Tuesday, April 23, 2013

Drop Shipment

What does drop shipment mean and when would you use it? Drop shipment refers to a shipment that is shipped to a specified location that is other than the purchasers standard location for receipt of a product. Drop shipment may be used for a number of situations. A buyer may order something to be shipped to their customer’s or a service provides location to meet a requirement to perform service or repair. A buyer may order products or services to be shipped to a customer location for their ultimate use in completing a project for the customer rather than have it shipped to the buyer to then have it shipped to the customer site. Drop ship may also be used when you want the item to be shipped to a third party under a loan of product situation, consignment or bailment. See http://knowledgetonegotiate.blogspot.com/2011/04/bailment-consignment-loan-of-product.html

If the buyer will not be receiving the shipment, when you use drop shipments you need a separate agreement with the third party that establishes their responsibility for the material. Common requirements may be to notify you of its receipt, notify you of any visual damage to the shipment or packaging material and insure the material against all perils while it is under their control. Other responsibilities will vary based upon whether it is a loan, consignment, or bailment situation.

In supply chains, the drop shipment of goods is common when trying to implement vendor managed inventory programs and especially when the ultimate destination is a foreign country. For example, a supplier could contract with a warehouse agent located within a free trade zone and ship them product for them to hold in inventory. When the local buyer wants the product they need to make a pull from that inventory, clear customs and arrange to have it delivered to their point of use. The warehouse agent would notify the supplier that inventory has been pulled and the supplier would then use that to invoice the customer for the items they pulled/purchased. Since the items were never imported into the country,
if the supplier needed that inventory elsewhere or they needed to adjust the inventory level being held there, they could have the warehouse agent ship items to their point of need.

The advantage of drop shipments is that it reduces the number of times a product is shipped, so it reduces the distribution cost, it reduces the number of times it must be handled (reducing that cost and the potential for damage. Eliminating that non-value added product shipping also reduced the product lead-time.

Friday, April 19, 2013

Evergreen versus self-extending contracts

An evergreen contract (meaning a contract with no end date) is not legal in many countries. Those locations require contracts be of a specific term. A self-extending or self-renewing contract is a contract that has a specific term, but may automatically extend unless one of the parties provides a notice to the other party that they do not want to have the agreement extend.

As contracts and procurement people are constantly being asked to do more with less people, one of the things you need to do is look for activities that you can eliminate. Many times you may be doing business with the same supplier for many years. When you have a specific term, it forces you to do an amendment each time to extend the agreement. If the extension does not happen before the end of the term of the contract the first thing you lose is contract coverage on purchases made after the expiration date. Once a contract has expired, it no longer legally exists so it can’t just be amended. You would need to do a new document to incorporate the terms of the expired document and would also need to make that new document retroactive to the termination date to get contract protection during the interim period. More important from a buyer's side, it open it up to having a new document that needs to be reviewed and approved. You may not have the same leverage you had when you negotiated the original contract and may now be dependent upon the supplier. What I also found was many times on a supplier side if an amendment to extend the agreement was required, you frequently will have the supplier's legal people or others that want to re-negotiate many of the terms. What you don't want is to be forced into accepting new terms simply because you need the supply.

A self-extending or renewing contact will allow either party to provide notice to not have the agreement self extend. If neither provides notice the contract extends for another year without the need for an amendment. The notice period needs to be long enough to allow you to take steps to ensure you do not have an interruption of supply on your side and allow the supplier time to backfill your business with another customer. On a production purchase you would need to take into account a products lead time and possibly the time required to qualify another supplier and product. If you use self-extending contracts you always want to provide for periodic price negotiations so you can adjust pricing. Self-extending contracts work well in situations where there are no firm commitments to purchase specific quantities. That way if there is a problem with the supplier or their pricing, you can simply not buy from them and then send the notice to not extend the contract. As situations and needs can change, if there are contracts that have firm purchase commitments, I would never have a renewal period be more than one year. The reason for that is simple. The cost to terminate a one year commitment will always be less than a multiple year commitment. The real advantage of self-renewing versus fixed term agreements is you avoid having to do amendments each year. Many companies I’ve worked for had contracts on a calendar year term which meant that most contracts would need to be amendment in that one period and that caused contracts to lapse and not have coverage. Not having to do amendments to extend the period is simple and time saving. All you really need to do from a Buyer’s side is to have a planning calendar which many contract systems have the functionality to provide key dates so you are reminded well in advance of the notice date that you may need to take action if you do not want that contract to be extended.

