Update to readers

Dear Readers

In preparing to publish updated electronic versions of my book I have decided to eliminate the glossary of common terms from the book. Instead I will publish the glossary on the new "Glossary" page in my website.

For those of you that have already purchased my book (I thank you and hope you have learned from it). I think this change will allow me to update the glossary on-line to make it a more robust tool that you can use.

For any prospective book purchasers, this will have no impact. The glossary will remain in the hard cover version to help understand the book better and once electronic versions are published they will include links to both the List of Blogs and Glossary.

The current glossary list has been been posted. To see it go to knowledgetonegotiate.com and click on the "Glossary" page/

Thank you,
John

Best pricing clauses (Part 2)

Two things come into play with best pricing clauses. They are extremely difficult, if not impossible, to enforce. The second issue is the potential impact on the Supplier, if a supplier provides best pricing for one customer without meeting all the conditions require under anti-trust law, they would be obligated to offer that same price to all customers or be in violation of the act. The net result is few suppliers are willing to accept best pricing clauses. Most, if not all, would not allow you audit rights to verify it for enforcement. It would require them opening up to audit not just pricing the offer others, but the terms, and any analysis of whether the party is similarly situated, etc. Without audit rights the clause is useless.

One of the problems that exists when individuals try to write best pricing clauses is they are unaware of the applicable anti-trust laws the sellers much follow. Under U.S. the Robinson-Patman Act requires a company to offer you similar pricing if it meets several criteria:
1. The buyers must must be equal or similarly situated companies. The similarly situated requirement would allow a supplier to price an item higher if a company is a higher credit risk.
2. You must be purchasing like quantities.
3. The purchases must be under like terms.
In addition a company is excused from offering the same pricing if:
a) There is a cost justification (such as cases where it costs more money to deal with one company versus another).
b) The seller needed to offer that price to match the price of a competitor in a competitive situation.
It is unlawful to knowingly to induce or receive discrimination in price.

On LinkedIN someone posted the following best pricing language:
“Supplier shall treat City of Los Angeles as a most favorable customer. Supplier represents that the prices for storage and services furnished to City of Los Angeles under this Agreement are not less favorable than the prices and provisions offered to any of the supplier’s other customers, unless the other customer receives lower prices or more favorable non-price treatment because of the higher volumes of storage and services, after taking into account the cost structure in a single district and the service requirements profile of other customers. If supplier offers lower prices or more favourable provisions to any other customers than those offered to City of Los Angeles under this Agreement (taking into account volume, account cost structures in single district and service requirement profiles) for similar storage and services, then supplier agrees to concurrently extend such prices or provisions to City of Los Angeles and this Agreement at City of Los Angeles’ option, shall be deemed amended to provide such terms to the City of Los Angeles.

Let’s look at what is wrong with this:
“Supplier shall treat City of Los Angeles as a most favorable customer. This is asking for most favored treatment without needing to meet the three requirements - Equal or similarly situated companies; purchasing like quantities; under like terms".

“Supplier represents that the prices for storage and services furnished to City of Los Angeles under this Agreement are not less favorable than the prices and provisions offered to any of the supplier’s other customers, unless the other customer receives lower prices or more favorable non-price treatment because of the higher volumes of storage and services, after taking into account the cost structure in a single district and the service requirements profile of other customers”. This is asking for both most favorable price and terms treatment, with the sole requirement for that being the difference of higher volumes. There is no link to the other requirements that the buyers must be similarly situated or that the purchases must be under the same terms. There is also ability to excuse that commitment under the circumstances listed in a) and b) above.

If supplier offers lower prices or more favorable provisions to any other customers than those offered to City of Los Angeles under this Agreement (taking into account volume, account cost structures in single district and service requirement profiles) for similar storage and services, then supplier agrees to concurrently extend such prices or provisions to City of Los Angeles and this Agreement at City of Los Angeles’ option, shall be deemed amended to provide such terms to the City of Los Angeles. Here the commitment to provide best pricing and best terms is only linked to account volume and cost structures for similar services. It doesn’t take into account the requirement that they be similarly situated, that they be based on similar terms and that it not apply if b) above applied. It further doesn’t take into account the fact that the company getting a more favorable terms in one area may also be getting a less favorable term on another area. It’s an attempt to cherry pick the best, when under anti-trust law the terms offered must be similar and that means that to get better terms in one area, they would need to accept worse terms in another area for the two to be similar.
Another problem is the first commitment was structured as a representation. It should have been structured as a warranty. Representations apply to facts that are in effect at the time of the representation. In this case that would be at the signing of the contract. Future pricing would not apply to this measure. Warranties are used for on-going commitments where you want a specific commitment to be maintained throughout the agreement term. This means that as long as the statement was true at the time of signing of the contract, the supplier will not have breached that section if they offer better pricing or terms to others in the future.

A further problem is while there was a commitment to make adjustments there was no mechanism in place to check or verify that they were getting the best price or better terms. If failed to identify how it will be administered and verified taking into account the standards set (like quantities under like terms) and the possible exceptions. My opinion is it would be legally enforceable.

