Friday, March 11, 2011

Importer of Record

If you purchase things internationally for resale to customers one of the issues that may arise is who will be the Importer of record? Most customs organizations require that the “Importer of Record” be the “Owner or Purchaser of the Goods”. This means that for the Supplier to be the importer of record they would need to own the goods at the time of import.  If you are purchasing from a Supplier subsidiary, it means that the Subsidiary owns the goods at the time of Import.

Most Suppliers would be reluctant to be the importer of record in a foreign location. The reason for that is if they do the import, when they sell the product to either their local subsidiary or Buyer that becomes a local sale.  To do a local sale:
  1. The Supplier must be legally registered to do business in that country and have an entity in that country.
  2. The Supplier becomes subject to the laws of that country as they are operating within its borders,
  3. The Supplier will be taxed on the profit made on that sale in the import country at the import country's tax rate. 
  4. The Supplier may be required to conduct the sale using local currency subjecting them to currency exchange risks
  5. The Supplier has to manage the repatriation of their profit from the Country
Having a supplier sell in a different country can significantly impact their profit and risks.

To avoid the impact of all these potential costs and risks Suppliers will sell into other countries three different ways;
  1. They will sell through an established subsidiary where they sell the Product to the subsidiary at “transfer price” (the standard price they sell to all subsidiaries) and the Subsidiary will be responsible for import and be the importer of record.
  2. If they don’t have an established subsidiary they may sell through a third party distributor. The distributor will purchase the product at a discount off the Supplier’s list price or at a target price specified by the Supplier. The distributor will then be responsible for the import and be the importer of record as they are owner of the product,
  3. The Supplier may sell direct to the Customer and the delivery terms or point where title is transferred will have the transfer occur outside the country and the Customer is responsible for the import.

If the Supplier won’t sell in a manner that makes them responsible for import (and most won’t) and they don’t have a local subsidiary that you could buy from, the decision comes down to whether you purchase it from their Distributor or buy it from the Supplier and manage the import yourself.  There are a number of factors that you would need to take into account. 

First and foremost is who is getting the better deal from the Supplier in the first place? If you buy from a Distributor, two things will impact the price charged. The margin the Supplier provides them in terms of their purchase discount and the margin the Distributor needs or wants to make from the sale.

The second issue with Buying through a local distributor is that the distributor may see your purchases as direct competition to their sales, which can make the relationship tenuous. Further, by placing your business through them, they become a potential larger competitor in that market as the more business they generate the higher the discounts they will get which can make competing with them more difficult.

The third issue is contract related. Once you purchase through a distributor, your purchases no longer have privity of contract with the Supplier. This means that unless you get the Supplier to agree that for all purchases through those channels, you can enforce the terms of your agreement directly with them, all the terms of your contract would not apply and the only company you can legally look to in the event of a problem is the Distributor.

Asking the Customer to be the importer of record, reduces the value added you provide and may cause them to look for another supplier which also isn’t good as many times product purchases frequently generate service revenues for the seller and losing the sale can cut off that annuity stream.

What’s the best solution?  If the Supplier or Supplier subsidiary will sell locally that’s best. If a distributor has a better deal than you, they may be viable. If not it will only add additional cost and complications to the relationship and you’d probably be better off managing the import directly or having the customer manage the import.

The issue of Importer of Record is frequently an issue when companies want their Suppliers to have stocking hubs close to their point of use. A common solution to that is having the Supplier either establish a hub or use a third party hub in a free trade zone where title transfers at the hub and the Buyer is responsible for import.  Sales that occur in free trade zones are not local sales as the Buyer takes title before import. 

Incentives, Rewards, Penalties, and Damages

Everyone has heard of “the carrot and the stick” as ways to drive performance.  The carrot is the incentive or reward, and the stick is to prod performance. In contracts, the carrots are the use of incentives, or rewards to provide incentive for the Supplier to manage to the desired performance.  The stick is the use of penalties or damages for failing to meet performance. In most cases, the approach you select doesn’t have to be an either / or situation as both may apply.  For example, you could include a financial incentive for the Supplier to complete the work on an earlier date. If that incentive isn’t sufficient to drive the Suppliers behavior, you still need the penalty or damage should they not meet the required date.

There are a number of different carrots or sticks you can include in a contract. For example:
  • Value engineering provisions are used to enlist the Supplier in trying to help reduce the cost of the work where the Buyer and Supplier share in the savings. 
  • Provisions that provide for a sharing of savings with Suppliers for them helping reduce the cost of purchases and subcontracts are used for the same reason. 
  • Incentives or rewards can be paid for early completion of the work.
  • Rewards could be paid for the work exceeding certain agreed goals.
  • Additional business may be committed based on exceeding performance goals
  • Price adjustments, penalties, damages or other remedies can be included for failing to meet agreed commitments or goals so if the Buyer receives less they pay less, and any additional costs they incur are covered by the Supplier.

