Tuesday, July 31, 2012

Offsetting Defects against Payment

In another forum I had an individual ask about whether you could offset the value of defects in the work against payment that are due and payable. Offset involves the setting off receivables versus payables as is a common law right.

The answer is always in the contract terms, and if I was involved in a situation where a buyer or owner was trying to do this to me, the first thing I would look at is the defects language. What is the other party’s responsibility to notify me of the defect? What obligations do I have to correct the defect? If I have obligations to correct the defects how long do I have from being notified of them to correct the defect? I would also look within that section to see whether there is a specific right to make an offset for the reasonable value of the defect in lieu of correcting the defect(s).

If the contract does not allow for the immediate right to offset the value of the defects, then the next thing I would want to verify is if the other party followed the process for correction of defects. If you were notified of the defect and failed to act within the time frame allowed to correct the defect(s), that would be an anticipatory breach where the other could claim damages that they seek to offset against payments. A repudiatory breach would exist if you have an obligation to correct the defect, and state that you will not perform that obligation. That would also create the situation where they could claim damages that they seek to offset against payments.

It is the breaches that give rise to damages that create something you would owe them that would allow the set-off. If there were no breaches, there are no damages and they would not have the right to set-off claims for defects. The exception to that would be if the contract specifically established the right to set off the value of those defects in lieu of correction of the defects. If a party withholds portion of the payment as a set-off against defects and they didn’t have the specific right to do so or if there was no breach, the party performing the set-off would have breached the payment obligations and would be subject to damages.

Always take the time to understand what the contract says about the issue, as you need to act within the rights and obligations you have under the contract.

Tuesday, July 24, 2012

Arbitration – Are the results of arbitration final and binding?

Arbitration is a process that may be enacted by laws as a way to reduce the number of cases or it may be something that is agreed by the parties in their agreement as a manner by which the parties want to resolve disputes. Simply agreeing to arbitration does not make the results of that arbitration final and binding, the language in the agreement needs to show the intent of the parties that it be final and binding.

For a court to honor or enforce a final and binding arbitration decision, the court would need to find:
(1) An agreement that contained an obligation to submit to arbitration is valid, enforceable, and irrevocable.
(2) The subject matter in dispute is subject to an agreement to arbitrate.
(3) All conditions precedent to the arbitration has been fulfilled.

A court may also consider things like whether the parties mutually and freely agreed upon the arbitration, who the arbitrator or arbitration panel would be and whether the parties the location of the arbitration. These would be considered to determine whether the commitment was fairly agreed. A court may also overturn an arbitration ruling if the arbitrator was in error. Typical errors are: the arbitrator not considering all the issues; the arbitrator considering issues outside of the agreement; or the arbitrtator providing a remedy that isn’t applicable to the issue being arbitrated. If the three conditions have been met and the court finds that it was freely agreed and there were no errors by the arbitrator, then the award would be final and binding.

That doesn’t mean that the parties are free from potential future litigation on the matter. While you have the arbitrator’s award, you may need to go to court to have the award be enforced. It is at that point where the laws of the individual jurisdiction regarding arbitration can have an impact especially in international contracts. It’s also at that point where a court could further review it in conjunction with local law or policy. It’s that local policy that you need to be worried about in an arbitration as local policy may tend to favor local companies and local governments at the expense of foreign companies.

Monday, July 23, 2012


Recent one of the big financial news stories has been about the manipulation of LIBOR. If you have not done business internationally you may not know what it means or how it may be used or have affected procurement or contracts. LIBOR stands for London Inter Bank Offer Rate, which is the interest rate that banks would charge their best customers (which they feel are other banks) based upon their cost of money. Their cost of money is the interest rates that those banks pay their customers or their cost to borrow from other banks. The LIBOR is then used as the basis for determining interest rates charged their customers who will pay incremental percentages above the LIBOR rate based upon their credit and risks with the loan. It the banks artificially kept the LIBOR rate higher than it should be, the banks would make higher profits on the interest from the loans because of the difference between the loan interest rates they charge and the interest rate they pay their customers or other sources of capital. Since banking is international in scope, the LIBOR rate is one of the factors that other locations take into account in setting their rates. For example the Prime Lending Rate in the U.S. takes into account a number of factors including the LIBOR rate.

If illegal manipulation of the LIBOR rate is proven, it has the potential of having a major impact in many areas. For example, in negotiating the cost of a project, the financing costs will have been based on rates that were tied back to LIBOR or the prime rate. Contract’s terms for things like late payments are frequently tied back to a percentage over and above these quoted rates. Costs of purchases by buyers
may have been inflated to cover incremental supplier costs of borrowing money. Homeowners with mortgages that are adjustable based on changes to these rates will have paid more.

