In contracts most companies seek to put a financial cap on their potential liability. A financial cap is only one way to limit liability. To understand what your potential liability would be, or to understand what the other party’s liability to you may be, you need to look the entire agreement. That is because in addition to financial caps, there are many other ways to effectively limit liability.
For example:
You can place limits on the types of damages that may be recovered such as “Neither party shall be liable for incidental, consequential, special damages, lost revenue or lost profits”. This would limit their liability and your recover to only direct damages.
You can have limits on various types of claims that can be made. For example an exclusion of warranties for merchantability or fitness for a particular purpose excludes liability that could exist under those implied warranties and reduces the potential overall liability.
You can have limits on the types of costs that may be recovered. For example “Supplier shall reimburse buyer’s reasonable out of pocket costs. That language requires a payment of costs and would preclude any of the other party’s internal expenses.
Your can have limits on remedies in individual sections. For example, if a section states a specific remedy followed by the statement “This shall be suppliers sole liability and buyers sole and exclusive remedy." This is limiting potential liability to only the cost of providing that remedy.
There may be limits on the amount of individual costs a party could recover. For example “Supplier shall not be liable for more than one times the price for any cost of re-procurement”. So if the supplier provided a defective product and failed to meet a warranty obligation to repair or replace, the maximum you could claim would be the
purchase price.
I’ve seen companies that, in the event of an Intellectual property infringement claims, want a remedy to be to refund the depreciated value of the product as a way of reducing their potential liability for infringement claims and letting the choose the lowest cost option to them. That may be the highest cost option to you.
There may be limits on periods when claims may be made. For example: “Any legal or other action related to a breach of this contract must be commenced no later than one (1) year from the date on which the cause of action arose”. This cuts of the period for claims to limit liability.
There may be limits on individual charges claimed. For example: “Supplier shall reimburse buyer for its actual and reasonable costs incurred”. This places a responsibility on the buyer to both keep the costs reasonable and to document the actual cost. It also reduces potential liability if the cost isn’t “reasonable” or can’t be proven.
Liquidated damage provisions are a form of limitation of liability for the specific provision that allows collection of the liquidated damage. Once a liquidated damage is agreed, that caps the liability for that breach and the other party cannot recover more than that amount.
Thresholds that must be met before it triggers the right to claim a remedy is a form of limitation of potential liability. “If one percent of the products are defective then supplier shall ….”. That type of language would have the buyer be assuming most of the cost until that threshold is met.
The standard of commitment used to describe the party’s obligation limits what the supplier is responsible for and what they could be potentially be liable for. For example “Supplier shall use reasonable commercial efforts to ___”. Any commitment that is not a firm commitment to do or complete the work is a limit on liability. All the party needs to do is prove they exercised the agreed level of effort. If they did, they would not be liable for damages even though you may not have gotten what you wanted.
Insurance helps reduce a company’s potential exposure for certain liability. For example if you have a financial cap, is the amount of insurance coverage in addition to or party of that cap. If it is included within the cap the supplier has less potential liability as the insurance company is assuming certain risks.
How a financial cap is structured can either limit or expand the potential liability. Caps may be fixed, multiple of sales or percent of business. They can be limits on total liability for the contract term limits on liability for a defined period such as annual limits or limits per occurrence.
What is included or excluded from the financial cap is also important. I want financial caps to only apply to the parties to the agreement and not limit what may be recovered by third party claims.
A supplier’s potential exposure or buyer’s potential recovery will be dependent upon how you manage all of these. I’ve seen buyers negotiate high financial caps with a supplier only to be giving back what they had negotiated through the other contract terms they agreed upon. They had a high cap but all the other limitations
they agreed, it reduced the real amount they could recover to something substantially less.
Fixed amount caps are good when there is a fixed amount to the contract. In negotiating financial for business with the supplier that is expected to grow over the term of the agreement I avoid fixed caps. That is because the potential risk grows as the volume increases and with a fixed cap the protection per item purchased is reduced with the volume. I also don’t like fixed amounts as claims that occur during the term reduce the value of protection you have in the future.
Saturday, November 17, 2012
Tuesday, November 13, 2012
Breach and the right to terminate a contract for cause.
A breach is the non-performance of a contract or a provision in the Contract. There are two types of breaches, minor and material. A minor breach is usually a cause for the collection of damages. A material breach is a failure to perform that goes to the heart of the Contract and may be cause for both termination of the contract and claim damages. In contract drafting how do you establish something as a material breach, which if uncured would give the right to terminate for cause?
