Friday, February 11, 2011
Most contracts contain what is referred to as a merger provision where “all prior discussions, representations and agreements are considered to be merged” into the Contract that is executed.
While merger provisions are seldom negotiated, as a Buyer in negotiating the contract you need to ensure that all discussions, representations or other agreements that you may have relied upon in selecting the Supplier have in fact been included in the Contract as a commitment by the Supplier. If you don’t, and you have a merger provision included in the agreement, you can’t hold the Supplier to any prior representations or commitments as they aren’t part of the Contract.
Merger provisions are also used to show the clear intent of the parties to the contract regarding how the contract will be interpreted if the contract is ever litigated in court. In interpreting a contract a Court will look at the intent of the parties that is expressed within the four corners of the contract. They will only look at external or “parol evidence” if the intent of the parties isn’t clear. In the event of a dispute between the parties, what the merger provision does is make it clear that the parties do not intend to look to prior discussions, representations and agreements between the parties in interpreting the agreement. They clearly intend that the intent be interpreted strictly by what’s included in the contract as that represents the entire understanding of the parties.
Prior to starting the negotiation have all parties that may have met with the Supplier identify any understanding or representations that were made that you have relied upon as part of your selection process. During the negotiation document all understandings and representations that were made in seeking to get your agreement. Then include them as part of the Contract, Specifications, or incorporate that document as part of the Contract. When you take Supplier’s representations and make them part of the Contract, you may find that they were more marketing/sales “puffing*”, and the Supplier is unwilling to make them part of Contract. Its better to know whether its real or not before you sign the Contract.
* Puffing is an exaggeration of a product or services capabilities or performance.
Many times Suppliers want to be free to make changes to their products they sell you for their own business reasons. As a Buyer you may want to prevent or restrict such changes because of their potential impact. For example, you may have two components from two Suppliers of the exact same specification and one of them works in your application and the other doesn’t. If the Supplier is free to make changes, the change they make could create a situation where the Product that previously worked in your application no longer works. That can cause huge problems, interrupt your production, etc. In many products you purchase there may be detailed testing that’s performed to qualify both the product, so you wouldn’t want the Supplier to make changes to what you’ve invested in qualifying.
Suppliers will frequently propose the right to make changes provided that they don’t affect the “form, fit, or function” of the product. There are several problems with form fit and function. First, it doesn’t ensure that it will continue to work in your application. Second, form, fit and function would allow the Supplier to make changes that could negatively impact you or the value of what you purchase as they could significantly cheapen the materials and still meet form, fit and function. This would provide you with a Product that is of lesser value. Form, fit and function also doesn’t address quality, so they could make a product of significantly less quality which still has the same form factor, the same fit and does the same function, but do you want something that’s a lesser quality? The same applies for reliability. Unless you have a specific reliability requirement included in your Specification, if they can make changes to the product, it could impact the reliability of the product once again impacting the value of what you receive for the purchase price and your life cycle cost.
You may also want to limit the process changes the Supplier can make, as every change in a process is a potential quality problem and in most cases the Buyer is the one that assumes the larger portion of the cost impact of quality problems.
If you have significant leverage in the relationship, always try to have approval over all changes. If you don’t have the leverage such as may occur in commodity products, the next best thing is to require that they provide you with advance notice of any changes. This provides you with the time needed to implement strategies to manage the potential risk. You could purchase of an inventory of the current product to meet your needs until such time as your can evaluate the changed product, or use the time to identify an alternative source.
As with other terms there is a clear link you need to make between control and responsibility. If the Supplier wants to have total control over how the can change their product, you should want them to have total responsibility for the problems and costs that the change causes. If they don’t want to have responsibility, you need the control so you can manage against the risk. Having neither leaves you with a risk and potential cost that you have no ability to manage.
If you have contracts where you agree to reimburse the Supplier for certain activities on a cost plus or time and materials basis, or you negotiate a form of most favored pricing commitment, you need to two things. The first is a requirement that the Supplier keep and maintain records of those costs for a specific period of time so they can be verified. Second you need to have some form of audit rights. If you have most favored price language in a contract without audit rights, the only way you could enforce it is if stumbled across information that could show that the Supplier was giving a better price to another customer. Odds are fairly high that they aren't going to volunteer to give the information on their own.
When audit rights language is negotiated, the typical things that are negotiated are:
1. Who can perform the audit.
2. When or how often it can be done.
3. The extent of the audit.
4. What records will or won’t be made available.
5. Who pays for the cost of the audit.
Audit rights are something that Suppliers are extremely reluctant to provide, as they are concerned about the information that the Buyer could discover. You should expect that Suppliers will as a minimum want to:
1) Limit it to an independent auditor, rather than Buyer personnel
2) Have agreement or approval over the auditor that will be used.
3) Have the scope of the audit be restricted to only that information required to verify the charges
4) Limit the frequency as much as possible to reduce the disruption and
5) Want the Buyer to pay for all costs.
As a Buyer, all of these restrictions will add to your cost. One way to help keep the Supplier honest is to negotiate the responsibility for the cost of the audit. If the audit discloses minimal discrepancies the Buyer will pay the full cost. If the Audit discloses discrepancies above a certain amount, the Supplier must pay for the cost of the Audit along with reasonable interest on the shortfall. Having the Buyer pay the cost of the audit will be viewed by the Supplier as something that will avoid frivolous audits. Having the Supplier pay plus interest is just a way do drive their behavior to act correctly in managing their records and charging you.
If you have Supplier personnel visiting or working on your site, there are several things to be concerned with.
The first is potential employment law claims. A number of years ago there was a major lawsuit filed by individuals that were contract workers of Microsoft claiming that in their work on behalf of Microsoft, by the way they were treated and managed they should have the same rights and benefits as Microsoft employees. It cost Microsoft ninety-seven million dollars to settle those claims. Since that lawsuit most companies have sought to manage the risk by not hiring contract workers directly, instead they hire them through independent companies. Further they make it clear that is the Supplier's responsibility to manage their people.
The second issue is potential liability. For example companies want Suppliers to be fully responsible for the safety of their personnel and will instruct their own personnel not to be directing a Supplier’s employee on how to perform their work, especially from a safety perspective. Buyer’s may require some safety standards that they require Supplier to meet, but again will place the responsibility for the overall management of safety for their employees on the Supplier. This is to try to avoid personal injury lawsuits by Supplier employees that are injured at the Buyer’s facilities. If the Supplier is responsible, in most locations the employee would be covered against those injuries by workers compensation. As a requirement you would also typically require the Supplier to carry the necessary workers compensation insurance as part of the insurance requirements.
The only objection a Supplier should have to this would be if you were instructing the Supplier employee what to do and how to do it including necessary safety precautions where they can’t manage the risk. If that’s necessary (which it shouldn’t be) Supplier’s may look for the Buyer to be responsible for any negligent instructions.