While I prefer to establish fixed rates in contracts, using published rates is sometimes needed. I approach them with caution. Rather than rely only on one, I may try to establish a blended rate. The goal of a blended rate is to minimize any impact of one of the individual rates being manipulated. I don’t always trust a single published rate based on my experience. In one of my jobs I was responsible for managing the procurement aspects in starting up new operations in countries where we didn’t have a presence. I would do the recruiting and hiring of personnel and manage their training and would manage the procurement of the facilities, and much of the locally available equipment and suppliers needed. One of these activities was the start up of a new plant in Brasil during a period in which the country was having hyper-inflation. When I say hyper- inflation I mean the inflation rate would increase 3% or more a day! This meant price was subject to adjustment based upon when the payment was made and how much inflation had occurred from the date the contract was signed to when payment was made. The challenge was which rate should I use. The government published an inflation rate that was considered by most to be lower than the actual rate of inflation. A contractor’s organization published an inflation rate that was traditionally considered higher than the rate of inflation. There was another rate based upon changes in the exchange rate between the Brazilian currency and the American Dollar. The problem was at the time Brazil had two different currency exchange rates. There was the official rate that banks would exchange money based on what the government told them the exchange rate was as the currency was controlled. There was also a “parallel” rate at which individuals and business would buy dollars at as a hedge against inflation. While it was a form of black market currency exchange, the parallel rate was published in all the papers and the changes in it reflected the inflation that was occurring as a result of the devaluation of the currency by inflation. The simplest thing would have been to have U.S. dollar based contracts, but by law you could not pay the Brazilian companies in U.S. dollars. So you needed to either use a rate to calculate the inflation.

I worked with our local finance people to come up with a formula that used all three rates to establish a blended rate that they felt would provide us with a fair result for us and the contractors and suppliers. We knew that if we used just the government rate, the contractors would have included significant contingencies for inflation in their price. We also knew that if we only used the contractor’s association rate we would have paid more that the actual inflation. By blending the three we sought to eliminate any contingencies for inflation. It was the only contract that I’ve ever written where the final monthly invoices and payments were more than the original contract price!

Friday, July 20, 2012

Master Data Management

I had an individual ask me to explain Master Data Management. Since the Blog is about procurement and procurement contracts, I’ll try to respond in that context. All master data management is about is discipline in the management of master data that is used through the company and with suppliers. That management may be done through systems, tools, or processes. One goal of master data management is to improve efficiency by avoiding the need to key in information that already exists. Another goal is to make the transition of data between systems to be seamless. For procurement the goal of master data management is to improve the quality of your data for doing things like identifying trends in purchases, trends with specific suppliers for use in developing strategies, plans, and negotiations

What is master data in procurement? Master date management for procurement would include things having like:
1. Having a system that assigns the unique Supplier Number for every supplier entity that includes all the pertinent information about the supplier that prevents duplicate numbers being issued for the same legal entity
2. Having a system that assigns the Purchase Order Number and applicable Contract Number for use with all applicable transaction.
3. A system or structure that assigns or identifies applicable Commodity Codes to be used with the purchases
4. A Part Number assignment system or process. Part numbers are used in materials planning, requisitioning, ordering, receiving and production and services inventory management. These usually need to map supplier part numbers to buyer part numbers.
5. Qualified supplier lists that identify the specific suppliers and part numbers that are qualified to supply the buyer part number.
Master data could also include specific information that is imputed about the purchase such as delivery, quality, failure data about a specific product or supplier.

Master data management is most needed where there will be large transmissions of that data within the company and with companies that have multiple entities or operations spread around the world. I once picked up responsibility for supporting a Network Services business that used a significant amount of third party product. The prior management had allowed each country to assign their own part numbers for what they purchased. There was no master data management for that business across the world. The net result was we had some country locations that had inventory of needed items, that no one else was aware of. We even had multiple locations in a country that didn't know what each other had for inventory. By not having master data management for part numbers for these products they did several things that cost the company.
1. We were paying premiums suppliers to expedite delivery to the location that needed it.
2. We were paying for premium freight and duties to import those items when frequently inventory already existed in another stocking hub in that country.
3. We were also consuming the company’s capital unnecessarily by buying new product while the other inventory aged.
4. When it came time to negotiate new volume purchase prices with the suppliers all the information needed to be pulled manually by each of the locations.

