In Linked in, an individual asked the question about who has the right to the bill of lading when an “F” type delivery term is used and the sale is by a letter of credit. As this question raised a couple of good topics I thought I would share my response.
A bill of lading is a document that may include the following type of information:
1. Name of the shipping company
2. Name of the shipper.
3. Name and address of the importer or consignee.
4. Name and address of the party to be notifies on arrival of the shipment.
5. Name of the vessel or carrier.
6. Whether freight is payable and whether it has been paid.
7. Number of originals in the set of the bill of lading documents.
8. Marks and number identifying the goods and a Brief description of the goods (possibly including weights and dimensions), number of packages.
9. Date on which the goods were received for shipment.
10. Signature of forwarder or carrier where they acknowledge receipt of goods.
Any INCOTERM that begins with an “F” such as FOB, FAS, FCA all place the responsibility on the buyer to arrange and pay for transport from the specified “F” point. The buyer does not need to get a copy of the Bill of Lading to arrange to have the forwarder pick up the goods. It is the forwarder that issues the Bill of Lading as proof of receipt of the goods. Multiple original copies of bills of lading may be produced.
Under a letter of credit situation you have four parties involved. The supplier, the supplier’s collecting bank, the issuing bank of the buyer, and the buyer. One of the standard conditions of a letter of credit is that a bill of lading must be provided to document that the goods have in fact been delivered to the buyer’s selected forwarder or carrier.
The flow goes as follows:
1. The supplier notifies the buyer that the goods are ready for pickup at the agreed “F” point.
2. The buyer contacts the carrier or freight forwarder to pick up the goods.
3. The carrier picks up the goods and provides the bill of lading to the supplier.
4. The supplier provides the bill of lading to the collecting bank showing their proof of delivery in accordance with the terms of the letter of credit.
5. The collecting bank provides a copy of the bill of lading to the issuing bank as part of their collection process under the letter of credit.
6. The buyer can get a copy of the bill of lading from the issuing bank for their records or in the event of a problem (such as a discrepancy between what is listed on the bill and what is actually received).
So the answer is if there was only one original bill of lading the Seller has the initial right to the bill of lading it as part of the letter of credit collection process. They do not keep the bill of lading and have to provide it to the bank to collect payment. The buyer will have the final right to it once payment is collected from the issuing bank as proof that both banks met their obligations under the letter of credit. As multiple original bills of lading may be issued, the forwarder could potentially prepare three. Two for the Supplier of which one they would keep and one they need to provide as part of the letter of credit payment process and one for the buyer’s records.
Monday, October 29, 2012
Tuesday, October 23, 2012
International Stocking and Sales
In a LinkedIn procurement group an individual asked what markup they should pay for a distributor or reseller to stock and resell products into local markets. In my responses to him it opened up a much broader discussion that I thought would be worthwhile to share with my readers.
In any reseller situation it is the OEM that decides the type of model they want their authorized resellers to follow. Some will sell to the reseller as a percentage off list price where the price the reseller pays is based upon their volumes. In that model the reseller needs to make their margin off the difference between what they buy it for and the price they can sell it to you at. Others OEM’s may have a more price protected model where the reseller is rewarded with discounts the more they stick to the targeted sales price the OEM wants to sell it at. What this means is that before you can get to the issue of what the margin should be, you need to understand what the OEM's sales model is to the reseller. Then you can select the best approach. For example, a cost plus model works well when the reseller is buying it at a discount off list. There the price they pay becomes the cost in your cost plus approach. It would not work if the OEM has the Distributor on a form of price protected model as they are getting compensated by the OEM for maintaining the target price. In a price protected situation neither approach work. The only time you would want to compensate more is if they are incurring additional costs.
The amount or percentage you will need to pay will be determined by two basic factors. The first factor is what services are you asking them to provide. The second is the point of sale that will decide where there profits are made and where they have to pay tax on those profits. In this case the individual wanted the reseller to be reselling into multiple countries. When you ask them to actually sell a product within another country, four things occur. First, the reseller would need to be legally registered to do business there. That can be costly, time consuming and expensive if they aren't already registered to do business there. Second, once they sell within that country they become subject to local laws. Third, the reseller becomes subject to payment of local income and sales taxes based upon those in-country sales. Fourth, since they will be paid in local currency, they can be subject to currency controls in terms of repatriating their profits and currency exchange risks. The combination of these can make the activity either something they don't want to do or very expensive for them, and impact your costs.
My suggestion was if the individual wanted the mark-up to be as small as possible and wanted the reseller to agree to work with them, they should be exploring the use of Bonded Free Trade Zones for each country that they want to sell into. A bonded free trade zone is an area set aside by the government where goods may be shipped into or out of and stored prior to the items clearing customs. If they set up a distribution center or contracted for one in a Bonded Free Trade Zone, they can operate in that location, but not be legally conducting business within that country. That can avoids the four problems that exist when you do business in the country. You do not need to be legally registered to do business in that country, as you are not conducting business in that country. Since you are not conducting business in that country, you aren’t subject to its laws or taxes. Since you are not selling within the country you can require that payment be made in a more stable currency and avoid being subject to currency controls or significant exchange risks. What you would need to do is have sales delivery terms where the customer purchases the goods within the bonded free trade zone and is responsible for import and transportation from that point forward.
There are many activities in procurement where people want suppliers to have local stocking point for pull replenishment programs or may want a distributor or reseller to stock items close to the customer base or point of use. If you want to be successful in establishing those types of programs, you need to always consider the impact and cost the other party will have and come up with a solution where you get close to what you want, and supplier has the ability to effectively manage the costs and risks and do that in a manner where the cost to you will be minimal. A smart supplier who wants to manage taxes could have a subsidiary based in a tax haven that establishes all these stocking areas. They could then have the profits they make on the sales (which won’t be subject to local sales or income tax) flow to the company in the tax haven where as long as the money is held there is also not subject to taxes. If they did that the percentage mark-up they need to charge you would be less.
