1. Getting the scope right
Be clear about what is and what isn’t included, and what each party expects to gain from the contract. Ensure that each requirement is measurable, with any constraints, dependencies or assumptions clearly identified. Accept that you probably won’t be able to capture everything (not just in relation to scope) – things are never black and white in the world of contracts. All you can do is ensure there is a clear mechanism for dealing with change – and pricing it.
Suppliers know from experience where and when scope (i.e. price) creep is likely. As well as ensuring the contract has a clear change process, customers can also protect themselves by engaging a third party, familiar with what is being procured, to help agree the scope so that scope creep is minimised if not eradicated.
2. Set out responsibilities
Ensure each party understands their responsibilities, when they need to be performed and the consequences of failure (including remedies available to the other party). Wherever possible, responsibilities should be linked to requirements and include any constraints, dependencies and assumptions.
If you fail to fulfil one of your responsibilities, it is likely to impact your other responsibilities and the responsibilities of the other party. Although termination might be the ultimate remedy if things aren’t resolved, it should not be your first option. Instead, include a realistic, structured process for remedying a responsibility failure.
This should include an extension of time equivalent to the delay suffered by the non-defaulting party, plus a right for this party to be reimbursed any direct costs it incurred as a direct result of the responsibility failure.
Customers often insist on a ‘catch-all’ provision requiring the supplier to do everything necessary to meet its requirements. The scope provisions might curtail this catch-all if the requirements are not clear. Upon seeing this catch-all, the supplier may price any associated risks upfront but then also play the scope creep card at the relevant time – so you end up paying twice for it!
3. Measuring performance
Mechanisms in the contract ensuring that performance takes place as prescribed, will be important to the customer as they ensure that it gets the services or goods that it wants on time – and what ‘penalties’ apply if it doesn’t.
Be clear about what remedies you want (e.g. service credits for failure to meet specified service levels) but keep in mind that above all you want to ensure that the supplier is incentivised to perform. Financial penalties are unlikely to incentivise a supplier sufficiently because they will (i) have already included any financial risk into their pricing; and (ii) argue that they have been prevented or delayed from performing their obligations because of something you have or haven’t done, or factors outside their reasonable control.
You need sufficient information to enable you to measure performance, e.g. management information from the supplier. Suppliers typically limit the information they give you, so ensure you understand what information you will get and how it will be set out, and request clarification if you have questions.
4. Limiting financial exposure
Each party wants to limit its liability, but also ensure that any limit of liability placed on the other party is adequate. There are legal restraints on the ability of parties to limit or restrict their liability, e.g. liability for death or personal injury cannot be excluded or limited under any circumstances.
Liability for breach of contract can only be excluded or limited to the extent it is reasonable to do so, taking into account all relevant factors (the ‘reasonableness test’). Both parties must accept that the other will try to exclude liability to the extent it can and to place a financial cap where it can’t.
Focus primarily on the types of liability likely to arise if the other party fails to meet its obligations. For example, if a supplier doesn’t deliver on time, what financial exposure will you incur internally and externally to your customers or other suppliers? You might incur internal administration costs and late delivery charges. In other words, what ‘direct’ losses would a reasonable person consider to be the ‘ordinary circumstances’ of something not happening as the contract requires?
Even if it is shown that the supplier’s breach caused those losses, if those losses were sufficiently unlikely, you would not be able to recover them from the supplier unless the supplier was aware of those losses when it entered into the contract. Bear in mind that insurance may cover a greater degree of liability than might be expected.
5. Protecting your IP
IP is likely to be one of the most valuable assets for both parties. Most commercial contracts involve some use of the other party’s IP (e.g. confidential information or software) and it is therefore important to ensure that obligations and restrictions on its use are included. In addition, IP may be created as a result of performance of the contract so the contract will need to set out who owns what.
Agreeing on who owns IP created or developed under a contract is usually contentious. The customer wants to retain all rights, including the right to commercially exploit or restrict others from using the IP so that it retains a competitive edge. On the other hand, the supplier may have developed something based on its proprietary IP and which it therefore wants to control and commercially exploit.
If ownership of IP is not being transferred, the solution is likely to be appropriate licensing of IP use (e.g. a perpetual licence to use and modify IP with annual royalty payments).
We can advise you on what protections you should include in your commercial contracts. Although these top five are based on our extensive experience of drafting and negotiating a variety of different types of commercial contracts for clients in all sectors, we recognise that each company will have their own priorities and negotiation style.
For more information on commercial contracts, please contact Lisa Downs by calling her on 01293 527744 or emailing firstname.lastname@example.org