Tips in drafting self-extending contracts:

Include clear language disavowing any firm obligation to purchase goods or services under the contract. For example:
“Buyer is under no obligation to purchase any Products or Services, except as ordered in Purchase Orders”

Include a clear description and mechanism of how goods or services will purchased (i.e. purchase order, master purchase order with calls, service order, work order, etc.).For example:
“All purchase will be made by Purchase Order in either electronic or tangible form and shall be Supplier’s authorization to conduct transactions under this Agreement.”

Include a clear description of what, if any, terms can be modified by the subsequent purchase document. For example:
“Any additional or differing terms or conditions on Buyer’s Purchase Order or Supplier’s acceptance shall be void unless accepted in writing by both parties.”

Include a description of how pricing may be changed. For example:
“One-hundred and twenty (120) days prior to the end of the current term, the parties shall meet to negotiate pricing for the next term. If the parties are unable to reach agreement by ninety-days prior to the end of the current term, the current pricing shall be extended for ninety-days into the new term. After ninety days of the new term have elapsed, either party may terminate this agreement without liability if new pricing has not been mutually agreed.

An example of a self-renewing clause:
The term of this Agreement shall be for two (2) years from the Effective Date and thereafter shall extend for successive one-year terms until either party provides notice of intention to terminate. Any notice of intention to terminate must be given at least _____ months prior to the end of the then current term.

Tuesday, April 16, 2013

Your “View" of Contracts will always depend upon where you sit.

Everyone tends to view contract issues based upon where they sit and the impact it will have on them, not the impact the issue may have on the other party. Owners, Contractors and Subcontractors have different views of the same issue. Individuals involved in negotiations usually have different views based upon the level they are at in the organization as their goals and motivations will be different. A sales person may be focused on making the sale and getting their commission. A sales manager or president may be more focused on adding a new customer or penetration into a new market. Individuals in different geographies, different cultures and with different laws will have different views than people from other locations where risks may be viewed differently. The economics of the project or work will always create a different view for both parties. The potential risks involved will be viewed differently. Between regions or countries business may be done differently and behavior may be different based on cultures. Different markets will have different dynamics. What may be common in one market may be an exception in another market. To be successful in negotiations you always need to view issues from both parties perspectives so you understand not just what they are saying but why they are saying it as it opens up possible common solutions. I’ve had CEO’s of companies ask why they didn’t get a contract and when I explained why, I would explain why I needed certain commitments and why I was not prepared to accept the position their team held. Many times their response was “oh, we could have agreed to that”. I’ve also escalated negotiations up to the sales VP or CEO level to make sure the “no” I was getting represented the company’s position.

Recently I had someone ask a question about survival of terms. As a service provider they didn’t like customer wanting certain clauses to survive perpetually. They thought there should be a certain time limit for survival. In asking their question they showed that they were only thinking about the issue from their perspective and not the buyer or owner’s perspective. They were looking at it from a supplier perspective of wanting to have a firm period after which they had no liability. My response was to share a buyer or owner perspective of why an owner might want certain terms to remain open.

There are two types of claims a party needs to be concerned with. One is contractual liability. The other is third party liability. In most countries there are legal statute of limitations. What a legal Statute of Limitations does is create a legal cut off period after which claims may not be brought in court. Claims made within that period will continue until the dispute is resolved by the agreed method in the contract. This means that for certain clauses having them be perpetual may provide no real value when there are Statute of Limitations laws that prevent claims from being made after the allowable period in the statute of limitations has passed.

For example, a third party that is injured in New York state has six years after injury in which to make a claim. In New York, a claim under a contract has a two-year limit to make claims after the completion of all obligations. This means that if you had a warranty that was five years, after that warranty was complete there would be 2 years from that to file a contract claim. After that no claim under the contract could be brought.

For some liabilities such as product liabilities both the supplier and the buyer (if they resold it to a third party) can be potentially liable over the life of the product, where you would be excused from liability on each individual claim only after the individual's claim rights have expired under the Statute of Limitations.

One of the keys in how the buyer would view the issue would be whether they can be liable for the acts of the supplier or contractor to a third party who suffers injuries or damages as a result of the supplier or contractor’s negligence. In many locations a buyer or owner could be liable for the supplier's negligent actions under the theory of agency. In those locations buyer contracts usually include indemnifications and insurance requirements to protect against third party claims. All these rights and concepts will vary of course based upon the laws of the location agreed for both applicable contract law to be applied and jurisdiction.

