Thursday, April 24, 2014

Warranty Self-Help and Liquidated Damages on spare parts

Frequently downtime on a product because of a defect is more than just an inconvenience, it can cause significant costs. I had a reader ask about how to manage against those collateral damages that may occur. I thought other readers might enjoy my response.

Normally in a warranty section there will be what the obligations are if something is defective and there will also be warranty exclusions that will relieve the supplier of their obligation to provide the warranty remedies. Many suppliers may also want to have the remedies they provide to be the “sole and exclusive” remedies for a defective product. The “sole and exclusive” language is primarily used to avoid damages being claimed for the defective item. If the sole and exclusive remedies were for repair or replacement, it would also eliminate the ability to claim a refund or credit. When you see “sole and exclusive” the first thing you should check is the scope of that limitation. You do not want it to be written in a way where it will limit your remedies for breach if they fail to honor their warranty obligations.

Warranty exclusions are language voids the warranty. Many suppliers will include very broad exclusions that can impact your ability to manage collateral damage from a defect. One of the most frequent exclusions is if there is damage caused by either self-help or the introduction of alternative parts where either of those actions causes collateral damage. In most contracts any collateral damage would also be consequential damages and may be excluded by the limitation of liability.

How do you protect against the significant cost of down-time? What I might do if facing this situation is carry a small inventory of items that can be expected to fail or wear out. For items that are a large cost or have a lesser incidence of potential failure, I would require the supplier to stock those spare parts for immediate delivery. While there may be some carrying costs to do that, it will be cheaper than having extended downtime. I would also require the supplier to provide you with a list of generic parts that may be substituted in the event there is a failure by them to deliver spare parts on time. Then I performance language in the spare parts section that would include language that if they fail to stock and deliver such parts in a timely manner as needed, the use of those generic parts by you and the performance of self-help will not void your warranty. I would also seek to include an language that if the use of those generic parts causes any collateral damage, the supplier shall have the responsibility to repair or replace the existing product. If the product you have actually requires repair at a supplier location such as a repair depot, you might also require that they inventory a spare, working product that they will loan you while repair is occurring.

He also asked if requiring the supplier to furnish commercial general liability insurance to cover collateral damage would help. Commercial General Liability (CGL) insurance policies cover specific types of perils. Normal CGL policies will not cover willful acts that self-help would be. Would it be possible to have them purchase additional insurance to cover it? While insurance companies issue unique policies they need to be able to price them. . Insurance pricing based on the average cost of the damages that would be sustained and the incidence or probability of the risk. It’s also not clear to me how they would be able to price it as there may be no history. Even if it was possible it might cost more that the other alternatives.

In another forum there was a discussion about a related issue of whether there should be liquidated damages provisions in spare parts agreements. Here is the problem that I see with the rush to seek apply L.D. to spare parts contracts. How predictable is the failure of that part and what is the lead-time for the supplier to produce that part? Ones that require replacement as a result of normal wear and tear can be predictable and the supplier should be able to manage that. However, many times the requirements are not from normal wear and tear. The failure or a part on a piece of equipment may be caused by negligence of the operator or the customer's failure to maintain the piece of equipment. That's not something that's predictable. Is that a risk that the supplier can manage? Then consider how old is the piece of equipment? If the equipment is old it may no longer be in production where you could pull one from the production line to meet the need? If it's old it may need to be produced from scratch. To protect against the liquidated damages it would force the supplier to carry virtually all items in inventory. That of course is going to significantly drive up the cost of all the spare parts.

My solution for that would be similar. The customer should carry an inventory of normal wear and tear parts, so time for replacement isn't critical. I would also require the supplier to carry a dedicated inventory of critical replacement parts, which if they fail would cause the equipment to not operate. For non-critical parts I wouldn't require an inventory as that only would add to the cost and timely delivery isn't needed as they not critical. I probably would agree to pay an inventory carrying charge on those critical parts. I would then seek LD only on their failure to deliver those critical parts. Lastly, as LD clauses will be read together with Limitations of Liability, I would want that LD clause carved out of the LOL, as many or costs you want to recover are not direct, they are consequential and may include lost profits.