One of the keys in including any type of incentive or reward in a contract is to make sure that the Supplier will only receive it if the Buyer actually benefits from it. You want to avoid situations where a Supplier could claim that they are owed compensation, as they would have earned it but for the acts of the Buyer or another Buyer controlled supplier.  One of the keys in creating any penalties, damages or remedies is under most country laws they need to approximate your loss and cannot be punitive in nature.  For example any liquidated damages should represent the approximate costs you would incur.

Which approach do you use?  My simple rule is that if the desired performance or meeting the goal will provide increase value to the Buyer or reduce the Buyer’s costs, incentives or rewards are appropriate. For example, if you are purchasing a service and there are goals regarding uptime for the service and the Supplier exceeds those goals, an incentive or reward may be appropriate. You just need to make sure the bar for providing those incentives or rewards is high enough. If the performance won’t provide any incremental value or savings to the Buyer, using penalties or damages is more appropriate.  For example, if you leased space to move offices and hired a contractor to modify the space to meet your needs, you may not have any benefit of the Supplier completing the work early, but would have a major impact if they failed to complete on time.

The same type of reward / penalty can also be used in annual negotiations.  In one year we implemented a program to measure the total cost of doing business with a supplier based on only one metric – delivery performance. In the next negotiation we produced a summary of what the Supplier’s performance was and what their performance cost us in terms of inventory carrying cost.  The negotiation then came down to telling them that they needed to reduce their price to take into account what their performance cost us, or they needed to commit to improve their performance.  Most wanted to make commitments and the commitment could have been structured as either an incentive or penalty. The incentive approach would be to pay the Supplier the reduced price where they could earn the full price by meeting performance goals. The penalty approach would be to assess damages for each time they failed to meet the committed performance.

Incentives can also be a tool in price negotiations.  For example in purchasing advertising services there is always a conflict between procurement (who wants to reduce cost by reducing the fee) and the internal customer (that want to get the maximum benefits from the advertising program). One way to avoid this conflict is to work with the internal customer to establish goals they want met and use those goals for the Supplier to earn the full compensation. In this the base price would be discounted and if the Supplier met all the goals of the program they would earn their full fee. If the goals aren’t met, you pay less because you received less value.  If the goals are met you pay the full price but that will probably be far less of a cost than the financial benefits you will get from meeting the performance goals.  

New to my Blog?  Here’s a quick tip on its organization.  The Blog is being loaded in reverse alphabetical order so that once the blog is completed all the topics will be alphabetically in order so subjects will be easier to find within the Blog.  

Incorporation By Reference

Many agreements include what are called “merger clauses” where the parties agree that all prior discussions have been merged into the agreement and the agreement represents the entire understanding between the parties. Further, under the rules of contract construction, the courts will only look to the “four corners” of the agreement to determine the intent of the parties. This means that if there are other documents, attachments, or exhibits that make up the agreement, those documents need to be “incorporated by reference” into the Agreement. 

Incorporation by reference is a method of making document become part of another document by stating in the original document that the other document is made part of the original document.
It is common drafting practice to incorporate by reference an existing writing into contracts, or other legal document in order to save space. To properly make them part of the Agreement they should be incorporated by reference within the body of the Agreement or within the body of another document that has been properly incorporated by reference into the Agreement.

Incorporation of a document by reference is done by stating the incorporation by reference in the body of the Agreement where the specific document is referred to, or incorporating those documents in listing of Attachments or exhibits within the Agreement.

For example:
Pricing is set forth in Attachment A, entitled “Product and Price List”, five (5) pages, dated January 2, 2011, which is incorporated by reference into this Agreement.

Section 11 Attachments and Exhibits.
The following Attachments and Exhibits are hereby incorporated by reference into this Agreement:                                                                                                          
Attachment A, entitled “Product and Price List”, 5 pages, dated January 2, 2002
Attachment B, entitled “Cancellation and Rescheduling Terms”, 1 page, dated January 2, 2002
Attachment C, entitled “Supplier Quality Agreement”, 5 pages, dated December 31, 2000
This Statement of Work adopts and incorporates by reference the terms and conditions of Agreement #_______) between Buyer and Supplier.                                                                                                           
The key thing you need to do is make it very clear exactly what document(s) you are incorporating by reference. To do that each document to be incorporated should have:
  • a name, title, or reference number.
  • a date, or formal revision number
This is so you know the exact version of the document that is included.

Exhibit 1 “Sample Return Material Authorization” form, 2 pages dated March 30, 2009.

If the document consists of multiple pages and not all pages need to be incorporated, you should list only the applicable page numbers being incorporated.

It is possible to incorporate the entire terms and conditions of another agreement to create a new agreement between different parties. This type of practice is frequently done in acquisitions and divestitures where you need to provide the company that’s buying the Business with agreements with existing suppliers and you can’t assign them because you need the agreements to be in place for other business with the Supplier.  I’ll discuss that in the topic called “adoption agreements”.