- Types of Contracts — A contract consists of both custom and standard terms and conditions. Standard terms and conditions are those that an organization wants to apply to every contract. Standard terms and conditions may deal with issues such as changes to the contract, cancellation, subcontracting, confidentiality, delivery, shipping, indemnity, legal venue, applicable laws, inspection, payment terms, packaging, and warranties.
Custom Ts & Cs are those that are unique to a specific contract. They may address topics such as acceptance testing, updating service information, emergency services, financing, installation, training, initial provisioning, maintenance, spare parts, and contract renewal. Recently, topics such as the supplier’s concerns and actions promoting environmental and social sustainability have also increasingly been included as custom Ts & Cs. For example, requiring suppliers to possess some type of environmental management certification, such as ISO 14001, has become quite common.
- When to use — It is appropriate to include on all solicitations and offers all of the Ts & Cs the organization wishes to apply to the eventual contract.
1. Appendix: Issues Addressed by Ts & Cs
There are many issues that can affect the contract performance, costs, and risks that are normally included in standard or custom Ts & Cs.
2. Advance Notification and Right to Subcontract
Unless explicitly addressed, contracts permit the prime contractor to subcontract to meet requirements. Supply management professionals typically reserve the right to evaluate subcontractors retained by the prime contractor.
3. Payment Terms
Payment terms involve a trade-off between the time the buying organization keeps the money before paying and the discount the supplier offers as an incentive for early payment. For instance, net 30 days means payment of the entire invoiced amount needs to be made within 30 days of the invoice date. The term 2 percent 10/net 30 generally means payments received within 10 days from the date of the invoice receive a two percent discount; otherwise, the full amount is due in 30 days. Payment terms have cash flow implications for both the buying organization and the supplier.
4. Insurance
In some situations, the supplier should carry a certain amount of insurance. Most supply management organizations specify in the contract the type and amount of insurance required. The clause might include statements about property damage, public liability, builder’s risk, errors and omissions, workers’ compensation, and related issues.
5. Indemnification
Indemnification clauses protect the buying organization or supplier from loss or damage. Hold harmless (or save harmless) and indemnify refer to being reimbursed for penalties or liabilities incurred by one party because of another’s actions, and normally pertain to financial or monetary loss. Contract Ts & Cs should always include clauses disclaiming or limiting the buying organization’s responsibility for damages resulting from a supplier’s violation of existing laws, product safety, product liability, recalls or defects, and patent infringement.
6. Termination and Exit Clauses
Termination means the “action of one party pursuant to specific contract language to end a contract for some reason other than breach by the other party” (ISM Glossary 6th edition). Upon termination, all obligations are discharged, except breach of rights and obligations based on prior performance. Typically, a termination for convenience clause is included that allows termination even though the supplier is complying with the terms of the contract. Cancellation differs from termination in that it implies cause and does not excuse the causing party from damages resulting from its failure to perform. “The right to cancel may be provided by law or in specific contract language” (ISM Glossary 6th edition).
7. Confidentiality Policies
Most information regarding customers, suppliers, and competitors is confidential. Also confidential is information such as sources of bids, supplier proposals, pricing, drawings, designs, strategies, wage and salary information, software programs, or scientific formulas. Many times there is a formal confidentiality or nondisclosure agreement that is a “freestanding agreement or contract provision restricting the disclosure of certain information, generally proprietary information, given by one party to the other in the course of contract performance and imposing liability for unauthorized disclosure” (ISM Glossary 6th edition).
8. Force Majeure
This term is a “contract provision under which major (and usually uncontrollable) events may excuse a party, in whole or in part, from the performance of its contractual obligations; examples include fire, war, or severe weather. It is sometimes referred to as Acts of God. This term can be written to include various events that are not actually acts of God, and may or may not be beyond the parties’ control” (ISM Glossary 6th edition). This provision normally is included in standard purchase order forms to protect both the buyer and the supplier.
9. Business Continuity
Contract clauses should address responsibilities and actions that should be taken if a disaster or other event threatens to disrupt the performance of a contract. Contracts should require the supplier to develop a business continuity plan that includes identifying risks and developing specific response and mitigation plans if a disruption occurs.
10. Assignability Provisions
Assignment refers to a transfer of one’s rights and/or duties under a contract. Standard Ts & Cs typically require the supplier to secure purchaser approval prior to assigning its performance under the contract to another party. Assigning all or part of the work without the purchaser’s approval would be cause for cancellation of the contract.
11. Source Code Escrow Accounts
When acquiring software or the rights to use software, an escrow account might become necessary. An independent third party serves as an escrow agent, physically stores the source code, and has title to it. The escrow agent also has authority to release it under specified conditions. This arrangement can facilitate the continued use of software in the event the supplier goes out of business, runs into financial difficulties, or discontinues support of the product.
12. Claims
A claim refers to “the right asserted by a plaintiff to payment or for an equitable remedy, such as the specific performance of a contract” (ISM Glossary 6th edition).
13. Limitations of Liability
Suppliers, in general, attempt to include contract language that will limit their liability for damages and loss due to warranty claims or other breaches of contract. Limitation of liability is a “contract provision that restricts either the remedies available or the amount of damages recoverable in the event of a breach of contract. Such provisions are typically initiated by sellers, and may cap overall liability or certain categories of liability under the contract, or may exclude liability for certain types of damages, such as consequential damages” (ISM Glossary 6th edition). One of the most common limitations addresses warranty claims that the supplier be permitted to repair or replace defective goods. In this case, the supply management organization is not permitted to cancel the contract and seek damages for loss.