The most common section that an owner or buyer may want to survive the completion of the contract are taxes, payment, warranties, indemnities, limitation of liability, choice of law and forum and order of precedence. Why would a buyer want each of these to survive the completion or expiration of a contract?

For taxes if a supplier failed to properly calculate or pay required taxes to a governmental authority the government could go against the owner or buyer at any time up until there is a statute of limitations that would prevent collection.

For payments, while this may apply in some cases where the supplier or contractor must pay the buyer or owner, in most cases this protects the supplier or contractor right to collect if the have not been paid.

Typical warranty clauses include both business warranties such as a period during which defective products or services will be repaired or replaced. That type of warranty can have a specific term that it will survive for. Other warranties are more legal and those are one that a owner or buyer would want to survive. For example a warranty that the work or product complied with applicable laws you would want to survive in the event that there was a claim by local authorities that it didn’t. Warranties can include commitments on behavior such as complying with applicable import or export laws as claims from applicable agencies could come at any time.

Indemnifications can be indemnifications against third party claims for injury, death or damage to personal property. They need extended periods as the third party can make claims at any time up to the Statute of Limitations has expired that would prevent the claim. You may also have intellectual property infringement indemnifications for third party claims that something the supplier or contractor used or provided infringes upon the intellectual property rights of a third party. In those cases the statute of limitations will vary based upon the location and may also vary based upon the type of intellectual property that is claimed to have been infringed upon. For example. in the U.S. claims of patent infringement have a six-year limitation. Infringement of copyright has a three year limitation.

Limitation of liability sections usually protect both parties and both parties should want those to survive as they may limit claims the buyer or owner can make against the supplier or contractor in that period after the contracts has been completed or expired. Without that surviving the supplier or contractor could potentially have unlimited liability.

The choice or laws and forum and order of precedence sections should survive so in the event of a dispute during the survival period, the courts will honor what was agreed by the parties. Further they will interpret the documents in the priority the parties agreed.

When you think about issues from both your and the other party’s perspective it becomes easier to explain what you need and why you need it to the other party. In the example, while the supplier may want to cut off liability. the buyer will be concerned with potential third party claims that could occur in the future based upon the supplier's actions or inaction during the contract. Excusing the supplier of liability to the buyer could have the buyer being solely responsible for the supplier's actions if the third party only sued the buyer.

Thursday, April 11, 2013

Battle of the forms

I had an individual ask me to explain “the battle of the forms” so I decided to add a post on that subject. The battle of the forms refers to a situation where documents have been exchanged, there is no mutual agreement by the parties on the terms, and the work has commenced or been performed. A common example of this is when a buyer issues their purchase order form and the supplier sends an acceptance with additional or differing terms. That acceptance form was a counter-offer that is never accepted by the buyer so there is no final meeting of minds of the parties.

The scenario he provided was:
1) Buyer sends to Seller a RFQ.
2) Seller sends quotation with attached Sellers T&C’s. The quote states “any additional or differing terms in Buyer’s PO shall be void unless accepted in writing by both parties”
3) Buyer issues a PO with Buyer Terms which may be additional or conflicting to what the supplier proposed.
4) There is no agreement in writing to those additional or different terms
5) Seller begins performance or ships the product.
In every battle of the forms situation the question in is whose terms control? To determine that you need to review all the documents involved. The first document you would review would be the RFQ. Things to look for in the RFQ would be whether the proposal would be considered an offer that could be accepted by the buyer and
Whether there was any language in the RFQ that limited what the supplier could propose. If the RFQ did not limit what the supplier could submit as part of their proposal, the Supplier has the ability to limit or restrict their proposal was considered an offer. If there proposal wasn’t considered an offer it was simply a proposal that would be subject to further agreement on terms. The supplier’s proposal providing their terms and excluded additional or differing terms without agreement in writing.

The next document you would look at would be the purchase order terms. Were the terms on the purchase order silent about additional or differing terms? If it was, the purchase order could be interpreted as in acceptance of the supplier’s proposal and the supplier’s terms would apply. If the purchase order terms precluded any additional or different terms, the issuance of the purchase order would be a counter-offer that would need to be accepted by the supplier. The question here is whether the supplier’s commencement of the work would be considered an acceptance of buyer’s. Since the supplier’s proposal made it clear that their intent was to only agree to additional or different terms in writing, their commencement of performance would not be considered an acceptance. That creates the situation where there was no meeting of the minds by the parties. A meeting of the minds is required to form a contract.

