The Top 10 Contract Issues When Doing Business with Large Companies
By: James E. Robinson Esq.
As your business grows, you may find yourself doing business with larger and larger companies. As this happens, it may become more common for customers to ask you use their standard form of contract instead of your own. Large-company contracts are often complex and they’re intended to protect the interests of the large company. To help you protect your interests we’ve prepared a list of 10 of the most important types of contract terms to look for and be aware of.
Even if your customers don’t insist that you use their form of contract, it will probably become more common as customers grow larger for the customer to have a lawyer review your contract and come back to you with requests for changes. The list below can be helpful in this case as well because you can speed the contracting process by understanding what types of contract terms large companies are expecting to see and how you can structure your contract to minimize requests for revisions.
1. Payment Terms
Many large companies will give themselves a significant amount of time to process and pay your invoices. 60 days is common. Some will agree to pay quickly but insist on a discount – perhaps two percent – when payment is made within a certain time period. One term that’s common, but doesn’t always jump out at you, is a term stating that the company won’t have to pay your invoice if you don’t bill them within a certain time after you’ve provided them with goods or services. Sometimes the period may be a year or six months, but other times it could be as short as 90 days or perhaps even less.
2. Price Increases
It’s not uncommon for contracts that are recurring or which will continue for several years to either prohibit price increases or limit them in a significant way. If price increases are allowed, they’re often limited to a set percentage per year or to the annual increase in the Consumer Price Index (CPI). A contract may even use multiple limits and state that the lower one will apply – for example, the lesser of three percent per year or the annual increase in the CPI. Occasionally, a contract will ask you to guarantee “most favored customer” status, meaning that you agree to ensure that the customer always receives the same price as the lowest price offered to any of your customers.
3. Termination for Convenience
More and more commonly, large companies are asking for the right to terminate contracts for convenience, that is, the right to terminate the contract at any time, for any reason (even if you’ve properly performed all of your obligations up to that point). If you think you’ve acquired a customer for two years, but that customer suddenly wants to terminate the contract after six months, then that can obviously have negative effects on your financial projections, your staffing plan, your ability to recover the cost of supplies or resources that you may have purchased for the job, etc. Even if a large company insists on a termination for convenience clause, however, there are ways in which the negative effects on your business can be reduced. For example, you might require that a significant amount of advance notice be given before the contract can be terminated for convenience.
4. Intellectual Property
The projects undertaken by software, consulting, entertainment, advertising and other types of businesses may involve the making of inventions, the authoring of software code or written materials, and other creative work. An important consideration in this regard is who will own the rights to the new product, computer program, book or other result of the work. Frequently, large company contracts will contain provisions defining the intellectual property that will belong to the company at the conclusion of the project, and these provisions are typically very broad and designed to err in favor of the large company. As a result, these provisions have to be carefully reviewed and care must be taken to retain for yourself ownership of those items that should belong to you, such as improvements to your own products that might be developed in the course of your work for the large company.
5. Acceptance, Warranty and Remedies
Contracts will often give the large company time to test your products or services before it accepts them and becomes obligated to pay for them. This isn’t necessarily surprising, but the specific terms need to be carefully understood – for example, the test period might be longer than you expect and it’s not uncommon for contracts to provide that you cannot charge for your products or services until the company formally agrees in writing that it has accepted them. Even after the products or services have been accepted, many contracts will require that they continue to be covered by a warranty for some period of time. Again, the basic concept isn’t surprising, but details such as the company’s remedy might be – for example, some contracts provide that if a product or service fails to perform, the company will be entitled to a full refund even if the product or service has been in use and performing properly for some time.
In general, indemnification clauses require you to reimburse ALL of the expenses that are incurred by the large company in the event that the large company is sued by another person or company as the result of your actions. If, for example, your actions result in a person being injured at the large company’s location and that person sues the large company, you might already be responsible for any money damages awarded to that person for their personal injury, but under the indemnification clause you might also be required to pay additional amounts, such as the legal fees paid by the large company to its lawyers in connection with the lawsuit. Indemnification clauses aren’t necessarily unfair, but because the effect can be to significantly expand your monetary exposure, it’s important to understand what circumstances they apply to and the scope of the costs or losses that you’re being asked to be responsible for.