My last concern with the way this was structured is the focus was strictly on purchase price.I guess that if that’s all you want to manage that’ may work, but I would always prefer to also address the total cost or total life cycle cost of the purchase.

I don't like best pricing clauses for a number of reasons. They are difficult to administer and validate. People think that they will automatically get savings, which they won't. They especially won't if the best pricing if the requirement violates anti-trust law. I prefer to use price-benchmarking clauses especially when you have longer term contracts. A price-benchmarking clause allows you to periodically get quotes from other suppliers under the same terms and quantities. This makes everything equal. Normally you would seek enough quotes to be able to throw out the high and low prices and average the remaining quotes to establish the benchmark price. The contract would require the supplier to adjust their price if their pricing is higher than the benchmark. An alternative would be if they aren't willing to meet the benchmark, the buyer would have the right to terminate the agreement with notice but without any liability. The advantage of price benchmarking is you don’t need to audit the supplier to verify their actions. If they need to adjust their price, they can do that without creating an anti-trust problem as the adjustment would fall under the exception of having to meet a competitive situation.

Cost of Cover

Someone asked whether the cost of cover or excess cost of re-procurement was a direct damage or an indirect damage, noting that many contracts in the U.S. traditionally exclude everything but direct damages.

For the U.S. the answer to the question is Sections 2-713 and 2-715 of the Uniform Commercial Code that has been adopted by all States and Territories. Section 2-713 Identifies Buyers damages as "the difference between the market price at the time for tender under the contract and the contract price" together with any incidental or consequential damages under Section 2-715, but less expenses saved in consequence of the seller's breach. Section 2-15 specifically defines Incidental damages as "expenses reasonably incurred in inspection, receipt, transportation and care and custody of goods rightfully rejected, any commercially reasonable charges, expenses or commissions in connection with effecting cover and any other reasonable expense incident to the delay or other breach".

When you have a contract in the U,S, that limits recovery to only direct damages, that language overrides only that portion of that section of the UCC that allows for incidental and consequential damages. That leaves you with the remaining damages specified in Section 2-713, which is the difference in contract price (which is the cost of cover).

The United Nation's Convention on Contracts for the International sale of Goods (CISG) in force in many countries that adopted it specifically provides for cover damages. Under its article 75, a party may recover the difference between the contract price and the price for the substitute transaction. This is in addition to any other damages including loss of profit, suffered by the party as a consequence of the breach, limited to a foreseeability requirement (CISG. art. 74). If a party (be it seller or buyer) decided not to enter into a substitute transaction, it may obtain current price damages, estimated as of the time of breach (CISG art. 76).

In both situations contract drafters need to understand that when you are dealing with an applicable law that has adopted either the UCC or CISG, if within your limitation of liability you fail to specifically exclude incidental, consequential damages, those laws would be applied and you would be subject to direct, incidental and consequential damages (which would include lost profits).

Import

In a LinkedIN group an individual asked what group within a company should be responsible for managing import. That gave me the idea to do a post about import from a contract’s perspective.

The delivery terms that you agree upon in the contract determines which contract party is responsible for export and corresponding import. Any term that has title transferred to the Buyer before the exporting country frontier where customs clearance is required would make the buyer responsible for export customs clearance. If title is transferred to the Buyer after that point, but before the importing country frontier, the Buyer would be responsible for import clearance. If title is not transferred to the buyer until after customs clearance such as with DDP terms, the buyer has no responsibility for import.

If the Buyer is responsible for export, they will need an export license from the country of export. In situations where you buy with a ex-works deliver term, FOB or FAS terms where the point of delivery is prior to the customs frontier, the contract should include two terms. One should be the right to terminate the agreement and get a full refund of any payments made in the event the Buyer is unable to secure the export license. The second thing to include in an agreement is a requirement for the supplier to provide you all information necessary to get the export license. To assist you in getting that export license you would normally hire a local customs broker. Being a Customs Broker is a profession that involves the "clearing" of goods through customs barrier. This involves the preparation of documents and/or electronic submissions, the calculation and payment of fees, taxes, duties and excises (if any are required for export), and facilitating communication between government authorities and the exporter. To better understand responsibilities of the parties for each of the different delivery terms you should read the current INCOTERMS published by the International Chamber of Commerce.

In addition to the required licenses, export/import required two key documents – the supplier invoice and the bill of lading.
Buyers will normally establish specific requirements for the information that must be included on the invoice. For example:
“Invoices to Buyer must include, at a minimum, the following: (i) applicable P.O line item numbers; (ii) Agreement and Purchase Order numbers; (iii) terms of payment; (iv) billing period dates; (v) applicable Product unit Prices; (vi) total amount invoiced; (vii) the Harmonized Tariff Code of the importing country for every Product; and, (viii) Product descriptions with sufficient detail to enable verification of associated Product categorical classifications. Of these the unit prices, total amount invoiced, Harmonized Tariff Code for the importing company and the Product Descriptions will be used for customs clearance and in determining what, if any, duty rate will apply. Each country establishes their own duty rates based upon three things. The type of material being imported, the country it is being imported from (as difference countries have different rates) and the cost of what is being imported as duties are usually a percentage of the cost. For readers that are not familiar with a Harmonized Tariff Code, in the U.S. the U.S. International Trade Commission create a unique tariff code for every possible type of goods you could think of (see http://hts.usitc.gov/). Duties are established by specific code by export country. For goods that are trans-shipped, the original country’s duty will apply unless value add was provided in the other country.

