monday, October 31, 2011

Making terms mutual

Every once in a while you may run into a negotiator on the supplier’s side that wants to mirror the terms in the agreement. This means that for requirements that you had for the supplier to meet, the supplier wants to make the commitment mutual so the buyer is providing the same commitment back to the supplier.

When I encounter this I usually rely upon two things to eliminate those requests.

First, I highlight the obligations of the parties under the contract. The buyer’s primary obligation under most agreements is to make payment for the goods or services they purchase. The supplier does not have the same obligations. For example the buyer may ask for a number of warranties and representations regarding the product or service that the supplier will be providing. What warranties does the buyer need to provide when their primary obligation is to make payment? Many of the terms don’t apply equally to both parties simply because the obligations of the parties aren’t equal and the risks aren’t equal.

Second, I highlight the difference in the legal relationship between the buyer and supplier. One of the reasons there is a difference is the legal concept of agency. Under agency the principal may be liable for the acts of the agent. The agent wouldn’t be liable for the acts of the principal. In the buyer / supplier relationship the buyer is the principal and the supplier would be considered the agent. This means that while a buyer can potentially be liable for the actions of a supplier under the concept of agency, a supplier cannot be liable for the actions of the buyer except in those cases where the buyer specifically directs what the supplier must provide (such as making something to buyer’s designs) or how they must implement their design. The latter situation is usually already addressed in most contracts where the supplier will not be responsible for providing indemnity for buyer provided instructions or designs.

Since the obligations, risks and legal relationship aren’t the same, why should the commitments be the same? If you are not successful with both of these arguments you need to consider whether mutuality of terms makes sense.

If a term makes no differentiation between the buyer and the supplier, they apply equally to both. For those terms no statement of mutuality is required. For example Definitions, Contract Term, Effective Date, Survival and a number of other terms apply equally to both parties. If a term describes something that is the sole responsibility of the buyer such as payment, there is no need to make the term be mutual unless other terms of the agreement could require that the supplier make payment to the buyer.

There will be terms in an agreement that are already written in a manner where they apply mutually. Most force majeure and limitation of liability provisions are written to be mutual. They don’t need to be changed.

In is usually in places like the indemnities, warranties, termination rights, insurances, and company or parent guarantees where suppliers may want terms to be mutual. Let’s look at each.

General Indemnity against personal injury, death or property damage caused by a product. For this term the concept of agency really applies. The buyer wants the indemnity from the Supplier as the Buyer may be liable for the supplier’s acts, whereas the supplier is not going to be liable for the buyer’s acts. If injury or damage sustained was caused by the buyer using the supplier’s product in a manner that was not allowed under the specifications or the agreement, that use would be a breach of the agreement and the supplier would not be required to indemnify the buyer. If the supplier was also sued as between the buyer and the supplier, the
buyer would be the one that was negligent and would be forced to pay.

Intellectual Property Infringement Indemnity. Most intellectual property infringement clauses have exceptions to the indemnity and one of those exceptions is when Buyer’s designs or directions cause the product to become infringing. In those cases the supplier would not be responsible to indemnify the buyer. In the U.S. infringement claims can be made in two ways. One is to file an infringement claim with the International Trade Commission seeking to prevent the import of the infringing product.

The other is to bring a claim against the seller of the infringing product seeking to both enjoin or restrict further sales and get damages for the infringing products that were sold. An ITC 337 claim of infringement is not a claim for damages, its simply a request to prevent the infringing products from being imported. So there would be no claim against the supplier that would need to be indemnified. In a lawsuit for infringement of Intellectual property rights that was based upon buyer provided design or instructions, as the primary goal of the suit is enjoin further sales of infringing products, there is little likelihood that the supplier would be sued as its the buyer that is selling the infringing goods to the marketplace. In the unlikely event that they were also sued, they would claim against the buyer as the buyer was the one that provided or instructed the product to be provided in a manner where it was infringing. The only real risk to the supplier would be if the buyer was unable to pay for the claim and the court found them to in any way be liable.

Standard Contracts contain a number of legal warranties such as:
Right to enter the contract. This could be mutual
Performance will comply with contract, laws, regulations, etc.. Under the theory of agency the supplier would not be liable for buyer’s acts so this need not be mutual.
No claims or liens threatened. Third party claims against supplier property as a result of buyer’s actions would not occur.
The Product or Service conforms to warranties and specifications of the contract. This is strictly a supplier warranty.
The product is free of defects in design and safe for use. This could be subject to a form of mutuality where you would carve out buyer provided designs and instructions/
The Product is new, and not re-conditioned. This is strictly a supplier warranty.
Performance complies with all applicable laws. Under the theory of agency the supplier would only be liable for their own performance. They would not be liable for the buyer’s complying with applicable laws

Taxes. The supplier may have responsibility to calculate and collect taxes from the buyer on the sale of the good or service. If they collect those taxes and fail to pay them the buyer could be liable to pay them. The supplier would never be liable to pay taxes that the buyer owes. They are the agent, not the principal.

Termination rights. In most termination provisions the right to terminate the agreement for cause is already mutual. If the buyer has the right to terminate the agreement without cause the supplier may want that same right. In most buyer only termination provisions the supplier is made whole in the event of the termination where the buyer has to pay the actual and reasonable costs associated with the termination. In deciding whether to give that same right to the supplier there are a number of factors that would need to be considered. First would be what the impact to the buyer would be. Could the buyer order from another supplier such that continuity of supply or service would not be impacted. If you couldn’t the period of time for the termination to take effect would need to be different. How much effort and cost was invested to qualify the supplier and produce the product or service. If the supplier isn’t going to pay you that for the right to terminate why would you agree. There could potentially be mutuality but the terms would clearly need to be structured differently.

Insurances. Insurance provisions are included to protect against third party claims for personal injury, property damage etc. Under the law of
agency the buyer can be liable for the acts of their agent which is the supplier. The agent (supplier) is never liable for the acts of the principal (buyer). Suppliers are not going to be liable for personal injury or property damage caused by the buyer or its employees. The buyer could be liable for workers compensation claims of from the supplier’s employees, but the supplier would never be liable for workers compensation claims of the buyer. The one area where the supplier may have a reasonable request for the buyer to carry insurance is when buyer owned equipment or materials are stored at the buyer’s site. Even then, either party could carry that insurance so its not something that only the buyer can do.

Parent or Company Guarantees. When I’ve asked suppliers for a parent or company guarantee when they wanted me to purchase through one of their subsidiaries that wasn’t financially qualified on its own, I’ve received requests that it be mutual. When that occurs I will usually point out the differences in responsibilities. As a buyer my primary responsibility is to pay for the goods or services that I purchase. So in dealing with me all the supplier needs to do is determine whether I have the ability to pay. In dealing with a supplier subsidiary there are many obligations that they as the supplier must meet. It’s not just whether they have the financial assets to perform its whether they could meet all of the obligations they have under the contract. Must supplier subsidiaries that a supplier wants you to deal with are sales subsidiaries and simply do not have the capability to do things like re-design a product that is defective or that needs to be changed as a result of a safety or infringement problem. If my agreement is only with that subsidiary, I have no privity of contract with the Supplier parent where I could force them to perform. They don’t need a parent guarantee if I can pay the bills, but I need one to ensure performance they have the resources of the parent to meet the contract commitments if the subsidiary can’t

For any other areas of the contract where the supplier wants terms to be mutual, always consider the potential impact of the mutuality. If acts are not of equal risk, remedies for failing to act should not be the same. In those cases mutuality should mean something that is commensurate with the potential cost or risk impact.

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