Thursday, February 10, 2011

Negotiation - Thoughts on Negotiating Subcontracting and Assignment

When you select a Supplier, a large portion of your decision criteria may be based upon who will perform the work. It can be at the heart of your having confidence in them to perform the work. It can  be the basis upon which you agree to pay the price or in the terms that you agree. If you contracted to buy a car from Mercedes, you wouldn’t want them to have Ford provide you the car. If you hired someone because of an individual or teams specific expertise, you wouldn’t want the work performed by someone of lesser capability. If you qualified a Supplier based on their high quality processes, you wouldn’t want the work to be actually performed by someone in the back alleys.

To protect against these situations Buyers want to control whether their contract may be assigned (performed by another party) and who the work may be performed by (control over subcontracting).

Supplier’s may want the right to assign the contract for their own business reasons and not have their hands tied in terms of who can perform the work by giving control over subcontracting to the Buyer.

In negotiating these provisions the Buyer should focus on several key messages.

  •  First, the contract is being awarded to the Supplier (not some third party) based on their perceived capabilities, quality and value the Supplier offer

  • Second, the contract is being awarded based upon Buyer’s assessment of the Supplier’s quality and processes, not the quality and processes of some third party.

  • Third, any problems with performance or quality will cause significantly more damage to the Buyer than the Buyer would be able to collect under the Contract.

For assignment the only thing you may be willing to agree to is if the assignment is in conjunction with the sale of the business or assets required to perform the work.  Even in that situation the Buyer may want to retain the right to cancel the contract without liability if they do not want to do business with the new Supplier (especially if the new Sipplier is a competitor or a Supplier they had a problem with in the past.

For subcontracting, you may allow them with freedom to make minor changes to who performs small portions of the work, but if who performs the work is important you need to retain the right of approval over subcontracting. Suppliers may agree to the right of approval if it’s tied to a reasonableness standard. Having the right of approval also gives you leverage to negotiate price reductions if you feel the alternative is providing less value or more risk.  

Most Suppliers hate to give up control over the right to assign or subcontract the work. The same ones usually don’t want to sign up for certain performance liabilities. I have a basic rule that I follow: If you agree to be liable for performance I may agree to reduce the level of control that’s needed to manage the risk. If you won’t agree to the liability then I need the control so I can manage the risk. Its one or the other, never both. 

The one situation where you won't have control is if the Supplier merges with or is acquired by another company as that is not an assignment. Officers of companies have a fiduciary obligation to do do what's best for their shareholders and as such would never be able to agree that they won't merge with of be acquired by another company.  If you had concerns in this area you would more likely include what is called a "change of control" provision where if it happens you as the Buyer will have additional rights you may not have had under the Agreement such as being able to terminate the agreement without liability or the requirement grant you certain licenses so you aren't dependent upon the new entity unless you want to be.

Negotiation - Thoughts on Negotiating Survival Provisions

In negotiating a “survival” provision the parties determine what obligations of the contract will continue to be in effect after the expiration or termination of the contract.  The reason why Buyer’s need Survival provisions are:
1.     There will be obligations of that are intended to be performed after the termination or expiration of the Agreement. A good example of this is any warranty obligations against defects in material and workmanship on products or services that were purchased during the term of the Agreement that are intended to run for a specific period. Many other warranties would also need to survive. Another example is the parties could agree to a specific term that the Parties agree to hold the other party’s confidential information as confidential for a specific term. 
2.     Many claims are not limited to the contract term. They are limited by the individual Statute of Limitations for the specific cause of action. For example under New York law there are different statute of limitation periods for the types of claims that may be brought.
·       Contracts - Six (6) years.
·       Personal Injury and Injury to Personal Property– Three (3) years
·       Medical Malpractice – thirty (30) months or one year from discovery of a foreign object in the body or when it should have been discovered.
·       Other types of malpractice – three (3) years
·       Libel, defamation or slander – one (1) year
·       Product liability – three (3) years
·       Fraud – six (6) years.
As a Buyer if you could still be liable for an action cause by the Supplier, why would you let
the Supplier be excused from being responsible to you for those actions and their 
responsibility to you? Including the applicable terms in the description of what will survive 
makes sure they will continue to be responsible until those statute of limitations expire.   

High on your list terms that need to survive would be warranties or defects provisions, indemnifications, and terms that address enforceability issues such as applicable laws, order of precedence, limitations of liability, and any confidentiality terms. High on the Supplier’s list is your obligation of payment.   