There is a good flowchart about the battle of the forms under the Uniform Commercial Code that can be found at

There you can see that if there isn’t a meeting of the minds, a contract may still need to be constructed if the parties acted like a contract was in place. In the example, since the supplier commenced performance that was an act like there was an agreement, and the supplier’s acting created a form of detrimental reliance so an agreement would need to be constructed. Under the UCC, the battle of the forms is resolved by reviewing the documents involved. All terms that are common to both parties will remain in place. If there are either buyer terms that conflict with what the seller proposed or included in a proposal or acceptance, those additional or different buyer terms will be struck down. Similarly, if there are supplier terms that are in addition to or different from the buyer’s terms, those additional or different supplier terms will be struck down. If that leaves the contract either with no term or an incomplete term, the standard UCC term would be inserted to create the agreement.

As a buyer the best way to avoid a “battle of the forms” is to make sure that you have complete agreement by the parties on the terms. If the supplier has proposed additional or differing terms as part of a proposal, make it clear in your contract or purchase order that you are not accepting those terms. For purchase orders make it clear that any additional or differing terms included in the supplier’s acceptance shall be void unless specifically agreed to in writing by the parties. For any documents that will be part of the agreement, read them to ensure they do not have additional or different terms. Order of precedence clauses protect you when there are conflicts between the two documents where the higher precedence document prevails. Order of precedence clauses do not protect you against additional terms if those additional terms do not conflict with a term in the higher precedence document.For differing terms, to the extent that the differing term would change the higher precedence term, the order of precedence will protect you against those changes. To the extent the differing term contains additional terms that do not conflict, the order of precedence does not protect against those being part of the agreement.

For example:
Supplier’s proposal included a term that had five remedies for a specific breach.
Your agreement included only three.
You incorporated the supplier’s proposal by reference into your agreement.
The agreement gave precedence to the contract.

What would happen is if any the 5 were in conflict with the 3, the priority would be to your contract term.
If only two conflicted and the other 3 there were not in conflict, those additional remedies would be also part of the

When incorporating a document by reference in a contract or purchase order, always read that document. If there is anything in that document that conflicts with or is in addition to what you want, you can do two things. One is to have the supplier re-submit the document without the problematic language and incorporate that. Alternatively,as part of the incorporation, specifically exclude the problematic language from the incorporation showing your intent to not be bound by those additional or different terms.

Monday, April 1, 2013

Dual Party Payee Checks

What do dual party payee checks have to do with contracts? The reality is sometimes you can run into situations where you either don’t trust the supplier or contractor to pay their subcontractors or they may not have the funds available to make the payment and you have a subcontractor that is critical to performance. Unless they get paid they may stop all work. As the buyer you cannot pay the subcontractor directly as you have no legal relationship with them. When you write a dual party payee check, neither of the payees can cash or deposit the check individually. One of the parties must endorse (sign) the check, and provide it to the other party for cashing or depositing. Since the supplier or contractor cannot get any benefit from it on their own, they will endorse the check over to the subcontractor. In construction contracting making sure that a subcontractor gets paid can have additional importance as in many locations unpaid subcontractors can place financial liens on the location for their protection using what is referred to as a mechanics or materialmans lien. To the owner this means that if the contractor fails to make payment, the owner could have to pay twice. One payment to the contractor and the other to have the lien removed.

Dual party payee checks frequently also may be used when the buyer or owner is either an “additional insured” or “loss payee” under the supplier or contractor’s insurances. As the insurance company’s primary contract relationship is with their policy holder they will always include the policy holder’s name on the check as a payee, but since the buyer or owner has the status as additional insured or loss payee, if they only paid the supplier or contractor and the contractor didn’t pay the buyer or owner, the buyer or owner could make a claim for payment against the insurance company. The insurance company could wind up paying twice. To avoid that potential situation they will use dual party payee checks to make sure the additional insured or loss payee gets paid.

Dual party payee checks are just another tool that contracts people should be aware of when you want to ensure that the subcontractor gets paid and you have serious concerns about the contractor paying them. For a subcontractor that gets paid this way, they can claim that they haven’t been paid, as you will have proof of payment by their endorsing the check.