Giving contracts 'the legal once-over" - Part Two

In Part One, I introduced the methodology I adopt when asked by clients to give a contract “the legal once-over”, and looked at some particular issues when the client is the purchaser. In this Part Two, I will look at some of the issues that are front of mind when the client is a supplier and the contract being reviewed will most likely have been tabled by the purchaser.

1. Risk management

One of the reasons I have acted for many of my clients for over a decade is that I always aim to understand how their product or service is delivered and what factors might impact on the client being able to deliver its offering as required by the contract. For example, one of my clients is a systems integrator - in order to provide the deliverables it will need the co-operation and timely response of my client’s customer as well as that customer’s other third party vendors. Therefore I will need to make sure that my client is not left on the hook with failure to deliver when in fact the reason it hasn’t met the key milestone dates is because its customer has not made the necessary facilities and resources available to my client, or for other legitimate reasons beyond the client’s control.

Often a connected point, I will be looking at the financial model for the contract - if it is a fixed price model, to what extent can the client push through a price increase where he has been delayed (and incurred further resource costs) due to factors reasonably outside of its control

2. “Time of the essence”

Purchaser-favourable contracts will often contain wording making time for delivery or performance “of the essence”. This has a technical legal implication which means that if the supplier is even 1 minute late in performing an obligation then the customer can terminate the contract and sue for damages. There is no concept of materiality attached to the consequences of the late delivery.

This is a major risk for the supplier and one that I would try to ameliorate if at all possible - either by striking the words “of the essence” altogether or at least trying to narrow down exactly which obligations are so important to the purchaser.

3. Change of control clauses

If the contract is a business critical long-term contract for the client, it is important that there is nothing in the contract which could prematurely trigger the end of the contract. This is why I will want to make sure that there are no “change of control” clauses. These clauses enable the other party to the contract to terminate in the event that the shareholding of the client changes. Just the sort of thing that you don't want to happen if you take on a round of new funding or are looking to realise an exit!

5. Limitations of liability

But, for the supplier contracts, it is not just about the price. I’ll also be looking to make sure that the supplier’s limitations of liability are present, sensible (so that they would actually work if tested in a court) and represent a fair allocation of risk. Unlimited liability of the supplier may sounds great for the purchaser, but actually how realistic is it in the circumstances where unlimited liability might force the supplier into insolvency. Isn’t it more sensible to put in place appropriate caps on the supplier’s liability which the represent a fair allocation of risk/reward for the supplier and are capable of backing off with insurance.  

6. Ownership of intellectual property

Very often with my clients, typically young, growing tech companies, their IP is their biggest and most valuable asset. Therefore, I am always very careful to make sure that ownership of intellectual property is appropriately dealt with. Customers often take the view that they have paid for it so they must own it. However, more often than not the customer can be persuaded to accept a right to use, and this maintains the supplier’s ownership of the IP which it can then use for other customers and in other products and services.

7. Indemnify

Finally, if I see the word “indemnify”, I will definitely have a close read of that one - the reason being that the person giving the indemnity is basically agreeing to a pound-for-pound compensation in the event of a specific event.

If you are being asked to indemnify, the usual rules on whether the contract breach has caused a loss and the calculation of damages don’t apply - it’s basically like an insurance policy. If my client is the one being asked to give the indemnity I will want to make very sure it is appropriate in the first place and if so, is clearly defined and limited in scope. After all, I don't want my clients to be liable for someone else's mistakes or commercial "challenges".

In summary:

As you can see, there is quite a lot to look out for in a "quick legal once-over". Whilst you may have been assured that this is their standard conditions of doing business, I still need to make sure you are signing up to something which is fair, and wouldn't bankrupt you if something goes wrong.

Of course there are plenty of other issues and pitfalls to snare the unwary and I will look at these in more detail in later posts.

Piers Clayden