Wednesday, July 18, 2012

Drafting the Contract

Everyone has their own approach to drafting an agreement. Most companies have a variety of standard templates that they use for various types of purchases. Most templates are written for average risk purchases from average risk suppliers. The key is making sure that the template meets the needs of the specific contract you need to write. To do that I go through the following process.

I start with the internal customer requirements. Does the template meet those requirements? If it doesn’t prepare any changes or additions so it provides what is needed.

My second step is to determine the potential costs or risks of the item being purchased. Does the template include terms and controls necessary to manage those costs and risk? If it doesn’t prepare any changes or additions needed.

Third, having pre-qualified the Supplier I will consider if there are any specific risks associated with the supplier that need to be managed by the contract. If there are, I will check the template to ensure the template manages them. If it doesn’t add to or change the template.

I check to see if “administrative” type provisions for the purchase have been included that describe how all the different processes the parties will use and whether those are applicable for this agreement:
o What is required for invoicing;
o How payments will be made;
o How Return Materials Authorization processes will be managed;
o How warranty returns are managed; who receives notices; etc.

I look to see if all the specific business provisions that change from purchase to purchase are included and work for the specific agreement.
o Pricing.
o Delivery.
o Logistics.
o Changes.
o Other factors such as the Supply Chain or the total cost and life cycle cost factors of the relationship.

I then review the performance provisions that define what is required and what happens if the requirements are not met to make sure they are included and meet the needs of the specific purchase. Performance provisions are requirements such as:
o Specifications;
o Drawings;
o Quality requirements,
o Performance improvement requirements,
o Certain warranty provisions,
o Delivery performance,
o Required costs reductions, etc.
I check to ensure there are tools included in the contract or other tools are incorporated into the contract.

Every contract should also identify how certain promises that are made will be backed up to make sure they are addressed. For example:
o If a supplier provides and indemnity against third party claims, that should usually be backed up with a requirement for the supplier to provide the necessary insurance coverage to stand behind the commitment.
o For smaller supplier it might mean a parent guarantee.
o For some work it could be bonds or financial guarantees provided by a third party

Most contracts have a number of key elements and I check to ensure that they are included and work:
A title
An introductory paragraph that identifies the parties
Recitals that describe the intent of the parties entering the contract
Definitions of terms
Key conditions for the contract
Representations, Guarantees, Product or Service warranties
Events of Default and Remedies for default
Legal Boilerplate terms such as applicable law and jurisdiction, waiver of rights, survival, limitations of liability, assignment rights, amendments, other warranties and indemnities, severability of of terms. force majeure, freedom of action, license grants.
Signature blocks
Exhibits and attachments

I will review the key purchase terms to ensure they are included and work: warranties, indemnities, guarantees project scope, key assumptions. supplier responsibilities, buyer responsibilities, confidentiality, deliverable materials, deliverables. buyer deliverables, acceptance criteria, test criteria, completion criteria, materials and equipment loaned, rates, charges, or fee schedule, changes. escalation procedure, project management requirements. payment, proprietary rights, security requirements. use of facilities, travel, training, documentation, maintenance and support, risk management terms. performance management tools.
I will check to ensure it defines what constitutes a material breach, the cure period allowed and the remedies for breach.

I make sure the agreement has appropriate rights to terminate the agreement for cause and without cause.

I will review the remedies to ensure they are appropriate for the purchase.

In all checking I will look at:
1. Whether the language is using the “active voice” to make commitments clear.
2. That I use defined terms from the Agreement.
3. That other documents made part of the agreement are compatibility with the Agreement
4. Whether the language use the right “standard of commitment” for each commitment.
5. I will check any “Incorporation by Reference” of any documents.
6. For each major commitment I will check to make sure that it answers the five questions.
1. Who is responsible to perform the action?
2. What is their responsibility?
3. Where must it be done?
4. When must it be done?
5. How must it be done?

I will check the document:
Did I avoid ambiguity?. Was I consistent? Did I avoid being redundant?. Did I use carve outs when appropriate? Did i define things to make the meaning clear? Are the time requirements clear? Did I use “and” or “or” correctly. If I used applicable, did I define what I mean by applicable? When I used cost or expense did I use them right? If I included a list did I make it clear whether they are examples of what it required and that more may be required or whether the list is intended to be inclusive? Did I manage the use of the word mutual? If I am relying on a representation made by the supplier, did I include that? Are all the numbers and formula accurate?

I will ask someone else to proof read it.

If you were forced to use the Supplier’s standard agreement, I would go through the same process for checking. I would read their document in conjunction with my template to help identify what’s missing that needs to be added.

