SELLER'S CHECKLIST FOR REVIEWING SALES CONTRACTS AND PURCHASE ORDERS
A typical sales contract/purchase order contains many of the provisions noted below. In order to reduce your business' exposure to liability each such contract should at least be reviewed for the following items. If the provisions are unsatisfactory, these terms should be negotiated with Buyer and Buyer's agreement to such changes reduced to writing and signed by the Buyer. While not inclusive, the following are some key points to look for when reviewing a sales contract or purchase order.
A. Your business may want (and will probably be expected) to warrant that the products meet certain defined specifications and are free from defects in material and workmanship.
B. Is the Buyer's remedy for breach of warranty expressly limited to repair or replacement of defective parts, or refund of the purchase price, at your business's option? A provision specifying repair, replacement or refund as the remedy for breach of warranty will not be deemed to preclude the Buyer from resorting to any other remedies not enumerated unless it is stated to be the sole or exclusive remedy.
C. What is the warranty period? If the contract doesn't say what it is, it will be limited only by the applicable state statute of limitations, which is typically four years.
D. Are implied warranties excluded? The warranty should be limited to that which is expressly stated and all implied warranties should be expressly excluded. Such exclusion should be conspicuous and specifically exclude the implied warranties of ``merchantability" and ``fitness for a particular purpose."
2. CONSEQUENTIAL DAMAGES
A. Does the contract disclaim liability on the part of your business for consequential damages? Your business should not agree to a provision permitting the Buyer to recover consequential damages. Furthermore such a right must be expressly disclaimed or Buyer's right to recover consequential damages will be implied under the UCC. Special, indirect, incidental and exemplary (punitive) damages should also be excluded.
A. Does the contract contain a ``force majeure clause" which excuses delay in delivery attributable to causes beyond your business' reasonable control? Make sure that it does and covers principal uncertainties, especially your business' ability to obtain material and parts in the ordinary course of business. This is especially important to protect your business against shortages which can only be remedied by paying premium prices for materials.
B. Does the contract contain a ``time is of the essence" clause? If so, delete it. This clause will have the opposite effect of a force majeure clause. This clause allows the Buyer to terminate and/or collect damages if your business is even one day late in delivery. Note that a "rate of deliveries is of the essence" does the same thing and should be deleted as well.
4. PATENT/IP INDEMNIFICATION
A. Does the contract provide protection of your business from broad patent, copyright and intellectual property indemnification? The patent indemnification should be limited to indemnifying Buyer for alleged infringement of U.S. Patents only, upon 10 days written notice and provide that your business may undertake the defense of any such action.
Your business should also have the right at its option to (a) procure for the Buyer the right to continue using the goods, (b) modify the goods so that they become non-infringing, or (c) refund the purchase price (preferably less depreciation). Your business will not indemnify Buyer, and the Buyer should indemnify your business, if the claimed infringement is a result of (w) Buyer's detailed specifications, (x) parts supplied or designated by Buyer, (y) modification of the goods, by someone other than your business, or (z) combination of your business' products with other products, the combination of which is alleged to be infringing.
A. Does the contract permit termination at Buyer's convenience? If so, what payment is the Buyer to make to your business? In the absence of anything to the contrary in the contract, when a Buyer terminates without any fault of your business, your business would be entitled to money damages which take into account lost profits and reasonable overhead as well. Watch for provisions which would limit the payment to the cost of work in process and raw materials allocable to the terminated work. There could be significant costs (overhead, department allocations) associated with termination which would not be covered simply by payment for the cost of the materials. Other termination provisions to watch for are:
- Buyer demanding broad audit rights
- No time limit for payment of termination charges
B. Does the contract permit Buyer to terminate for your business' failure to comply with any term of the contract? This should not be allowed. Buyer's right to terminate should occur only for a material default and upon 30 days written notice with an opportunity to cure the default during such 30 days.
C. Does the contract permit your business to terminate the contract on Buyer's material default? If it is the Buyer's form, this probably will not be in the agreement, but you should request that it be placed in there.
A. Does the contract contain any provisions which purport to defer the time of acceptance of the goods or permit the Buyer to reject the goods well after the time of delivery? After the Buyer has accepted the goods, its remedies generally are limited to those specified in the warranty clause -- which hopefully have been expressly limited to repair, replacement or refund. Before the time of acceptance, the Buyer's remedies are much broader -- e.g., it may reject non conforming goods and recover money damages.