The second document required for import is the Bill of Lading. The bill of lading includes:
Information about the shipper: Name, Address, City, State/Province, Country, Zip,
Bill of Lading Number
Information about consignee: Name, Address, City, State/Province, Country, Zip
Information about freight charges: Entity that is paying the freight and amount.
Description of Items shipped: Handling units, package type, pieces, whether they include hazardous materials, written description of what is being shipped, weight, NMFC freight Code, Class, Cube,
Description of Carrier responsibility for loss and any insurance required
EEI / SED Exemptions
Name of Customs Broker for import
Shipper certification that goods are in proper condition for transportation, and are properly classified, marked, described, packaged
Carrier certification that they received the packages and required placards. Both the commercial invoice and the bill of
Lading will be provided with the shipment
Note: EEI / SED in a bill of lading is used when goods are being exported from the U.S, SED stands for Shipper’s Export Declaration and has been replaced by EEI (Electronic Export Information) which is an on-line advance notification that the goods will be exported.

The importer must provide a “declared cost” for the import. The declared cost includes:
•The seller’s price which is listed on the commercial invoice).
If the following items are not included in the price, you must also add:
•The costs of delivery to the import border. Those costs are listed on the bill of lading.
•Any selling commissions paid.
•Royalties and license fees paid by you on the imported goods as a condition of sale
•Cost of containers and packing. For example, the cost of any special containers for ocean shipment.
•Any other proceeds of resale the seller will receive.
•Any goods and services you provide to the seller for free or at a reduced cost (referred to as an “assist”)

From the Bill of Lading, Custom’s will contract Customs Broker to arrange for clearance.

The actual duties to be paid for import will be calculated based upon the declared cost, the harmonized tariff code, and the applicable duty rate for that specific tariff code for that specific exporting country.

The importer can be subject to fines and penalties if either of the documents fail to provide correct information about the declared cost or the correct harmonized tariff code. or if they fail to provide information needed to correctly determine what code should apply. If the buyer is the exporter you need they supplier to provide you with a correct invoice, and consider making them liable to pay for any fines or penalties for failing to provide you with that correct information. If the supplier is the exporter you need the supplier to also provide you with correct information on the bill of lading and possibly make them liable for any fines or penalties that were cause by either document being incorrect.

Deviation Requests

A deviation request is a document that is generated by a supplier (or more frequently a contractor) where they are looking to have a change to the required work. Most of the time they could be looking for a change in the materials specified, a change to the design or the substitution equipment to be provided. Since the supplier or contractor doesn’t have the legal right to change what is required by the contract, the buyer has the option of accepting or reject the proposed deviation.

The reasons for requesting a deviation can be many:
•The supplier may found an alternative that is cheaper (but in their mind equal), where they want to make more money by the substitution.
•The deviation request could cost the contractor more, and not provide the employer with any additional benefit or lesser benefit. It is made because of availability of material or equipment and the potential impact that could have on the schedule.
•As designed, the item may not be able to consistently be produced in the desired quality.

In determining whether to accept of reject a deviation request, the buyer should consider a number of factors:
1.Will it provide equal, lesser, or greater value to the Buyer?
2.Will the deviation cause the same, less or more life-cycle cost?
3.Is the change acceptable to the internal customer it terms of its aesthetics, quality, and operation?
4.Will not approving the deviation have negative impact on performance of the contract such as potential delay in the time for completion or additional quality problems?

It’s a simple decision to make if the deviation provides greater value, has the same or less life-cycle costs, is totally acceptable to the customer and will benefit performance. It’s usually also a simple decision to make if the change is not acceptable to the internal customer. For all other situations whether you would accept or reject it is mostly a financial decision. Is the supplier or contractor willing to provide appropriate credit to the contract price to offset your decreased value received and any additional costs you incur.

Here’s an example. You have contracted with a contractor to add a addition on to your current manufacturing facility. Your specification called for the contractor to install 4 additional Carrier air conditioning roof top units of a specific model. The contractor makes a deviation request an proposes the use of a Trane air conditioning models of the same capacity. In making your decision you would want to consider:
a). What is the cost of the Carrier versus the Trane models?
b). Is there any difference in energy consumption between the models?
c). Will there be a difference in your service and maintenance costs?
d). What impact will it have on the spare parts you inventory?

Add these additional facts:
1. The reasons why Carrier was specified was the original facility has those same units installed.
2. There is additional energy consumption with the Trane units.
3. With the two different company’s equipment, you will need two different suppliers to perform the service and maintenance.
4. You will need to stock both Carrier and Trane parts and that increases your inventory.

If I were negotiating this I would make it clear that to approve any deviation request as a minimum it needs to be “cost neutral”. My definition of cost neutral is any difference in the cost of the units plus any additional life cycle costs (operation, service & maintenance, and inventory carrying costs would need to be credited against the contract price.