Cover all bases

In this article, the second in a series of three relating to the negotiation and management of contracts, Tom Purton outlines the key points to bear in mind when your business is entering into a contract as a purchaser of goods and/or services.

Terms of purchase

Suppliers will generally want to use their own standard terms as the basis for a contract and will often give the impression that those terms are not negotiable. However, customers can and should insist on changes where their own interests are not best served by contracting on terms which are likely to favour the supplier. It may even be possible to insist that the supplier contracts on your own standard terms of purchase. For most customers, the best that can be achieved is to modify the supplier’s standard terms. Although it would be best practice for a supplier’s standard terms to be drawn to a customer’s attention, they are often simply attached to quotations and other correspondence without being discussed. Unless challenged or changed in some way, such terms will be likely to form the basis of the contract.

What are you buying?

A contract should state exactly what goods and/or services the customer is purchasing, yet it is frequently overlooked – often because the negotiations are focused on pricing and both sides simply assume that they have a common understanding as to what the contract is intended to cover. In practice, however, it is dangerous to assume that the supplier shares your priorities. Customers should therefore ensure that a contract includes a detailed specification of what is required, along with standards or service level bench-marks to be met and key outcomes to be achieved. For example, if a customer wanted a company website designed, it would be essential to include a full design specification for the site and a detailed timetable for design and delivery.

Often these details will have been set out in a separate document. It is important to ensure that any such document is referred to clearly in the main body of the contract – otherwise the supplier may be able to argue that it was never intended to be a legally binding statement of its obligations. Ideally, this document should be incorporated as a schedule to the main terms, which should themselves include a clear obligation on the supplier to meet the schedule requirements.

Promises, promises

A supplier’s standard terms will typically ensure that you are obliged to pay for any goods/services provided – with provisions including interest on late payment, suspension of supply and retention of title of goods until payment is received in full – but will often be much less onerous when it comes to promises relating to the supplier’s side of the bargain.

For example, suppliers typically seek to exclude statutory implied terms about the quality of goods or services, such as those derived from the Sale of Goods Act 1979 and the Sale of Goods and Services Act 1982. Although it may be possible to address some of these concerns by incorporating a detailed, legally binding specification, customers should consider inserting express requirements for goods to be ‘of satisfactory quality and fit for their purpose’ and for services to be provided with ‘reasonable care and skill’ and ‘in accordance with all applicable laws and regulations’. Other provisions which customers may wish to insert include obligations on the supplier to:

• Observe good industry practice
• Act in good faith
• Use best/reasonable endeavours to achieve particular outcomes

Do not rely on the sales pitch

To win your business, suppliers will often have made a sales pitch full of reassuring language about the high quality of goods and standards of service you can expect to receive. However, most supplier standard terms will contain a clause which seeks to limit the terms of the contract to those provisions actually set out in the written contract (entire agreement clauses). This means that any pre-contract documents, such as sales pitches, are unlikely to be regarded as forming part of the contract. Some supplier standard terms also stipulate that the parties have not relied on any statements – including pre-contract discussions – other than those set out in the contract (‘non-reliance’ clauses). It follows that, if you want to rely on any promises made during any pitch or negotiation, you need to ensure that these are set out in full in the contract itself.

Pricing and payment

The timing of payments proposed by the supplier will often require amendment. For example, the contract may have been drafted so that the customer is required to make the majority of payments before the supplier has actually performed all its key obligations – which tends to reduce the supplier’s commercial incentive to do what it has actually promised. Where possible, you should be looking to ensure that payments are tied to key milestones in the performance of the supplier’s obligations and that a significant portion of the overall price is only payable on delivery of the goods or completion of the relevant services. To avoid costly and lengthy disputes, for example, where concepts such as ‘gross’ and ‘net’ are used, these need to be defined to avoid confusion at a later stage. It is also vital not to make assumptions about what the other party understands even apparently straightforward payment terms to mean.

Notice periods

Many contracts are open-ended, in that they will continue until terminated by either party on notice. Suppliers will often stipulate short termination notice periods which at first sight appear very reasonable. However, closer reading will often reveal that any such notice of termination can only be exercised within a very narrow window – and if you miss that window, you may well be tied in to using the same supplier for another year. For example, a clause that allows termination ‘at any time subject to three months’ written notice ending on the anniversary of the agreement’ may give the impression that you can bring the contract to an end within a relatively short period (three months), at a time of your choosing. In fact, the agreement can only be terminated at the anniversary of its commencement – and then only by ensuring that at least three months’ notice has been given in advance of that date.

