Scope of the License Grant

Unlike goods that when you purchase them you can pretty much use them any way you like once you have purchased them, software is different. Under a license you are being provided with a right to use the software in accordance with the license grant. The scope of that license grant can vary and the scope of the grant is one of the most important parts of the license agreement. As you are getting rights to both the software and documentation the scope of the license grant should cover both.

For the software grant the common variables are:
Is the license revocable or irrevocable?
Is the license exclusive or nonexclusive?
Is the license transferrable or non-transferable?
Is the license for a limited term or is it a perpetual license?
Is the license for worldwide use or for a limited scope?
Do you have the right to sublicense?
Will the licensor provide both object code & source code under the license or just object code?
Is the use limited to a site, and individual CPU, a cluster or network, is it for another use such as SAAS (Software as a service) or cloud?
Is there any limit on its use such as internal use only? Does it allow consultants or contractors to use it? Does it prohibit potential competing uses?
Do you have the right to make and keep archival copies?

For the license to documentation the common variables are:
Do you have right to make copies?
Do you have the rights to prepare derivative works such as for internal training?
Do you have the right to make and keep archival copies?

Let’s look at each of these from a licensee’s perspective.

Is the license revocable or irrevocable? As a licensee you want the license to be irrevocable. The reason for that is you will normally have made an investment in using it and may be depending upon it, so you don’t want to provide the licensor the ability to simply stop its use. Most license agreements also will include provisions where the licensor can terminate the license for cause if you fail to meet your obligations under the license. If you allowed the license to be revocable, it would be equivalent to providing the licensor the right to terminate without cause and without liability.

Is the license exclusive or nonexclusive? Unless the software is being created exclusively for you (in which case you should own it) you normally wouldn’t want the grant to be exclusive. The licensor may not be able to do that if they previously licensed copies. If they didn’t it would dramatically increase any license fee you would have to pay as they couldn’t license it to others.

Is the license transferrable or non-transferable? Most licensors do not want licenses to be transferrable. Whether it’s important to the licensee will depend upon the circumstances. If you were purchasing it for a customer as part of a customer solution you definitely need to be able to transfer it. If you purchased it in conjunction with a piece of capital equipment you would want it transferable so it doesn’t decrease the residual value in the equipment when you sell it. In other situations you may not need to have it be transferrable but you may want the right to assign it in conjunction with the sale of a business unit that used it.

Is the license for a limited term or is it a perpetual license? Most licensees would want a perpetual license for many of the same reasons you don’t want the license to be revocable. You invested in it, you trained your people and it may be an integral portion of your business. Do you want to negotiate a new term when you have little leverage and much invested? You only want to pay the license fee once.

Is the license for worldwide use or for a limited geographic scope? The answer to this depends upon what type of license you are negotiating. For example if you were negotiating a master license for potential use by all the operations you have around the world, you would want it to be worldwide.
If you were negotiating it for an operation where the work could be transferred to another location and would want to change the installed location you would want it to be worldwide. If you had neither of those concerns you probably could agree to a limited scope. The licensor would want to limit the scope of geographic use for two main reasons. The licensing fees may be significantly different in different locations or licensor may be restricted by other business agreements. For example, they may not be the developer buy may simply have a license from the developer to license in within at specific geography or they may be the developer and may have given exclusive rights in certain areas to another company.

Do you have the right to sublicense? For licensees, unless you are licensing the software for resale to a customer, you would not need the right to sublicense the software.

Will the licensor provide both object code & source code under the license or just object code? The first thing you need to take into account is if you want source code, licensors consider their source code as confidential information and will require protection as such. With the acceptance of confidential information comes potential liability if you fail to protect it or were to use any of that information without authorization. Where source code may be needed is if the licensor is unable to or fails to provide the licensor with the support that is need. That is usually addressed through escrow requirements where source is placed in escrow and released to the licensee in the event certain things occur. Based on this the grant probably should be only for object code.

What will be the licensed installation location? Normally what may occur here is the licensor may have different licensing options with different fees associated. This could be things like individual user, seats, concurrent users, etc.. It is up to the licensee to determine which of these options best meets their needs.

Is there any limit on its use such as internal use only? While licensors don’t want the licensee allowing other companies to be using the software, licensees need to think about who may need access to the software. Many companies have outsourced suppliers performing functions on their locations. They may have contractors and consultants that need to access and use the licensee’s systems. As long as internal use takes into account the use by those parties, an internal use restriction may be acceptable.

Does it prohibit potential competing uses? Whether this type of restriction would be acceptable to a licensee would depend upon what the restriction is and how they intend to use the licensed product.
A licensor may need to put a restriction on competing uses as some, if not all of the product may have been licensed from a third party that wants to restrict it from being used by its competitors.

Do you have the right to make and keep archival copies of the software and documentation? This is a right that the licensee should absolutely have as archival copies in remote locations are critical to disaster recovery. As the only time you use those copies is when you can’t use the original or the original has been destroyed, you shouldn’t have to pay anything. You are still using the license in accordance with the original grant.

Do you have right to make copies or make extracts of the documentation for internal use such as training? For the licensor the answer to this will depend upon how much they want documentation to function as a revenue source. With the movement to electronic documentation that has dramatically reduced the cost, and the buyer’s ability to put that on line for people to read, the issue of copies of documentation has become less. If a supplier is unwilling to agree to that it will increase you life cycle cost to use the product.

Do you have the rights to prepare derivative works such as translating the documentation for use by employees in other locations or for internal training? Many licensors are sensitive to allowing the licensee to create derivative works. If you want the right to prepare derivative works of the documentation many suppliers may in turn what a royalty free license to use and sublicense such derivative works. If you feel that you may need it and are willing to agree to restrictions such as it can be used for internal purposes only and you are willing to license the supplier, there aren’t too many good reasons why they shouldn’t agree.

Software - common definitions

There are many different types of software and many different licensing approaches. These posts are intended to provide a basic understanding of software licensing starting with a simple license of a program for internal use. For internal use these are the common terms that would be defined:

Licensor means the individual or company that is providing the license grant to use the software and documentation.
Licensee means the individual or company that is paying the licensing fee to use the software and documentation
Derivative Work is something that is prepared based upon the underlying code or documentation that would infringe the Licensor’s copyright in the work unless authorized.
Designated Installation(s) would define the physical location where the software will be installed. It could be an individual computer or CPU, a cluster of CPU’s, a network, a cloud. In SAAS (Software as a service) it could even be maintained at the licensor, with the licensee being provided access to the software.
Internal Use means software that is used by the licensor, their employees, contractors or consultants on the licensee’s computer.
Licensed Product means the software and associated documentation.
Licensed Software mean the software only
Object Code is code primarily in binary form that can be executed by a computer
Source Code is code that is readable and understandable by a programmer
Documentation means user manuals or other materials provided by the licensor
Material Errors are errors in code that affect the operation or use of the program that must be corrected.
Minor Error or Bugs are errors in the code that do not affect the operation or use of the code that the licensor may, but is not obligated to correct
Enhancements are changes or additions to the code or documentation that improve the licensed product. Depending upon the licensor enhancements may be provided without charge for licensed products that are under warranty or have a maintenance agreement in place. Other licensors may have separate charges for enhancements.
Upgrades are enhancements of the licensed product that add substantial value and must be licensed for an additional charge.
Escrowed Materials would define what materials would need to be placed in escrow with an escrow agent if the license agreement requires the licensor to hold the materials in escrow.

Software

As I am running out of regular subjects to post I decided to start doing posts on software. The differences between licensing software versus purchasing a good or service stems from the difference in intellectual property rights. With goods you buy and own them, With software you have the rights it use it. I wrote a post called “Differences between tangible property and intellectual property that highlights some of the differences.