7. Limitation of Damages
A limitation of damages provision is just what it sounds like – it limits the amount of money that one party to a contract can sue the other party for. Sometimes the limit is a fixed dollar amount, but it’s common for the limit to involve a calculation based on the value of the contract – for example, it might be stated that damages may not exceed the total amount of fees paid by one party to the other party during the preceding 12 months. In general, limitations of damages are helpful because they allow you to place a cap on the amount of your exposure. Depending on the nature of your business, however, you may need to be careful to ensure that certain types of claims are NOT covered by a limitation of damages. For example, if your confidential information were misused by the other party, or if one of your personnel were injured, then you would not want your right to recover damages to be capped at dollar value that might be significantly less than the amount of the harm that was actually caused.
8. Non-Solicitation of Employees
It’s not uncommon to find that a contract includes a provision that prohibits you from hiring employees of the large company to work for your company. If there is such a provision, then you should familiarize yourself with the specific terms in order to avoid the possibility of a dispute or unexpected liability. One significant term is the applicable time period – often, the prohibition on hiring will apply during the time that the contract is in effect and for a fixed period of time afterwards, perhaps another six months or a year following the completion of your work with the other company. Another important point to note is that the provision will often ask you to agree to a specific penalty or amount of damages that must be paid in the event that you hire away an employee of the large company in violation of the restrictions. Typically, this is tied to the salary of the employee and you might be required to pay a penalty equal to six or twelve months’ worth of the employee’s salary.
9. Audit Rights
Another type of provision that’s commonly encountered is one that allows the large company to audit or review different aspects of your business or operations. One aspect might be billing records related to your contract with the large company – for example, if you provide services on a time and materials basis, then the large company might want the right to check records such as time sheets against the invoices that it has received. Two things to watch for in this case: (i) the provision may require you to continue to keep your billing records for some time period after the contract has been completed – three years perhaps; and (ii) the provision may also address what will happen if an audit reveals that the large company has been over-billed, and require you not only to refund the amount of the overcharge, but also to reimburse the large company for its accounting fees. Another aspect of your business that the large company may seek the right to audit is your physical or computer security. In this case, it’s important to look for terms stating how often tests or inspections can occur, how much advance notice you’re entitled to, and exactly what types of tests or inspections can be done.
10. Restrictions on Subcontracting
Finally, you may find that a contract includes a prohibition on the use of subcontractors, or at least requires you to obtain written consent prior to having any part of the contract performed by a person or company other than your own company. If you typically use subcontractors, then you might wish to consider addressing the issue in the contract and obtaining pre-approval for any subcontractors you intend to use. An important point to note is that even if you’re permitted to use subcontractors, many contracts will require you to agree to be responsible for any mistakes or other improper performance by your subcontractors. In essence, the large company’s position is that it’s making a contract with your company and that if there’s a problem they’re going to look to you to make it right or pay any damages, and leave it you to sort things out with your subcontractors. Accordingly, you may need to take steps to protect yourself, such as requiring your subcontractors to provide you with proof of adequate insurance coverage and requiring them to agree to indemnify you for any costs or expenses that you might incur as the result of a mistake or improper performance on their part.
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We’ve helped clients to negotiate complex contracts with large companies and we’ve also helped clients to optimize their own contracts. If you’d like to discuss whether we might be able to help you, please feel free to contact us.
This is an expanded version of an article that we previously published. You can read the original article here.
Please note that this article is intended only as a general discussion of some of the issues that may be confronted in negotiating contracts and that it should not be taken as creating an attorney-client relationship or as legal advice with respect to any particular person, business or situation. Circumstances and the applicable legal principles vary and you should consult with an attorney before entering into any contract or agreement.