Tuesday, July 17, 2012

What is a circular sale?

With increasingly different supply changes and procurement models I thought I would do a quick post about circular sales. A circular sale is when a buyer purchase an item from one supplier and sells that item to a supplier and the supplier then sells the item back to the buyer either in its original state or a part of value added they provide. There are a number of ways and reasons why a circular sale can occur. A buyer may purchase items from Supplier B and sell them to the Supplier A because:
1. Supplier B will supplier will not sell to Supplier A for a variety of reasons (past history, credit, etc.)
2. The Buyer may have competitive pricing with Supplier B that it wants to mask from Supplier A.
3. The Buyer may have excess inventory on hand that it wants to liquidate by sale to free up the cash.

There is nothing wrong with circular sales as long as those circular sales are not being used to avoid the payment of income taxes. For it to not be an illegal circular sale, the cost the Buyer sells it for needs to be without overhead and profit, or the cost of the purchase of the item by Buyer from Supplier needs to be adjusted to reflect any overhead and profit the Buyer made on that initial sale.

Here’s an example of how an illegal circular sale would work.
The Buyer makes a purchase of a product from Supplier B in a tax free location.
The buyer sells that product to Supplier A at a rate that includes both overhead and profit.
Supplier A sells a higher level product back to the Buyer.
The cost of Supplier’s product includes their value added plus the cost of their purchase from the Buyer. If the Buyer treats that purchase cost from Supplier A as their cost of good in their sale of that product to a customer, that cost reduces the taxes the Buyer will pay on those sales.

The tax authorities look upon that as an illegal circular sale with the purpose of avoidance of taxes. The profits and overhead they added to the selling price in the sale from Buyer to Supplier A cannot be used to reduce the taxes. For example if the Buyer added a $100 profit to the sale of the product in its sale to Supplier A and that was allowed to flow through as a cost in its purchase back from Supplier A, at the U.S. Corporate Tax rate of 35% for corporations, that profit on which they paid no tax would generate a reduction of $35.00 on their U.S. income tax on that product. Tax authorities don’t want un-taxed profits to be used to reduce their U.S. taxes when it comes time to pay income tax on the customer sales profit. If the sale occurred in the
U.S., the company would have to pay taxes on the profit they made in the sale to Supplier A so it wouldn't be considered a circular sale to avoid taxes as the taxes would need to have been paid.

America Job Loss

It’s another election year in the U.S. and once again the politicians are playing the blame game. If you listen to the Obama campaign you will hear them place the blame on companies like Bain Capital who was run by Mitt Romney his opponent. They are claiming that companies like Bain destroy companies and drive jobs off-shore. While I’m no fan of either candidate I believe that people need to understand facts.

What is Bain Capital? They are a private asset management firm. This means that they make investment on behalf of their customers. When an asset management company buys a firm much of the time the company was troubled and losing money and asset management firms take the gamble that they can turn the company around and make a profit on their investment by either making the shares more profitable where they either hold or sell off those shares. In a way its not much different than someone that purchases a foreclosed home that needs in a number of repairs and makes those investments in an attempt to make a profit. If the business can’t be made profitable, it is only then that they will do a liquidation of a company to recover some of its investments. Like any other investor they have some wins and they also have losses that have affected jobs. When there are wins, the companies they invest in grow and expand and generate new jobs. When they don’t win, jobs are lost. What people fail to consider is that without the infusion of their investments, the troubled company probably would have have lost those same jobs earlier without the infusion of cash investment. One of the things that has harmed American companies is the high U.S. Corporate tax rate of 35% when they compete against companies based in locations with lower corporate tax rates. Only Japan has a higher corporate tax rate.

They also want people to believe that it is companies like Bain that are the cause of the problem. The root cause of the problem is something that could be resolved by the current administration and house and senate, but no attempt has been made to solve it. In business when you have a problem you don’t try to treat the symptoms, you look for the root cause. In this case the root cause for the decline of manufacturing and service jobs in America rests with the U.S. Corporate Tax Rate and tax laws. It is those rates and laws that have allowed both individuals and companies to implement aggressive tax management programs to avoid paying U.S. Taxes. If companies like Bain helped drive offshoring and outsourcing, it was fueled by aggressive tax management that has been enabled by the U.S. Corporate tax rate and tax laws that only congress and the administration can change.