If you say nothing in your contract, it would be up to the court to determine whether it was minor or material and whether you would have the right to terminate the agreement. I don’t like to leave issues to chance, nor do I want a court to determine after the fact that I didn’t have the right to terminate the agreement. So within the agreement I want to use language to establish that right when it’s needed. Since termination is a right, not a duty, I want to use that right to drive the behavior I want from the supplier.
Let me give you an example, if you have a supplier who fails to deliver on time, money damages for the late delivery may be sufficient. If you have a supplier who you committed to purchase a high volume from and they are consistently not delivering on time, you probably want the right to terminate the agreement. If the Contract had language that said “time and rate of delivery of Products is of the essence of this Contract, and failure to meet time and rate of delivery shall be a material breach of this contract. You could establish the right to terminate for cause in that section, or more likely you would establish that right in a separate termination for cause section.
For example a termination for cause section could read: “Either party may terminate this Agreement, without any cancellation charge, for a material breach of this Agreement by the other party. Such termination will be effective at the end of a thirty (30) day written notice period if the material breach remains uncured.” In doing that you can spell out the specific sections, where the breach of that section constitutes a material breach.
Should breach of warranties be a material breach of the contract? In my opinion, that depends upon the warranty and the impact of the breach.
For example a contract may have a warranty against defects in material and workmanship.
Should a breach of that be both a material breach and also give rise to the right to terminate the agreement? While money damages might seem sufficient, what if the supplier wasn’t repairing or replacing any defective products? Would you want the right to terminate the agreement.
Standard Contracts also contain a number of legal warranties such as:
The party signing the contract has the right to enter into the contract.
Performance will comply with contract, laws, regulations, etc.
Product or Service doesn’t infringe the Intellectual Property rights of a 3rd party.
The Product or Service conforms to warranties and specifications of the contract.
Free of defects in design and safe for use.
The Product is new, and not re-conditioned.
Which of these would you want the right to terminate?
Always think about the impact of a breach. For the above list of warranties how would you respond?
The party signing the contract has the right to enter into the contract. I would want the right to terminate simply because if the individual didn’t have the authority, it’s not an enforceable agreement against the other party.
Performance will comply with contract, laws, regulations, etc.. Whether I would want the right would depend on the circumstances. If I had on-going purchase obligations I would want the right to terminate.
Product or Service doesn’t infringe the Intellectual Property rights of a 3rd party. If this prevented me from being able to use. Resell, or sublicense the item I would want the right to terminate.
The Product or Service conforms to warranties and specifications of the contract. If I bought it for internal use, money damages might be sufficient. If I was buying it to resell or use in a product that was for sale, I would want the right to terminate.
Free of defects in design and safe for use. I would always want the right to terminate. I don’t want to buy products that aren’t safe simply because of potential liability issues.
The Product is new, and not re-conditioned. . If I bought it for internal use, money damages might be sufficient. If I was buying it to resell or use in a product that was for sale, I would want the right to terminate. The reason for that is if you use a re-conditioned item, you cannot sell a product as new and that reduces the value of the product and customers may not want to purchase products that contain reconditioned parts.
If you say nothing in your contract, it would be up to the court to determine whether it was minor or material and whether you would have the right to terminate the agreement. I don’t like to leave issues to chance, nor do I want a court to determine after the fact that I didn’t have the right to terminate the agreement. So within the agreement I want to use language to establish that right when it’s needed. Since termination is a right, not a duty, I want to use that right to drive the behavior I want from the supplier.
Let me give you an example, if you have a supplier who fails to deliver on time, money damages for the late delivery may be sufficient. If you have a supplier who you committed to purchase a high volume from and they are consistently not delivering on time, you probably want the right to terminate the agreement. If the Contract had language that said “time and rate of delivery of Products is of the essence of this Contract, and failure to meet time and rate of delivery shall be a material breach of this contract. You could establish the right to terminate for cause in that section, or more likely you would establish that right in a separate termination for cause section.
For example a termination for cause section could read: “Either party may terminate this Agreement, without any cancellation charge, for a material breach of this Agreement by the other party. Such termination will be effective at the end of a thirty (30) day written notice period if the material breach remains uncured.” In doing that you can spell out the specific sections, where the breach of that section constitutes a material breach.
