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 nonconformance, inspection, and payment terms. This week is a bit manufacturing-centric as we talk about product changes or discontinuations and the buyer’s property clauses. We’re in the thick of the contract now, where more custom clauses depend on buyer and seller’s industries and what the buyer is actually buying.
The example contract clauses and discussions of them below are separated by horizontal dividers to help you switch between them.
Product Changes/Discontinuation Clauses
12. PRODUCT CHANGES / DISCONTINUATION
12.1 Seller’s Engineering Changes. Seller shall provide not less than one hundred twenty (120) calendar days’ notice of proposed changes that may affect form, fit or function of the Product (including software), to allow Buyer to evaluate such changes. Seller shall provide all related documentation and/or samples reasonably requested by Buyer to complete Buyer’s evaluation of such changes. No change may be made without Buyer’s consent in the form of a written agreed-to Engineering Change Notice (“ECN”). If Buyer rejects such requested changes, Buyer may either: (a) cancel accepted Purchase Orders for Products without charge or liability to Buyer, or (b) request that Seller continues to provide Products without such engineering change. For significant Product changes, Seller shall review the impact on Buyer’s inventory and shall replace or rework Product inventory at the expense of Seller. Buyer shall not be liable to purchase excess Product inventory from Seller once the change is agreed to by the Parties.
The product change clauses are broken down by seller-driven changes and buyer-driven changes, which are typically treated differently. The clauses here are very focused on the seller being a manufacturer and the seller providing a physical product or material, so they certainly won’t apply in every situation. I don’t see many changes to this clause, other than sometimes to the timeline or occasionally to the cost obligations of the seller. However, as this is seller-driven, they do have some control over their own timing most of the time. If a supplier pushes back on this clause, I usually argue back that the seller has this level of control. Unless the supplier has a robust change order process that runs counter to this clause, I don’t typically accept redlines to it.
Side Note: For a construction contract or a software implementation, these clauses are still extremely necessary to outline who can make and approve changes, and what that process looks like. In many purchases, a shocking amount of the cost tracks back to change orders. So if your contract template does not contain these clauses, consider adding them in as a control mechanism for runaway costs.
Story Time! I once had a boss who would tell a story from when he was the project manager for building a coal plant. He always said that every change costs something. When the project’s executive leader walked through the plant before completion, he asked to change the color of the safety handrails. My boss told him that would cost the price of the paint plus seven pizzas.
“Seven pizzas?! Why?” exclaimed the executive.
“Because the construction and safety teams spent quite some time arguing over the paint color for those railings and only just reached agreement. If you’re going to change it and they have to repaint the railing, I’m going to need seven pizzas to feed them all and keep them happy.”
The executive ended up leaving the railings the paint color they started.
12.2 Buyer Requested Changes. Buyer may make changes to any Product to be specially manufactured or provided by Seller, provided that no change shall be effective, nor shall Buyer be obligated to pay any increase in price as a result of a change, unless such change is documented in a Purchase Order. Seller must notify Buyer of an increase or decrease in price to a Product change within five (5) business days of Buyer’s request or notice. Any price changes pursuant to this Section shall be mutually agreed in writing and Exhibits A and B shall be amended accordingly.
This clause is the counterpoint to the seller change clause, and is typically written loosely on the buyer. If change orders are an issue in your business, the contract clause can be loose but must be backed up with some internal processes that are more robust. The most common redline here is the lack of an obligation to pay a price increase, which can be replaced with some sort of clause about deciding on a new price between buyer and seller based on actual cost changes. I also occasionally see redlines to the timeline to change the price. Most of these kinds of price changes are more covered by value add/value engineering (VA/VE) articles, which is where the buyer and seller work together to engineer more value into a product or the process to make it. In this contract template, the VA/VE clause is in Exhibit A.