How pervasive is aggressive tax management? An article in the New York Times last year said that 55% of the U.S, Corporations paid nothing in one or more years over a seven-year span. In an article http://coupons.org/pages/tax the author describes what they call the Nine Trillion Dollar Loophole and lists only a limited number of countries that help companies manage their avoidance of U.S. Income taxes. There are plenty more. How did companies like Cisco get forty billion dollars in off-shore accounts? How did Apple get sixty-four billion in off-shore accounts? How does Google pay only a 2.5% effective tax rate in the U.S.. Why do we allow over 8,000 hedge funds who can manipulate the cost of what Americans pay for everything to be domiciled in the Cayman Islands where there is no tax. It is the tax rate that has driven companies to outsource and establish off-shore companies where profits are made outside the U.S. and as such are not taxed. In doing aggressive tax management jobs have been lost and its all been perfectly legal.

The question voters should be asking the incumbents is why haven’t they done anything to change this and change the tax rates and close the loopholes that would help bring jobs back? All the rhetoric about taxes that they roll out every four years only talks about personal taxes when you have major U.S. corporations that make Billions of dollars pay a far less percentage than individuals. For individuals that use these legal loopholes I don’t blame them, I blame the Congress and administration for allowing such loopholes to exist in the first place and to exist for as long as they have existed.

What do I mean when say “tax management strategies”? Here are a few examples:

A company has products produced in locations where the labor is lower cost. They will have a subsidiary company based in a tax haven or low tax country purchase those products. That subsidiary adds significant overhead and profit to the product so the majority of the profit the company will make accrues in that low or no tax country. They then sell that product at what’s called the “transfer price” to all the company’s subsidiaries around the world including the company’s U.S. based sales subsidiaries. For the profits they make in those tax havens they pay no tax. To the U.S. Company the purchase of the product at the transfer price is a cost of the good. They will add their local overhead and profit as part of their selling price. This creates the situation where the net income on the sale of that product that gets taxed in the U.S. will only be a small portion of the actual profit that was made by the company. The remaining profit, as long as it’s held off-shore, is never subject to U.S. Tax. To repatriate that profit, a company is subject to a ten-percent tax. That tax is as high as some countries corporate tax rate. What that tax rate does is create a negative incentive for those companies to bring money back into the United States to invest. That is why U.S. Companies have approximately nine trillion dollars in profits sitting outside the U.S.

Companies will have services provided by subsidiaries based in tax havens or lower tax rate countries. For example Ireland has a corporate tax rate of only ten-percent versus the U.S.’s thirty-five percent. When they sell services to the U.S. subsidiary or other subsidiaries, they will include substantial overhead and profit on those services. That profit accrues in that country, not the U.S. or the other subsidiary countries. To the U.S, subsidiary the purchase of those the services is an expense. With the significant overhead and profited added to the service they purchase, this reduced the profits the U.S. company makes and that reduces the taxes they pay. That’s another way they drive down their effective tax rate.

For international shipment of commodities such as oil, the cargo may be sold a number of times while that item is in transit. All of the profits from those sales, since they are occurring in international waters, are international sales are not taxable. This means that companies and individuals that consume those items have the cost burdened by those profits upon which no taxes are being paid as long as the purchase and sales of those are by companies or subsidiaries based in tax havens. Maybe that’s why so many hedge funds are headquartered in the Cayman Islands where there is zero tax. The problem is the America consumers wind up paying for those profits that don’t get taxed so the tax burden or the American taxpayer is high.

If small business is one of the things that drives job creation, what the tax laws have done is create an un-even playing field where it’s harder for small businesses to compete and win. They have to compete against companies that by outsourcing and offshoring don’t have to pay the same effective tax rates. They don’t have to pay the same wages. Further, the company that outsources or offshores their business has a substantially less percentage burden placed upon by all the governmental programs that drive cost to the business. Did anyone consider the impact the recent health care bill will have on business?

How do politicians expect to keep and attract jobs when they do so many things to drive them away? Maybe they just don’t care.

Thursday, July 12, 2012


In contracts, notices may be used as either a pre-condition to establishing a right or a condition required prior to exercising a right. For example, providing a notice of a claim for an extension of time may require that the other party be provided with a notice of such a claim within a reasonable period. That’s a pre-condition to establishing the right. Before you can terminate an agreement for cause, you are normally required to provide the other party with a cure notice and failure to cure within the time frame allowed, provides you to the right issue a termination notice. Notices may also be a right of their own.

There are three basic elements in establishing a contract notice requirement.
1. How the notice must be provided.
2. The means by which it must be delivered
3. When it is provided or effective.