Just like purchases of goods or services where there is a variety of templates and terms depending upon what you are purchasing, software has a variety of templates and terms that are based upon what is being licensed and how it is being licensed. For example a software license for a standard software product may be different in a number of aspects than a license for software that is licensed in conjunction with the purchase of a piece of capital equipment that needs the software to operate, The needs of the parties are different and the risks are different..

To start to blog about software I decided to first post a checklist of the types of terms that a buyer who will be negotiating terms for the “licensee” would be looking for in either drafting a license agreement or in reviewing a software developer’s (the “licensor”) standard template.

In future posts I will explain each of those focusing on terms that are unique to licensing software.If a term is common with one that’s used with the purchase of goods or services, I’ll refer the readers to the existing post.

Software License Worksheet for Standard Products

1. Definitions
CPU
Derivative Works
Designated Installation(s)
Internal Use
Licensed Product
Licensed Software
Object Code
Source Code
Documentation
Material Errors
Upgrades
Enhancements

2.Scope of license
A) Software License
Is it revocable or irrevocable?
Is it exclusive or nonexclusive?
Is it transferrable or non-transferable?
Is it for a limited term or is it a perpetual license?
Is it for worldwide use or for a limited scope?
Dou you have the right to sublicense?
Will the licensor provide both object code & source code under the license or just object code?
Is the use limited to a site, and individual CPU, a cluster or network, is it for another use such as SAAS (Software as a service) or cloud?
Is there any limit on its use such as internal use only? Does it allow consultants or contractors to use it? Does it prohibit 3rd party or potential competing uses?

B) Documentation
License to documentation.
Do you have rights to make copies?
Rights to prepare derivative works for internal training?

3. License fees, Payment, Taxes
What is the cost of the initial license?
Do you need options to purchase additional licenses? If you do, how long will the price remain firm?
What are the payment terms for the license, maintenance fees and other services?
Obligations of the parties to pay any applicable taxes.

4.Delivery and Responsibility to Install.
What is the lead-time for delivery?
Whose responsibility is it to install the software (licensor or licensee)?
If responsibility is with the licensee, what are the requirements for customer installation?
If the licensor will install, is the installation cost included in the license fee or is that a separate charge?
What is the lead-time for the installation?

5. Acceptance / Acceptance Test:
After installation is complete how long do you have in which to commence the acceptance testing?
What is the agreed duration period for the testing?
What is the agreed acceptance and test criteria that will decide whether the software meets it defined specifications?
If there are material errors discovered, how long does the Licensor have to correct them?
What rights does the licensee have if the licensor fails to correct them within the period to correct?
If Licensor corrects the defects, does the duration to perform the acceptance and test restart?

6.Warranties:
A. Warranties
When do the warranties start and what is duration of the warranty period?
What are the responsibilities to correct minor errors versus material errors?
Are you relying on the software product to be fit for a particular purpose? Does the specification define that purpose?
Are you relying upon representations made by the Licensor? If yes, have you made those part of the agreement?
B. Legal warranties
>Right to enter the license agreement
>Sufficient rights in the licensed product to make the grants and commitments
>Conform to the specifications when used unmodified.
>No security measures, restrictions or limitations have been incorporated
>No harmful code
>No open source code unless advised and agreed
C. Warranty on services (such as maintenance). Use reasonable care and skill in performing,
D. Warranty redemption rights and remedies
How long does the licensor have to correct material errors?
What remedies does the licensee have if the licensor fails to correct material errors within the agreed time frame?

7.Infringement & Indemnities:
General Indemnification
Intellectual property indemnity
Licensor’s options to cure infringement of intellectual property claims.
Licensees remedies if Licensor fails to cure.

8.Confidentiality:
Standard of confidentiality Licensor is obligated to use with licensed product.
Obligation to return or destroy materials upon termination (except for termination by licensee for cause)
Limits on copying: basic rights vs. expanded use; e.g. disaster recovery.
Obligations to include copyright and proprietary legends on licensed copies.
Licensee exemptions for maintain the licensed product as confidentiality

9.Limitation of Liability:
Any limitation on types of damages that may be claimed by either party?
Any financial limitations for both parties on the amount of the allowable types of damages that may be claimed.

10. Insurances Required of Licensor

11. Maintenance
Scope responsibilities and services provided
Cost
Error correction responsibility during maintenance period?
Response times?
Escalation process?
What hotlines or on-line help is included and what are their hours of operation?
Does maintenance include enhancements?

12. Enhancements:
Planned and rights to planned
What constitutes an enhancement
Scope of enhancements
Cost or enhancements

13. Training
a. Recommended levels of training required?
b. What training is included in the price?
c. What are the locations and costs for additional training by course?

14. Documentation, Media and Method of Delivery
a. What documentation is provided with the initial license fee?
b. What is the cost to purchase additional documentation?
c. Can you reproduce excepts for internal training?
d. Do you have the right to make derivative works of the documentation?
e. What is the media or authorized manner for delivery of the code?

15. Source Code
a. Is source code provided or will it be escrowed?
b. If escrowed: Who is escrow agent and location?
c. Do you have agreed triggers where you can demand the release of the source code?
d. What are the provisions for release?
e. What rights and obligations do you have in using the released source code?
16. Rights to Archival Copies
17. Term of the Agreement
18. Termination
Rights, if any, to terminate the license without cause. Licensee’s remedies in the event of termination.
Rights of licensor to terminate for cause by Licensor.
a) Causes that allow termination rights.
b) Licensee’s rights to cure and cure period.
c) Licensee obligations in the event of termination.
Termination by Licensee for Cause,
a) Causes for license termination.
b) License Grant in the event of termination.
LICENSEE termination rights without cause, licensee obligations in the event of terminating.
19. Electronic Self Help
Rights or prohibitions against licensor being able to electronically be able to reposess or disable the software in the event of breach or failure of the licensor to pay fees or maintenance charges,
20. Purchase Orders

21. Licensor’s Commitment Period to Support Multiple Releases
This establishes how long the licensee can plan to use an existing version of a product and have the supplier provide maintenance services before being either forced to either
either operate without the supplier support, terminate the license without cause and return the software, or purchase an upgrade version of the product

20. Miscellaneous Terms:
a. Governing law and jurisdiction
b. Force Majeure
c. Assignment rights for both parties
d. Specifications made part of contract
e. Compliance with laws
f. Merger of terms
g. Survival
h. Waver
I. Notices
J. Publicity Restrictions

Other things to check:
Operating systems and revision levels supported
Planned Future Releases and rights to future releases
Hardware and software pre-requisites
Additional consulting services and costs
Local language variants

Where Reducing Cost isn’t the Number 1 Priority

While most procurement groups are focused on cost and cost reduction there are a number of situations where cost may not be the primary factor. The simple fact is purchasing spend is an investment by the business or company. Investments are measured based upon the value or return that they provide. Time has an impact on the value or return that will be provided. Many people think of cost as being the rate you pay. It’s the rate times the demand and in many purchases it can be more important to manage the demand.

If you ever worked in new product development in a competitive industry you know that time to market is a key factor in decisions. That’s because of the competitive advantages that you get when you are first to market. You may have a supplier that says they can provide you a product at less cost than someone that already has a product that meets your needs. If using that supplier would push out when your product will be available for market, you probably won’t get much support for using the lower cost supplier.

If you work in the mining or energy sector you know that time to revenue is a key factor in those decisions.The revenue that one day generates from the completed work may far outweigh any cost savings you could generate. If reducing cost will have any negative impact on that schedule you won’t get much support there.