Buyer contract templates will usually have a list of specific sections that are required to survive the termination of expiration of the agreement.  If you have added any additional terms that contemplate performance after the agreement ends or that may need enforcement in the future, make sure those are added.

I’ve had Suppliers that wanted to have nothing survive simply because they wanted all potential liability to end. This is an area where you can make it clear that what you are asking for is reasonable. The commitments they make in the contract are of no value to you if when you need them they aren’t there.  It would make it equivalent to selling the good or service to you “as is” with no warranties, indemnifications etc. and the value of that is substantially less.

Thoughts on Negotiating Taxes

There could be a number of potential taxes that relate to a product or services. Buyer’s want to make sure all of those taxes, with the exception of taxes that are based on the sale of the product or service are included in the price they pay for the product or service to avoid taxes being a hidden extra to their cost.

Except for products purchased for internal consumption of the Buyer, in most cases the Buyer would normally be able to be exempt from paying sales taxes provided it provides the Seller with what is called a statutory resale certificate. In locations where there is value added taxes the rules are different and each country may be unique in how they are implemented.

In most tax provisions the things that get negotiated are:
1) Who is responsible to pay?
2) What are the responsibilities if the tax is incorrect, not paid, other there is a problem with the tax exemption. 

Buyer’s want all taxes that would be required prior to delivery to them in accordance with the agreed delivery terms to be paid by the Supplier and be part of the purchase price. Taxes that are to be collected in conjunction with the actual sale of the product or service are then the Buyer’s responsibility to pay, although it may be Supplier’s responsibility to actually collect the taxes.

Other than determining whose responsibility it is to pay the tax, tax provisions also address the things that can go wrong:
1) The Supplier could collect it, but not remit it to the taxing authorities or it could be remitted late.
2) The amount collected could be incorrect,
3) There could be a problem with Buyer’s exemption.

All of these could subject the parties to fines, interest and penalties from the taxing authorities so part of the negotiation is determining responsibility for those costs if any of those problems occur. For the first problem Buyer’s want to be indemnified by the Supplier for such claims as the Buyer already made the payment and it was the Supplier’s fault in not paying it or not paying it in a timely manner. As to the incorrect amount, Buyer’s would want to pay only the incremental amount of the tax, but not any interest, penalties or fines because it was the Supplier’s responsibility to properly calculate it.  As to the last point Suppliers would expect that all costs associated with a Buyer exemption be borne by the Buyer as the Supplier did nothing wrong.

In negotiation of taxes provisions it’s more of a positioning costs to responsibility. If they cause the problem, they should pay. If you cause the problem, you should pay. Having a tax term that would require the Supplier to pay what the Buyer should have paid if the tax had been correctly calculated probably would not be enforceable as it would be what the courts call “unjust enrichment” and the courts would look upon it as a penalty.

In locations where there are Value Added Taxes that need to get negotiated you need guidance from your local legal and tax personnel as the requirements will be different.

Negotiation -Thoughts on Negotiating The Termination with Cause Provision

To terminate a contract for cause, the party claiming the breach must prove that the other party had an obligation to them, they failed to meet that obligation, the obligation was material, after providing the breaching party with notice of the breach they further failed to correct (“cure”) it within the time allotted. If you meet all of those criteria you can then terminate the contract, at which time any obligations you had under the contract (except those which were agreed to survive the termination) will end. Further you would have the ability to sue the breaching party for the damages you sustained.

Since damages may be substantial, the negotiation of termination for cause provisions normally revolves around defining what individual breaches would be grounds for terminating the contract for cause, and what the parties rights of cure would be. This is usually managed by either having it be “material” breaches of the contract, which itself would be open to argument, or specific causes could be defined as being a “material” breach. If specific causes are negotiated, from a Buyer’s perspective the only thing that would constitute a material breach by Buyer would normally be the failure to make required payments although there could be other Buyer obligations that would constitute a material breach such as the Buyer refusing to provide the Supplier with access to premises where the work needed to be performed.. Material breaches by Supplier may include financial insolvency /bankruptcy but also their failure to meet other key obligations of the contract such as on-time delivery, warranty, indemnifications, etc. 