How the notice must be provided will normally include that it must be in writing. If you are dealing with companies in another country it may require the language the notice must be written in. It will also spell out the authorized parties that may provide or receive notices so that notices are sent to someone who will know what they need to do when they issue or receive a notice. The means by which it must be delivered usually required delivery by a reliable means that provides proof of delivery. For example it could be by certified or registered mail, by a private carrier that provides receipt of delivery. It may also allow for delivery by fax with the proof that all pages of the fax were delivered. The when portion of a notice is used to determine when the notice was effective and most notices require actions within a specific time period after receipt. It may be on receipt as would be substantiated by the documents that confirm the delivery.

In addition there may also be language that addresses problems with the delivery. As companies may have changed their address without notifying the other party or the party being notified could refuse to accept delivery, a notice provision may also address those issues from the perspective that notice would be deemed to have been provided when delivery has been attempted at the last agreed address unless you were notified of a change of address.

Notices aren’t only used to establish or exercise a right. You can include notice requirements with less stringent requirements for use in managing performance. For example, if a supplier makes a change to the process they use to manufacture a product or perform a service that can impact your quality. If you were unable to get a supplier to agree to get your approval prior to changing their process, the next best alternative would be to require the supplier to provide you with notice of the change in advance of making it. You might also require notices for things like: site location change (quality); Tooling change/addition/removal (quality); process flow change (quality); design changes (application); packaging change (risk of damage in transit), Test/inspection change (quality); material source change (quality and supply chain risk); Process chemical change (quality); price changes (sourcing), Lead-time changes
(planing and sourcing), end of life (inventory management), End of service (contingency planning).

Tuesday, July 10, 2012

Different or unique requirements or terms

In another forum someone mentioned that a customer was asking for “unrestricted” warranties be provided them for equipment suppliers that were used by a contractor. Anytime someone asks for a term that is unique or different you should always take the time to understand what the term means and what the impact would be. When there are three parties to the equation and you are standing in the middle, you also need to consider what you are getting from the supplier versus what you are committing to the customer as any difference in those commitments become your responsibility.

I've never heard of an un-conditional warranty and my feeling is a contractor would be crazy to agree to it as manufacturers always include conditions on their warranties. Those conditions are restrictions. For example, they will always include a time limit during which their obligation to repair or replace the product at no cost will end. The reason for that is simple, the vast majority of product will not last forever and failures will occur over time and usage. The longer the usage, the higher the statistical probability the item will fail. Products are also designed to work within defined operating tolerances, so if a customer uses the product outside those operating tolerances they may either cause the product to fail or they may be accelerating wear to the product that will cause a pre-mature failure. In addition to tolerances most suppliers want to make sure that they will not be responsible for providing warranty replacement if the customer abuses, mis-uses, fails to maintain or service the product, or has performed unauthorized modifications or repairs to the product as all of those can cause the product to fail or wear out pre-maturely.

If a contractor agreed to an unrestricted warranty, they would be assuming all the risks of any difference between what they get from the supplier / manufacturer versus that unconditional commitment. The more common practices are to either simply pass through whatever warranty the manufacturer provides. An alternative is the customer needs to specify the specific warranty they require so the contractor can try to get those from the suppliers. If they can’t, the contractor has several options. One is they can seek to limit liability for those suppliers to only what they can recover from them. The second option would be to determine the risk of any difference and include a contingency for those risks into their contract price. The third option would be to walk away if you simply couldn’t manage the potential risk and costs.

Always take the time to understand what any unique or different term means and the impact it would have. Don’t just read the words, always put it into perspective with different examples as that will help identify if it works or doesn’t or whether it works in all situations. Don’t assume you know the answer.

Rights, waivers of rights and lapse of rights.

Individual contract rights are established in the contract. Some rights be subject to pre-conditions to establish them and others may be ended by a condition subsequent occurring. When it comes to contract rights, once you have them, they exist until either a condition subsequent occurs that would end the right or you waive them. You may waive a right or you may lose rights by not enforcing them. For example if you fail to exercise a right, by your inaction you may have waived that right and could be prevented from enforcing it in the future under what is called “promissory estoppel”.

A well drafted contract will include “waiver” clauses that do two things. First, they require that a wavier be made in writing. They may also require that only authorized persons may agree to waive a right. That is to protect against the failing to act constituting a waiver. Second they state that a waiver in one instance, does not waive that right in future instances. For example, if you don’t claim remedies for one late delivery, in doing so you are not giving up the right to claim remedies for future late deliveries.

An example of a condition-precedent would be if you were required to provide a notice for a potential claim for additional monies and extension of time, and the contract required that timely notice as a pre-condition for the right to make the claim. If you failed to meet the notice requirement, you failed to meet the pre-condition and you would not have established the right to make a claim. I would avoid rights being preconditioned by notices.