In any reseller situation it is the OEM that decides the type of model they want their authorized resellers to follow. Some will sell to the reseller as a percentage off list price where the price the reseller pays is based upon their volumes. In that model the reseller needs to make their margin off the difference between what they buy it for and the price they can sell it to you at. Others OEM’s may have a more price protected model where the reseller is rewarded with discounts the more they stick to the targeted sales price the OEM wants to sell it at. What this means is that before you can get to the issue of what the margin should be, you need to understand what the OEM's sales model is to the reseller. Then you can select the best approach. For example, a cost plus model works well when the reseller is buying it at a discount off list. There the price they pay becomes the cost in your cost plus approach. It would not work if the OEM has the Distributor on a form of price protected model as they are getting compensated by the OEM for maintaining the target price. In a price protected situation neither approach work. The only time you would want to compensate more is if they are incurring additional costs.
The amount or percentage you will need to pay will be determined by two basic factors. The first factor is what services are you asking them to provide. The second is the point of sale that will decide where there profits are made and where they have to pay tax on those profits. In this case the individual wanted the reseller to be reselling into multiple countries. When you ask them to actually sell a product within another country, four things occur. First, the reseller would need to be legally registered to do business there. That can be costly, time consuming and expensive if they aren't already registered to do business there. Second, once they sell within that country they become subject to local laws. Third, the reseller becomes subject to payment of local income and sales taxes based upon those in-country sales. Fourth, since they will be paid in local currency, they can be subject to currency controls in terms of repatriating their profits and currency exchange risks. The combination of these can make the activity either something they don't want to do or very expensive for them, and impact your costs.
My suggestion was if the individual wanted the mark-up to be as small as possible and wanted the reseller to agree to work with them, they should be exploring the use of Bonded Free Trade Zones for each country that they want to sell into. A bonded free trade zone is an area set aside by the government where goods may be shipped into or out of and stored prior to the items clearing customs. If they set up a distribution center or contracted for one in a Bonded Free Trade Zone, they can operate in that location, but not be legally conducting business within that country. That can avoids the four problems that exist when you do business in the country. You do not need to be legally registered to do business in that country, as you are not conducting business in that country. Since you are not conducting business in that country, you aren’t subject to its laws or taxes. Since you are not selling within the country you can require that payment be made in a more stable currency and avoid being subject to currency controls or significant exchange risks. What you would need to do is have sales delivery terms where the customer purchases the goods within the bonded free trade zone and is responsible for import and transportation from that point forward.
There are many activities in procurement where people want suppliers to have local stocking point for pull replenishment programs or may want a distributor or reseller to stock items close to the customer base or point of use. If you want to be successful in establishing those types of programs, you need to always consider the impact and cost the other party will have and come up with a solution where you get close to what you want, and supplier has the ability to effectively manage the costs and risks and do that in a manner where the cost to you will be minimal. A smart supplier who wants to manage taxes could have a subsidiary based in a tax haven that establishes all these stocking areas. They could then have the profits they make on the sales (which won’t be subject to local sales or income tax) flow to the company in the tax haven where as long as the money is held there is also not subject to taxes. If they did that the percentage mark-up they need to charge you would be less.
Monday, October 22, 2012
Severability Clauses
I had a question on my LinkedIN group about when was the best time to add a severability clause. I thought it would be a good topic for the blog.
A severability clause is one that allows an individual clause or section of a clause to be severed from the agreement, if that clause or subsection is subsequently unenforceable at law. It allows the contract to remain in effect and operate without the clause that was severed. An example of a severability clause would be: "If any term in this contract is found by competent judicial authority to be unenforceable in any respect, the validity of the remainder of this contract will be unaffected, provided that such unenforceability does not materially affect the parties’ rights under this contract."
In the above clause several things are required:
1.The decision on enforceability needs to have been made by a competent judicial authority. It doesn’t require the specific language of the contract be reviewed. There could be prior case precedent making the concept included in the clause be unenforceable.
2.It’s severability cannot materially affect the parties rights under the agreement. This means the impact must got to the heart of the agreement and have a material impact on either party’s rights.
The answer to the individual question about when to include the severability clause is when you are initially drafting the contract. In fact many companies have standard boilerplate legal terms and the severability clause is usually one of those standard clauses. The reason why you would include a severability clause in the agreement from the beginning is that without it, if there was a term in the agreement that was found unenforceable, either party could argue that they are excused from performance under the agreement because of the unenforceable term. That would be an easy way to get out of a bad deal.
When you include it, it places a different standard on the parties. Not only does the term need to be unenforceable at law, it also needs to materially affect the party's rights. It it didn't materially affect either party’s rights, the agreement would remain in effect without that term. In the event of a dispute between the parties a court may determine a reasonable, substitute for that term in interpreting the contract.
What are “unenforceable terms”? They may terms requiring illegal or subsequently illegal acts. They can include terms or acts prohibited by statute. They may be terms that would be considered void as against public policy. Finally they can also be terms that would make a contract voidable such as duress, undue influence, or unconscionable.
A severability clause is one that allows an individual clause or section of a clause to be severed from the agreement, if that clause or subsection is subsequently unenforceable at law. It allows the contract to remain in effect and operate without the clause that was severed. An example of a severability clause would be: "If any term in this contract is found by competent judicial authority to be unenforceable in any respect, the validity of the remainder of this contract will be unaffected, provided that such unenforceability does not materially affect the parties’ rights under this contract."
In the above clause several things are required:
1.The decision on enforceability needs to have been made by a competent judicial authority. It doesn’t require the specific language of the contract be reviewed. There could be prior case precedent making the concept included in the clause be unenforceable.
2.It’s severability cannot materially affect the parties rights under the agreement. This means the impact must got to the heart of the agreement and have a material impact on either party’s rights.