If your business buys and resells other companies products you probably know that the focus is usually not on what the product costs, it’s on what margin are you going to be able to make. If you can’t make the margin you need the cost doesn’t matter.

If you need to hire a supplier on a time and materials basis, you know that the real cost is rate times the demand and the way to keep the cost down is not to focus on the rate as much as making sure that you have experienced people who know what they are doing and aren’t learning at your expense. That keeps the demand for labor hours down so it keeps the cost down. If all you focus on is the rate you may get a lower rate but at much higher end cost.

Time and value the purchase will provide has a huge impact on what to focus on. I remember being called to meet with a Vice President whose business needed to have a building constructed in Hong Kong. He made it very clear that he didn’t want any delays in the procurement and contracting process. He gave me one key fact that highlighted that. Once in operation in the first six-month period they would make more profit than the building would cost. Based on that we fast tracked all of the procurement and negotiations. The focus was on speed, not cost. We didn’t throw unnecessary money at getting it done, but we also didn’t delay things with extended cost negotiations.

If you focus only on the rate and not the demand you lose significant opportunity to reduce the cost. To do that you need to involve the business, understand what their priorities are and work with them as only they can take steps to reduce demand.

In negotiating contracts, one of the things you need to be on the look out for is terms that will drive demand for activities that will add to your cost. I wrote a separate post on that called Managing Demand.

Financial Obligations at Contract Close

The financial obligations that you will have at contract close will vary based upon the industry, the type of contract, and whether you are the buyer or supplier. For example, if you had a construction contract that was based upon measured quantities, the actual amount to be paid my not be established until the quantity surveyor does a final measurement of the quantities and all claims are established and sorted through.

For other industries the obligations are different and most will vary based upon the specific terms of your contract. For example as a buyer if you:
1. Made no firm commitments for the quantity you will purchase, and
2. Didn't have the supplier amortizing any one-time costs into the price, and
3. Didn't have the supplier holding inventory of any kind for logistics programs, and
4. Met all other obligations of the agreement,
You would probably have no further financial obligations or liability at the time of contract close.

As a buyer where you would have financial obligations and potential future liability is:
1. You made firm commitments for the quantity, that you didn't meet or,
2. You had the supplier amortize one time costs in the price and failed to purchase the complete quantity for that to be fully amortized, or
3. You had the supplier holding inventory for logistics programs and failed to consume that, or
4. You terminated the agreement early where your termination without cause provision would determine your liability, or
5. You failed to meet all other obligations of the agreement where they would have potential claims for damages etc.

If you were the supplier you would have financial obligations and potential future liability for:
1. Any obligations to pay or refund the buyer with monies that have not been paid.
2. Failure to return any buyer owned or loaned materials.
3. Any liability that you would have for any breach of the agreement that resulted in damages to the buyer.
4. Any future financial obligations necessary to meet terms that have been agreed to survive the termination or expiration of the agreement, such as cost of warranties that will extend past the contract close.
5. Any liability that you may incur in the future as a result of failing to meet the obligations of the agreement that were agreed to survive the termination of expiration of the agreement. For example indemnities for third party claims for personal injury or property damages, product liability claims and intellectual indemnity indemnification claims normally survive until the statute of limitations expires.

If you entered into a confidentiality or non-disclosure agreement the party receiving confidential information would be liable for wrongful disclosures during the term that the parties agreed that the information be held as confidential as long as that commitment survives the expiration of the contract, or when the obligation is excused by other actions that are specified in the agreement.. For example the recipient could be excused because the information was made public through no wrongful act on the recipient’s part, That would end the recipient’s potential liability for any future disclosures. It would not excuse the recipient for any wrongful disclosures that occurred prior to that point.

Individual country laws may specify how long a specific obligation will exist. If there isn’t a specific law obligations terms that are specified to survive the expiration or termination of the agreement will be in effect until the agreed time period has passed. If no time limit for those surviving obligations was specified, they would cease when the statute of limitations for that specific type of obligation or claim would expire (See post on statute of limitations).

For example, assume you wrote a confidentiality agreement with a two year term. You included a five-year period to hold the information confidential. You failed to include language that has the confidentiality obligation survive the term of the agreement. In New York State the statute of limitations for contract claims is two (2) years after the expiration or termination of the agreement. The impact of this would be that since you failed to have that specific provision survive the expiration of the contract you could not sue the recipient if they made an unauthorized disclosure still within the five-year period but after the statute of limitations for contract claims had expired.

Always make sure that any obligations that you want to remain in effect after the termination or expiration of the agreement are specified to survive the expiration. If you need a longer term that what the statute of limitations would provide specify it.

Business Interruption Coverage

While most procurement contracts may include insurance requirements for Comprehensive general liability, Comprehensive Automobile Liability, Workers Compensation or Employers Liability, and Property Liability there is another type of insurance that many companies carry that negotiators should be aware of. That insurance is Business Interruption Coverage. Business Interruption insurance deals with situations where the company has a natural disaster or force majeure event where it can’t operate. Those insurances can be written to include the profit that would have been earned during the period in which they were unable to operate, any fixed costs still being incurred at the location that wasn’t usable, cost to move to and operate from a temporary facility and other reasonable expenses to continue operation while the property is being repaired.

Where you would use this knowledge is in negotiating a cancellation or termination right in the force majeure section for situations where there will be an extended recovery period. If the supplier’s recovery time is six months or a year, do you really want to be obligated to honor orders you made? You may not need them at that point in time. As force majeure is an excusable delay you would be obligated to honor them unless you build in the right to terminate if the recovery period will be long. As the supplier has done nothing wrong and hasn’t breached the agreement you can’t terminate for cause. What you could do is include language that allows you to terminate without cause and without liability to either party in the event there is an extended force majeure. Making it without liability differentiates that use of termination without liability from a general termination without cause where you would have agreed to reimburse certain of the suppliers costs for things like work in process, materials that are unique or can’t be re-used.

If a Supplier has regular insurance coverage all of the materials that were damaged or no longer usable would be covered by their property insurance. The profits they would lose by not selling to you during the force majeure period would be covered by the Business Interruption insurance. The only way they would be impacted would be if they made a major investment based upon a firm purchase commitment. In that situation they would not want to allow the termination to be without liability. How I would deal with that would be to pursue the right to cancel any open orders so I don’t have liability for those. I would also want the right to have all orders that I would have made during the period of the force majeure count against any volume purchase commitment. With Business Interruption coverage they would be making profit as if they were selling those anyway. That would reduce the potential liability you would have if you failed to meet the commitment or later decided to terminate without cause. I would also want to have any period that I needed to make the purchases within be extended by the period of the force majeure. The reason for that is if there was a long force majeure you probably brought on an alternative supplier. Having the longer period allows you to phase the original supplier back into your supply gradually. It would also give you time to allocate volumes between them based upon what was best for you financially based upon any commitments you needed to make to the alternative supplier.

If a supplier asks you whether your company carries business interruption insurance coverage its most likely because they want you to use that before you have any claim against them. There are two problems with that. Your business interruption coverage should be used for natural disasters or for your negligence, not for the negligence of the supplier or contractor. Second, always remember that the premium your company will pay in the future will be based upon the incidence or claims. To keep your future costs of that insurance down, you want the supplier or the supplier’s insurance to be the primary protection for damages, injuries or losses that they cause.

Or Equal

In specifications for things like construction in is not uncommon for a specific piece of equipment to be specified by name with the words “or equal” used.In doing that you are establishing the named equipment’s specification as being the requirement to be provided. The “or equal” is to allow for other competitive products to be used so there is competition and the equipment supplier doesn’t consider themselves to be single sourced. Or equal can also be potentially used when the specified equipment may not be available within the time frame needed for the schedule.