A good example of a condition subsequent is options included in a contract. Those options are rights. When those options have a date by which they must be exercised, if you failed to exercise them by that date, those rights no longer exist. The failure to exercise those rights by the specified date will cause them to lapse. The exercise date functions as a condition subsequent to the right causing it to end.

Everyone that has studied contract law knows that if a party has made an offer that requires it to be accepted by a specific date and acceptance has not occurred by that date, the offer will have lapsed. Legal rights may lapse. For example claims that are not filed within the applicable “statute of limitations” for that type of claim will extinguish the right to make those claims. Many laws and regulations have specific periods or dates by which something must be filed. If it hasn’t been filed by that date, then right to file it has lapsed. For example if you receive a new tax assessment on your property and have ninety days from the date of that notice to contest that assessment, if you fail to meet that requirement, your right to contest the assessment will have lapsed for that assessment.

I had someone ask men about rights to make claims for either an extension of time or a payment for extra costs? Does the failure to do those within the contract time period allowed, cause those rights to lapse or be waived? Like every question about contracts, that would all depend upon what the contract says. If you had language in the agreement that 1) established a specific time period in which the party must give notice and 2) stated that the failure to give notice within that time period constituted a waiver of their right to make a claim for that qualifying event, then failing to provide that timely notice would waive that right. If you didn't have the language that establishes the failure as a waiver, you may have breached the obligation of timely notice but that would only be a minor breach, and its unlikely the other party would have taken any action relying upon that where they could argue promissory estoppel. So the right wouldn't have been waived.

What if the contract had language that required timely notice of a claim as a pre-condition for establishing the right to make the claim? If you failed to provide the timely notice technically the condition to claiming additional monies and an extension of time hasn’t been met. Not all may be lost
if you didn’t. You would need to understand how the specific jurisdiction deals with the issue of penalties. If penalties are not allowed by law, such language could be considered a penalty as it would unjustly enrich the other party by an amount far greater any actual damage they would have sustained as a result of the failure to meet the required notice requirement.

In contracts, as a Buyer it’s always best to not have rights that would apply to you to be established on meeting a notice pre-condition. For example the right to make a claim for an extension of time or additional compensation should have the right established by several preconditions. Either the other party changed the scope of the work, or the other party or entities controlled by them failed to act within the agreed period or by the specific date. Once either of those conditions exists you have established the right to claim for additional monies or an extension of time. If the contract provides rights to the other party if you fail to act within the specified period or date, always spell out what the remedy will be if there is a failure to comply with that time period. Do not leave it open-ended. For example compare these two provisions dealing with the submission of claims for payments.

“Supplier will in no case submit invoices, corrected invoices, or other such claims for reimbursement, to Buyer more than one (1) year after the inspection, test or acceptance of Products or the satisfactory completion of Services unless specifically authorized or requested by Buyer.


Within twelve months after the acceptance of the Product or Service, Supplier shall submit all invoices, corrected invoices, or other claims for reimbursement to Buyer. Supplier understands and agrees that the failure of the Supplier to submit the invoices, corrected invoices or claims within this period shall constitute a waiver of its right to claim reimbursement.

In the first example you have told them what that can’t do, but you have not identified what the remedy would be if they breach that. In the second example you have made it clear that in failing to submit claims for payment within the specified period they are waiving their right to payment of any amounts not previously invoiced or claimed by that date. The key in the enforcement of the second one would be whether the intent was to create a penalty and provide you with unjust enrichment. A court might consider whether the time frame provided was reasonable in the determination of the intent of the clause. If they found that the period was reasonable they might not consider the language as a penalty as you have given the other party sufficient time to provide invoices or a claim. Courts are not against cutting off rights, the statute of limitations in many locations does just that irrespective of whether one party could be unjustly enriched as a result.

Thursday, July 5, 2012

What does it take to source and do contracts internationally?

That was a question someone asked. While anyone can source internationally, it takes a substantial amount of knowledge and skills to be able to do it right.

There are differences in general laws of each country and their contract law. For example in some countries penalties are allowed whereas in others penalties are prohibited.

There are differences languages, cultures and the way business operates in different parts of the world. For example, if you have never done business with a Japanese company before you may not know that culturally they will not say no. They will say that something will be very difficult. You may think that they will do it, while they have no intention of doing it.

Each location may also have different risks such as political and financial. For example the current economic crisis in places like Greece would create significant risks as it can make both the currency unstable and the interest rates increase or funding dry up.

