Change Order Mechanisms For Good Contracts – Two Examples

Building in the right change order procedure into a contract can go a long way towards making the contractual relationship stronger and avoiding disagreements down the road.

My elevator speech (as it is now – you never know) emphasizes three attributes that I think any good business-to-business contract should have:

  1. The contract should be a win-win for both parties
  2. It should contain the necessary mechanisms so it works on a day-to-day basis
  3. The contract should last for a long time without requiring major fixes

My last blog covered why I believe contracts should be a win-win. This post focuses on one of the mechanisms.

These mechanisms “impose” policies and procedures on one or both side from which they will benefit. The best way to relate this is with a couple of examples: one from a master services contract and its equivalent from a master sales contract.

Master Service Contract Example

Every master service contract should provide for change orders. Successfully modifying a statement of work requires these documents.

I see some agreements without any provision for change orders, which invites “project creep”. People on both sides make changes, in the field and on the fly, to services and deliverables. The poor service provider may not realize what happened until the once-profitable project comes in at a very low margin or even at a loss. So, every master service agreement should have a requirement that no changes to the services or deliverables take place without a change order, signed by both parties. That’s not optimal, though.

Just saying a change order will be required ignores the issue of how it will come into being. Without a process for negotiating them, the chances that the change order will get created, regardless of the requirement in the contract to do so, decreases substantially.

For this example, let’s assume the client wants to change the services and/or deliverables. Construct the master service contract such the following occur:

  • The client provides that request in writing to the service provider
  • The service provider has time to think about the change, and to calculate a new price to address the financial impact
  • This revised proposal should be provided to the client in writing

    People Around Table Agreeing on Change Order
    © Can Stock Photo / pressmaster
  • The client should have adequate time to consider and accept or reject the proposed revision.
  • There should be mechanisms (with time limits) around negotiating the final change order, which the parties then sign
  • Finally, a procedure is needed in the event of an impasse, in which case the change order does not happen, and the parties agree not to make the change or just part ways

Master Sales Contract Example

The example here is simpler: the buyer wishes to cancel its purchase order before the product ships. The example assumes manufactured products. IP deliverables, such as software, fit the model as well.

  • Within a certain period before shipment, say 120 days, perhaps there should be no penalty for cancelling the purchase order
  • Within a much shorter period prior to shipment, the buyer should have to pay the full price or at least the cost of acquired long lead-time materials plus labor
  • For the times between the two extremes, a good solution is a table with various percentages of the purchase price the buyer must pay, depending on the period before the ship date the order is cancelled. For example:

Days Before Ship Date

Percentage Payment Required

90

25%

60

50%

30

100%

 

Both the change order and order cancellation process may tilt slightly in favor of the service provider or seller. But, if the client does not get a surprise bill for “project creep”, and the buyer does not get a demand for the entire purchase price because of cancelling six months out, they win as well.

If litigation is avoided, both parties save a lot of money.

If drafted properly,these are simple solutions for handling what could become major stumbling blocks in the contract.

3 Reasons Contracts Should Be a Win-Win

3 Reasons Contracts Should be Win-Win

In my practice I have always advocated that contracts should be a win-win, i.e., they should provide equivalent benefits to both parties. Here are three (of many) reasons why I think that’s so.

  1. Failure of Purpose. If you are doing contracts with companies, whether customer, suppliers, strategic allies, or almost any other type of contract, the aim should be so that you can work together and both benefit from the arrangement. If that is not so, why are you doing business with that other party? If you insist on “winning big” in the contract negotiation, are you showing good business sense or hubris? Good business sense says you must protect yourself, but that the contractual relationship should demonstrate good faith and the fact that you will be a good partner in the endeavor.
  2. Wasting Time. If you send out a contract that is very one-sided, with unilateral onerous provisions for the other party, it is often a waste of time and resources for both parties. The chances of the other party
    Two Business People Fighting Over Contracts
    © Can Stock Photo / AndreyPopov

    missing the harsh terms is pretty low, and the draft is going to be rejected out of hand or sent back well marked up. And the other party may have been forced to spend a lot more money to have its reply prepared. Is that going to improve the dynamics between the companies or damage the relationship?

