Disclaimer: I am not an attorney and cannot give legal advice. This series is from a supply chain practitioner’s perspective on negotiating contracts and is simply offering my perspective on common contract clauses. Seek professional legal advice for your own contracts.
In our continuing series on contract clauses from a supply chain perspective, last week we talked about training and insurance, and I went on a mini-rant about Certificates of Insurance. This week we talk about very legalese clauses – Indemnification and Termination. Crunchy as these clauses are, they are probably the most important in the contract from a risk perspective
The example contract clauses and discussions of them below are separated by horizontal dividers to help you switch between them.
Indemnification Clauses
18. INDEMNIFICATION
18.1 General Indemnification. Seller shall defend, indemnify and hold harmless Buyer, its shareholders and affiliated companies, and their respective directors, officers, employees, agents, representatives, customers, successors and assigns, from and against any and all actions, claims demands, liabilities, damages, penalties, fines, losses, costs and expenses including, but not limited to, fees of attorneys expert witnesses, and professionals and costs, and the cost of enforcing any right to indemnification, hereunder and the cost of pursuing any insurance providers (collectively, “Losses”), arising from or related to (a) Seller’s breach or failure to perform any obligation, provision or condition of this Agreement or respective Purchase Orders; (b) personal injury, death, or property damage arising from the manufacture, sale and/or use of the Products; (c) alleged or actual infringement or misappropriation of any patent, copyright, trade secret, trade name, trademark, service mark or other third-party intellectual property rights arising from the manufacture, design, failure to warn, sale and/or use of the Products; and (d) any and all recall actions arising from recall of the Products provided, however, that Seller shall not be responsible for recall actions and/or costs related to recalls where the issue relates solely to Buyer’s design.
18.2 Settlement and Handling of Indemnity Claims. Where any claim affects Buyer’s interests, Seller shall not consummate any settlement without Buyer’s prior written consent. Buyer, at its expense, will have the right, but not the obligation, to participate in the handling, adjustment or defense of any such matter. If Seller fails to assume its obligations under this Section, Buyer will have the right, but not the obligation, to proceed to defend itself and to require from Seller reimbursement and indemnification for any and all costs and expenses incurred by Buyer in connection therewith.
Indemnification is tricky. This is one of those clauses that I typically defer major redlines to a qualified legal team, simply because indemnification is always deep in the legalese weeds. The basics of this clause is that it represents who is liable (has to pay/be responsible) for any issues. The clause typically covers that suppliers must be responsible for issues that they cause, and occasionally a supplier will redline it to make both parties liable for their own issues. Some legal teams accept those redlines and some want to keep it one-sided because of the buyer/supplier relationship. Making both parties liable quickly gets very tricky in the courts and causes things like arguments over the word “and”. These two clauses are here to lay out both the definition of what the Seller is liable for, and to outline how claims against that liability should be handled. As I already mentioned, I would defer redlines in these sections to the legal team.
A note about limitation of liability: It is increasingly common for buyer templates to NOT have a limitation of liability clause, and for suppliers to add one. The most common one I see limits a supplier’s liability to the cost of the purchase order that caused the issue. I once had a very smart attorney explain this to me this way:
Imagine you have a furnace inspector come and inspect your furnace who charges you $150 for the inspection. While they’re in your house, they do something to the gas furnace that causes a leak in your gas line. You signed their standard terms, which included a limitation of liability to the cost of their purchase order (the inspection fee). The inspector leaves, and because of what they did, your house explodes due to that gas leak. Let’s say no one was home at the time and so no one was hurt by this action. You still have a house that is a total loss, worth maybe $300,000. Now is when that limitation of liability clause kicks in. The fire investigator tells you that it’s very clear something the furnace inspector did caused your gas leak, and the furnace inspector agrees. Because of the limitation of liability clause, the furnace inspector hands you $150 for your $300,000 house. In addition, the furnace inspector’s insurance company, which has up to $1,000,000 in liability coverage, says they will not pay more because the limitation of liability means they are not required to pay any more than their customer is liable for (the $150). They pay the furnace inspector back their $150 and move along their merry way. Meanwhile, you’ve gone to your own insurance company for a payout for your house. Depending on your insurance company, they may not pay either because they would say the furnace inspector is liable to pay for damages. Ultimately, no one pays you for your house and it’s all completely legal for them not to do so.