If there is a problem with what you purchase, how successful you would be in enforcing your contract rights will vary by country. Even if you had the contract be your local law as being applicable and the case litigated in your jurisdiction, unless the other party has significant assets in your country you would still need to try to enforce the judgment in their country through their court system.

How long it may take to resolve disputes or the dispute resolution process used will vary by country. For example arbitration is standard to use for contract disputes in India as the legal system is so clogged it could take fifteen years for a case to be heard.

If you buy through distribution channels you need to understand the impact that has on your contract and who is standing behind the commitments. If you buy through distribution the privity of contract on that purchase is with the distributor, not the supplier.

In establishing a landed cost model you need to understand distribution costs, costs of licenses, fees and duties that will be charged and you will need to be able to hire customs brokers and shippers to move product. For example products from some countries when shipped into the United States are subject to anti-dumping fees that could add significantly to the landed cost of the product.

There are significant differences in import laws and import duties that can have a major impact on a supplier’s ability to acquire materials from certain countries.

If you have high value product you probably would want to know shipping lanes that have the highest frequency of loss. Piracy still exists and there are still locations where the potential loss of a shipment is high due to theft.

Currency and hedging is also knowledge you should have, as you have your currency, the supplier’s currency, and possibly another country’s currency involved. If you agree to pay in the supplier’s local currency the exchange rates can impact your cost either positively or negatively and you may need to hedge against that risk by buying forward rate contracts.

If you are supplying your IP or designs you need to know that IP will be protected. Not all countries, especially those of a communist background, provide the same protection for a company’s IP rights.

You may need to check to ensure the supplier isn't making extra of your product to sell into the black market that may compete with you as a way to improve their profits.

Each country and each company is at different levels in their management of quality. You need to know what you will be getting into so you can manage it.

These are only some of the issues.

A good book to read about the cultural differences so you don’t alienate the other party is “Bow, Kiss or Shake Hands, (the Best selling guide to doing business in 60 countries)” by Terri Morrison and Wayne A. Conaway.

Tuesday, July 3, 2012

Different categories of ownership in negotiating development contracts.

In development ofnew hardware, software etc, there will be three categories of intellectual property rights. There may be supplier owned pre-existing materials and tools. There may be buyer pre-existing materials. Last there will be the new intellectual property that is created under the contract.

When a supplier or consultant has and wants to retain ownership of their pre-existing materials usually the agreement will list those. As the buyer will need to use those, they will be granted a license to use those. There are a number of reasons why you would allow them to retain ownership in those pre-existing materials. The first is it keeps the cost down. You would need to either purchase the right to them, which would add to your cost or you would need to do all new development, which also adds to your cost. A supplier may not be able to give you exclusive rights to those as they may have licensed those previously to others. Most of the time they want to continue to own those for use in future work so they be more competitive. Retaining existing material ownership is a fairly common practice, however if it was for a very sensitive use, the buyer may want only newly developed materials that only they own and can totally control.

Buyer owned materials would usually not be licensed to the supplier although they could be if they weren’t sensitive to the buyer’s operation. If they were licensed, most of the time there would be a restriction against using them with a competitor of the buyer.

That leaves the issue of who owns the new work that gets developed. There are several options here.
1. The Buyer can own it.
2. The Buyer can own it and license its use to the Supplier
3. The Supplier can own it and the buyer is provided with a license

In deciding who should own the new work there is usually two major factors. The first is the sensitivity of the development to the buyer. The second factor is the impact on the development cost. Usually if the buyer funds the full development cost they will want to own it. If it will provide the buyer a competitive edge in the marketplace, they will want to own it. Having a competitive edge only last so long or to protect that competitive edge it may not be an “all or none” decision. To reduce the cost of the development the buyer may agree to license portions of the new work, or license all of it to the supplier with restrictions on use. The most common restrictions would be that it not be used for work with any competitor. Another common restriction is a waiting period before the supplier can use the license with others. A waiting period restriction is used to provide the buyer with exclusive use so they have a competitive edge during that period.

If the end product has significant value to others, the Buyer may allow the supplier to own it and could license buyer owned material to the supplier where the supplier must pay royalties for any reuse of developed materials as compensation for giving up that right of ownership. The collection of those royalties reduces the buyer’s costs in the development. While some people may think it might be better to own and license things yourself, if your goal is to get revenue from that to reduce your investment cost, you always need to ask the question about who would better be able to use, sell and provide customers with additional value added they want. Most of the time that answer isn’t the Buyer.