The answer to the individual question about when to include the severability clause is when you are initially drafting the contract. In fact many companies have standard boilerplate legal terms and the severability clause is usually one of those standard clauses. The reason why you would include a severability clause in the agreement from the beginning is that without it, if there was a term in the agreement that was found unenforceable, either party could argue that they are excused from performance under the agreement because of the unenforceable term. That would be an easy way to get out of a bad deal.
When you include it, it places a different standard on the parties. Not only does the term need to be unenforceable at law, it also needs to materially affect the party's rights. It it didn't materially affect either party’s rights, the agreement would remain in effect without that term. In the event of a dispute between the parties a court may determine a reasonable, substitute for that term in interpreting the contract.
What are “unenforceable terms”? They may terms requiring illegal or subsequently illegal acts. They can include terms or acts prohibited by statute. They may be terms that would be considered void as against public policy. Finally they can also be terms that would make a contract voidable such as duress, undue influence, or unconscionable.
Thursday, October 18, 2012
Open Source Software risks
Open-source software (OSS) is software that is available in source code form. OSS is frequently developed in a collaborative manner, but could be developed by anyone that wants to share the software they developed in source code form. As with any software, the key to the rights a party will have is the specific license grant that is applicable to the software. There are a variety of different types of license grants, but usual ones for open source software will permit users to study, change, improve and distribute the software. The most common, referred to as the General Public License or GPL, grants the recipients of the software the right to free distribution under the condition that further developments and applications are put under the same license.
The first risk is comes from the conditions of the license grant. For example if you used General Public License program in developing a product that you wanted to license, your license to your customer has to be under the terms of the original license. The terms have to be GPL terms. If it were provided to you for free, you would need to license it to your customers for free. If you had the right to change, improve and distribute the software, you would need to provide those same rights to your customer not just on the original OSS code, but for the entire application that contains the OSS code.
When you use OSS code or license software or buy equipment that that uses OSS code, the fact that it is Open Source Code does not protect you against claims that the OSS code may be infringing upon a third party’s intellectual property rights, patents or copyrights. This means you could potentially be sued for infringement or you could have your use of stopped by injunction because it was infringing. If the equipment you buy needs the software program to operate, if you were stopped from using the code it would make your equipment useless.
To protect against these risks the first step is to first require the supplier to disclose whether any third party code (including open source code is used. When open source code is used, you want to understand the source of that code and a copy of the license it was licensed under to review. The source of the code can help identify the potential risk. The license will tell you what rights or limitations you will have with what you can do with that code. For example I was negotiating the purchase of a product that had open source code that was both on a General Public License and was by our evaluation from a risky source. Rather than include that code as part of our code, which would made our code subject to a GPL license, we kept the code separate and had customers, license the GPL code directly. The last way to protect against the risks if to make it clear exactly what the Supplier’s responsibility will be in the event there is an infringement claim against the open source code such as making sure that there is an Intellectual Property Indemnity provision in the agreement where they have the responsibility to license the right to use, make the item non-infringing. Many times a supplier may want the option to provide a refund of the price, or worse a refund of the depreciated value of the item in the event of a claim. Always consider what the impact of not being able to use the software or equipment would be if you could no longer use it.
The first risk is comes from the conditions of the license grant. For example if you used General Public License program in developing a product that you wanted to license, your license to your customer has to be under the terms of the original license. The terms have to be GPL terms. If it were provided to you for free, you would need to license it to your customers for free. If you had the right to change, improve and distribute the software, you would need to provide those same rights to your customer not just on the original OSS code, but for the entire application that contains the OSS code.
When you use OSS code or license software or buy equipment that that uses OSS code, the fact that it is Open Source Code does not protect you against claims that the OSS code may be infringing upon a third party’s intellectual property rights, patents or copyrights. This means you could potentially be sued for infringement or you could have your use of stopped by injunction because it was infringing. If the equipment you buy needs the software program to operate, if you were stopped from using the code it would make your equipment useless.
To protect against these risks the first step is to first require the supplier to disclose whether any third party code (including open source code is used. When open source code is used, you want to understand the source of that code and a copy of the license it was licensed under to review. The source of the code can help identify the potential risk. The license will tell you what rights or limitations you will have with what you can do with that code. For example I was negotiating the purchase of a product that had open source code that was both on a General Public License and was by our evaluation from a risky source. Rather than include that code as part of our code, which would made our code subject to a GPL license, we kept the code separate and had customers, license the GPL code directly. The last way to protect against the risks if to make it clear exactly what the Supplier’s responsibility will be in the event there is an infringement claim against the open source code such as making sure that there is an Intellectual Property Indemnity provision in the agreement where they have the responsibility to license the right to use, make the item non-infringing. Many times a supplier may want the option to provide a refund of the price, or worse a refund of the depreciated value of the item in the event of a claim. Always consider what the impact of not being able to use the software or equipment would be if you could no longer use it.
Friday, October 12, 2012
Ask them to explain what they mean.
In the Linkedin group Contracts Questions and Answers that I manage an individual asked for a plain English explanation for the following language in a section:
"Nothing in this clause shall not confer any right or remedy upon the Customer to which it would not otherwise be legally entitled".
Without seeing the wording used in its actual context it's hard to know what the intent is. For example, is “Customer” a party to the contract or are they a third party defined in the agreement. The general consensus from the parties that responded was whoever wrote it either 1) doesn't understand English very well as the language includes a triple negative, they don't proofread well, or (iii) they were trying to obscure their intent.
In David Munn’s response to the question he viewed the intent of the wording was to say: "No matter what rights the customer is given under this clause, the customer doesn't really get those rights unless the applicable law or something else in the contract gives the customer those rights." In other words, it could potentially negate all the rights and remedies given to the customer in the rest of the clause. That would clearly be an attempt to obscure the intent where the reader could think they are getting certain rights or remedies that they will not get.
