Tuesday, July 5, 2011

Indemnity types

Indemnities are described in a number of different ways depending upon the scope of the indemnification and the subject matter.  The indemnitor is the party providing the indemnity and the indemnitee is the party being protected by the indemnification.

A “broad form” indemnity has indemnitor hold the indemnity harmless from the risk in question, even if the entire loss was caused by the indemnitee. 

A “intermediate form” requires the indemnitor to assume all of the risks associated with the subject of the indemnification, but not if the sole cause of risk is attributable to the indemnitee. 

A “comparative fault” indemnity, would hold the indemnitor responsible only for the loss caused by the indemnitor, or to the extent caused by the indemnitor. 

A “mutual” indemnity has each party indemnifying the other party for losses that they caused the other party. For example the supplier indemnifies the buyer for losses the supplier causes and the buyer indemnifies the supplier for losses the buyer caused.

In many jurisdictions a broad form indemnity may not be enforceable as it goes against the principles of equity where the party providing the indemnity is being penalized for something they didn’t do. Most buyers prefer intermediate form indemnities rather than comparative fault or indemnities.  The reason why they don’t like comparative fault remedies is it almost always requires both parties going to court to establish their percentage liability.  Mutual indemnities are not frequently used as between a buyer and supplier the liability risks are different. A buyer may be liable for the acts of a Supplier because the law of agency would consider the buyer the principal and the supplier the agent, and principal are liable for the acts of their agents. A supplier would not be liable for the acts of the buyer under the theory of agency.  As a result most indemnity provisions will carve actions of the Buyer out of the indemnification.  For example, in an indemnity provision against personal injury or property damage claims,  injuries or damage caused by the sole negligence of the buyer would be carved out of the suppliers indemnification.  For intellectual property indemnifications suppliers will want to be excused from providing the indemnification in situations where the Buyer caused the infringement.

There are other potential indemnities such as “work related” indemnities that relate to the indemnitor’s  work and would not require negligence. In many contracts rather than include an indemnity the buyer may include a warranty that would require certain facts be true now and in the future or they could require insurance.  For example a partially constructed building could have damage in which the contractor wasn’t negligent so instead of an indemnity you might require insurance on the completed operations as protection against the loss. A “financial” indemnity is nothing more than a guarantee of payment by a third party to the indemnitee.  For example the buyer a third party to purchase items directly from the supplier and the supplier wants protection from the buyer that the third party will pay for what they purchase. Most buyers seek to avoid providing any form of financial indemnity or other payment guarantees for third parties such as other suppliers as the risk can be managed in a number of other ways.


Why should you purchase my book "Negotiating Procurement Contracts - The Knowledge to Negotiate"

If you read my blog you know that my primary focus is on helping build all the different types of knowledge that you need to effectively negotiate. Neither negotiation tactics or negotiation strategies on their own will make you successful.It’s knowledge that makes your strategies more effective and it’s knowledge that makes your tactics work. My book “Negotiating Procurement Contracts:The Knowledge To Negotiate” was written to be complimentary with the blog. It adds a number of new topics and expands upon many of the topics in the blog. What makes this book different from other negotiation books is that it is 100% focused on providing more knowledge about procurement negotiations.