Termination and handover

Common law will normally allow an innocent party to terminate a contract if the other party has committed a ‘repudiatory breach’ – i.e. a breach that deprives the innocent party of ‘substantially the whole benefit of the contract’. However, in practice, this often means that the contract cannot be terminated for breach except in the case of the most serious and substantial breaches by the supplier.

As a customer, you should ensure that you have a right to terminate for ‘material breach’ by the supplier, where you need only show that it is significant – as opposed to going to the very ‘heart of the contract’.

Beyond issues of termination for breach, it is important to consider what is commercially important to you in relation to the contract as a whole. For example, including an insolvency event affecting the supplier is important, because it will allow you to exit the contract quickly if the supplier ceases trading and to appoint another provider – likewise, if the supplier ceases or threatens to cease to carry on its business. Additionally, if the ownership of the supplier is important, you may want to be able to terminate for a ‘change of control’. Similarly, you may wish to prevent the supplier from transferring or sub-contracting its obligations to a third party. This can be avoided by providing that the consent of the customer is required for any transfer or sub-contracting to take place.

Should the worst happen, it is also worth considering handover provisions which provide for a clear and efficient exit from the contractual relationship and a smooth handover to a new supplier. Without such obligations, the outgoing supplier may have little incentive to co-operate.

Tales of the unexpected

Contracts typically contain ‘force majeure’ clauses that exclude or suspend liability for non-performance due to unpredictable external events such as industrial action, riots and acts of God (e.g. hurricane, flooding). However, they can be far more comprehensive and favourable to suppliers. For example, they might attempt to exclude liability for failure of an upstream supplier to supply products in time. As such, force majeure clauses should be checked carefully to ensure suppliers bear the risk for issues that should be their responsibility to manage effectively or insure against.

Available remedies

Supplier standard terms may seek to limit the remedies available to you if something goes wrong. Damages for breach of contract will normally be available, but careful consideration of liability provisions is likely to be needed to ensure that you can secure a meaningful level of financial compensation. It is also worth considering whether other remedies would assist. For example, in business to business contracts for the sale of goods, there is no statutory right to repair if the goods malfunction – but it may be helpful to insert this as an additional contractual right. Similarly, in relation to services, it may be beneficial to insert a right to have some or all of the services re-performed if certain key objectives are not achieved.

Limitations of liability

From a customer perspective, two issues are key when reviewing liability clauses:

• Excluded categories of loss: suppliers will typically seek to exclude certain types of loss altogether, such as loss of profit, loss of business, loss of revenue or data and indirect/consequential loss. Depending on the nature of the contract, it may be important to you as the customer to be able to recover at least some of your loss falling within these categories. You may need to strike out some of these ‘blanket’ exclusions.
• Liability caps and insurance: suppliers will also typically seek to impose an overall limit on the amount they have to pay in the event of breach. Customers need to consider what might go wrong and how much they would stand to lose financially. If the cap is below that level, press for it to be increased to a level which would cover a greater proportion of your total loss. If the supplier resists this, it may be worth exploring the possibility of the supplier taking out insurance against its own breach; this may mean that the supplier is more comfortable agreeing to a higher cap. If the supplier has limited resources, it may be worth imposing a requirement on the supplier to maintain adequate insurance and ensure that you, as the customer, are the co-insured on the policy – that way, if the supplier is unable to pay, you at least have the possibility of recovering your loss from its insurer.

Good housekeeping

Often the customer will not keep an adequate record of its contract with a supplier. It is vital to do this and to document any agreed changes to it. Equally, on the assumption that a customer will have multiple suppliers on different terms, it is a good idea to keep a schedule of key supply contracts setting out the key terms – namely, the parties, term and termination (including key dates for exercising any rights to terminate, price and key deliverables). This greatly reduces the risk of key dates, deliverables or milestones being outdated given that reference to the long-form contract usually only occurs once a problem has arisen and the ‘horse has bolted’.

Tom Purton is a Partner at Travers Smith LLP and Head of the Commercial, IP and Technology Department

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