Sunday, April 13, 2014

Does continuing work void a termination?

Sometimes I’m amazed by some of the opinions expressed on on-line contracts forums. They do provide me with subject matter to write about.

In the situation the individual said that the contract had been terminated by the employer but they continued to perform work. In his opinion he felt that the continuing of work voided the termination. That simply does not happen. Once a contract is terminated, it has ended, except for any obligations that were agreed to survive the termination. Once that contract has been terminated if there is continuing work being performed it needs to be done either under a new contract, or the work is being done without no contract in place. Creating that new contract could be as easy as writing a one page agreement that incorporates the terms of the terminated agreement for the remaining scope of work with a new period of performance.

A further concern he had was the employer was seeking to go against some of the guarantees in the terminated document over two years after the agreement was terminated. For the employer to be able to do that you would need to check two things. First, since the agreement was terminated did the guarantees survive that termination.The second thing to be checked is what is the statute of limitations in that jurisdiction for bringing a contract claim. You see in many jurisdictions an action under contract has a two year statute of limitations. If that statute of limitations had passed, they may no longer have the right to make a claim against the guarantee. The guarantee only applied to the contract that was terminated. It did not apply to the additional work where there was no contract. Allowing additional work to be performed outside of the original contract does not extend the statute of limitations period on the terminated contract.

Thursday, April 10, 2014

Multiple Documents – Does a later writing constitute a merger of documents?

In a discussion that I participated in an individual asked a question about when a contract starts. The problem in a bid some conditions were included. There was a letter of authorization based upon the bid. In a subsequent contract those bid conditions were missing. As this discussion included a number of issues I thought I would post my response here.

What is the starting point of the contract. That issue will depend upon the LOA. If it has language making a firm commitment where it is accepting a clear offer of the other party to enter into an agreement. That creates a contract.

If the Bid form used to solicit the bid that is being accepted included specific terms, and the bid conditions conflicted with those, the two documents would be read together along with the letter of authorization. The general rule in contracts is later writings in time have priority over prior documents. If the party that wrote the letter of authorization didn’t address the conflict, they were accepting the bid documents as modified by the supplier’s offer. If the LOA objected to the suppliers terms, no agreement would be formed as the letter would constitute a counter offer that needed to be accepted by the bidder

The date the LOA is signed would be the starting date of the contract, unless something to the contrary is specifically included in the LOA. When you sign a contract after making a commitment under the LOA, normally what would be done is you would incorporate the LOA by reference into the agreement and the effective date of the agreement should be retroactive back to the date of the LOA.

The second issue is what happens if the two are different where something included in the LOA does not get included in the contract. If you failed to incorporate the LOA by reference into the agreement or include what was covered by the LOA in the agreement, once again the general rule is the latest writing in time has priority in the event of a conflict. That means that the contract would have priority. As priority is applied only when there are conflicts, the later writing in time (the Contract) does not exclude non-conflicting language.

If this question applied to the U.S. and was governed by the UCC, the UCC does not make a presumption that the mere signing of the later agreement presumes the intent of the parties for it to be the final and complete expression of the parties. Instead, the UCC makes it clear that both parties must evidence their intent for it to be the final and complete expression of both parties. I believe that in the U.S. even though the UCC does not apply to all contracts, courts would follow that same rationale.

For it to show that the parties intend the new agreement to represent the final agreement of the parties, my opinion is you would need to have merger language in the new agreement specifically to that effect. An example of merger language is “This Agreement replaces any prior oral or written agreements or other communication between the parties with respect to the subject matter of this Agreement.” In the situation being discussed there wasn’t any merger language.

Without a merger clause what you wind up having is two legal documents that are both in effect as they have not been merged into one. Those two documents would need to be read together to determine the scope of the agreement. The contract being the later writing in time
has priority in the event of a conflict. If the omitted conditions conflicted with the terms of the contract, the terms of contract would prevail. If there is no conflict between the omitted item and the terms of the later contract, the two documents would be read together and those non-conflicting conditions would be part of the agreement.

