Monday, February 25, 2013

Company structures and their impact on contracts.

A large company will normally consist of one parent company and a number of individual subsidiary companies. Subsidiary companies may be wholly owned by the parent company or the parent may have only a majority or controlling interest in the subsidiary. Each subsidiary is a separate legal entity from both the parent company and other subsidiaries. Each subsidiary has their own board of directors. Each may issue stock in that subsidiary company’s location stock market. Subsidiaries are created for a number of different reasons. The primary reason is the management of potential liability. You see unless the parent company becomes party to a contract between their subsidiary and a third party such as a supplier or customer, the parent company will not be liable for the actions or inaction of the subsidiary and that is how they manage potential liability. The need to manage potential liability can be for a number of reasons. For example, in many countries to have a subsidiary in that country that sells to the local market there may be a requirement of a certain percentage of local ownership. When that happens, a parent company that may only have fifty-one percent ownership in that subsidiary does not want to be 100% liable for the acts or inaction of the subsidiary.

Another reason for the separation of the entities is taxes. If a parent company becomes too involved in the management of the subsidiary, from a tax perspective they could be looked upon as a single entity. In that case the profits made by that subsidiary could be subject to taxation by the tax officials of the parent company’s headquarters location. In these days of offshore use of tax havens to manage taxes there needs to be what’s called arms length transactions that keep the entities separate.

Companies may create different subsidiaries for high-risk activities. They may have separate subsidiaries that sell to government that have to comply with governmental requirements. They may have subsidiaries set up to perform or sell services to other subsidiaries. For example, you could have a real estate subsidiary that leases the property, You could have a subsidiary that purchases and sells insurance. If a common function can be performed in one location and sold to other subsidiaries, it may
be a subsidiary.

In a large multinational corporation you may each country may have their own sales subsidiaries. They may have a subsidiary in each country to perform services. If there are development or manufacturing locations in a country, they too may be separate subsidiaries. Further each subsidiary may be owned completely or in part by a separate subsidiary called a holding company that is ultimately owned by the parent company. Major multinationals will usually have hundreds of subsidiary companies. You can also have subsidiaries that are called affiliates. The way I define an affiliate is the situation where no one company has fifty-one percent interest in the company, but a parent company has multiple subsidiaries that own a majority interest in the company so in effect they control the company.

What does all this have to do with contracts? Since each subsidiary is a separate legal entity when you contract with one subsidiary, that subsidiary is the only party that you have privity of contract with. That means you can only look to that company’s resources and assets in the event of a problem. This means you should ensure that they have the necessary assets and resources to stand behind their contractual commitments. Those commitments include performance, indemnifications, and damages that could occur upon breach of other commitments such as carrying required insurances.

The only way you can look to the assets or resources of the parent or other subsidiaries is if they are either a party to the agreement where they agree to be jointly and severally liable. Simply having them as a signatory on the contract isn’t enough. They need to agree to be jointly liable so they are responsible for the actions of the subsidiary if you can’t collect from that subsidiary. Another way they can become responsible is if they provide what is called a corporate or parent guarantee for their subsidiary where they agree to be financially responsible for the subsidiary’s acts or inaction. (See the blog post Parent Guarantees.)

In contracts you can agree to have litigation or arbitration in one location, using the law of that or another location. That will get you a ruling. The next issue is enforcement or collection. When you have a court award or a binding arbitration ruling issues in one location, if you want to enforce it against a subsidiary or parent company in another location to collect what is owed, you would need to get a court order in the location of the company whose assets you seek to go against. This means that collection is not 100% guaranteed. To enforce a foreign judgment, a court would look to its “conflict of laws” procedural rules. Things that would be against local law or policy may not be enforced. For example if the contract with the subsidiary provided for a penalty for non-performance, and the jurisdiction where you are seeking enforcement does not honor penalties, they may not honor the portion of the award that represents a penalty.

The best advice is to know who you are contracting with and know whether they have the assets and resources to stand behind their commitments. If they don’t, either have the parent or another subsidiary that has the assets sign the agreement and agree to be jointly and severally liable or have them provide a parent guarantee or a financial guarantee. Also check to see in general whether that location would normally honor foreign judgments or binding arbitration findings.

Friday, February 22, 2013

The Value of Contract Management

In these days of metrics and key performance indicators (KPI’s) people look to measure the value that contract management provides. In fact someone recently asked the question on LinkedIN. My initial response was the I had never seen one. I believed that there are always too many different variables. As I thought about it more I decided to write a blog post about the value of Contract Management.

To start, I don’t think there is a common definition of contract management. My definition of contract management is managing all contract aspects from initial definition of a need or potential sale through all the phases until the contract has ended or been closed and all obligations have been met.

