Identifying and Managing Risks in Supply Chain Agreements
Kevin Slaughter and Tiffany Presley
January 11, 2018
Introduction
This CLE will cover three of the most heavily negotiated provisions in supply chain agreements - warranty, indemnification and limitation of liability.
These provisions are the primary provisions used to allocate risks between the contracting parties.
We will briefly discuss the purpose of each provision, identify some of the risk that negotiators should be aware of, and discuss strategies for understanding and managing risks.
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Agenda
• Damages
• Indemnification
• Warranty
• Limitation of Liability
• Q&A
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Common Agreements Used in Supply Chain Operations
• Supply Agreements
• Master Services Agreements
• Transportation Agreements
• Distribution Agreements
• License Agreements
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Damages
• Most Common Damages in Commercial Agreements
• Direct Damages – The cost of a party getting what it was supposed to get under the agreement had the other party not breached the agreement. (No special knowledge needed to predict direct damages)
• Consequential Damages – Those beyond direct damages that require an understanding of the specific facts and circumstances of the transaction including: (i) what the non-breaching party has at stake under the contract, and (ii) the ramifications the non-breaching party will suffer in the event of a breach (e.g., - loss profits, loss of use)
• Incidental Damages – Costs and expenses incurred by the non-breaching party to avoid other direct and consequential losses caused by the breach (e.g., - costs associated with finding suitable replacement parts/services, inspection costs, stopping delivery, caring for goods after breach)
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Indemnification
• An allocation of risk by express agreement by where one party (the indemnifying party) agrees to compensate the other party (the indemnified party) for direct claims, third-party claims, or both (covered events)
• Reduces the likelihood of litigation concerning the allocation of liability between the parties and any available remedies
• Provides predictability and certainty of recourse in the event of a breach
• May be mutual or unilateral
• Heavily negotiated provision
• Risk Alert: Scope of indemnification may not align with commercial reality of the transaction.
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Indemnification
Sample Unilateral Provision:
Supplier agrees to indemnify and hold harmless Purchaser, its customers, affiliates, subsidiaries, officers,directors, agents and employees from and against all losses, costs, damages or expenses including reasonableattorney’s fees ("Losses"), arising out of or connected with (i) any actual or alleged breach by Supplier of anywarranty or covenant set forth in this Agreement, (ii) any claim alleging the infringement of any third party'spatent, trademark, copyright or other rights due to its sale or use, alone or in combination, of the Products,including the Products and designs developed by Supplier, except to the extent the alleged infringement is directlyattributable to the Products being manufactured solely in accordance with the specifications; (iii) any Productrecalls; or (iv) any actual or alleged death or injury to any person, damage to any property, or any other damageor loss, by whomever suffered, except to the extent such death, injury, damage, or loss arises from thespecifications or any material alteration, modification or improper or unauthorized service and repair of theProduct performed by Purchaser or its customers.
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Indemnifying Party
Indemnified Parties
Recoverable Damages
Nexus Phrase
Covered Events
Carve-Out
Indemnification
Managing the Risks:
• Determine risks to Supplier (e.g., compliance with Buyer’s requirements, Buyer’s use of products or services, Buyer’s incorporation of Supplier’s products into its own before selling to third parties, and Buyer’s acts or omissions).
• Determine risks to Buyer (e.g., quality, condition, legality of goods or services, and Supplier’s infringement).
• Do not rely on boilerplate language. Instead, focus on the particulars of the industry, business practices, and commercial context to properly define the scope of the indemnity - i.e., covered individuals, covered events, materiality qualifiers, and carve-outs.
• Anticipate problems: the “what ifs” and gauge the probability of occurrences.
• Ensure that scope of indemnification is in line with commercial context – i.e., the scope fits the commercial reality of the transaction.
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Indemnification
In Practice
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Warranty
• A promise or affirmation by a seller that a fact about the goods that constitutes the basis of the bargain is or will be as stated or promised
• UCC Article 2 (UCC §§ 2-312 to 2-316) – Warranties related sale of goods
• 2-312 – Implied Warranty of Title and Against Infringement
• 2-313 – Express Warranties
• 2-314 – Implied Warranty of Merchantability; Usage of Trade
• 2-315 – Implied Warranty of Fitness of a Particular Purpose
• 2-316 – Permits Disclaimer of Express and Implied Warranties
• May be express or implied
• Commercial Agreements - typically include express warranties with a waiver of statutory or implied warranties.
• Traditionally fault based - i.e., applicable when supplier fails to meet a certain standard
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Warranty
Sample Provisions:
Products Example: Supplier warrants to Buyer that, for a period of [number] [month[s]/years[s]] from the date of [manufacture/shipment/delivery/use] of the Goods, such Goods will [materially] conform to the specifications set forth in Exhibit A as of the date of [manufacture/shipment/delivery/use] and will be free from [material] defects in material and workmanship.
Services Example: Supplier warrants to Buyer that the Services shall be carried out with all reasonable skill, care and diligence commensurate with the standard of care of similar consultants performing similar Services in Supplier’s industry and that Supplier personnel assigned to perform the Services possess the training, skills, competence and experience necessary to safely and properly perform the Services.