The key in the use of or equal is making sure that you as the buyer have approval over whether a substitute item is really equal. From that perspective you as the buyer want to have the final right to decide whether the item is equal. If you don’t what can occur is the contractor may propose using something and arguing that it is equal simply because they were able to buy it for a better price. If you have the right of approval, and feel that it isn’t equal you have two options. You can refuse to approve it and require the original, or you can make the approval be conditioned based upon being provided a credit for the difference in value or cost. Their contract price was based upon providing the item or equal and not something less.

In some cases you may simply not want another supplier’s equipment used for other reasons. For example, if you had an existing building that had all Carrier HVAC (heating, ventilation and air conditioning) units and were building an addition, you probably wouldn’t want the contractor to propose Crane HVAC units be used. While the Crane unit may be equal to the carrier one, mixing the manufacturers would increase your life cycle cost because you would need to have two different inventories of supplies and spare parts. You want your right to approve the “or equal” as an absolute right so that only you can determine what’s equal. In doing that you hopefully get the benefit of competition from the “or equal” language in the contractors negotiation with the equipment supplier, but still have the right to control what is best for you.

If the item really is not available in time to meet the schedule, you might need to approve an alternative. Just make sure that you get a credit for anything that is less or will cost you more.

Blanket Agreements

Blanket agreements describe a contractual relationship where the majority if not all terms are agreed by the parties in advance. Specific requirements are managed by a statement of work, or scope of work that incorporate by reference the terms of the blanket agreement. They may also be structured where individual purchase orders are issued against the blanket agreement. Blanket agreements can save time so those same legal terms that most of them contain do not need to be negotiated each time there will be a purchase. Most blanket agreements also function similar to a credit card agreement, they set the terms in the event you elect to make a purchase but they do not obligate you to make purchases. This means that you don’t traditionally assume any obligations under those agreements until you also issue a document that specifically commits you to make the purchase.

While Blanket Agreements simplify the need to do negotiations of all the terms one of the concerns that you always need to manage are:
1.Competitiveness in terms of pricing over the term.
2.Performance over the term.
3.The impact the term may have on the protection you get.
4.As needs and product or service requirements may change over the term of the agreement you also need to have the ability to change terms to the agreement to keep up with those changes.
5.Availability when you do need it.

As to pricing the key is what trends do you see and how long will the supplier agree to offer you the price without adding in significant contingencies. For example if you agree that price will only be in effect for one year, you need to protect yourself against being surprised with follow on pricing. This means that you need to take the time it would require to source an alternative supplier plus the product lead time and back that off from then end of the first year terms and need to negotiate your price before that. If you don’t want to be forced to have to use an alternative supplier your contract would need to have a pre-agreed formula or agreed benchmark process that will establish the price such as agreeing to a price escalation clause or making it subject to an index. For example in the U.S. you could use the Producer Price Index rate for a specific category.

With respect to performance, since you do not have a firm commitment to purchase from the supplier you have the option to not buy from the supplier if they don’t perform. If you will use a supplier as a sole source and it will be difficult or costly to change, your agreement needs to include tools to drive performance so you alone are not bearing the full cost of performance problems.

The term can have an impact on the value of the protection you receive. The best example of this is if you have a fixed cap on liability the longer the term, the greater the potential that there could be prior claims that effectively reduce the amount of protection available in the later years. To manage something like that you need to negotiate either a much higher limit, or have agreement that the limitations are annual limitations and the amount resets in each new year of the agreement.

Any agreement that will have an extended term needs to have a robust changes provision so when you have different needs or the business changes, you can add or deduct products or services being purchased or change the ways things are managed. If every change requires the supplier’s approval that can impact the value of the agreement if the Supplier is unwilling to make the changes you need. Since you made no firm commitments you can simply stop buying if they don’t agree to what you need. If its important for you to be able to make changes and not change suppliers, you might want to include the right to direct the supplier to makes reasonable changes to the scope provide you agree to reimburse them for the reasonable costs they incur in making the change.

With respect to availability, it does you little good to have blanket agreement be in place where at the time you want to use it the supplier can reject the purchase order or not have it available for you to buy.That can be managed in a blanket agreement in a number of ways. A. You can require the supplier to accept orders that conform with the terms of the agreement including agreed lead-times. B. You could establish a forecasting process where they will hold spots in their order queue that get released if you fail to book an order within a specific time frame.

The real advantage of extended blanket agreements is that once you have negotiated the critical legal terms you don’t have to re-visit them with any frequency. The disadvantage is your initial negotiation may be a little more complex as you need to build in terms that address the concerns. It becomes even more complex if you make a firm purchase commitment or commit to any form of requirements contract. With those your option to simply stop buying is not an option. When you introduce firm comitments to a basic agreement what you do need to include is a termination without cause provision that will allow you out of the contract and not be forced to purchase all of those from a problem supplier. Alternatively, you could make those commitments contingent upon the supplier meeting agreed metrics where the failure to meet those metrics would excuse you of the commitment while allowing the agreement to remain in effect for you to use as needed.

Who should select the carrier?

The answer to that will depend upon which delivery term you agree upon and where the risk of loss passes from the supplier to the buyer. If the supplier is paying for the shipment and it’s the suppliers risk for any loss or damage that occurs while the goods are in transit, the supplier will want control the selection. If the buyer is purchasing the item ex-works the supplier’s dock or stocking hub, the buyer will want to select the carrier to manage the cost of delivery and the potential risk. The simple fact is not all carriers are equal, there are good ones and bad ones. A second factor is not all shipping lanes that the carrier uses are of equal risk. For ocean shipments there are a number of areas around the world where there is still piracy.

If it’s at your cost and at your risk, most of the time the supplier’s main concern is making sure that you specify the carrier in advance so they can be scheduled to pick the item up when its ready. If they’ve had problems with you or with other customers providing timely notice of choice of carrier, suppliers will want the right to specify the carrier so its not clogging up their shipping dock. While that may be a reasonable request, I wouldn’t allow that to be open ended. Remember its at your cost and your risk so if you allow them to select the carrier if you failed to specify it, you should include parameters or standards to guide them. For example, you could ask them for a list of their preferred carriers and if
they are acceptable, limit their selection to only those carriers. You could also require that all shipments be by surface mode unless otherwise specified. You never want things to be open ended when you are paying the bill. For example, I was in a negotiation with a supplier. We were negotiating remedies for late delivery. One of those remedies was the supplier had to pay for the premium costs to ship the late delivery by air. The supplier wanted to make sure the clause specified that it be reasonable costs and that it be for normally scheduled airfreight. There is normally a story behind such requests so I asked them why. They explained that they had a customer who chartered a plane to ship the late materials and wanted to charge them for that.

Large companies normally have contracted carriers for specific shipping lanes that they use most and want their suppliers to use those contracted carriers. They will normally provide the supplier with the list of contracted carriers and the shipping lanes for the supplier to follow. In those situations the issues of selecting the carrier can arise when the shipment’s destination isn’t to one of those contracted lanes. Even if you have contracted carriers that you specify the supplier to use for shipments, you may still want the right to specify the carrier when shipments are to locations not covered by the contracted lanes.