7. MOST FAVORED CUSTOMERS
A. Does the contract contain a ``most favored nations" or ``most favored customer" clause?
These should be refused, or, at the very least substantially restricted as such a clause will impede your ability to extend or negotiate certain benefits to large volume, long term customers without extending those same benefits to every other ``most favored customer" both past and future.
If you must agree, certain minimum restrictions on the applicability should be included:
- The same or substantially identical product
- Sold in the same volumes
- To similar customers
- On substantially similar terms
- Should NOT apply to promotional pricing
- Should apply only for so long as extended to a third party
A. Does the contract require your business to defend and indemnify Buyer against all claims, liabilities, losses and damages arising out of actual or alleged defects in material or workmanship, or anything else? If it does, your business may be assuming significant contingent liabilities. It is commercially reasonable to limit your business's responsibility to repair, replacement, or refund at your business' option. This should be covered in the warranty clause.
Other indemnification provisions should be reviewed carefully by your lawyer. In no event should your business indemnify the Buyer for the Buyer's negligent or willful acts.
9. ENTIRE AGREEMENT
A. Does the contract contain a provision to the effect that it embodies the entire agreement of the parties and supersedes all other agreements, oral or written, with respect to the subject matter?
If it does not, the Buyer may later claim that certain materials extraneous to the written contract are part of the agreement of the parties -- e.g., representations in sales presentations.
A. Is the procedure of making modifications to the contract clear?
The contract should provide that no changes will be deemed binding upon a party without its written consent. Care should be taken not to proceed with substantial changes, or changes which might alter the delivery schedule, without getting Buyer's commitment in writing.
A. Does the contract contain a clause requiring both parties to retain in confidence proprietary information obtained from the other?
B. Or, is an adequate nondisclosure agreement in place?
12. PRODUCT LICENSES
A. Does the contract purport to give Buyer ownership of your business's source code, patents, technology or know-how?
B. Does the contract purport to grant Buyer a license to your business' source code, patents, technology or know-how?Your business should not agree to either clause.
C. Your business should not consider escrowing its source code, except in the most exceptional situations. Clauses requiring escrow should be rejected.
13. COMPLIANCE WITH GOVERNMENT REGULATIONS OR STANDARDS
A. Buyers will insist that the goods meet certain standards such as UL, CSA, VDE, FCC. These requirements should be set out specifically in the specifications for the goods. If not, these requirements may be added to the warranty provision, thereby limiting the Buyer's remedies to repair, replacement or refund. Additionally, the warranty should be limited to those regulations or standards in effect on the date of the contract.
B. Buyer may insist on compliance with OSHA or other government regulations. This clause should be resisted, if possible, as the regulations are complicated and confusing.If such provision is to be included, it should be treated in the same manner as UL or FCC, thereby limiting Buyer's remedies.
14. CHOICE OF LAW
A. What law, if any, is specified as the governing law of the contract?
Preferably it will be your state law, however, the importance of this is diminished since all states but Louisiana have adopted the UCC. The state chosen must have some connection to the transaction. Do not agree to foreign law.
Do not agree to provisions which confer jurisdiction in the courts of a particular state or require that any action be brought in a particular state.
15. F.O.B. POINT
A. At what point does risk of loss pass?
B. When does title pass?
C. Who is to bear the expenses of transportation?
In the absence of anything to the contrary set forth elsewhere in the contract, the F.O.B. point will determine the point at which risk of loss, title and transportation expenses shift from your business to Buyer. Make sure that there is no confusion on these points.
A. Does the contract have a clause which requires the Buyer to pay all taxes, duties and other governmental charges in connection with the sale, purchase, transportation, delivery or use of any of the goods (except for taxes based upon your business' net income)?
Make sure that the contract doesn't limit the Buyer's responsibility to sales and use taxes. Many states have gross receipts taxes in lieu of sales taxes, and these should normally be for the account of the Buyer.
In conclusion, you should remember two things: (1) The clauses discussed in this section are commercially reasonable and standard for any Seller. In fact, your customer, when it acts as a seller, most likely has the very same clauses in its sales agreements. So do not let the Buyer whine that you are being unreasonable. YOU ARE NOT! (2) These changes should be negotiated at the outset, reduced to writing and signed by your Buyer before your business commences work under a sales contract or purchase order or they may be ineffective.