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Warranty
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Sample Disclaimer Provision: EXCEPT FOR THE WARRANTIES SET FORTH ABOVE,SUPPLIER MAKES NO WARRANTY WHATSOEVER WITHRESPECT TO THE GOODS, INCLUDING ANY: (A)WARRANTY OF MERCHANTABILITY; (B) WARRANTY OFFITNESS FOR A PARTICULAR PURPOSE; (C) WARRANTYOF TITLE; (D) WARRANTY AGAINST INFRINGEMENT OFINTELLECTUAL PROPERTY RIGHTS OF A THIRD PARTY;WHETHER EXPRESS OR IMPLIED BY LAW, COURSE OFDEALING, COURSE OF PERFORMANCE, USAGE OFTRADE OR OTHERWISE.
Risk Alert: Remember where parties have a history ofdealing, warranties may be implied based on thecustom or past conduct of the parties. Be sure tounderstand past conduct between the parties todetermine whether or not we want to waive orpreserve warranties implied by course of dealing orpast conduct.
Warranty
Common Warranty Remedies• Repair/Redo
• Replace
• Refund
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Warranty
Managing the Risks: • Ensure warranty tracks the “bargain” - i.e., what was promised to be delivered;
specifications; documentations
• Ensure remedy is appropriate for circumstances - remedies include repair or replace. (e.g., Does a refund make purchaser whole?)
• Consider whether Supplier and Customer has a history of dealing
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Warranty
Recent Developments
• Shared Model
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Limitation of Liability
• Important tool for defining the scope and magnitude of the parties’ contractual liabilities
• Typically used when commercial reality and risk allocation are out of sync
• May or may not be necessary -consider facts and circumstances
• May be unilateral or mutual
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Limitation of Liability
Two Common Types of Limitations:
Limitation of the Amount of Liability
• Common Caps: fixed dollar amount, amount covered by indemnitor's insurance, and fees received under the contract over a period of time (e.g., 3x the annual value of the contract)
Limitation of the Type of Liability
• Exclusion of certain types of damages - e.g., consequential damages
• RISK ALERT: Inappropriate waiver of indirect and consequential damages.
Common Carve-Outs: third-party claims under indemnification provisions, breach of confidentiality, gross negligence, and willful misconduct or fraud
• RISK ALERT: Failure to include appropriate carve-outs.
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Limitation of Liability
Sample Provision:EXCEPT AS OTHERWISE PROVIDED IN SECTIONS A (INDEMNIFICATION) AND B (BREACH OF CONFIDENTIALITY, ORLIABILITY FOR INFRINGEMENT OR MISAPPROPRIATION OF INTELLECTUAL PROPERTY RIGHTS), IN NO EVENT SHALL[SUPPLIER'S/CUSTOMER'S/EITHER PARTY'S] AGGREGATE LIABILITY ARISING OUT OF OR RELATED TO THISAGREEMENT, WHETHER ARISING OUT OF OR RELATED TO BREACH OF CONTRACT, TORT (INCLUDING NEGLIGENCE)OR OTHERWISE, EXCEED [[NUMBER] [TIMES/[PERCENTAGE] OF]] THE TOTAL OF THE AMOUNTS PAID TO SUPPLIERPURSUANT TO THIS AGREEMENT IN THE [NUMBER] [YEAR/MONTH] PERIOD PRECEDING THE EVENT GIVING RISE TOTHE CLAIM [OR $[AMOUNT], WHICHEVER IS [GREATER/LESS]]. IN NO EVENT SHALL [SUPPLIER/CUSTOMER/EITHERPARTY] [OR ANY OF ITS REPRESENTATIVES] BE LIABLE [UNDER THIS AGREEMENT TO [CUSTOMER/SUPPLIER/THEOTHER PARTY] OR ANY THIRD PARTY] FOR CONSEQUENTIAL, INDIRECT, INCIDENTAL, SPECIAL, EXEMPLARY, PUNITIVEOR ENHANCED DAMAGES, LOST PROFITS OR DIMINUTION IN VALUE, ARISING OUT OF, OR RELATING TO, AND/OR INCONNECTION WITH ANY BREACH OF THIS AGREEMENT, REGARDLESS OF (A) WHETHER SUCH DAMAGES WEREFORESEEABLE, (B) WHETHER OR NOT [SUPPLIER/CUSTOMER/IT] WAS ADVISED OF THE POSSIBILITY OF SUCHDAMAGES AND (C) THE LEGAL OR EQUITABLE THEORY (CONTRACT, TORT OR OTHERWISE) UPON WHICH THE CLAIMIS BASED.
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Carve-Outs
Cap on Amount of Liability
Waiver of Damages
Limitation of Liability
Managing the Risks:
• Should align with the entire contract (e.g., indemnities and cumulative remedies provisions)
• Should be tailored to fit the commercial reality of the transaction
• Include appropriate carve-outs
• Determine whether limitation apply to the contract as a whole, only specific contract terms, individual transactions (e.g., specific purchase orders) or one or both parties
• Should be clear, unequivocal and conspicuous
• Should be in CAPS or bold
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Limitation of Liability
In Practice
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© 2018 Quarles & Brady LLP -This document provides information of a general nature. None of the information contained herein is intended as legal advice or opinion relative to specific matters, facts, situations or issues. Additional facts and information or future developments may affect the subjects addressed in this document. You should consult with a lawyer about your particular circumstances before acting on any of this information because it may not be applicable to you or your situation.
Thank You! Questions?
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Kevin Slaughter312.715.5151 [email protected]
Tiffany Presley317.399.2858 [email protected]