If you have multiple documents always be cautious in reviewing that later document for two reasons. The first as I pointed out here they can potentially exclude or have priority over what was previously agreed. Second always be cautious in writing contract amendments. Contract amendments are later writings in time and will have priority over the contract. Make sure those amendments properly reflect your intent in making the amendment. If the intent of the amendment only applies to one situation, make it clear in the amendment that it only applies to that situation. Otherwise you will be amending it for the entire contract.

Monday, April 7, 2014

Parol Evidence

“Parol Evidence” is evidence that exists outside the four corners of the contract. It can be things like discussions, messages, prior communications, quotes, and drafts that existed prior to the
execution of the contract.

The question is whether such parol evidence can be part of, or be considered, in interpreting the contract. In the U.S. the Uniform Commercial Code (UCC) does not make a presumption that the mere signing of the agreement presumes the intent of the parties for it to be the final and complete expression of the parties intent. The code and its notes also make it clear that both parties must evidence the intent for it to be the final and complete expression of both parties.

If the agreement was silent on that intent, the UCC would allow parol evidence to be used. However, most contracts have what is called a merger language included in the contract. An example of merger language would be:

“This Agreement replaces any prior oral or written agreements or other communication between the parties with respect to the subject matter of this Agreement.

If your contract includes similar language, all parol evidence will be excluded in interpreting the contract. The merger language meets the requirements of the UCC to exclude parol evidence by making clear the parties intend the agreement to be the final and complete expression of the parties.

If there is important parol evidence such as conditions a seller included in a quote or prior document generated by the buyer, you need to ensure that those are either included in the agreement itself or incorporated by reference into the agreement. If you don’t, the merger provision will exclude it.

Most language in a contract is there for a specific reason. Merger language is included to meet the requirements of the UCC needed to exclude the use of parol evidence.

Friday, April 4, 2014

INCOTERMS (Updated) April 3, 2014

If you negotiate international contracts you or your department should have a copy of the latest version of INCOTERMS or as a minimum their wall chart of the different terms. INCOTERMS is a publication of the International Chamber of Commerce that was started back in the 1930‘s and provides detailed information on the common delivery terms that may be used.

The advantages of using INCOTERMS and specifying the specific INCOTERM delivery term and date of the INCOTERM publication is:
1.In comparing quotes from different suppliers, if they quote a different delivery, you should take the cost differences into account in deciding who to award the business to.
2.From a contracts perspective, when you include them in you agreement you are incorporating the following by reference into the contract.
a.The responsibilities of each party from the suppliers dock to the buyers dock for all the activities involved such as loading, transport, preparation of paperwork, export, import, customs clearance, payment of duties and insurance.
b.The point at which the risk of loss for the shipment transfers from the supplier to the buyer for each of the different terms.
If you didn't use them, you would need to address all of the applicable portions of those in your agreement’s delivery section.

Each of responsibilities has a cost involved, so when you use them it's clear which party is bearing those costs. That way you know what the true cost of the purchase or sale is and who is insuring the shipment against risk of loss or damage while in transit.

I use the 2010 version. When I use them, I would do it by including language such as:
“The delivery term shall be Ex-Works (as defined in INCOTERMS 2010) Supplier’s Dock in Taipei, Taiwan”.

Like anything else, if a specific INCOTERM does not match your exact needs, you can still incorporate it and then modify it to meet your needs. For example:
“The delivery term shall be Ex-Works (as defined in INCOTERMS 2010 except as modified below) Supplier’s Dock in Taipei, Taiwan. The modifications to INCOTERMS 2010 shall be ......”

Thursday, April 3, 2014

Transfer of Title

On linkedIN, I responded to a discussion about where title should transfer. Title means the legal ownership in the product of equipment that is sold. In the past many companies would have sales terms where title would not pass until payment was made. Since title did not transfer if the seller wasn’t paid, they could bring an action of replevin to seek to recover the unpaid goods or equipment. As commerce has expanded internationally, pursuing an action of replevin to recover unpaid goods or equipment can be both costly and lengthy. You would need to get an order of replevin in your country and have that accepted by the courts of the buyer’s country. The days of companies having large inventories just sitting there are done. Goods delivered one day may be incorporated into products shipped to many countries in a matter of days or weeks. A third thing that makes withholding title until payment undesirable is GAAP (Generally Accepted Accounting Principles). Under GAAP you cannot claim the item has been sold until title has transferred. There are other forms of protection to help ensure you get paid beyond retaining title such as letters of credit, bank guarantees or bonds.