Resulting Behavior

One of the many tactics negotiators may use is to explain the problem their position is creating for you. A tactic that is similar in nature is to take the time to explain how a supplier’s position will impact your behavior, especially when it will drive behavior on your part that would be against their interests. This can exist in a number of areas. One of my favorite ones involves suppliers that want to have extremely low limitations of liability. For that I explain the behavior by posing a number of questions to them:

1. Do you think we would ever single source you with that limit?
2. Do you think we would have you as a primary source with that limit?
3. Do you think we would invest substantial money working with you to develop a new product with that limit?
4. Do you think we will give you business at the same or higher price than with suppliers that provide higher limits?
5. Do you think we would enter into a long-term agreement with those limits?
6. If there have been claims that have reduced the remaining value of the limit. Do you think we would still give you the same volume level of business?
7. Are you ok with entering into a short relationship where you know that at best you will be is a second or third source and to win that business your price will need to be lower than the competition?

The point each of these questions is trying to explain is their position will drive a resulting behavior.They are limiting their liability, but at the same time they they will drive me to take actions that will severely limit the business they can expect.

In negotiations you always need to consider the impact to both sides. Many times a negotiator’s position may not be well thought out. They may not have thought out how you would respond based upon it. As a negotiator sometimes you need to provide them with a reality check. Get them to think about the behavior their position will drive.

In this case these are all loaded questions that the supplier’s salesperson simply doesn’t want to hear. Every salesperson wants the relationship to generate the maximum potential volume. When you make it clear that their position will get in the way of getting business, they need to decide whether they want to accept that or go back to their management to see if they will change the position.

Product deterioration

Many items that you may purchase can deteriorate over time even when they are not in use. The length of time the product is usually acceptable to be used is called its shelf life. This is similar to “best before dates” listed on food products.If deterioration is caused or accelerated by the way a product is stored, the buyer may require that all products be stored in a particular environment. For example over time and exposure to humid air a product may have corrosion that occurs that could affect its operation. Proximity to certain operations that use chemicals could also cause deterioration. If deterioration occurs over time, the buyer may require several things. First would be a date code showing when the product was manufactured be included on the product. That allows you to understand how old the product is. While you would expect that most suppliers would manage their inventory on a FIFO model (first in- first out), not all do and some have inventories of aging products or discover inventories held at other locations that they now must sell. Then you require that unless you otherwise agree, the supplier will not ship any products to you that are older than a specified period from when the item was manufactured. That period should be no more than the expected shelf life of the product. You might agree to accept out of date products at times when there are product shortages after evaluating the potential risk.

Products will also deteriorate over time based upon usage. That type of deterioration may cause product failures that are expressed as reliability failures. I discuss those types of failures in a separate post on reliability measurements.

One of the biggest areas of risk with respect to product deterioration is for products that are purchased through the broker or independent distributor market. While you can still verify the date code if it was stamped on the product, what you can’t verify how the product was stored, packaged etc. Once it was excess to the original purchaser you don’t know where or how they stored it. Once they made the decision to sell their excess, you don’t know how it was packaged for shipment or how that shipment was managed. It may have been sold to one broker and you don’t know how it was stored or handled by that broker. They may have sold it to the broker or independent distributor that now wants to sell it to you. At best you may be able to verify how they stored the product at their location, but that won’t provide you a true picture of how it was stored or handled.If you buy product from the original supplier there is always less of a concern about deterioration and handling. They provide a warranty so if they don’t manage it correctly they will have a warranty costs or possibly epidemic defects costs. When you buy it from a broker or independent distributor, since it was not purchased from an authorized channel, the suppliers warranty does not apply.

Signed for record purposes only.

Signed for record purposes only is a qualifying statement that is most commonly used in construction contract documents. For the owner, having a contractor sign a document “for record purposes only” is simply not something you want to accept. The reason for that is the statement isn’t making any representation that the information is complete and accurate. The contractor wants to have the document be part of the records under the agreement where they could potentially use that to bill or make a claim against. What this does is place the burden of proof on the owner as to its accuracy to ensure that what was included is accurate. It also could be viewed as an attempt to avoid claims for fraud as there was no statement that it was accurate. If a supplier is preparing a document that is the basis for them wanting to be paid or for them to potentially use in a claim, I would want a representation that the information is complete and accurate.

For the owner using “signed for record purposes only” on documents they acknowledge makes sense. If I was allowing a clerk of the works or site engineers to sign contractor documents, I would want those signed for record purposes only. For example a contractor may want a record of the materials that they brought on site as part of documenting that as an additional cost. When the clerk or site engineer signs that for record purposes only, all they are doing is agreeing that the activity occurred, they are not agreeing to it. This leaves it up to the owner to determine what should or shouldn’t be covered under the agreement.

In a claim the contractor would use that document as proof of what they had delivered to the site. In defending against the claim the owner would do a number of things. Normally if you have a clerk of the works or site engineer you require them to maintain a daily site log of all the activities that are occurring on site. You would review that site log to see all materials brought on or taken off the site. They would also review the architect or engineers instructions to the contractor about its operations and protection of the materials. The owner would use all of that information to determine whether they supplier did anything to cause the problem that required the additional soil. Based on that they would determine what, if anything, the supplier should be paid.

Having a record of an action and agreeing that the owner is responsible for costs associated with that action are two different things.

Owner Specified Suppliers or Subcontractors

The first time I ran into the term “nominated subcontractors” was in managing a construction contract in England. Under the UK system if there was a supplier or subcontractor that the owner required be used in the performance of the work, those suppliers were treated differently under the contract between the contractor and the owner. The contractor would be excused of certain liabilities or responsibilities if there were problems caused by the nominated subcontractor.
The rationale for contractually treating nominated subcontractors differently was easy. First the subcontractor was not selected by the contractors on their own. Second because the nominated supplier or subcontractor was favored by the owner, the contractor may not have been able to negotiate the applicable terms they would need to transfer risks and costs to the nominated sub-contractor that the contractor had to assume in their agreement with the owner..

In a number of other types of contracting that occurs today there are similar situations to nominated subcontractors that exist.A customer may demand a specific software supplier as part of a solution that the prime contractor has been hired to provide. In those situations the subcontracts manager for the prime contractor needs to manage those in the same manner.They need to flow down all of the applicable terms of the prime agreement to those specified suppliers or subcontractors. They need to advise the deal team with any provisions that they are not able to flow down so exclusions in the prime contract can be included if the cause of a problem was the specified supplier or subcontractor. For any damages they could be liable for in the event of a performance problem or breach, they need to be assured that they could collect those from the preferred supplier and the preferred supplier has the assets and resources to stand behind to commitments. Otherwise they need to carve financial liability arising out of performance caused by the preferred supplier out of their potential responsibility..

The key is making sure that one of three things happens:
1. They have made the preferred supplier fully responsible of any problems they cause, or
2. They have carved responsibility for what they can’t get from the preferred supplier out of their responsibility to the customer, or
3. They have included a significant enough of a contingency in the price with the customer to assume the risks.

If the contractor can’t get any of those, they need to convince the customer to allow different suppliers or subcontractors for the work to proceed. If the customer in not willing to agree to that, they need to walk away from the deal. The easiest way to lose money is to be assuming risks and costs you can’t manage and not have appropriate contingencies built into the contract.

Buyer instructions.

The risk in the buyer providing instructions on what to do or how to do something is that in doing so, the buyer becomes responsible if there is a problem that results from those instructions. The same could apply if the buyer requires the supplier to use a specific supplier or subcontractor. For example if the buyer specified safety requirements for work being performed, the buyer could be liable if a party was injured when complying with those safety requirements. Whether the buyer should include safety requirements really depends upon who has control over the area where the work is being performed. If the Buyer retains control over the area, normally the buyer would want the supplier to meet their safety requirements. If the buyer turned control over a specific area to the supplier such as may occur when a contractor is hired to modify an existing building area, you would normally require the supplier have their own safety requirements and be responsible for managing the safety of their personnel. Once the supplier is operating under their safety requirements and a supplier employee is injured, since you provided no instructions and make the supplier or contractor responsible for safety, the buyer would not be liable. The same issue about buyer instructions can impact responsibilities for designs or responsibilities for whether a product meets the specification, a service meets the requirements, or responsibility for the work.