In a blog post called Negotiation Stages, I describe what I view as the potential stages in negotiation.
For a Supplier those phases of negotiation include
1)Conceptual Planning
2)Product or Service Development
3)Marketing and prospecting
4)Pre-qualification by Buyer
5)Bid. Quote, Proposal Stage
6)Negotiation Planning / Preparation
8)Agreement is reached and signed
12)Close out
If you were a contract manager for a supplier you would normally not manage 1-3 but could be involved in 4-14

For a Buyer the phases of negotiation include:
1)Identification and quantification of a need
2)Identification and pre-qualification of potential supplier
3)Bid. Quote, Proposal Stage
4.Review of Suppliers bid or proposal
5.Planning / Preparation
7.Agreement is reached and signed
8.Management during mobilization
9.Management of performance
10. Management of changes
11.Management of close out
12.Management of warranty obligations
13.Management of claims.
In addition the contract manager needs to manage the administrative acts required by the contract such as submittals, notices, approvals, insurances, etc.

One of the problems with creating a metric for contract management value is few projects are exactly alike. Even if you had projects of the same design being used, you would always have the variables of local governmental requirements, local labor, different site conditions, different contractors, subcontractors, the prime contractor’s capability, their financial and performance risks plus availability of materials etc.

One way to look at value is not what you consider to be value such as cost savings or cost avoidance, it’s to consider what your internal the customer values. That will vary depending upon whether you are managing work for the supplier or buyer. It will also vary depending on the value they get from the completed contract. For example in the same company it’s easy to have customer’s that place different values on contract completion. For example a customer may be driven by time to market needs to time to revenue needs who are less concerned about cost than having performance on time or early so the can win in the marketplace or generate revenue. Other customers may value cost simply because they have limited budgets and the more you can save them, the more funds they have available for other needs.

The value that contract management can provide is having the knowledge and skills to work with the customer, understand their needs and what they value and why and the work with them to identify available contracting options, the cost, schedule and risks of each so the business can make the decision on how to best proceed. In negotiations the contract manager or negotiator needs to work with their internal customer to advise them of potential cost or risk impact of agreeing with certain terms. Once the contract has been agreed, the contract manager needs to manage all of the remaining phases according to what has been agreed.

The important thing to understand is that negotiation is not a single point in time activity. It occurs in one form or another throughout all phases of the contract relationship so the contract manager is a negotiator. As a negotiator there are three important things you need to remember:
1) How well you manage all the activities leading up to the formal negotiation will have a major impact on how successful you’ll be in the negotiation and whether your tactics will work.
2) How well you manage all the activities following the formal negotiation will determine how much of the value you negotiated you’ll actually keep.
3)Anything left un-managed will always cost more.

This means my view of the value of contract management is best measured by customer satisfaction measurements. Based upon what they agreed to as their value, their needs, and the risks they agreed, did you meet their needs> Further any measurement of a contract manager should be only based upon those phases that you actually control. Decisions made and actions taken in prior stages frequently impact what a contract manager has to manage. For example, if your company selected the wrong contractor or supplier for the work, there is a high probability that you will spend significantly more time having to manage that contract. To me the best way to lear contract management is to manage contract "cradle to grave" or from inception to close. That way you see first hand how what you do early in the process will impact success later on in the contract life and have to live with the problems you created.

Sunday, February 10, 2013

Managing Confidential Information

When you agree to accept another party’s confidential information several things occur. You accept the responsibility to manage the information as required by the discloser. You assume liability in the event the information is wrongfully disclosed. You also potentially subject your company to claims of misappropriation of trade secrets if you were to use that company’s confidential information for your own purposes. The management of the risks associated with the receipt of confidential information are managed in two ways. First in the terms you agree upon in agreeing to accept confidential information. The second is how you internally manage that information.

To manage it contractually:

1. You need a clear definition of what constitutes confidential information. That should be further limited to only information that meets the criteria for trade secret information:
a) The information is not generally known to the relevant portion of the public;
b) It provides an economic benefit to the discloser that is not generally known;
c). The discloser uses reasonable efforts (both internally and externally) to maintain its secrecy.
Confidential information should not include copyrighted or patented information as the discloser is already protected on those. It should never include all correspondence from the discloser.

2. It needs to be marked so there is no question that it is confidential and would be subject to the requirements of the agreement. Suppliers may not like the extra work for them of marking it, but that shouldn't create both increased management costs and increased risks for you that would occur if they don't. If you run into a company that doesn't want to mark information, they will generally want all the information shared to be considered confidential. As a recipient that's not something you would want as is dramatically increases the potential risks to your company.

3. If you are going to allow oral disclosures you need to keep the number of them limited so they will be managed. Your confidentiality agreement (CDA) or non-disclosure agreement (NDA) should require several things for oral disclosures. First, at the time of the oral disclosure the discloser must identify that information as confidential. That way the recipient knows that it is confidential and they will be able to manage it accordingly. Second, the agreement should also require the discloser to immediately send a notice confirming the disclosure and what was disclosed orally. That way it’s not just one person’s word against the other. That way if something was disclosed to an engineer, and the contract manager is the one that manages and documents the receipt of confidential information they will get that notice of the disclosure. The burden of confirming the disclosure should always be on the discloser, it’s their information to be protected.

