Sunday, January 30, 2011

Order of Precedence

In the event of a conflict between terms of an agreement, the conflict will normally be resolved by determining the precedence that the parties gave to the various documents. If the parties fail to establish an order of precedence:
  • Unless otherwise stated or agreed the latest writing in time between the parties will have precedence over the prior writings. This means that documents like amendments or change orders need to be carefully written.
  • All documents that are incorporated by reference into a document will have the same precedence as the document.  For example, if you had a Statement of Work that incorporated the Supplier’s specifications into it, and the Statement of Work was silent on precedence, the Supplier’s Specifications would have the same priority as the Statement of Work.
  • Agreements are interpreted as a whole. The simple example of this is if Document 1 required items A through M to be done and Document 2 required N through Z to be done, The requirement would be A through Z.  If part of M conflicted with part of Z only then would you consider the precedence between the two documents that include the conflicting language. 

Order of Precedence only deals with conflicts between documents. In the same situation described above, if you incorporated the Suppliers specifications into the SOW and that contained contract terms,  those would be included in your contract. You need to read and make sure you understand and agree with any document you incorporate.

Precedence is established in several ways:
  1. As between multiple documents the precedence is normally established by an order of precedence provision.
  2. As between documents of the same priority, the precedence is given to the latest writing in time between the parties on the same subject matter.
  3. Precedence may also be established where there is a clear showing of intent shown within the agreement such as stating the requirements included in a specific section shall not apply or not have precedence over what is being agreed to in that section. (This is called a “Trumping” provision).

The more complex your agreement and the more documents you have incorporated by reference into the agreement, the more important it is to have the right order of precedence. For example, if multiple documents will be incorporated into an agreement you should establish the precedence between that agreement and those documents and if some are more important than others create a precedence between those individual documents. If your contract is made up of multiple documents such as Master Agreement. A Statement of Work, individual Work Statements, and Purchase Orders, you need to establish the precedence between those document or they will be considered to be complimentary and equal priority will be given to all.

There are two areas where additional caution should be used in establishing the order of precedence.
  1. When you incorporate Supplier generated documents into your agreement, those documents could contain terms that may restrict or limit the protection of your contract given the precedence that would be given to those Supplier documents. An Order of Precedence only protects against conflicting terms. It doesn’t protect against additional terms. So always read the Supplier documents and exclude any terms in them that you don’t want to be included in your agreement. 
  2. As amendments are a later writing in time between the parties on the same subject matter, the amendment will have priority over both prior amendments that have been written and the agreement that the amendment is written against. Amendments need to be written carefully so it’s very clear exactly what is being amend and for what purpose. For example you may have a single product that you want to have slightly different terms on, if you aren’t clear you could me making that change for all. Here’s a simple example.  A Commodity Manager had a Master Agreement and a Statement of Work with the Supplier.  The Master Agreement was evergreen with no fixed expiration date and the Statement of Work had a 2 year term. The Commodity Manager wrote an amendment that referenced both the Base Agreement and the SOW that extended the term to a specific date. That amendment changed the date of the SOW to the desired date, which is what they wanted to do. That amendment also changed  the Master Agreement from being an evergreen contract to a contract that now had a limited term.  

When purchasing something that involves both drawings and specifications to avoid potential conflicts you may want to add language that says that they are “complimentary and what is required for one is required by all. This is used to avoid potential conflicts between the documents and giving them equal priority so the requirements will be interpreted as a whole by reading both together.

The use of order of precedence language is not limited to documents incorporated into the contract. Documents that are made part of the contract may incorporate more documents, so it may make sense to establish the precedence between those individual documents. For example a specification may be consolidation of a number of different documents such as the Buyer’s RFP, the Suppliers response, clarifying Buyer letters and clarifying supplier letters all of which make up the agreed specification. As there could be conflicts between those documents you may need to establish the order of precedence as between those documents. As part of your final clarifying letter you would also exclude anything in the Supplier's proposal, Supplier clarifying letters that .

In many contracts every time a number is used, good legal writing would require that the number be expressed both alphabetically and numerically.  By including both if the two conflict are in conflict you could look at parol evidence to determine the correct amount. That is why you traditionally don’t see a precedence being established between the written number versus the numeric number. If you were to set a precedence between the two, you need to ensure that the one you established as having priority is accurate in all instances. If you set a precedence between the two the Courts won’t look beyong the four corners of your agreement as there would be no conflict since you established the precedence between the two.

Here’s an example of how order of precedence will work:

Contracts are read to be complimentary and what an order of precedence does is give priority in the event of a conflict. This means that if you had two documents (priority 1 (P1) and priority 2 (P2), if the P1 document required items A-M and the P2 document required N-Z there would be no conflict. It would be interpreted to require A-Z. However If P1 said Supplier will provide X and P2 said Owner will provide X, then you would have a conflict between the two documents and then the order of precedence would come into play. It would be interpreted that the Supplier must provide it because that was established in the higher priority document.


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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