Many businesses categorise themselves as suppliers suppliers of raw products, finished goods or even services. Fewer businesses categorise themselves as receivers of goods or services.
It follows that a large proportion of businesses pay attention (in varying degrees) to their supply terms, whether they are “standard” terms of trade documents which are generic and used for each transaction, or more comprehensive “purpose built” supply agreements drafted specifically for a specific transaction. However, a far less proportion of businesses pay the same amount of attention to the supply terms received from others.
Of course it is almost without exception that businesses are both suppliers and customers in their day to day trading activities.
For this very reason, it is critical for businesses to look at their trading activities from both the perspective of a supplier and a customer when reviewing policies and procedures as they relate to entering into relationships with third parties.
A failure to be vigilant when entering into supply relationships can result in disastrous consequences if businesses unwittingly agree to unfavourable contractual terms.
I am often asked by clients to review business contracts concerning supply relationships. I generally categorise such documentation as either:
Terms of Trade
Not peculiar for each transaction.
Prepared heavily in favour of the party proffering them.
Standard “fine print”, often contained “over leaf” or simply referred to a website for full particulars.
Attached to quotes, credit applications and purchase orders.
Often overlooked contain “sleepers” that can cause harm to an unsuspecting signatory at a later date.
Looks and feels like a real contract (as a result, is more often reviewed by legal advisors, rather than just signed but not always).
Specifically drafted and negotiated for a particular job/transaction.
Includes finer detail.
If administered and executed correctly, both documents are legally binding. For the purposes of this paper, I will refer to both types of documents as “contracts.”
Why are they important?
Properly negotiated, drafted and executed supply contracts are critical in business relations.
Such contracts assist in clearly setting out the rights and responsibilities of each party to the transaction thereby removing ambiguity.
Contracts can set mechanics of the transaction (payment, governing laws, disputation and unavoidable delays) and define limits (time limits, costings, warranty periods, etc).
Arguably most importantly, contracts can clearly apportion liability and minimise (or at least define) legal and financial risk for all parties involved.
The Usual Suspects
There are a number of “usual” topics which are generally covered by supply contracts. These include:
Description of supply and timetables for delivery
Performance criteria and/or specifications
Supply site and safety
Title to and risk in goods
Price, invoicing and payment
Inspections/defects liability periods
Variations to contractual works
Insurance, indemnities and limitation of liability
Security personal guarantees, retention amount, bank guarantee
Boiler plate clauses severability, governing law, ability to assign rights, entire understanding of the parties, and the list goes on.
A Closer look at Supply Contracts:
Warranties are promises by one party to another that certain matters are true and correct or that the supply of goods or services will meet certain criteria. Warranties can be implied by statute. For example, the Trade Practices Act 1974 (Cth) implies certain warranties that goods supplied are fit for their purpose and services are performed with due care and skill.
Warranties can also be expressly stated in a contract. Some things to consider:
Customers need to ensure that all representations made by a supplier as to the virtues of a particular product are restated as warranties in a contract; and
Suppliers need to ensure that warranties are limited to those contained in the contract (where possible) and are specifically drafted to suit each occasion. Eg, if a customer designs goods, then the supplier should not (and cannot) always warrant that goods will perform in a specific way.
Defects Liability Period
Defects Liability Period is the period of time during which a customer can oblige a supplier to rectify any “defects” with goods or the results of services performed.
A customer should (among other things):
Make sure the period is adequate to allow any “bugs” to be ironed out; and
Consider including a retention amount or some form of guarantee (of x% of contract sum) until the expiry of the period as a safeguard.
A supplier needs to ensure (among other things):
There is a sunset date (so that regardless of when the warranty starts, whether its delivery of a product or ultimate commissioning, you know when the period will finish);
The definition of “defect” is adequate, and is exhaustive; and
It specifically excludes any defects arising out of or connected to the misuse, negligence or continued use (after defect arises) by the customer.
Limitation of Liability
Limitation of Liability is commonly referred to as a “carve out” or “exclusion” clause. Whilst it is not possible to avoid all liability in a commercial transaction, the idea for both parties is to limit your exposure to liability and risk where possible.
It is good practice for suppliers to ensure that despite the content of the rest of a contract, there is an overarching clause that:
Excludes all implied warranties (where it is legal to do so);
Reduces liability where warranty is breached (to replacement or cost of replacement);
Reduces liability where failure to meet warranty (or breach of contract) is caused or contributed to by the customer;
Removes liability for indirect or consequential loss (ie loss of profits);
Limits aggregate liability under contract to a figure, whether its a percentage of the total contract sum or the proceeds of any insurance payment.
Risk and Title
Risk and Title is commonly referred to as a “retention of title” or “romalpa” clause. The fundamental elements of the clause are that “risk” in goods (responsibility for security and safety of goods) passes to the customer on delivery, rather than acceptance, payment or otherwise.
However, “title” in goods (legal ownership), does not pass to the customer until payment has been made in full. There is a distinction between different types of clauses that can either be “invoice specific” or “all monies”. They have different effects depending on the type and frequency of transactions occurring between the parties.
Indemnity is a promise made by one party to protect another from specified loss or damage.
A customer should ensure (among other things) that they have the protection of an adequate indemnity clause which is properly linked to a stringent insurance clause so as to protect a customer from any possible damage arising out of breach of contract or negligence of a supplier.
A Supplier should try and delete or at least restrict indemnities to direct damage resulting from breach of contract and reduce liability where the customer causes or contributes to that liability. In any event, both indemnity and insurance clauses should be reviewed by a supplier’s insurance broker to make sure that the supplier has adequate coverage to insure against claims under the indemnity clause and to make sure entry into the contract does not void insurance coverage.
Guarantee is a promise by a third party (often a director of a corporate party) to honour the obligations of one of the contracting parties in the event that contracting party breaches the contract.