Whenever you encounter language that is confusing to read, always ask the drafter what the intent of the language is. What are they trying to accomplish? Then make sure the language is written in clear and simple language that both parties understand. If needed provide an example to further clarify the intent. This is an example of qualifying language. Every time qualifying language is used in section of a contract it may be done to either limit or expand rights. For example:
If the Customer was a third party you could have language in the warranty section such as “Nothing in this Section shall confer any right or remedy to Customer that they would not be entitled under law.” This would prevent the buyer from passing contract rights or remedies in that section down to the customer. The only rights the end customer would have with the supplier would be what they would be entitled to under law.
If the Customer was the buyer you could have language that says something like “In addition to any rights or remedies in this Section, Customer shall have all rights and remedies available at law or in equity.” This creates and expansion of their rights.
If the Supplier was trying to limit the remedies they could say: ”The remedies set forth in this Section shall be the Customer’s sole and exclusive remedies.” This would eliminate any remedies that might have been available at law.
Never let confusing language or language with double or triple negatives into your contracts.
"Nothing in this clause shall not confer any right or remedy upon the Customer to which it would not otherwise be legally entitled".
Without seeing the wording used in its actual context it's hard to know what the intent is. For example, is “Customer” a party to the contract or are they a third party defined in the agreement. The general consensus from the parties that responded was whoever wrote it either 1) doesn't understand English very well as the language includes a triple negative, they don't proofread well, or (iii) they were trying to obscure their intent.
In David Munn’s response to the question he viewed the intent of the wording was to say: "No matter what rights the customer is given under this clause, the customer doesn't really get those rights unless the applicable law or something else in the contract gives the customer those rights." In other words, it could potentially negate all the rights and remedies given to the customer in the rest of the clause. That would clearly be an attempt to obscure the intent where the reader could think they are getting certain rights or remedies that they will not get.
Whenever you encounter language that is confusing to read, always ask the drafter what the intent of the language is. What are they trying to accomplish? Then make sure the language is written in clear and simple language that both parties understand. If needed provide an example to further clarify the intent. This is an example of qualifying language. Every time qualifying language is used in section of a contract it may be done to either limit or expand rights. For example:
If the Customer was a third party you could have language in the warranty section such as “Nothing in this Section shall confer any right or remedy to Customer that they would not be entitled under law.” This would prevent the buyer from passing contract rights or remedies in that section down to the customer. The only rights the end customer would have with the supplier would be what they would be entitled to under law.
If the Customer was the buyer you could have language that says something like “In addition to any rights or remedies in this Section, Customer shall have all rights and remedies available at law or in equity.” This creates and expansion of their rights.
If the Supplier was trying to limit the remedies they could say: ”The remedies set forth in this Section shall be the Customer’s sole and exclusive remedies.” This would eliminate any remedies that might have been available at law.
Never let confusing language or language with double or triple negatives into your contracts.
Wednesday, October 10, 2012
Getting Supplier Information Back in Your Desired Format
As part of the contracting process frequently you go through a process to solicit information from the Supplier. Different locations, and companies may call them different things so I thought I would describe the ones that I am most familiar with. To simply solicit information about potential work you would normally use a RFI which is short for “request for information”. RFI’s are informational and are not intended to be a binding offer to conduct business by either party. The next acronym used is RFQ which stands for “request for quotes”. An RFQ usually solicits minimum information such as the price, lead-time and availability if the buyer were to place an order. RFQ’s are not intended to be a binding offer and usually what occurs is the buyer may issue a purchase order based on what was quoted based using the buyer’s standard purchase terms that the supplier can accept or reject. An RFP, which is an acronym for “request for proposals” may be used in multiple ways depending on the language that is used in the RFP. For example it could include complete terms that the buyer wants to purchase under and advise the supplier that their signing of the proposal is an offer that buyer may accept. An RFP that doesn’t contain those two things normally does not constitute a binding offer as the terms of the agreement have not been established, so there is no meeting of the minds that is required to form a contract. The last document IFB is an acronym for “invitation for bids”. Invitation for bids normally include the buyers standard agreement, and a format that they want the suppliers to complete and sign that constitutes a formal offer to perform the work at those terms at the price(s) quoted. There are a number of other variations or permutations that may exist by geography, by industry and especially where it is a public or commercial activity.
One of the biggest frustrations of the individuals that manage these processes is you request information be provided in your format, so you can do a simple “apples to apples” comparison and what you get from suppliers looks nothing like what you asked them to provide, so you now have to compare “apples to pears, oranges, and pineapples”. The reasons why suppliers do this can be:
1. They have a standard system they use that breaks the information down a different format and don't want to convert that to your format.
2. They may feel that their format makes them look better and if they used the standard format their proposal wouldn't look as good.
3. They may be concerned about your using the information they provide in a further negotiation and are trying to avoid giving you that tool.
4. Unless they will get all of the business, they may do it to avoid having you "cherry pick" (which means to take the best from all of the different bidders).
5. They may also be concerned that any breakdown would be used for deductions to the scope of the work.
Like everything in negotiating a lot depends upon the leverage you have. The bigger you are, the more they want your business, they will listen more. If you have leverage make it expressly clear (Bold and Underline) a statement that only proposals in your format will be honored. Allow them to submit an alternate only if they have responded to your format. In the document you provide them, tell them in advance what the basis is for the award, and that will potentially eliminate some of their concerns and get better responses. If a supplier doesn’t use the format, let them know that it their document was non-responsive to the requirements and was disqualified because they didn’t follow the specified format. When a bid team has to go back to their management and explain that not only did the not win the work, their proposal wasn't even considered because it was considered non-responsive, that sends a message to not do it the next time. That sends a message that will get out to other suppliers.. Once they know that you are serious about having the responses be in your format, suppliers will either respond correctly, or won’t respond at all. The only time you can't do that is when you need them or you don't have sufficient competition. In those cases you probably should be negotiating with them instead of taking in proposals.