To manage against the risk associated with buyer instructions there are several things you need to do. First, if you feel that you will need to give instructions, you need to limit who is authorized to provide those instructions. You would also want to define how those instructions will be provided. The more formal the process the better.If you have people within your company that may be able to help with the design or activity you may also to include language to deal with that. For example, you may retain the right to make suggestions that the supplier or contractor is free to accept or reject. In conjunction with the right to make suggestions you would also want to make it clear that if the supplier or contractor agrees to accept those suggestions, they will take as their own and remain fully responsible for the work as if they proposed it in the first place.

Access to premises, premises restrictions.

Many times it may makes sense to have a supplier be located on your site to provide services or support quickly and efficiently. You could even provide a separate area in a warehouse for the supplier to perform line side stocking of inventory and manage replenishment. The problem is what the supplier can do on that site may need to be controlled by your contract and the supplier employees are not your employees. When a supplier will be performing work on the buyer’s site or customer site or when you have a supplier set up an operation at your site you may want to place controls or restrictions on how they and their personnel conduct themselves and what activities they are allowed to perform. There are a number of reasons why you many want to impose such restrictions.

You may want to avoid potential problems between supplier personnel with your own employees, customers or others on the site. For example if a supplier employee is harassing any of your employees in any ways, you want the right to be able to remove them from the site.

You may want them to not create any security problems or risks to the site. You may need to control what areas they have access to and require that they sign individual non-disclosure agreements if they have access to areas that have sensitive data.

You may want to make sure that supplier personnel do not interfere with your operations.

You may want to place restriction on the supplier’s use of the premises such as prohibiting certain types of work from being done. You want them to only be using it for the purpose you intended.

You may want the supplier employees to follow your safety and site rules for things like smoking, parking, what may be carried into the building etc.

You may want the supplier employees to follow the same restrictions as your employees in terms of behavior. For example you wouldn’t want someone that is inappropriately dressed working there.

If a supplier employee becomes a problem, you may want to right to restrict their access and require another employee. If you don’t your company could potentially be liable for failing to act.

You may want to limit the types of activities the supplier and their employees are able to perform on your site for a variety of reasons. You may not want them running an activity out of your location that supports other customers. You wouldn’t want them conducting business on your site that would not be best for the corporate image you want to portray. You wouldn’t want them performing actions that could create safety risks to your employees or visitors or be conducting things that would be disruptive to your people or your operations such as creating obnoxious odors or sounds.

Many large companies develop guidelines that they make part of the suppliers agreements that make it clear what those suppliers and their employees are expected to meet for work performed on the buyer’s or the buyer’s customers premises. If your company doesn’t have such a guideline you need to document want you want the supplier and their employees to do or not to do and make that part of your agreement.

Bankruptcy - What happens when a supplier files for bankruptcy protection?

The first thing that occurs is a trustee in bankruptcy is appointed by the Bankruptcy Court. The trustee in bankruptcy does not have to honor your agreement with the supplier. This means that any contract rights or options no longer exist unless the trustee agrees to honor them. For example if you had materials held in escrow and a license grant that triggered with a certain event, If you failed to exercise those rights prior the Supplier bankruptcy the trustee does not have to honor them.The supplier’s bankruptcy does not excuse you of any obligations that you have if the trustee elects to continue to honor the agreement.For example if you made a firm commitment to purchase a set quantity and the trustee continues to ship them at the agreed price, you would still be obligated to purchase them.

If the supplier has existing inventory that can be sold, the trustee must do what is best for the creditors. This means they don’t have to sell the inventory to you at your contracted price they need to sell it for the best price they can get. So while they could force you to honor a firm quantity commitment, they may not if they can get a better price elsewhere.

If you have buyer owned inventory at the supplier or a location controlled by the supplier, unless that inventory is identified as being owned by the buyer, it becomes part of the assets of the supplier.If you have buyer loaned product or equipment at the supplier, unless those products or equipment are identified as being owned by the buyer, they become part of the assets of the supplier.If you have consigned material to them, unless that consigned material is identified as being owned by the buyer, it becomes part of the assets of the supplier. In these three situations you would have a claim in bankruptcy as an unsecured creditor.

Bankruptcy has a hierarchy that determines who gets paid first. At the top of the list is the Trustee who may also serve as a liquidator of the bankrupt company. that is appointed by the bankruptcy court. Next is any government claims such as claims for taxes. Third is secured creditors. This could be a company that sold a piece of capital equipment to the supplier under credit terms and holds a security interest in the equipment. Secured creditors are similar to a bank having a lien against the title to a car you purchased because they loaned you money for the purchase.Bond holders are frequently considered to be secured creditors. Next comes unsecured creditors. If there are any assets remaining after unsecured creditors are paid, those remaining assets would be disbursed first to any preferred stockholders and last to any common shareholders.

In any agreement where there will be buyer owned product held under the supplier’s control,
Buyer owned products or equipment or any consignment of buyer owned materials, you want those items to be held in a separate area and be specifically and when possible labeled as being owned by the buyer.The reason for that is if you can prove ownership you will be protected by the law. You are not a creditor, you are the owner of that property. As an owner you can pursue the right of replevin where with court order and accompanied by police, you could legally enter the supplier’s premises where your items are being held and remove them.

Saying that you may terminate an agreement for cause in the event the supplier files for bankruptcy doesn’t buy you much. If they filed for bankruptcy, the trustee does not have to honor that right. Further any damages that you may be awarded would fall under the category of unsecured creditors.

If you are dealing with a financially troubled supplier and need things like license and escrow materials delivered you need to have the trigger for that to occur prior to a company filing bankruptcy. One trigger could be a further deterioration in their financial statement. That way its already in place and not subject to the trustee’s decisions.

Trustees in bankruptcy don’t care about you or your companies needs. They are hired to get the most for the creditors of the bankrupt company. To do anything else would put them in breach of their fiduciary responsibilities to the court that appointed them.

Bankruptcy laws and responsibilities will vary by jurisdiction.



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When should your require escrow agreements?

There are a number of different types of escrow agreements that could be created. In procurement
the most common are software source code escrow agreements and manufacturing package escrow agreements. Both types of documents normally require a breach or some other major event as a pre-condition of releasing the materials held in escrow along with language in the agreement that provides the buyer with a license grant to use those materials to support themselves in the future.

For manufacturing package escrows, for them to be of any value you would need to be have all the necessary tools and equipment or find a supplier that has those so you can use them to replicate the supplier’s manufacturing processes. The more unique the supplier’s processes or tools that they use internally, the more difficult it will be to have a cost effective approach to use the licensed documentation. Continuity of supply may be better protected with second sourcing or alternative sourcing than relying upon a escrow package. A second problem with manufacturing escrow package is they are not common. Suppliers will expect the buyer to pay the costs of the escrow agent. A third concern is always whether the package is correct and up to date. If a supplier is going bankrupt, and they failed to maintain the package, your remedy would be to stand in line behind all the other unsecured creditors to claim damages for breach. Collecting damages for breach does not provide you with products you need. Before requiring a manufacturing package escrow you need to determine whether it will really provide you with the desired protection when you need it.