While this example is extreme and the chances it happens are low, companies sign away this level of risk in limitation of liability clauses all the time. At the very least, counter any limitation of liability clause with one that caps at insurance limits, which you should have negotiated in your insurance clause discussions. If you would like to look at the case law, in the 2012 case Valenzuela v. ADT Sec. Services Inc., a jewelry store with $800,000 in stolen goods was paid $1000 for damages from the faulty security system because of a limitation of liability clause. If you peek behind the curtain of every limitation of liability clause, you’re likely to find an insurance company requiring suppliers to put that clause in all of their contracts in order to not have to pay out on the insurance. If a supplier refuses to remove the clause or increase it to insurance limits, I often point out that they are paying for expensive insurance that they just made sure they will never use.
Recall Clause
19. RECALL
Notwithstanding anything to the contrary in this Agreement, Seller shall indemnify and hold harmless Buyer against any and all recall actions necessary to be taken due to a recall of Seller’s Product, either voluntarily or pursuant to the recommendation or direction of any state, federal or local agency. In the event Buyer or Seller elects, either voluntarily or pursuant to recommendations or directions of any governing authority to recall any Product, such recall will be at the sole responsibility and cost of Seller. Any recall solely related to Seller’s Product, will be the responsibility of Seller to file such recall and notify Buyer accordingly. Buyer will cooperate in making available records and other information as are reasonably necessary to enable Seller to complete such recall. Seller shall perform, at its sole cost and expense, all necessary repairs or modifications of recalled Products, except to any extent Seller and Buyer agree to the performance of such repairs by Buyer upon mutually acceptable terms.
The recall clause is in my contract template, but it’s another one that is very manufacturing-centric. Even more than that, it’s focused on manufacturing that provides material more directly to consumers. If your company sells products directly to consumers, or directly enough (such as with automotive parts) that you will be responsible for recalls, consider a clause like this one to ensure suppliers are helpful and cooperative in the event of an issue. While a supplier relationship should ensure they do the right thing, the contract is also all about backing up that relationship with some clear, written language. I seldom see redlines to this clause, except perhaps to make the costs more subject to negotiation than to default to the seller. Depending on the supplier, I would allow those edits in exchange for other “wins” elsewhere in the redline.
Termination Clauses
20. TERMINATION
20.1 Termination for Cause. In addition to any rights or remedies Buyer may have at law or in equity, Buyer may terminate this Agreement and any outstanding Purchase Orders for cause, effective immediately if:
20.1.1 Seller breaches any term or condition of this Agreement or, in Buyer’s reasonable opinion, is otherwise unable to perform its contractual obligations hereunder;
20.1.2 Seller files, voluntarily or involuntarily, a petition in bankruptcy under any section of the Bankruptcy Act; becomes insolvent; makes any assignment for the benefit of creditors; or has a receiver appointed for it;
20.1.3 Seller fails to maintain the quality or delivery requirements set forth herein;
20.1.4 Seller is found to be non-compliant with Section 5 (Compliance With Laws) herein; or
20.1.5 Seller does not remain competitive with respect to the Products in terms of quality, technology, total cost and delivery with any supplier of the same or similar Products and quantities during the term of this Agreement. Seller shall have thirty (30) calendar days after receipt of written notice by Buyer to make its Product(s) competitive and available for delivery. If Seller is unable to make Products competitive within such period without violating the proprietary rights of any other party, Buyer may terminate this Agreement or remove the non-competitive Products from Exhibits A and B without affecting this Agreement upon thirty (30) calendar days written notice to Seller, unless otherwise agreed between the Parties.