What does the book include? Here is a list by chapter.
1. Building negotiation knowledge. This chapter stresses the importance of knowledge as part of negotiation.
2 Understanding Cost. As most procurement negotiations are about cost and this chapter helps you understand all the potential costs that can exist in a procurement relationship that may need to be addressed in the contract and negotiation.
3 Understanding Cost in Contract Terms. I wrote this chapter to help you identify the different costs that are addressed in individual contract terms so that you better understand the terms and they costs they are designed to mange. Understanding the helps you do a better job of negotiating them.
4 Understanding Procurement Risks. To negotiate contracts you need to understand the potential risks that can exist in a procurement relationship. The better you understand the potential risks, the better you should be in drafting and negotiating contracts.
5 Understanding Contracts. This chapter addresses 15 different things about contracts you should know if you are going to negotiate contracts. The goal of this is not to make you a lawyer but to understand these key issues from the perspective of how to draft and negotiate contracts. It expands upon many of the contract related topic in the blog.
6. Limits of Liability. To effectively write and negotiate contracts you need to understand all of the ways in which liability can be limited in a contract and its not just the limitation of liability section. This discusses all the different types of limitations so you are aware of them and can use them or quickly spot when they are being used on you.
7 Structuring Contracts to Drive Behavior and Performance. The terms you include in your contract influence how the supplier will respond. This chapter focuses on how to write and negotiate terms that drive the right behavior and performance.
8. How Companies Operate. One of the things that always amazed me was how little knowledge procurement and contracts people had about how a company operates and how they sell. These impact a number of different things in a negotiation and in enforcement in the event of a problem, so its best to learn how they operate and the impact it can have on your negotiation.
9. Standard Terms, Why Are They There? I’ve had procurement people tell me that terms were a bunch of “legal mumble jumble. That’s because they didn’t understand what they meant or why they were included. If you understand that you are better positioned to negotiate them,
10. Negotiation Basics. This is a brief chapter that talks about different negotiation strategies and all the different phases of negotiation. My view of negotiate is the process starts well before you sit down at the table and continues long after the contract is signed. If you write or negotiate contracts you should understand this
11. Using Prequalification to Prepare to Negotiate. I’ve written a small amount about this in the blog. This expands upon that and talks about why prequalification is a very important tool for use in negotiations.
12. Negotiation. Here I talk about preparing for the negotiation, establishing and managing the negotiation team and the tools a negotiator should have when negotiating. I also provide some general thoughts on negotiation that are in addition to the specific topics on the blog.
13. The Remaining Phases of Negotiation. The emphasis here is making sure that you understand that the negotiation doesn’t end when the contract is signed. What you do prior to the negotiation determines how successful you will be in the negotiation. What you do after the negotiation determines how much of the bargain you negotiated for you will keep.
14. Buyer and Supplier Negotiation Goals. This chapter provides a general listing of both the buyer and suppliers goals of which many are in direct conflict. If there were agreement on goals there would be nothing to negotiate.
15. Communication In Negotiation. As I have written significantly about communication in negotiation in the blog, chapter is brief and that focuses on general communication activities in negotiations and the importance of asking questions in a negotiation.
16. Avoiding Enforceability Problem Costs. Having the best contract in the world doesn’t do you any good unless its enforceable. In this chapter I provide a number of tips in terms of how to write and negotiate contracts to avoid enforceability problems.
17. How Suppliers Attempt To Manage Liability. The major focus of this chapter is all the different words and terms that suppliers try to include in agreements to reduce their potential liability. If you learn that you’ll easily be able to spot them when a supplier tries to use them on you.
18. Buyer’s Management of Risk and Liability. This chapter includes a few tips on things buyer can do to help manage risk and liability.
19. A Contract Negotiation Example. In this chapter I take a red-line of a clause where a supplier made a large number of proposed changes and highlight what they are doing, why they did it and what the impact of that proposed change would be. If you will be negotiating contracts you need to quickly identify what the real impact of a proposed change will be.
20. Negotiating Concessions. In this chapter I briefly highlight what needs to be in place for a supplier to be willing to make concessions and buyer’s role in persuading the supplier to agree to make the change.
21. Negotiating Cost. If you are going to negotiate on a cost basis, you need to understand cost terms, the different types of cost models and how to use them to negotiate cost. In this chapter I expand upon all the blog posts about cost and negotiating cost including discussing various cost models that can be used for cost negotiations
22. Discounts. Discounts don’t have to be limited to the volume of purchases. There are a number of different types of discounts that I’ve negotiated and seen negotiated and I wanted to share them as food for thought.
23. Negotiating Delivery. If you are going to negotiate internationally you need to understand all the different delivery term and how to negotiate delivery. This expands upon some of the delivery related blog posts.
24. Negotiating Quality, Managing Quality Cost. Since quality is a key cost in procurement relationships I summarize my thoughts on negotiating quality and managing quality cost.
Glossary of Terms. If you are going to write and negotiate contracts you need to learn how to speak the language and understand what the terms mean. In the glossary I have taken virtually every term I’ve ever encountered in negotiating procurement contracts and have defined them or explained what they mean as a tool for both reading the book and the blog but in also building your vocabulary of common procurement terms.

What is really meant by "Good Faith" ?

There can be many different standard of commitment based upon the words that are used. Will or shall are firm commitments. When you talk about "efforts" you can have best efforts, reasonable efforts and commercially reasonable efforts and the only commitment out of those is the party making that commitment only needs to exercise that level of effort. Good faith is a level of commitment that is less that the different efforts standards. All it means is that the party has to exercise "good faith" in their dealings. There is no obligation that they have to agree, nor do they have to extend a level of effort to agree. It is very difficult to prove bad faith, so using good faith alone is something I don’t recommend.

If there are issues that are open and you need to use good faith as a minimum I would require that “neither party shall unreasonably delay or withhold the agreement”.  That makes the commitment subject to the standard that they must act reasonable.  A standard that they must be reasonable is more enforceable.  Another alternative could be to set a parameter in advance for the agreement.  For example if you could not determine the final price until a final design was complete you could agree to negotiate the price in good faith in the future but include a not greater than amount or a band width for agreement.  By including the parameter, if you offered to pay the price at the not greater than amount, the failure of the other side to agree would be bad faith.