As to software source code escrow provisions many companies may want supplier provided escrow on all the packages they purchase. To me it’s a business call that should be driven by several factors:
1.How critical is the application is to your business?,
2.How long and what cost would it take to change to another supplier?
3.How stable is the software?
4.How much you would need to modify or change the software in the future?
5.What is the cost to have the materials held?
6.How long would it take your people or a third party to understand the application and how it works to be able to support it or to make changes.For complex programs unless you were able to hire someone that thoroughly knew the program it could take multiple years to understand the program and its structure enough to make changes.

I’m a firm believer that if someone is prepared to provide something to me for no additional cost, I’m happy to let them do it even if I don’t need it or plan on relying upon it.If a supplier puts a master copy in escrow for all customers to potentially access, its an easy decision to make. For escrows that would require payment of the escrow agent’s cost I would go back to the business to review the real benefits and costs of using the escrow..

Is it critical? If no, I probably would not recommend paying for holding the materials in escrow.

Can it quickly and cheaply be replaced? If yes, I probably wouldn’t recommend paying for materials to be held in escrow?

How financially stable is the developer? If they are strong financially I probably wouldn't recommend paying for it..

How stable is the software? If it’s stable, I may not need the materials to be held in escrow so I wouldn’t pay for it.

Do I needed to be able to modify or change it in the future? If I did I would want to have it held in escrow.

How long would it take to use it? If it was going to require years and a substantial investment of people to be able to use it to support, modify, or change it, I would want to take that into account in terms of which is better. Continuing to support something that will be unique to you or investing in a new application where the supplier will be making and selling upgrades to their customer where it will cost much less for support.

Having an escrow does not provide you 100% protection if there is a problem. It provides you only part of what you may need. The key to its value is how long will it take for you to understand what you received so you can potentially use it. The second key is how much will it cost you to use and support it. It may be more than you want or can afford to pay.

These are decisions that the using business needs to decide.



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Disclaimers

There are a number of disclaimers that suppliers may want to include in their proposal or contract. A disclaimer is statement to the effect that something shall not apply. For example a common disclaimer that suppliers want to add is disclaiming any implied warranties for fitness for a particular purpose or the implied warranties of merchantability.

In consumer products the consumers get bombarded with disclaimers in advertisements. “Use only as directed” is a disclaimer of responsibility and liability if you used it otherwise. “Your results may vary” is a disclaimer that you will achieve the advertised results. “Past performance is not a guarantee of future performance” is a disclaimer that past stock or fund performance is not guaranteed for future investments. “Dispose of properly is a disclaimer of responsibility of the supplier for the way you dispose of it. “Do not purchase if seal is broken” is a disclaimer against liability for potentially tampered items.

In contracts suppliers want may want to use other disclaimers. For example, if a product has a limited shelf life they may want to include “use before date stamped” to avoid responsibility for problems that could occur because of deterioration. Break the seal software is a form of disclaimer, “breaking the seal constitutes acceptance of the license” is disclaiming the buyer’s right to negotiate the license if they broke the seal. “Reproduction of documents is prohibited” disclaims any right to reproduce them.“Price does not include taxes, shipping and handling” disclaims those items from being included in the price. “This specification is subject to change without notice” disclaims any buyer right to have approval over changes to the specification. “Supplier shall not be responsible for any indirect, incidental or consequential damages resulting from any defect” would disclaim the buyers right to claim those types of damages.

In many locations the laws require that for a disclaimer to be effective it must be conspicuous. This means that it must be written in a manner where the reasonable person to whom the disclaimer will operate against will notice the disclaimer. If you write a contract and want to include a disclaimer, the most common practice would be to write the disclaimer in all CAPITAL letters so there is no argument that the disclaimer was conspicuous. If you write agreements in location where the alphabet does not include capital letters, you would need to use a different convention to make it conspicuous. Anything that would draw a reasonable reader’s attention to that section should work.

I’ve seen suppliers try to include disclaimers at the very back of their product specifications written in a font that was much smaller than the rest of the specification. To me what they were trying to do is slide it through and not have it noticed. That’s not the smartest approach, as it may not be enforced. When I would run into those situations I could have simply not dealt with it and later argue that the disclaimer wasn’t effective because it failed to meet the requirement that it be conspicuous. That’s not my style and I wouldn’t want to take the chance that a court might enforce it. I would always negotiate it out or negotiate a disclaimer that I could live with. I would include that disclaimer in the agreement and make it clear that the disclaimer in the product specification did not apply.

If a disclaimer is important to you, don’t try to hide it. Make it clear and conspicuous. If you don’t your disclaimer may not be applied. In the end, which is worse? Having a disclaimer that you had to negotiate, or a disclaimer that may not be enforced?


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Defined Terms, Defined term conventions, Managing Defined terms

When terms used in an Agreement have a specific definition/meaning, they are usually defined either in a Definitions section at the beginning of the Agreement or they may be defined within the body of the Agreement where it is first used by adding language that makes it a defined term. In major contracts I’ve seen attachments that listed all the defined terms used in the agreement. Common uses of defined terms are to establish a specific meaning when a word or phrase may have multiple meanings that could be interpreted differently. Another use is to keep the actual contract shorter where the full meaning of it does not have to be repeated each time it its used.

There are multiple potential conventions that may be used to create a defined term. The most common ways to create defined terms is by either capitalizing the first letter only of the defined term or terms that make up the definition or by capitalizing the entire word or words when you create the defined term. Some people prefer to use all capital letters so it’s easy to see when a defined term is being used and so there is no confusion if you used a defined term to start a sentence. If you use the initial letter capitalized approach, when drafting language make sure that you don't a use a defined terms to start the sentence so it’s clear that you are using a defined term.

All that is really required to create a defined term is a convention that is established when you create the defined term that makes it conspicuous that the defined term is being used. There are some languages and alphabets where the capitals don't exist and can’t be used in creating defined terms. If you were to do an agreement in those languages to create a defined term you would need to establish a different convention. There are a number of ways that could be done:

You could say all words that are underlined in this agreement shall have the meaning of the defined term. Then when you create and use the defined term it would need to be underlined.

You could create the convention in the definition such as “ day” or “days” shall mean calendar days. For example when you used that you would say: supplier shall deliver in thirty (30) “days”.

You could bold only defined terms.

You could potentially use a larger or different font.

Just like a disclaimer, you need to make it clear that that it is different and it represents the use of the defined term. To make it clear you would want to clearly define that the specific convention you are using means the use of a defined terms. For example, all words that are “bolded” shall have the meaning of the defined term. Each time you need to use the defined term you would follow the specific convention you established. It’s very important to be consistent in the use of the defined term. At the first point in the contract where you create a defined term you need to decide which convention you will use. Then you use only that that approach to create defined terms in both the definitions section or elsewhere in the agreement where you may be creating defined terms within the context they are first being used..

For example if you say “Supplier” shall mean X Company to create the defined term. Every time you need to use the defined term you need to use Supplier. If you said “SUPPLIER” shall mean X Company, every time you want to use the defined term you need to use SUPPLIER with all letters capitalized. What you can't do is switch back and forth or use an all lower case word when the defined term was created with an upper case convention. Anything else may not be interpreted to have the meaning of the defined term.

Negotiation:
In negotiating you need to check each time a defined word is used throughout the Agreement and any associated documents to ensure it is used properly as a defined term. If it should be a used as defined term, you need to follow the convention you established. If it should not be used as a defined term, don’t follow the convention. In negotiations the other party may want to make changes to the definition of a defined term. To understand whether to accept the proposed change you need to identify the potential impact. To determine the impact you need to search for all places within all the documents that make up your agreement to see where that defined term is used and then see whether the proposed change negatively impacts that commitment.

For example I one had a supplier that made the following proposed changes to the definition of Personnel.
"Personnel” means agents, employees or subcontractors engaged or appointed by Buyer or Supplier.