20.2 Termination Without Cause. Buyer may terminate this Agreement and/or any outstanding Purchase Order for its convenience, in whole or in part, upon thirty (30) days prior written notice to Seller.
Termination clauses are the “teeth” for the rest of the contract terms, but are also the last resort. A contract that ends in termination for cause is a contract that did its job, but where the supplier-buyer relationship has failed. Termination for cause should be at the end of a long process of supplier negotiations, relationship building, and mutual efforts to make things right, and used as a last resort. Ensure lesser requirements (like for uptime requirements) have different penalties than termination, such as set credits to the account for supplier failures. The set of conditions for which the buyer can terminate the contract for cause are laid out in this first clause, and are fairly standard. Every one denotes a supplier failure to deliver the expected product or service.
The second section allows the buyer to terminate the agreement without having a clear cause, simply terminating the contract at will. Most redlines I see are to the second clause, and are typically to extend the notice for termination without cause (also called a termination for convenience), or even to make this clause mutual where either party can terminate the contract without cause. This is another redline response that is dependent on your company and its philosophy toward contract termination.
Often suppliers who try to remove the termination for convenience clause entirely are using the contract as leverage to secure funding or loans on the open market, where they tell the market they have contracted business for a certain annual volume. If the buyer can simply terminate the contract at will and with short notice, the supplier cannot use the contract as leverage on the market. It is up to you whether that factors into your negotiations.
20.3 Return of Property. The following shall occur upon the effective date of termination of this Agreement, or other such date as specified by Buyer:
20.1.1 At Buyer’s sole discretion, Seller will cooperate with Buyer to either: (i) immediately make available to Buyer or its representative all of Buyer’s property including, but not limited to, all tooling, equipment, parts and materials, for Buyer or its representative to remove from Seller’s premise(s); or (ii) immediately return to Buyer, all Buyer’s property including, but not limited to, all tooling, equipment, parts and materials of Buyer;
20.1.2 Seller will discontinue all work under this Agreement and any outstanding Purchase Orders, unless otherwise directed by Buyer;
20.1.3 Seller will take all actions necessary to protect Buyer’s property or any other property in which Buyer has an interest; and
20.1.4 Seller shall return Buyer’s Confidential Information in accordance with Section 2.3 hereof.
20.4 Effect of Termination: If Buyer terminates this Agreement or any Purchase Orders issued hereunder in accordance with Section 20.1 or Section 20.2 (Termination for Cause or Termination without Cause), Buyer’s sole liability and Seller’s sole and exclusive remedy is the payment by Buyer for Products delivered and accepted by Buyer prior to the termination. Buyer shall be relieved of all further obligations hereunder. All of Seller’s warranties for Products purchased under this Agreement and obligations under Section 18 (Indemnification) will survive termination of this Agreement.
This last set of termination clauses describes what happens next upon termination of the contract. The first clause (20.3) outlines returning the buyer’s property, such as tooling or other equipment, and stopping work. It also contractually outlines that the seller cannot take action to destroy property, such as smashing up tooling in response to the buyer terminating the contract. The second clause (20.4) is almost a continuation of the Return of Property clause and basically says that work stops immediately. The buyer is only responsible for products already delivered and accepted. Sometimes I see a supplier redline the section about the products being accepted, which I usually fight. The alternative is that the supplier quickly creates a bunch of products and says they were already in production when the contract was terminated, so the buyer is obligated to take and pay for those products. That wraps up this week’s deep dive into contracts. Next week we’re starting the downhill slide to completing our contract review, with some miscellaneous clauses. Specifically, we’ll talk about clauses covering the supplier manual, party relationships, contract assignment, notices, headings, waiver, severability, and disputes. If you’d like to talk to me about your company’s contract clauses, let’s chat.