I personally always provide a copy of the agreement I want them to sign and require them to identify any assumptions and exceptions in their proposal. That way I can quickly see what they want changed. If you take in their contracts with their wording it creates a much more difficult task that requires detailed evaluation. A change in one word can make something have a significantly different meaning.
A clause may look similar, but if you read and understand the difference in terms of what it means, normally what a supplier wants to offer you is something that transfers a higher percentage of the risk and cost to the buyer.
If you did work off their contract there are three focus to a review:
1. What is different from your proposed agreement or standard, and what is the impact of that different?
2. What is in addition to your proposed agreement of standard agreement, and what is the impact of or those additional items?
3. What is missing in their agreement from your proposed or standard agreement, and what is the impact of those missing items.
One of the biggest frustrations of the individuals that manage these processes is you request information be provided in your format, so you can do a simple “apples to apples” comparison and what you get from suppliers looks nothing like what you asked them to provide, so you now have to compare “apples to pears, oranges, and pineapples”. The reasons why suppliers do this can be:
1. They have a standard system they use that breaks the information down a different format and don't want to convert that to your format.
2. They may feel that their format makes them look better and if they used the standard format their proposal wouldn't look as good.
3. They may be concerned about your using the information they provide in a further negotiation and are trying to avoid giving you that tool.
4. Unless they will get all of the business, they may do it to avoid having you "cherry pick" (which means to take the best from all of the different bidders).
5. They may also be concerned that any breakdown would be used for deductions to the scope of the work.
Like everything in negotiating a lot depends upon the leverage you have. The bigger you are, the more they want your business, they will listen more. If you have leverage make it expressly clear (Bold and Underline) a statement that only proposals in your format will be honored. Allow them to submit an alternate only if they have responded to your format. In the document you provide them, tell them in advance what the basis is for the award, and that will potentially eliminate some of their concerns and get better responses. If a supplier doesn’t use the format, let them know that it their document was non-responsive to the requirements and was disqualified because they didn’t follow the specified format. When a bid team has to go back to their management and explain that not only did the not win the work, their proposal wasn't even considered because it was considered non-responsive, that sends a message to not do it the next time. That sends a message that will get out to other suppliers.. Once they know that you are serious about having the responses be in your format, suppliers will either respond correctly, or won’t respond at all. The only time you can't do that is when you need them or you don't have sufficient competition. In those cases you probably should be negotiating with them instead of taking in proposals.
I personally always provide a copy of the agreement I want them to sign and require them to identify any assumptions and exceptions in their proposal. That way I can quickly see what they want changed. If you take in their contracts with their wording it creates a much more difficult task that requires detailed evaluation. A change in one word can make something have a significantly different meaning.
A clause may look similar, but if you read and understand the difference in terms of what it means, normally what a supplier wants to offer you is something that transfers a higher percentage of the risk and cost to the buyer.
If you did work off their contract there are three focus to a review:
1. What is different from your proposed agreement or standard, and what is the impact of that different?
2. What is in addition to your proposed agreement of standard agreement, and what is the impact of or those additional items?
3. What is missing in their agreement from your proposed or standard agreement, and what is the impact of those missing items.
Sunday, October 7, 2012
“Not to Exceed” versus “Guaranteed Maximum Sum”
In cost plus contracts,either of the above terms may used. What is the difference between the two terms?
When you write a contract that includes a not to exceed amount, the supplier or contractor is required to stop all work once that not to exceed amount has been reached. The problem is that the work itself may not be fully completed and the supplier has no obligation to complete it unless you increase the “not to exceed” amount. A “not to exceed” amount is established by the buyer. Under a not to exceed amount the supplier or contractor has no responsibility to manage the costs as they will get reimbursed for all cost and they aren’t guaranteeing the work will be completed for that amount.
When you include a guaranteed maximum sum in the contract, the supplier or contractor is required to complete the work. The agreement is still a cost plus type of agreement, but the supplier or contractor needs to manage those costs so they can complete the work at no more than the guaranteed maximum sum. Guaranteed maximum sum amounts get negotiated between the parties and may include incentives for the supplier or contractor to deliver the work for less than the guaranteed maximum sum. If the work is not completed and the guaranteed maximum sum amount has been reached, the supplier or contractor has to pay for any additional costs to complete the work.
Since in either case it’s the buyer’s money that is being spend, the decision on which approach you use will impact the amount of time you spend managing the supplier or contractor. If you select a not to exceed approach you need to spend more time managing the supplier or contractor as their performance can cause you to need to spend more money to complete the work. If you select a guaranteed maximum sum approach you can spend less time managing the supplier or contractor as you have established the total amount you will pay and if incentives were build in for a sharing of the savings you will pay less.
In some situations you could potentially use both approaches. For example if the work wasn't fully defined you could start the work on a cost plus basis and include a not to exceed amount. Once the work is fully defined you could then negotiate a guaranteed maximum sum commitment.
When you write a contract that includes a not to exceed amount, the supplier or contractor is required to stop all work once that not to exceed amount has been reached. The problem is that the work itself may not be fully completed and the supplier has no obligation to complete it unless you increase the “not to exceed” amount. A “not to exceed” amount is established by the buyer. Under a not to exceed amount the supplier or contractor has no responsibility to manage the costs as they will get reimbursed for all cost and they aren’t guaranteeing the work will be completed for that amount.
When you include a guaranteed maximum sum in the contract, the supplier or contractor is required to complete the work. The agreement is still a cost plus type of agreement, but the supplier or contractor needs to manage those costs so they can complete the work at no more than the guaranteed maximum sum. Guaranteed maximum sum amounts get negotiated between the parties and may include incentives for the supplier or contractor to deliver the work for less than the guaranteed maximum sum. If the work is not completed and the guaranteed maximum sum amount has been reached, the supplier or contractor has to pay for any additional costs to complete the work.
