Thursday, February 17, 2011

Negotiation - Thoughts on Negotiating Warranty Exclusions

For the most part when Buyer’s think about warranties they do so in the context of the right to return the defective material for repair or replacement. These types of warranties against defects in material or workmanship are provided for a specific term.

Standard Contracts also contain a number of legal warranties such as:
  • Making a commitment that they party signing it has the right to enter the contract.
  • Performance under the contract will comply with contract, laws, regulations, etc.
  • No claims or liens exist or are threatened that could affect the use of the product or service
  • The Product or Service doesn’t infringe the IP rights of a 3rd party
  • The Product or Service conforms to the warranties, specifications, and other requirements of the contract
  • The product is free of defects in design and is safe for use
  • The Product is new, and not re-conditioned
All of these warranties are there to drive the Supplier’s behavior to manage against specific risks that could impact the Buyer or Buyer’s Customer’s.  For example:
  • Providing a warranty that they have the right to enter the contract is used to help ensure that the individual had the authority to bind the company. If they didn’t they would be personally liable.
  • The compliance with laws and regulations warranty is to ensure that the product or service may be legally used or sold.  If correction needs to be made to comply the Supplier is responsible for the cost of those corrections or would be in breach of the warranty,
  • The warranty against claims is to allow the Buyer with the right to terminate the agreement for cause and collect damages if they have breached that warranty. The warranty against liens is to protect the Buyer from having to pay a third party to have the lien released.
  • The specific warranty against infringement of IP rights is to allow the Buyer with the right to terminate the agreement for cause and collect damages if they have breached that warranty. 
  • The warranty that Product or Service conforms to the warranties and specifications, provides the Buyer with the right to have the non-conformance to be corrected or allow the Buyer to collect damages to correct the problem of provide the Buyer with the right  claim a payment for difference in value.
  • The product is free of defects in design and is safe for use. The warranty against defects in design is to have the Supplier be responsible for the cost of correcting any defects in design or be subject to the contract being terminated and being subject to damages.  The warranty of the product being safe for use would be included for several reasons. One is to have the Supplier cover any costs to correct the problem or be subject to termination and damages. Another reason is to use in any potential liability claim made by a third party where as part of showing that the Buyer wasn’t negligent that would offer the fact that the Supplier made the warranty that the item was safe.
  • The Product is new warranty is used in situations where the product will be re-sold. You cannot sell a product as new if it includes re-conditioned materials. Buyer’s want this warranty to be able to provide their customers with the assurance that the Product is new and have the ability to collect damages from the Supplier if it wasn’t. 

 The failure to meet these warranties will provide the Buyer with remedies for breach of the warranties under the Contract in which the Buyer could pursue appropriate damages. Because of the criticality of many of these terms any negotiation should be done with the involvement of your legal counsel.

In negotiating the warranty against defects in material and workmanship, the Supplier’s motivation in negotiating the term of the warranty may be one of either managing risk or generating revenue. If the warranties will be provided at Suppliers expense, the shorter the warranty period, the fewer the expected failures and the less the financial risk they have in providing the warranty. For products that have on-going maintenance or service contracts, the Suppliers want to negotiate short warranty terms so they can sell those maintenance or service contracts. If you are negotiating a warranty on a product where the Supplier’s main motivation is management of the financial risk, one of the best tools to help with the negotiation is the Supplier’s own data about their product’s reliability. If a product is marketed to have a mean time between failures of 100,000 hours, which means it shouldn’t fail on average for over 12 years. If the Supplier is trying to offer only a one-year warranty, use their reliability figures against them. The argument is simple. If they really have a product with 100,000 hours, the incidence (and resulting cost) of failures that would occur in a year 2 or 3 are minimal, so the two are inconsistent.

Supplier may also want to have a term on all the other warranties. The keys in negotiating those are:
1.     Does the warranty tie to a potential third party claims and if they do, what is the statute of limitations on those types of claims? As long as the Buyer can be liable to a 3rd party, you want the suppliers obligations to correct the problems that gave rise to the 3rd party claim to be in effect.
2.     For warranties that don’t have a link to third party claims, what warranty do you provide your Customer? During your warranty period if there is a problem and the Supplier isn’t responsible to correct you pay the cost. Once your warranty to the Customer has expired you have no obligations or you can take the potential costs and risks into account in you maintenance of service pricing.  

Exclusions to warranties are important as they can dramatically impact your coverage or cost. For example, some Suppliers may provide a ‘parts only” warranty when the real cost of a problem is the labor it takes to correct it. Other exclusions can be so broad that almost anything will negate it. If you agree to any warranty exclusions, they should be capable of being objectively measured and be limited to only those damages that have been caused by parties other than the Supplier, such as Buyer or Buyer’s customer’s abuse or mishandling of the product. They should also be for damage that occurs outside what would be the ordinary or expected use for the product.

One way to narrow down discussions on warranty exclusions is to use the “Show me” tactic. If they want to exclude damages caused improper installation, ask them to show you where in their specification it describes how installation is to be done correctly. If they want to exclude damage caused by misuse, ask them to show you where in the specification it describes what proper use is. Never let an exclusion be based on a subjective opinion of the Supplier.