I don’t like good faith commitments. Most of the time what happens is when it comes time to agree in good faith on an item you usually have less leverage.  For a good faith commitment to work both parties need to be at risk if there is failure to come to agreement.  For example it probably would work if you structured your contract where you could terminate with no liability if you failed to reach agreement on that item.   The supplier would lose what they have into the work and you would lose by having to start over again with a new supplier. It won’t work if you have a high cost of terminating the agreement.

If you really need performance on an issue, avoid using "good faith" and use a higher standard of commitment.


In the early 1950s the Uniform Commercial Code ("UCC") was created in the United States. Every state in the United States has adopted the use of the UCC. Article 2 of the UCC governs the sale of goods. In 1980 the United Nations enacted the United Nations Convention on Contracts for the International Sale of Goods (CISG). CISG has been adopted by seventy-six countries including most of the major trading countries. Major exceptions are the United Kingdom, Ireland and Brasil. Many countries also have their own statutes or laws regarding the sale of goods between companies.

If you write a contract with a U.S. company and the applicable law is any state but Louisiana, the UCC will apply unless you opt out of having the UCC apply. CISG does not apply to domestic sales within a country. CISG only applies to international sales. If you write a international contract and both parties are in countries that have adopted CISG, CISG will apply unless the agreement specifically disclaims the CISG from applying.

For example, if the parties do not agree to the contrary, a commercial sales agreement between a business in Chicago and one in Toronto would automatically be subject to its provisions. If they agree to exclude CISG from applying:
·       They could agree U.S. law where the UCC would apply.
·       They could agree upon Ontario law, where the Ontario sales laws would apply.
·       They could agree to have the laws of another location apply. This is done when that other location may be more favorable to the specific type of transaction or may have more law or case law on the subject.

In the U.S, the scope and impact of CISG depends upon whether it is purely a domestic sale or international. For domestic U.S. sales CISG does not apply. For international sales the impact is significant, as use of CISG would replace UCC Article 2. Many U.S. companies opt out of using CISG, preferring to use the familiar UCC where there is substantially more case law.  As most purchase orders of U.S. Companies are drafted relying upon the protections of the UCC, if you will use your purchase order form for international purchases, the purchase order terms should also opt out of CISG.

In foreign transaction whether CISG should be used will depend upon a number of factors because there are differences between CISG and the UCC and there will be differences between CISG and local sale of goods laws.
For example, here are a few differences between the UCC and CISG,

Applicable transactions
Applies to both consumer and commercial transactions
Specifically excludes consumer sales from its provisions
Sale of goods
Excludes goods purchased at auction, securities, aircraft, ships, electricity, and service contracts. 
Statute of Frauds
Requires writing over $500
Writing not required
Requirements of contract
Mutual assent, consideration, legal capacity, legal purpose.
Not directly concerned with validity of the contract
Offer & Acceptance
Modifications in acceptance are counter offer.
Modifications are counter-offer, unless they do not materially alter the terms and are not objectionable to the offeror. Requires offeror to object verbally without undue delay, or terms become those of the offer, as modified by the acceptance.
Buyer has the right to terminate when the seller has breached a "condition" of the sale, no matter how minor.

Allows the seller who fails to perform on time, or who delivers nonconforming goods, to correct the performance as long as it does not cause the buyer an unreasonable delay or inconvenience.
Withholding shipments
Unless authorized by the contract, Seller has no right to withhold delivery simply due to fear of non-payment.

If seller provides notice, they may suspend delivery or prevent the release of goods if buyer may not have the ability to pay for the merchandise. Seller must deliver if the buyer then provides adequate assurance of payment.
Price reduction for non-conforming goods
Would be addressed as damages for breach
Allows buyer the right to reduce the price in the same proportion as the decrease in the value of the goods.
Includes incidental and consequential damages. Consequential damages are limited to those that could not be reasonably prevented.
Includes lost profit that the other party foresaw or should have forseen.

When might the use of CISG make sense for U.S. based companies? The first thing you would consider is whether the country you are dealing with has adopted CISG. If they have not it would not automatically apply as it will only automatically apply to transactions between countries that have adopted CISG.  If the buyer or seller are from countries that haven’t adopted it, it doesn’t automatically apply although the parties could mutually agree to have CISG apply.

If you were doing an international transaction with a supplier that was unwilling to agree to have U.S. law be applicable to a transaction, you would need to get local guidance on which approach will better protect the buyer. Will it be local sales laws or CISG?  A problem with having CISG apply for a buyer or seller that is located in a country that has not adopted CISG is since it hasn’t been adopted there will be no local case law governing its interpretation. If CISG was determined to be the better alternative than local sales law, you could always agree to have the applicable law and jurisdiction become a third country that has adopted CISG.

My own opinion of CISG is I feel that it is more favorable to sellers than buyers.

Want to learn more? The companion book "Negotiating Procurement Contracts - The Knowledge to Negotiate" is now available on Amazon.com.