Should breach of warranties be a material breach of the contract? In my opinion, that depends upon the warranty and the impact of the breach.
For example a contract may have a warranty against defects in material and workmanship.
Should a breach of that be both a material breach and also give rise to the right to terminate the agreement? While money damages might seem sufficient, what if the supplier wasn’t repairing or replacing any defective products? Would you want the right to terminate the agreement.
Standard Contracts also contain a number of legal warranties such as:
The party signing the contract has the right to enter into the contract.
Performance will comply with contract, laws, regulations, etc.
Product or Service doesn’t infringe the Intellectual Property rights of a 3rd party.
The Product or Service conforms to warranties and specifications of the contract.
Free of defects in design and safe for use.
The Product is new, and not re-conditioned.
Which of these would you want the right to terminate?
Always think about the impact of a breach. For the above list of warranties how would you respond?
The party signing the contract has the right to enter into the contract. I would want the right to terminate simply because if the individual didn’t have the authority, it’s not an enforceable agreement against the other party.
Performance will comply with contract, laws, regulations, etc.. Whether I would want the right would depend on the circumstances. If I had on-going purchase obligations I would want the right to terminate.
Product or Service doesn’t infringe the Intellectual Property rights of a 3rd party. If this prevented me from being able to use. Resell, or sublicense the item I would want the right to terminate.
The Product or Service conforms to warranties and specifications of the contract. If I bought it for internal use, money damages might be sufficient. If I was buying it to resell or use in a product that was for sale, I would want the right to terminate.
Free of defects in design and safe for use. I would always want the right to terminate. I don’t want to buy products that aren’t safe simply because of potential liability issues.
The Product is new, and not re-conditioned. . If I bought it for internal use, money damages might be sufficient. If I was buying it to resell or use in a product that was for sale, I would want the right to terminate. The reason for that is if you use a re-conditioned item, you cannot sell a product as new and that reduces the value of the product and customers may not want to purchase products that contain reconditioned parts.
Monday, November 5, 2012
Construction Contract Documents - mutually explanatory of one another or complimentary
In contracts that have both specifications and drawings included as part of the contract documents you will frequently find a statement that documents are to be taken as “mutually explanatory” or “complimentary”. For example, in construction if a document such as a bill of quantities stated the specific amount of soil for excavation and a specification stated the specific size of excavation footings and foundations, what would happen if the amount specified had been consumed, but there was still more excavation required to comply with the specification? Using “mutually explanatory” or “complimentary” is an attempt to have the multiple documents read together to determine the full requirements so not only did the contractor have to excavate the specified quantity, they also had to meet the specification even if that required additional excavation.
In most of those contracts that use “mutually explanatory” or “complimentary” there may be no order of precedence established between the drawings and specification. If there is an Architect or Engineer involved in the design, most of the time they would prefer to not have an order of precedence and have themselves be the decider of the conflict. If they do include an order of precedence it may give precedence to the most costly of the two items in conflict. As a representative of an owner I always preferred to include an order of precedence to deal with these types of potential conflicts. I didn’t want the architect or engineer to be free to spend my company’s money, and that could occur if you gave them full authority to make these decisions. Construction is local, so an Architect or Engineer and a contractor may have had significant prior dealings and relationships so while ethically they should be neutral, they may not always be neutral.
As between drawings and specifications, which should have precedence? Architects or engineers will say neither, they should be considered complimentary or mutually explanatory. Some groups give precedence to the drawings over the specifications and some give precedence to the specifications over the drawings. The keys in deciding the priority should be is 1) what document provides a more detailed description of the requirements and 2) what type of contract are you buying the construction under.
For example, using the soil excavation issue if the contract was based upon measured quantities under a bill of materials system, you have two things in conflict. The quantities listed in the Bill of Materials, and the quantities required by the specification. If the quantity in the bill of materials and didn’t take into account the amount of total excavation required to comply with the specification, the contractor would perform the work to meet specification and bill and be paid for the additional quantities measured. If the soil issue arose under a lump sum contract, there would be no estimated quantities provided, and the contractor should have determined the total amount of excavation required to meet the specifications.
I’ve always recommended against providing quantities in a lump sum contract because of the potential for conflict and claims that can arise if there is a difference between the stated quantity and the actual quantity required. If there is something where the volume could not be reasonably determined, there are other options than providing a specific quantity. For example the amount of soil that would need to be removed and replaced on a specific site because of concerns about the soil quality. In that case the owner would be concerned that the Contractor would include too high of a contingency because of the uncertainty. You can always exclude portions of the work from the lump sum and have that work be done on a unit rate basis that gets measured.
