In companies there often needs to be a routine review of commercial contracts between vendors, suppliers and services providers. Supply chain managers responsible for this are expected to get the help of attorneys and other compliance professionals in order to do a thorough and proper review. Here are four aspects to pay attention to when reviewing the findings:
In the existence of a valid contract, there needs to be clear terms and understanding too of how the parties involved can get out of the contract. Contracts usually have a fixed term that can sometimes be extended. The extension period, however needs to be approved by both parties although one might have the right to extend the term unilaterally. At times, some terms automatically renew unless either party notifies the other party within a certain period of its intention not to renew the contract. Contracts often award each party the right to terminate the contract depending on various circumstances.
The underlying economics of the contracts are important and the terms relating to price, quantity and quality are key. It is essential to understand how these terms are determined. Are the key economic terms fixed, or do they fluctuate? If the economic terms fluctuate, is the variability based upon a fixed schedule, or upon some other external source, such as the consumer price index? Can the economic terms be modified through mutual consent, or does one party have the right to change any of the economic terms unilaterally? Do any of the economic terms come with minimum requirements? For example, in a supply contract, are there minimum purchase or minimum supply commitments? Are there penalties if either party falls short of its commitment?
Indemnification provisions are often greatly negotiated as the wording of these provisions can create, mitigate or avoid significant liability. Indemnifications means agreeing to cover someone in certain situations. Contractual indemnification provisions enable the parties to cover each other for certain risks that are incidental to the work to be performed under the contract. When reviewing these provisions, it’s important to note whether the parties have agreed to limit their liability to a fixed amount (for example, the total fees paid under the contract, or a multiple thereof). It is also important to note whether the parties have limited the types of damages the indemnified party (i.e., the party being covered) has the right to receive. Damages include many different categories such as special or indirect damages, lost profits or consequential, direct damages and punitive or exemplary damages. It is also crucial to note any exceptions that apply disclaimed damages or limited liability.
Other Noteworthy Provisions
It is also significant to pay attention to provisions that put restrictions on either party’s freedom to operate or that could affect either party’s business in the future. These can take place in forms of prohibition of a party from engaging in certain line or business, conducting business in certain geographic area or attaining customers, clients or employees of the other party. Another key economic restriction a contract may contain is price. A party, for example, may be stopped from lowering its price to its customers without also lowering for the other party too.
In addition, most contracts contain provisions regarding dispute resolution, and the process and venue for bringing legal claims relating to the contract. It is also important to take note of these provisions, in the event that disputes arise.
If you are reviewing contracts in connection with a potential acquisition or litigation, the sooner you involve an appropriate subject matter expert the better.
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Source: Supply Chain Management Review