Sunday, January 26, 2014

Privity - retaining privity in complex supply chains and outsourced relationships.

Today’s world of complex supply chains and outsourcing has created a number of situations where you either are having third parties purchase products or services for you or you need to purchase from third parties. When this happens, several questions you should be asking are:
1.What will be the impact on contract protections?
2.Will the third party that you are now buying from be able to stand behind key contract protections? For example, can a third party cure and I.P. Infringement?
If you had significant leverage in negotiating the contract with the supplier you probably don’t want to risk losing those by no longer having privity of contract with the supplier on those purchases.

Having faced these situations I thought I would share my thoughts on approaches to these.

Example 1. Purchasing of contract services like contract manufacturing.
The Buyer has a contract with a Supplier. The Buyer hires a contract manufacturer (CM) to manufacture the Buyer’s product and will buy the completed product from the CM. Your options are:

1. To maintain privity with the supplier you could purchase and consign the goods. That is complex and costly. If you fail to provide them on-time the CM can make claims for the delays.

2. You could ask the supplier to allow the CM can purchase off the Buyer’s contract with the Supplier and the Buyer is a third party beneficiary to those purchases. One of the problems with that is the Buyer could be liable for the CM’s actions and the supplier could potentially cause a breach and termination of the agreement.

3. You could ask the supplier to enter into a separate agreement with the CM and provide the same terms and have the buyer be a third party beneficiary to that agreement. The problem with this approach is many suppliers simply do not want to extend any Buyer’s special terms to the CM. The main reason is the CM would want to use those terms with all their customers and that impacts the Supplier’s profit and risk structure.

4. You could be to have the CM buy directly from the Supplier under whatever terms they could negotiate. Those may be less that what the Buyer had. If the Buyer doesn’t want to lose the special protections they negotiated directly with the Supplier you could:
a)Have the Supplier and CM to establish whatever agreement makes business sense between them.
b)Have the Supplier either extend the contract price to the CM or agree to provide the Buyer with a rebate for any price difference.
c)You want agreement with the Supplier that the Buyer is a third party beneficiary to those CM purchases.
d)You want the Supplier’s agreement that that the Buyer can enforce either the terms of the CM’s agreement with the Supplier or the Buyer’s agreement with the Supplier on those purchases.
e)The supplier will want to make sure that since they will be liable to both the CM and the Buyer, that their cumulative liability is no more than what they would have been liable for under their agreement with the Buyer.
f)I want that separate agreement between the CM and the Supplier so the Buyer does not assume any liability under that agreement and to make sure that a breach of that agreement it does not impact the Buyer-Supplier Agreement that the Buyer may need for other business.
g)In the Agreement between the Buyer and the CM, I want several things included:
1. I want the products ordered by the same part number so I can verify consumption and make sure that purchases are not being made for other use.
2. I want the CM to agree that they will only use those parts in the manufacture or repair of
my company’s products. This is important for dealing with allocations of supply.

Example 2. Purchasing of products through distribution.

The Buyer wants to buy Supplier’s product for resale as part of solutions it sells its customers. The Supplier either doesn’t want to sell directly to the Buyer because of the impact that would have on its sales channels, or the Buyer wants to acquire the products through a distributor because of advantages the distributor can provide such as stocking with quick delivery. The Buyer is concerned with the contract protection it will get if purchases are from the distributor with no privity of contract with the supplier. Key concerns are usually warranties and the indemnifications. While the distributor can pass thru what the supplier agrees they can pass thru, for any protection above that the Distributor cannot provide the necessary protections on their own.

As all of the business will be conducted through distribution, you need an agreement with the distributor for those purchases. Then to get privity with the supplier you could then create a simple one-page agreement with the supplier to create privity on purchases through their authorized distributors. For example the preamble of such an agreement to create privity could be:

“Buyer and Supplier agree that all Supplier products (hereafter “Products”) that Buyer may acquire directly or by Buyer Authorized Third Parties from any authorized distributor of Supplier offering those Products for resale, shall be subject to the terms of this Agreement. Supplier agrees to honor the following terms with respect to all such Products acquired by Buyer or Buyers Authorized Third Parties and Buyer may enforce these terms directly on Supplier.”

I’d be interested in hearing how others have addressed this.

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