In doing a lump sum contract I would never provide Bills of Quantities. If you do, and your quantities are wrong or inadequate to complete the work, there will be a claim. If you don't provide quantities, it is up to the contractor to determine what quantities are required to meet the design. If you must include quantities, I would always make the document that lists those quantities have the lowest priority. Using the excavation example, I would have the specification that required specific depths for the footings and foundations have priority over the bill of quantities so when the two are in conflict, the specification requirements would have priority in the conflict between the two documents. A second reason to not provide quantities under a lump sum agreement is under lump sum agreements you don’t staff the site to measure quantities. So you wouldn't know if the quantities were or if there were exceeded.
If an order of precedence does not exist, all terms of the contract documents have equal standing. When you include an order of precedence provision all that does is say that in the event there is a conflict between a higher precedence document and a lower precedence document, the term or requirement of the higher precedence document shall prevail.
Each time you have multiple documents that make up a contract, always consider and establish the precedence you want between all of the documents that are incorporated. This is especially important if you will be incorporating any of the supplier or contractor's documents as part of the agreement.
In most of those contracts that use “mutually explanatory” or “complimentary” there may be no order of precedence established between the drawings and specification. If there is an Architect or Engineer involved in the design, most of the time they would prefer to not have an order of precedence and have themselves be the decider of the conflict. If they do include an order of precedence it may give precedence to the most costly of the two items in conflict. As a representative of an owner I always preferred to include an order of precedence to deal with these types of potential conflicts. I didn’t want the architect or engineer to be free to spend my company’s money, and that could occur if you gave them full authority to make these decisions. Construction is local, so an Architect or Engineer and a contractor may have had significant prior dealings and relationships so while ethically they should be neutral, they may not always be neutral.
As between drawings and specifications, which should have precedence? Architects or engineers will say neither, they should be considered complimentary or mutually explanatory. Some groups give precedence to the drawings over the specifications and some give precedence to the specifications over the drawings. The keys in deciding the priority should be is 1) what document provides a more detailed description of the requirements and 2) what type of contract are you buying the construction under.
For example, using the soil excavation issue if the contract was based upon measured quantities under a bill of materials system, you have two things in conflict. The quantities listed in the Bill of Materials, and the quantities required by the specification. If the quantity in the bill of materials and didn’t take into account the amount of total excavation required to comply with the specification, the contractor would perform the work to meet specification and bill and be paid for the additional quantities measured. If the soil issue arose under a lump sum contract, there would be no estimated quantities provided, and the contractor should have determined the total amount of excavation required to meet the specifications.
I’ve always recommended against providing quantities in a lump sum contract because of the potential for conflict and claims that can arise if there is a difference between the stated quantity and the actual quantity required. If there is something where the volume could not be reasonably determined, there are other options than providing a specific quantity. For example the amount of soil that would need to be removed and replaced on a specific site because of concerns about the soil quality. In that case the owner would be concerned that the Contractor would include too high of a contingency because of the uncertainty. You can always exclude portions of the work from the lump sum and have that work be done on a unit rate basis that gets measured.
In doing a lump sum contract I would never provide Bills of Quantities. If you do, and your quantities are wrong or inadequate to complete the work, there will be a claim. If you don't provide quantities, it is up to the contractor to determine what quantities are required to meet the design. If you must include quantities, I would always make the document that lists those quantities have the lowest priority. Using the excavation example, I would have the specification that required specific depths for the footings and foundations have priority over the bill of quantities so when the two are in conflict, the specification requirements would have priority in the conflict between the two documents. A second reason to not provide quantities under a lump sum agreement is under lump sum agreements you don’t staff the site to measure quantities. So you wouldn't know if the quantities were or if there were exceeded.
If an order of precedence does not exist, all terms of the contract documents have equal standing. When you include an order of precedence provision all that does is say that in the event there is a conflict between a higher precedence document and a lower precedence document, the term or requirement of the higher precedence document shall prevail.
Each time you have multiple documents that make up a contract, always consider and establish the precedence you want between all of the documents that are incorporated. This is especially important if you will be incorporating any of the supplier or contractor's documents as part of the agreement.
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