Since in either case it’s the buyer’s money that is being spend, the decision on which approach you use will impact the amount of time you spend managing the supplier or contractor. If you select a not to exceed approach you need to spend more time managing the supplier or contractor as their performance can cause you to need to spend more money to complete the work. If you select a guaranteed maximum sum approach you can spend less time managing the supplier or contractor as you have established the total amount you will pay and if incentives were build in for a sharing of the savings you will pay less.
In some situations you could potentially use both approaches. For example if the work wasn't fully defined you could start the work on a cost plus basis and include a not to exceed amount. Once the work is fully defined you could then negotiate a guaranteed maximum sum commitment.
Limitation Of Liability - What Should Be Excluded ?
In a recent post on LinkedIn an individual asked whether warranty obligations should be included within the limitation amount, which was the value of the contract. That gave me the idea to discuss what should be excluded from the limitations. Limitation of liability traditionally consist of two limitations. The first limitation is on the types of damages that may be claimed. The second limitation is one that places a financial limit on the amount of agreed type of damages that may claimed. For example if the limitation limited recoveries to only direct damages, any financial limit would be on those direct damages.
I have a simple view of limitation of liability provisions. I believe they should only apply to claims between the parties to the contract for breaches of the contract. Based on this I have always sought to exclude costs or damages associated with any third party claims. There can be third party claims by the government for things such as not complying with applicable laws or failure to pay taxes. There may also be third party claims for personal injury, property damage, and intellectual property infringement. Even thought the buyer may not have caused the injury or damages, or been the party that infringed the third party intellectual property right, they may still be liable under the principal of agency. As a buyer you have no control over what the third party may claim as damages. Further for things like product liability claims any attempt by a seller to limit liability would probably be void as against public policy. As a buyer if you don’t exclude liability for third party claims, such as you would find in indemnifications, you can wind up in the situation where the third party can recover significant amounts from you, and you could only recover what may be remaining under the limitation of liability. That amount may have been reduced by other claims.
I also seek to exclude warranty obligations from the limitations. My argument is the limitation of liability should only apply to claims between the parties to the contract. Meeting the requirements of the warranty is an obligation, not a claim. The price you paid is based upon the commitment of the supplier that they will meet those obligations. If you included warranty obligations as part of the limitation of liability amount you would either need to have a substantially higher amount or you could have the situation where because of prior claims, there is nothing left and they could stop meeting their warranty obligations. My argument is that it’s in the supplier’s best interest to exclude warranty obligations from the limit rather than agree to a higher limit to include them. The reason is if the product has minimal failures or need for warranty repair or replacement, all they are doing is increasing the potential recovery amount for other claims.
If you provided the supplier with loaned material or equipment or shared confidential information with them I would also exclude claims for those from any limitation of liability. For loaned material or equipment the best way to manage those is by a separate agreement that would not be subject to the limitation of liability. As most limitation of liability provisions limit the types of damages that may be recovered and traditionally exclude lost profits, you need to exclude breach of any confidential information. The primary damages you sustain for the breach of a confidentiality obligations is lost profits. It’s better to manage confidential information under a separate agreement where it would not be subject to the limitation of liability provision.
As a buyer, I would never agree to a limitation of liability cap amount at the amount of the contract and have that include everything unless I had one hundred percent certainty that there would be no third party claim and the impact to me of any failure to perform and my cost to recover would be no more than what I paid. There are very few, if any, contracting situations that I’ve run into where that would apply. If you are going to agree to have a financial cap on the limitation of liability, the amount you should require should be dependent on how many things you have been able to exclude from the limitation. The more you can exclude the lower the cap can be and vice versa, Just as with liquidated damages the amount should be a reasonable estimate of what your damages could potentially be. My personal favorite approach to financial limitation is to have a minimum amount that increases as the amount of the business between the parties increases. If you agree upon a set amount and the business grows your potential risks are bigger and a fixed cap amount may not provide adequate protection.
I have a simple view of limitation of liability provisions. I believe they should only apply to claims between the parties to the contract for breaches of the contract. Based on this I have always sought to exclude costs or damages associated with any third party claims. There can be third party claims by the government for things such as not complying with applicable laws or failure to pay taxes. There may also be third party claims for personal injury, property damage, and intellectual property infringement. Even thought the buyer may not have caused the injury or damages, or been the party that infringed the third party intellectual property right, they may still be liable under the principal of agency. As a buyer you have no control over what the third party may claim as damages. Further for things like product liability claims any attempt by a seller to limit liability would probably be void as against public policy. As a buyer if you don’t exclude liability for third party claims, such as you would find in indemnifications, you can wind up in the situation where the third party can recover significant amounts from you, and you could only recover what may be remaining under the limitation of liability. That amount may have been reduced by other claims.
I also seek to exclude warranty obligations from the limitations. My argument is the limitation of liability should only apply to claims between the parties to the contract. Meeting the requirements of the warranty is an obligation, not a claim. The price you paid is based upon the commitment of the supplier that they will meet those obligations. If you included warranty obligations as part of the limitation of liability amount you would either need to have a substantially higher amount or you could have the situation where because of prior claims, there is nothing left and they could stop meeting their warranty obligations. My argument is that it’s in the supplier’s best interest to exclude warranty obligations from the limit rather than agree to a higher limit to include them. The reason is if the product has minimal failures or need for warranty repair or replacement, all they are doing is increasing the potential recovery amount for other claims.
If you provided the supplier with loaned material or equipment or shared confidential information with them I would also exclude claims for those from any limitation of liability. For loaned material or equipment the best way to manage those is by a separate agreement that would not be subject to the limitation of liability. As most limitation of liability provisions limit the types of damages that may be recovered and traditionally exclude lost profits, you need to exclude breach of any confidential information. The primary damages you sustain for the breach of a confidentiality obligations is lost profits. It’s better to manage confidential information under a separate agreement where it would not be subject to the limitation of liability provision.