One thing to consider is the extent of the Supplier’s rights to cure. How long do they have? What's appropriate will depend upon the circumstances and especially the impact to the Buyer of the breach.
A single time frame like thirty days may not work as a cure period for all breaches. Some breaches may not be cured. For example if the Supplier breached confidentiality obligations and disclosed information to another party, there is no way that can be cured. Some breaches should be able to be cured quickly and others may take longer to cure. If you have a single cure period, the Supplier will want that to be the worst case period. If you agree to that you are giving the Supplier a longer period to cure those other breaches that could have been cured sooner. Breaches are usually causing you problems so why would you want to give them a longer period to correct it. Another thing you want to 
avoid is having Suppliers continually breaching and curing the breach as that would cause you substantial operational problems without any remedy. I those situations, you may want to place a limit on the number of times the Supplier has the right to cure for that type of breach within a certain period just to avoid the constant breach/cure, breach/cure possibility. 

Suppliers may want to try to negotiate in the responsibility of the Buyer to pay for work in process in the event of a termination for cause. If the Buyer has breached the contract these costs would already be included in their damages so it’s not necessary. If the Supplier is the one that breaches the contract, agreeing to pay for such costs is tantamount to rewarding then for their breaching the contract and is something you should never do. Simply tell them that it’s a risk they take if they fail to cure, so they need to take that into account in their actions. It may be sufficient for them to make the investments required to cure.

Providing a supplier a cure notice where you notify them of your intent to terminate if they fail to cure is something that always needs to be done in conjunction with both the business and legal team to ensure that it’s the right strategy.  If you have no obligation to pay for work that is not completed at the time of the termination, the Supplier will always look at the probability they will be able to cure versus the potential additional cost they will incur in the interim that will be at risk if they fail to cure.  If the risk is great and the cost is high, Suppliers may simply stop work. If you need them to continue you may need to negotiate an alternative term to allow for a smoother transition.    

Negotiating - Thoughts on Negotiating Termination Without Cause

The value of termination without cause provisions will vary depending upon the circumstances. If you have a contract to purchase products with no binding commitments, you can effectively have a termination without cause by simply not ordering any more product. Where a termination without cause provision provides value is when you have situations where you either need to make and immediate cancellation of a contract or order because the circumstances or need has changed and the Supplier may be partially completed with the contract work. Where it also makes sense is when you are in a relationship with a Supplier that isn’t working. The Supplier may have overstated their capabilities or you may have other conflicts where the two companies are simply not compatible.  You can use it when there aren’t sufficient grounds for you to terminate for cause, but you don’t want the relationship to continue.

In termination without cause the Suppliers concerns are mostly financial. The termination will cause a break in their work or production that they may not be able to backfill with other work causing downtime. The termination will impact the work in process they have not yet completed and it will also impact outstanding orders they may have with their Suppliers. The larger your business is to the Supplier and the more custom your work is, the more the Supplier will be concerned and the broader the protection they will want if there is a termination without cause. If you simply buy a standard product, the argument should always be that they can readily sell that standard product to others so you should have no liability, or at best your liability should be some small amount to cover their holding costs until they can sell it to someone else.

If your product is custom, you always need to understand at what point in the work or process it becomes custom. For all the orders that are affected before it reaches that custom point, you should negotiate your liability the same way as a standard product to look at the cost of the work that had been performed. Once it has become custom, in most cases it’s of no value to any other potential customer so the Supplier will want the Buyer to assume all the costs of the work in process, or have those products be completed.  The negotiation of liability for their for purchases from their Suppliers should be limited to only for those that are non-cancelable or in which a cancellation fee is charged. The question to ask on these is whether those materials are also custom or unique to the Buyer. If the excess could be used for other customers the maximum you would want to pay as a small carrying charge to cover the additional time it would take to consume them. The impact to the Supplier’s production in terms of downtime is something that really depends on the nature of the relationship. If you have a contract in which you have no made firm commitments to a specific volume of purchases, why should you be liable for anything beyond their investment in their WIP (work in process) and any unique non-cancelable materials?

The greater the problem to the Supplier the cancellation would have on them, the more reluctant the Supplier will be to agreeing to a cancellation without cause without compensation.  For the Buyer the last thing you want to have occur is having the Supplier continue to do work, add value and add cost to something you no longer need or want. They shouldn’t benefit while you lose and that’s something you should remind them about. Most termination without cause provisions will have the Buyer be able to terminate provided it pays the Supplier’s actual and reasonable costs associated with the termination. Buyers want that commitment conditioned on the Supplier using reasonable efforts to mitigate the cost. That way both parties will work together to reduce the impact.