14. Waiver of Consequential Damages
To promote goodwill and to limit the potential escalation of damage disputes, contracting parties from both sides may agree to a waiver of consequential damages. Consequential damages refer to “damage, loss or injury that arises not directly from a party’s act (for example, breach of contract) but from some consequence or result of that act (for example, lost profit, lost revenue, personal inquiry, or property damage) (ISM Glossary 6th edition).
15. Collusive Offers
Collusion is a secret agreement to operate in a fraudulent or deceitful manner. In collusive offers, suppliers act together “to ‘fix’ their bids in a collectively advantageous manner and thus eliminate genuine competition in bidding” (ISM Glossary 6th edition). Federal antitrust laws are designed to prevent such collusive offers on the part of suppliers. Seek the advice of counsel in cases where collusion is suspected.
16. Suspension
The buying organization may temporarily suspend activities on a contract. When this occurs, the supplier must be given reasonable written notice and will need to be compensated on suspension based on the percentage of contract completion until the effective date of the suspension, less any previous payments.
17. Reservation of Rights
The buying organization should reserve all rights to contract performance in accordance with the stated Ts & Cs. A modifications clause prohibits suppliers from making any changes in the contract without the consent of the buying organization. A waiver clause may be used to protect against possible loss of contractual rights in the event the buying organization inadvertently fails to enforce certain rights.
18. Estoppel
Estoppel is “a legal principle that prevents a person from asserting a position that is inconsistent with his or her prior conduct if injustice would thereby result to a person who has changed position in justifiable reliance on that conduct” (ISM Glossary 6th edition). One example of this principle might occur in agency law when a purported agent is actually an impostor.
19. Ethics and Social Responsibility Issues
Contracts addressing issues such as child labor, worker safety, nondiscrimination, ethical business practices, and environmentally responsible practices should be included in contracts.
20. Domain/Jurisdiction
Domain or jurisdiction refers to an area that has the legal authority to hear and render a decision in a particular situation. Most contracts specify the jurisdiction.
21. Damages
The ISM Glossary 6th edition defines damages as “compensation for loss or injury suffered by one party as a result of another party’s actions.” Damages can be liquidated, direct, indirect, consequential, or punitive. To avoid the problems of calculating and proving damages in a lawsuit, contracting parties often will state a predetermined amount of damages, known as liquidated damages, in their contract. Direct damages are determined as the difference between the value of the performance received and the value that had been agreed upon in the contract. Indirect damages, also referred to as incidental damages, are expenses reasonably incurred in the inspection, receipt, transportation, and care of goods rightfully rejected by the purchaser (ISM Glossary 6th edition). According to the ISM Glossary 6th edition, consequential damages are not a direct result of a breach but happen as a result of the breach, for example lost sales or personal injury. Punitive damages punish the other party and generally are not allowed in contract law cases.
22. Warranties
A warranty is “a legally enforceable promise or representation as to quality or performance of goods or services made by the seller” (ISM Glossary 6th edition). Warranties may be express, which is assurance by the supplier, either orally or in writing, about the product’s or service’s quality, performance, or other characteristics. In the U.S., implied warranties are provided by the Uniform Commercial Code (UCC) and do not need to be listed specifically in the contract to apply. Implicit in contracts between “merchants” is that the supplier has full legal ownership of the goods being sold; that they are not subject to security interests, liens, or any other encumbrance not known to the purchaser at the time of contract formation; and that the supplier has a right to sell or otherwise transfer the goods accordingly. Fitness for intended purpose is implied assuming: 1) the seller must know the buyer’s intended use for the goods; and 2) the buyer must rely on the seller’s expertise in choosing the goods; by implication the seller warrants that these goods will be fit for the buyer’s intended use (ISM Glossary 6th edition).
23. Disclaimer of Warranty
The UCC allows suppliers to disclaim the implied warranties of merchantability and fitness for use by conspicuous use of specific language, and to limit express warranties to repair or replacement. It is important to use well-designed Ts & Cs to cancel out supplier disclaimers.
24. Duties, Breach, Notice, Cure, and Remedies
A breach of contract occurs when either of the parties fails to perform its contractual obligations (ISM Glossary 6th edition). When this happens, the party that has caused the breach needs to be notified. Notice clauses explain how notices are to be communicated. Remedies “relieve or correct a legal wrong. In contract terms, available remedies are money damages or an order of the court for specific performance” (ISM Glossary 6th edition). Generally, there is a timeframe that the breaching party is given to correct the breach and return to the original agreement called a cure (ISM Glossary 6th edition). Cover is a remedy available to a buyer. After displaying due diligence, the buyer is entitled to obtain goods in the open market and recover damages from the supplier (ISM Glossary 6th edition).
25. Asset Management
Contracts typically include clauses that address how tangible assets such as equipment, buildings, and property, or intangible assets, such as digital content and software, will be managed.
26. Third-Party Beneficiaries
In some cases, third parties who do not directly enter into the contract as the offeree or the offeror may receive benefits (ISM Glossary, 6th edition). Their rights should be explicitly defined.