As a buyer, I would never agree to a limitation of liability cap amount at the amount of the contract and have that include everything unless I had one hundred percent certainty that there would be no third party claim and the impact to me of any failure to perform and my cost to recover would be no more than what I paid. There are very few, if any, contracting situations that I’ve run into where that would apply. If you are going to agree to have a financial cap on the limitation of liability, the amount you should require should be dependent on how many things you have been able to exclude from the limitation. The more you can exclude the lower the cap can be and vice versa, Just as with liquidated damages the amount should be a reasonable estimate of what your damages could potentially be. My personal favorite approach to financial limitation is to have a minimum amount that increases as the amount of the business between the parties increases. If you agree upon a set amount and the business grows your potential risks are bigger and a fixed cap amount may not provide adequate protection.
Tuesday, October 2, 2012
Stopping Work for Non-Payment
In contracts between owners and contractors or between prime contractors and subcontractors delays in payment are frequently a concern. In some jurisdictions, and for specific industries such as construction,a contractor or subcontractor may want to include the right by statute to stop or suspend work if they have not been paid. In jurisdictions where those types of statutes do not exist, the right to stop work for non-payment needs to be included within the agreement. Not paying on time may be a breach of the contract, but in most cases it would be considered a minor breach where only money damages could be claimed unless the delay is unreasonable. As a result a contractor or subcontractor could wind up continuing to invest more in the work and risk having to sue the breaching party to collect the money and damages. Many prime contractors have tried to implement “pay when paid” provisions so they don’t have to pay a subcontractor until the prime contractor receives payment from the buyer (see separate post on “Pay when paid”). That doesn’t do much to protect the subcontractor.
If I were the subcontractor I would want several things to protect me against the unethical owner or prime contractor. First, I would want to be paid interest on late payments so I’m not providing free financing to either the owner or prime contractor. Second, to deal with the issue of disputed amounts invoiced, I would want language in the agreement that in the event of a dispute in the amount of the payment, the other party may withhold only the reasonable value of the actual amount under dispute. That way they cannot withhold payment of an entire invoice. Third, I would want the right to stop work if any undisputed payment was more than thirty days late. Fourth if the work is stopped I would want to be paid any additional costs to start up the work and have the work be extended day for day for each day it was stopped for non-payment. Last, I would want the right to be able to terminate the agreement for cause if payment was more than sixty days late.
From a procedural standpoint I would add a concept that is frequently used in governmental contracts but seldom used in commercial contracts which is a show cause notice. No one likes to be surprised, and simply stopping the work without any advance notice would be just that. A show cause notice is similar to a cure notice and would provide the facts, remind them of your contract rights, and ask them to provide you with a reason why you shouldn’t exercise your rights. For example,
Invoice number 1234 was submitted for payment on October 1, 2012. In accordance with the terms of the contract EXCO was required to make payment on November 1, 2012. That payment was not received. Invoice 1234 remains unpaid as of the date of this notice. In accordance with Section 9.1.5 of the contract, in the event of payment is more than thirty days late (December 1,2012, SUBCO has the right to stop work for non-payment. This notice is to remind you of your payment obligation and put you on notice of our right to stop work if payment is not made by December 1, 2012. Please show cause why work should not be stopped if payment is not made by that date.
If you were not paid you could both stop the work and send a cure notice that they have breach the agreement for non-payment and the other party would have the cure period in which to correct the breach or be terminated and be subject to damages.
The unethical owner or prime contractor may not want to agree to this as it would take away their ability make money at the expense of their contractor or subcontractors. If an owner or prime contractor is ethical, agreeing to this language places no additional burden on them. They would already pay when they are obligated to pay.
If I were the subcontractor I would want several things to protect me against the unethical owner or prime contractor. First, I would want to be paid interest on late payments so I’m not providing free financing to either the owner or prime contractor. Second, to deal with the issue of disputed amounts invoiced, I would want language in the agreement that in the event of a dispute in the amount of the payment, the other party may withhold only the reasonable value of the actual amount under dispute. That way they cannot withhold payment of an entire invoice. Third, I would want the right to stop work if any undisputed payment was more than thirty days late. Fourth if the work is stopped I would want to be paid any additional costs to start up the work and have the work be extended day for day for each day it was stopped for non-payment. Last, I would want the right to be able to terminate the agreement for cause if payment was more than sixty days late.
From a procedural standpoint I would add a concept that is frequently used in governmental contracts but seldom used in commercial contracts which is a show cause notice. No one likes to be surprised, and simply stopping the work without any advance notice would be just that. A show cause notice is similar to a cure notice and would provide the facts, remind them of your contract rights, and ask them to provide you with a reason why you shouldn’t exercise your rights. For example,
Invoice number 1234 was submitted for payment on October 1, 2012. In accordance with the terms of the contract EXCO was required to make payment on November 1, 2012. That payment was not received. Invoice 1234 remains unpaid as of the date of this notice. In accordance with Section 9.1.5 of the contract, in the event of payment is more than thirty days late (December 1,2012, SUBCO has the right to stop work for non-payment. This notice is to remind you of your payment obligation and put you on notice of our right to stop work if payment is not made by December 1, 2012. Please show cause why work should not be stopped if payment is not made by that date.
If you were not paid you could both stop the work and send a cure notice that they have breach the agreement for non-payment and the other party would have the cure period in which to correct the breach or be terminated and be subject to damages.
The unethical owner or prime contractor may not want to agree to this as it would take away their ability make money at the expense of their contractor or subcontractors. If an owner or prime contractor is ethical, agreeing to this language places no additional burden on them. They would already pay when they are obligated to pay.