12.3 Discontinued Products. Seller shall give Buyer not less than one hundred eighty (180) calendar days written notice if Seller decides to discontinue or otherwise cease manufacture of any of Seller’s Production Products. In the event Seller discontinues or ceases manufacture of any Production Product, Seller agrees to not hold Buyer responsible for any excess Product inventory, work in process, and finished goods. Seller agrees to hold for Buyer a “last time buy” inventory of such Production Products as set forth in Exhibit A, and to continue to supply such Production Products for up to two (2) years after notification.
This clause is more about requiring the supplier to help you predict their bad days or otherwise predict disruptions to your business. Having 180 days warning about discontinuing a product is nice, but doesn’t always happen. This is one of those clauses that is in the contract and is seldom redlined, but is hard to enforce. The most common redline is the very last clause, where the supplier agrees to continue making production products for two years after notification (18 months after their planned date to stop production because of the six month warning required here). I usually don’t fight that clause very hard, but will fight to keep a “last time buy” clause to allow time to pivot production and provide for my customer’s warranty claims.
12.4 Addition or Removal of Products. From time to time and during the term of this Agreement, Buyer may elect to purchase other products from Seller. The Parties agree that those purchases are governed by the terms and conditions found in this Agreement. The price for those other products purchased shall be evidenced in Buyer’s purchase order. Buyer reserves the right to add or delete any Product by part number to or from this Agreement with thirty (30) days written notice to Seller.
This clause simply allows for changes to the products being purchased, mostly it’s for additions instead of deletions. Amendments still have to be signed and countersigned, and this clause is clerical. Because this contract does not have an exclusivity clause requiring the buyer to purchase a certain quantity or percentage from the seller, this clause is not critical and seldom redlined. In a contract with a very minimal approach, this might be a clause I would remove.
Buyer’s Property Clause
13. BUYER’S PROPERTY
Buyer shall have and retain title and ownership to all supplies, materials, tools, jigs, dies, gauges, fixtures, molds patterns, equipment and other items furnished by Buyer to Seller, either directly or indirectly through reimbursement or payment by Buyer or other means. Seller shall bear all risk of loss and damage to Buyer’s property while in Seller’s possession. Buyer’s property shall, at all times, be properly housed and maintained by Seller; shall be used solely by Seller for the production of Products for Buyer pursuant to this Agreement and any respective Purchase Orders; shall be deemed to be Buyer’s personal property and marked as such by Seller; shall not be commingled with the property of Seller or any third person or entity; and shall not be moved from Seller’s premises without Buyer’s prior written approval. Buyer owned property on site at Seller’s location, as stated in Exhibit C, shall not be scrapped without prior written consent from Buyer. Upon Buyer’s request and in accordance with its instructions, any and all property of Buyer shall be immediately released to or delivered to Buyer at the cost and expenses of Seller.
The buyer’s property clause is very particular to manufacturing that purchases custom-designed components from suppliers. This clause applies most to tooling, such as the molds for casting processes, machining jigs used to hold or measure pieces during manufacture, or boards used to build wire harnesses. Unless volumes are very high (like in the automotive industry), it is common for a buyer to pay the cost to create this tooling, which can cost thousands or tens of thousands of dollars. Due to that cost and the fact that the buyer paid for the tooling, the buyer owns that asset. Theoretically, the buyer could have that mold or jig shipped to another supplier, who would then use it to build the same product. In practice, that does not work. While the mold itself might be the same between suppliers, every casting process and machine has different holes, mount points, and small changes in its tooling that can make existing tooling built by another supplier completely worthless.
This clause is important to ensure a supplier takes good care of this buyer-owned expensive asset, but a buyer should always consider tooling to be exclusive to that supplier and basically a startup cost for using that supplier. Do not fall into the trap of thinking you can move tooling from Supplier A to Supplier B and avoid tooling costs. Ensure when calculating your switching costs between suppliers that you consider the full cost of new tooling in your total cost of ownership calculations.
That wraps up this week’s deep dive into contracts, next week we will talk about warranties and hazardous products (hazmat). If you’d like to talk to me about your company’s contract clauses, schedule a time to chat.