4. I would limit the confidential information the discloser may provide based upon two criteria. It either must be requested by an authorized party of your company, or it must be provided only in situations where the recipient has the “need to know” the information to perform their obligations under the contract. The simple fact is the more information you receive the greater the potential risk you have for potential misappropriation of trade secret claims. The request by an authorized party is to limit individuals like engineers from asking for information that would increase your liability when they don’t need the information to perform their job. Think of a product as being like a black box that performs certain functionality. Many times an engineer may want to understand what goes on within the black box (which is confidential) when all they need to know is what goes into the black box and what comes out of the black box (which shouldn’t be confidential). The more information you receive the greater the potential risk to your company so managing the inflow of information is very important, especially to help avoid potential trade secret infringement claims.

5. As all confidential information provides the company an economic benefit for only a limited period of time, you need to end your obligation to maintain it as confidential by having a term after which you no longer have the obligation to maintain it as confidential. Most information has no real economic benefit more than 7 years after disclosure and frequently less.

6. If you need the ability to share the information and would get authorization to disclose information to:
(i) your employees and contractors who have a need to know;
(ii) any other party with the Discloser’s prior written consent.
In managing liability if the disclosure will be to a third party, you need that third party to meet the same obligations and indemnify your company against claims from the discloser for that third party’s failure or misuse or you need a separate confidentiality agreement between the discloser and the third party so you aren’t liable for their acts.

7. You need no obligation to maintain the information to expire if certain conditions exist:
(i) You already rightfully have the information without a nondisclosure obligation;
(ii) You develop the same or similar information independent of the Discloser;
(iii) The information publicly available when received, or thereafter becomes publicly available through no fault of the Recipient;
(iv) It is disclosed by the Discloser without meeting the disclosure requirements such as marking.
(v) It is disclosed by Discloser to a third party without a nondisclosure obligation.

8. It should address the potential for disclosures that are required by law. When you are required by law to produce a document you can’t not do that, as you would be violating the law. In these situations the best a discloser can ask for is a prompt notification of any orders to provide the information so they may seek to intervene to stop the requirement of production of the confidential information. Barring that you should be able to disclose the information.

Managing Confidential Information Internally

As receipt of confidential information creates potential significant liability for a company, to manage the risk you need to manage and control the information. Several ways to manage and control the information are:
1. Single point of access for the receipt of information where all information is logged.
2. Limiting access to the information to only authorized individuals that have a need to know.
3. Placing restrictions on copying of information and controls over further duplication of the information or excerpts of the information.
4. Management of the security of the information as required by the contract or as a minimum as required for your confidential information. For example if a specific way of managing the information isn’t specified you would use the same controls as you use to manage your own confidential information.

In managing the information there are two risks you are trying to manage. The first risk is to make sure that there in no breach of your obligation to manage the information as confidential. In most companies the even greater risk is managing against that information being spread throughout your organization where even inadvertent use could be the basis for a claim of misappropriation of the trade secrets included within that confidential information.

In a misappropriation suit you would need to prove that your information was independently developed and the best way to prove that it was independently developed is with strict controls and limited access to the information so only a limited number of employees are exposed to that information. It is also best that individuals that have been exposed to confidential information not be assigned to potentially competing work as they will always have the retained

I’ve worked on projects where we had a single coordinator for both companies to manage the flow of confidential information and all disclosures and receipts had to flow through those individuals. The coordinator would limit access to only those authorized on a “need to know” basis. Copies were numbered and bound with instructions not to make any copies. Individuals had to sign for each access including what information they accessed.

When the obligation to maintain the confidential information has either expired or been excused we would collect all information and copies. Verify them against our log and records, and then depending upon the requirement of the contract either return or destroy all copies and if required certify the destruction of such materials.

Where managing confidential information is extremely important is when you may have development of products that may compete with the discloser or you do work with suppliers or subcontractors that compete with the discloser. It’s in those instances where you may need to show all the steps that you took to make sure that the information was protected as required and your product or your supplier or subcontractor’s products were independently developed with no involvement from your people that had access to the information and might have it retained in their minds.

The last reason for managing it contractually and internally is unlike other contracts most CDA’s or NDA’s have no limitation on the type of damages that may be claimed. They also don’t have limits on the amount of damages that may be claimed. In some locations, as a further deterrent to breaching the obligation of confidentiality, there may also be penalties that may be claimed. That means in most cases you have unlimited liability and that’s why most companies keep their confidentiality agreements separate from their other agreements in which there may be limits on both remedies and amounts of damages.