The other concern that I have with the location where you transfer title after payment is when you are selling internationally you run the risk that it may be considered a local sale in the jurisdiction where the customer is located. If that happens it would mean that you need to be registered to do business in that country, become subject to local laws, and the profits that you will make on that sale will be subject to local tax. If it is considered a local sale you also have countries in which it is illegal to pay in anything other than local currency. That creates both currency exposure issues and the issue of repatriating that money. The local laws may further impact contract obligations such as warranties, or other requirements that must be met.

While the parties to a contract have the right to specify the applicable law, jurisdiction and forum, that is for the interpretation of the contract. The laws you become subject to will always be based upon the location of the sale. If the sale occurs prior to export clearance, the seller is responsible to comply with that country's laws irrespective of the applicable laws selected for interpretation of that contract. A good example of that is the need to comply with export control laws. If the sale occurs "while the goods are on the high seas" meaning any point after the export frontier and before the import frontier, it becomes an international sale. For international sales unless the customer specified specific requirements that must be met, it becomes the customer’s responsibility to import the item and ensure its compliance with the local law. For international sales the seller is not subject to that local law.

If you actually have the sale occur within the import country, that is a local sale. Irrespective of what the contract may say about the applicable law for the interpretation of the contract if you are conducting business within their country you are subject to their laws and taxes. The fact that GAAP considers it not to be a sale until title transfers could be used by local countries arguing that it is a local sale if title does not transfer until after payment is made (which is after it has been delivered into the customer’s country).

In the discussion the individual’s customer wanted to have the product installed and accepted at their location as a condition of payment. That would clearly make the entire contract a local sale.
The impact of that requested term would be that the Seller would be responsible for:
1. Providing transit to the port of export.
2. Clearing customs at the export country.
3. Providing transit to the port of import.
4. Clearing customs and paying any duties for import.
5. Providing transit to the customer’s site.
6. Arranging for riggers to place the equipment at the customer’s site.
7. Installing the equipment at the customer’s site.
8. Performing all work needed for test and acceptance.
Since work would be performed at the customer location and the supplier has the responsibility for import, they would need to be registered to do business within that country. They would be subject to local laws and local taxes on the profits made from the entire sale.

Another thing that impacts where title should transfer is custom’s clearance. Only the owner of the product or a representative of the owner (such as a customs broker), can perform export and import clearance of the product. That means that whoever holds the title determines the ownership and establishes who must perform customs clearance. If the supplier withheld title until after payment, and payment was conditioned on delivery and acceptance at the customer’s location, the supplier would be responsible for both export and import customer clearance as they still have title.

While there are a number of options that could be available, here’s another option they might want to consider. Have the sale to the customer and have title transfer simultaneously after the goods have cleared export customs.
In that the supplier responsibilities would be:
1. Providing transit to the port of export.
2. Clearing customs at the export country.

The customer responsibilities would be:
1. Providing transit to the port of import.
2. Clearing customs and paying any duties for import.
3. Providing transit to the customer’s site
4. Arranging for riggers to place the equipment at the customer’s site.
5. Installing the equipment at the customer’s site.
6. Assuming the risk of loss or damage from the port of export until installed at the customer site.

When a company sells a product and that requires installation and testing another solution would be to unbundle the two and price the two separately. To offer protection to the customer that the work will be completed and accepted you could consider offering a bank guarantee of bond. With the two separated only the local work to be performed could be subject to local law and taxes. You could either have the installation part of the work subcontracted to a local company and have someone oversea the installation, or you could have a team fly in to perform the installation. Whether that would be considered as conducting business in that location, would be decided by the government. If they did consider it local, the only thing potentially subject to local taxation would be the installation portion of the contract.