Show Cause Notices and Cure Notices
One of the problems with contracting is the same terminology can be used in different settings and have a different meaning. For example a court issued show cause notice requires the recipient to appear before the court and explain why a certain action should not be taken. In business companies may use a form of show cause notice to place employees or other parties on notice that there has been a performance problem or misconduct that needs to be corrected. In government contracting a show cause notice may be a precursor to terminating the agreement where they want the supplier to explain why they should not be terminated.
In most commercial contracts companies seldom use the concept of show cause notices. Instead if a party is in breach of the obligations under the agreement they will issue what’s called a cure notice. Most commercial contract termination for cause provisions requires several things prior to being able to terminate. First there must be a material breach of the agreement. In drafting this clause to avoid any misunderstanding, the parties may agree what specific terms, which breached, would constitute a material breach of the agreement. Second, the non-breaching party needs to provide notice to the breaching of the circumstances of the breach. That notice is called a “cure notice”, Third, the breaching party will have the right to remedy or “cure” the breach within the period of time specified in the termination for cause
section. If the breaching party cures the breach, the non-breaching party cannot terminate the agreement as the breach has been cured. If the breaching party fails to cure the breach, the non-breaching party has the right, but not the obligation, to terminate the agreement for cause.
That doesn’t mean that a show cause notice cannot be used in commercial contracting. In fact is could be a preliminary notice that could be used to notify the other party that is something isn’t corrected within a specific period, that you would take a certain action or exercise a specific right. An example of that will be in my next post called “Stopping Work for Non-Payment”.
In most commercial contracts companies seldom use the concept of show cause notices. Instead if a party is in breach of the obligations under the agreement they will issue what’s called a cure notice. Most commercial contract termination for cause provisions requires several things prior to being able to terminate. First there must be a material breach of the agreement. In drafting this clause to avoid any misunderstanding, the parties may agree what specific terms, which breached, would constitute a material breach of the agreement. Second, the non-breaching party needs to provide notice to the breaching of the circumstances of the breach. That notice is called a “cure notice”, Third, the breaching party will have the right to remedy or “cure” the breach within the period of time specified in the termination for cause
section. If the breaching party cures the breach, the non-breaching party cannot terminate the agreement as the breach has been cured. If the breaching party fails to cure the breach, the non-breaching party has the right, but not the obligation, to terminate the agreement for cause.
That doesn’t mean that a show cause notice cannot be used in commercial contracting. In fact is could be a preliminary notice that could be used to notify the other party that is something isn’t corrected within a specific period, that you would take a certain action or exercise a specific right. An example of that will be in my next post called “Stopping Work for Non-Payment”.
Completion Types in Construction Contracts.
In construction contracting you may define and refer to three types of completion: substantial completion, final completion, and completion of the defects liability period. In many construction contracts to owner will retain a portion of each payment as a form of making sure that the contractor completes the work, or having those funds available it they need someone else to complete the work.
Contractors don’t like to have those funds, which may be substantial, to be retained any longer than absolutely necessary. From that the concept of substantial completion was created is used to allow the release of a significant portion of those retained funds. A common definition of substantial completion is the work is complete with the exception of a small “punch list” or “snag list” of items that still need to be corrected or finished. When substantial completion is certified by a third party such as an architect or engineer or agreed, the contractor will invoice for payment of the amount of funds or percentage to be released at substantial completion. The owner retains the remaining amounts as protection that the contractor will complete the remaining work.
Once all the defects have been corrected and all work is completed, if there is an architect or engineer involved they will issue a certificate of final completion. The final completion does two things. First, it allows the contractor to invoice the remaining amounts withheld, except for any amounts withheld for the defects liability period. The second thing it does is serve as the start of the defects liability or warranty period on the work.
The completion of defect liability period ends the buyer ability to make future defect claims. It does not end the contractors responsibility to correct defects that were identified during the defects liability period. If the buyer was retaining monies during the defects liability period, most agreement do not include anything similar to substantial completion for the defect liability period. The owner would have the right to withhold the remaining amount until the correction of all defects listed defects are complete. Depending upon the relationship, amount withheld, and the value of the defects remaining to be corrected, a Buyer may agree to release further funds and still withhold enough to correct the work if the contractor failed to complete the correction of the remaining defects.
The primary alternative to retaining funds is the requirement that the supplier provide bonds or guarantees given by a third party that guarantee performance by the contractor.
Contractors don’t like to have those funds, which may be substantial, to be retained any longer than absolutely necessary. From that the concept of substantial completion was created is used to allow the release of a significant portion of those retained funds. A common definition of substantial completion is the work is complete with the exception of a small “punch list” or “snag list” of items that still need to be corrected or finished. When substantial completion is certified by a third party such as an architect or engineer or agreed, the contractor will invoice for payment of the amount of funds or percentage to be released at substantial completion. The owner retains the remaining amounts as protection that the contractor will complete the remaining work.
Once all the defects have been corrected and all work is completed, if there is an architect or engineer involved they will issue a certificate of final completion. The final completion does two things. First, it allows the contractor to invoice the remaining amounts withheld, except for any amounts withheld for the defects liability period. The second thing it does is serve as the start of the defects liability or warranty period on the work.
The completion of defect liability period ends the buyer ability to make future defect claims. It does not end the contractors responsibility to correct defects that were identified during the defects liability period. If the buyer was retaining monies during the defects liability period, most agreement do not include anything similar to substantial completion for the defect liability period. The owner would have the right to withhold the remaining amount until the correction of all defects listed defects are complete. Depending upon the relationship, amount withheld, and the value of the defects remaining to be corrected, a Buyer may agree to release further funds and still withhold enough to correct the work if the contractor failed to complete the correction of the remaining defects.
The primary alternative to retaining funds is the requirement that the supplier provide bonds or guarantees given by a third party that guarantee performance by the contractor.
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