To understand the impact on the deletion of “agents” and “subcontractors” from the definition, I had to search the agreement for the defined term “Personnel”. I discovered that it is used in two places. It was used in the General Indemnity. With the proposed change to the definition the supplier would not be required to indemnify the buyer against negligent or intentional acts of either the supplier’s agents or subcontractors, leaving the buyer exposed. The second place I found it was in a section about responsibility for management of supplier Personnel. The impact of the proposed change would be that the Supplier would not be responsible for managing contract requirements for Supplier personnel with their agents or Subcontractors. Since it would substantially change the commitments in both these areas and increases the potential liability, I rejected the proposed change. I made it clear that I had no contract relationship with those two parties so I could not manage the risk. The supplier did and they needed to be the ones to manage it.

There are two ways a Supplier can change a commitment in a Section. The obvious one is when they modify the section itself. The more subtle way is by changes to defined terms that are used in the Section. To make sure you get what you need, you must manage both.

In proof reading your contract the easiest way to check for correct use is to use the “find” functionality in your word processing program. Search for each time the word is used. Read that in in context to determine whether it needs to be a defined term or not.

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As-is

As-is is a term that means that what the supplier is selling is the item in its current state, with all faults. The term as-is may may used to disclaim potential implied warranties on sales such as the product being of merchantable quality or being fit for a particular purpose. As-is makes no statement as to the quality of the product. As-is also effectively says that the product is not going to be changed to fit a particular purpose. It is what it is and nothing more.

The term as-is is most commonly used with the sale of used products. Suppliers of new product normally sell a product with a warranty and that warranty is intended to demonstrate both the quality and reliability of the product showing its value because the price paid is based on the value perceived. As-is sales of new product are rare but they do occur in certain circumstances. A supplier might sell a new product on an “as-is” basis if the product was a pre-production where it had not been fully tested or not had been assembled using normal production means. A supplier might also use as-is if they simply do not want to be responsible to provide warranty on product where they know they have a problem. For example, if they had a lot that was returned to them by a customer because it had a number of defects, they could potentially sell the product elsewhere on an as-is basis and provide no warranty for repair or replacement for a lower price. In that case the buyer of the product would be trading off the benefit they get by the reduced price against the risk of a high number of defective products.

A buyer might also want to use the term “as-is” when selling excess inventory. When you sell excess inventory you are now legally functioning as the seller you could be subject to implied warranties. Most Supplier agreements will also not allow you their Customer to pass through warranties or indemnities they receive to another company. That’s because they don’t want their customer potentially functioning as a distributor and competing with their distributors. The biggest risk that you have in reselling product is you become part of the sales chain. As part of the sales chain you may liable if injury or property damage to a third party occurs in the use of the product.

Some companies may prefer to simply destroy any excess to avoid the potential liability especially if who they are selling it to has limited resources such as a broker or independent distributor. Others might include something like: “Seller is selling the Product on an as-is basis, without any indemnities or warranties express or implied. Seller’s sole liability for any Product shall be limited to the Price.” By doing that what the seller is doing is limiting the liability they can limit which is the liability with respect to the purchaser of the product. What they can’t limit is their potential liability to injured third parties. That is one reason why a Buyer may not want to resell excess. Selling a product on an as-is basis does not protect the seller against that potential third party liability.

If you sell something “as-is” you want to avoid providing detailed descriptions as even though you sold it as-is they buyer could reject the product if it failed to meet the description. If you are buying an as-is product you want a description so you can reject it if it fails to meet that description. Selling something as-is also would not protect you if you were fraudulent. If fraud was involved the contract is voidable meaning the other party can void the contract. If they void the contract, it no longer exists, so it doesn’t matter what you said in that contract.


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Using a prior agreement or another’s company’s template to create your contract

Writing contracts is not easy, especially to do it correctly. Many times people may want to take a shortcut and simply take a prior agreement and work from that. If you don’t have a template that matches, people may also look for sample templates from others. While these may save time, both approaches are risky. For example, a supplier may suggest that you can use their template. It’s easy to see what’s included and whether that works or not. What is more difficult is identifying what is not included that should be there and being able to analyze what’s there to determine if it will meet your needs.

Let’s talk first about using a prior agreement. This is risky as the prior agreement represents a final negotiated position. Before using a prior agreement you would need to do your homework. You need to first understand what the negotiator started with. Then you need to learn what the circumstances were that caused the negotiator to change from their initial desired positions to what they finally agreed. Once you do that, you need to determine if those same conditions are present for your negotiation. If they aren’t and you have more leverage, you want to start out looking for more, not negotiating from an already negotiated position. If they are or you have less leverage for this negotiation, you may need to push to get what you had. If you go for more and open the entire agreement up to negotiation, there is the clear risk that you may wind up with less than you previously had. Use prior precedence when it’s to your advantage. If prior precedence isn’t to your advantage, be prepared with arguments on why it doesn’t apply in the current negotiation. Before I would ever consider using someone else’s agreement I would also want to make sure that the prior individual had a strong reputation for consistently creating good agreements. What you don’t want to do is to be replicating problems or language that could be problematic. An important point to remember is just because they had no problems when they used it, that doesn’t guarantee that you won’t have problems. Every procurement is different and each supplier is different.

In working for major corporations one of the things I found was each company had a library of a number of templates. They will have versions of each template that have been tailored to meet the applicable laws and practices of individual countries where they operate. While many different company templates may look alike, each has their subtle differences based upon the they risks they want managed, their priorities, how they manage the business, what they need for resale, and what costs are they willing to accept and manage. They will vary based upon the quality of the individuals that drafted them. As business evolves and changes templates should be changed. If they aren’t they may not work or work well.

In using templates I have a number of key questions I would ask.
1. You can see what’s in the template, but the key is what’s missing that you may need.
2. Does it will work with the way you and your company manages the business.
3. Does it reflect the way you actually are conducting business?
4. Does the template provide you with the necessary tools to manage performance?
5. Does it adequately manage the costs and risks of that specific purchase.
6. Does it adequately manage specific risks you have with the supplier?
7. In the negotiation, if the supplier is unwilling to accept certain risks, does it give you the control you need over what the supplier can do that could impact those risks?
8. What country was it drafted for and will it work and be enforceable in my location?
9. Does the document include risks my company would traditionally accept?
10. Is the contracting approach something that we will have the resources and expertise to manage?

Someone could provide you with a sample purchase of goods template where they use it for purchase of goods for internal consumption. That probably will not work well if you are purchasing goods in a production environment. Contracts are not like a hat where the manufacturer may say that one size fits all.

Prior agreements or standard templates can be good starting point, but they should never be looked upon as the final solution. As I say elsewhere most templates are designed to manage average risk purchasing activities with average risk suppliers. This means that unless what you are dealing with fits exactly into that norm, it may not fit and may not work.

The biggest problem I see with re-use and using a standard template is you never go through the process of thinking about what you need and why you need it. It’s that thought process that helps you learn how to effectively write contracts.

I write a blog called Knowledge to Negotiate where I share a wealth of information about what you need to know to write and negotiate contracts. My website KnowledgeToNegotiate.com makes it easy to find blog topics. A page called “Links to Blog” lists they 400+ posts alphabetically by subject. Each topic is hyperlinked to my blog post on that subject. To get you to think about how to create your own agreement that works there are two posts I would start with. The first is
Contracts - what should be in a contract. The second is: Writing purchase specifications, statements of work, scope of work


If you learned from this post, think about how much more you could learn from the book.
The book is only US$24.95 plus shipping. The hot-link to amazon.com is above the date.