  3. Ethics and Perceptions. Some people believe businesses should be ethical in their behavior. Actually, a lot people believe it and I am one of them. When a client of mine receives an NDA with hugely one-sided and onerous terms, I sometimes advise them not to sign and to end the relationship right there. The other party had assumed my client was stupid and would not read the document, that it might be able to “sneak” the terrible provisions through anyway, or that it is the bigger player and the smaller company has to give in, so take every advantage. Even if any of those is ethical (I obviously think not), the party being taken advantage of will be on the defensive from the outset and will not trust the other party’s ethics. That is not a recipe for a successful business relationship of any duration.

The presentation of a one-sided contract engenders mistrust and creates doubts about doing business with the drafting company. Even if such a contract gets signed, the relationship is unlikely to work smoothly or be long lasting.

To Write or Not to Write – Written vs. “Drop-Down” MSAs and SOWs

The Question: Should You Use Drop Down MSAs and/or SOWs?

Here is an example of a company using a drop-down term sheet as a Master Service Agreement, or  MSA, and a fill-in-the-blank form to create the Statement of Work, or SOW.

A current client provides content creation (websites, logos. etc.). The firm also provides ongoing marketing services (SEO, social media work, ads, etc.)

The client was well on its way to providing the marketing services via a click-on license. The customer could choose various types of services and the amount of help it needed from drop down menus. There was a click-on terms sheet that came up once the decisions were made.

The question that came up was whether the client could provide the creative services – the creation of creative content – on the same, click-on basis. The master service agreement would be the drop-down term sheet, and the process might require a statement of work at the end, but the customer would be inputting its needs and wants.

This article is merely an opinion piece, not a lecture. I have no idea if my arguments are correct, persuasive or based on correct assumptions. All legal aspects of the question are ignored entirely. This is no more than my opinion.

Observations and Opinions

My reasons for landing on the side of the written statement of work (SOW) and Master Services Agreement (MSA) signed by both parties include:

Statement of Work

Information Gathering

  • If the customer inputs its needs and wants into a system, the program (short of the deployment of AI) has a limited ability to change the next set of questions according to the previous answers. Yes, a decision
    Man-Typing-on-keyboard

    (c) Can Stock Photo / Kzenon

    tree could do some selection. But a decision tree has a finite number of choices and cannot pick up nuances. In the arena of targeted creative content, the decision tree would also have to be huge.

  • If my client is asking the questions in real time, there are several advantages:
    • The client has a good idea of the starting point – what questions need to be asked first – based on its experience with various industries, company size, etc. The customer is seen holistically when determining what to ask. A decision tree would require the prospect to fill in a huge number of blanks to approximate this outcome.
    • My client probably has a better idea of what the customer really needs than the customer. The gathering of the information will be much more efficient in total. If the prospect were filling in blanks, it might be the wrong blanks with the wrong answers.
    • The client’s team can react to nuances in the customer’s input as the questions are asked and answered. That means the questions will focus in on the actual needs (and wants) of the customer.
    • My Client also knows what the end product – the SOW – should look like and can tailor questions to reach the correct end point.

Reduced Ambiguity & Errors of Omission

  • If it were possible to create a complete SOW online, which I obviously doubt, and even if both parties had to sign it, there still is room for ambiguity and errors of omission.
    • The customer may focus on the wrong aspects of the SOW.
    • Nuances may be missed.
    • My client knows what sections to go over with a customer to be certain they are on the same page as far as deliverables and specifications.
    • Ambiguities can be corrected before they become a problem.
  • This interactive, real-time process reduces the probability of errors of omission.

MSA

The MSA is Read Before it is Signed

  • A drop down MSA may not be read carefully by the customer.
  • I will not address the legal implications if, as is often said, most people never read drop-down agreements (though I do admit to being curious.)
  • My preference is to do everything possible to make certain that the customer has read at least the key commercial aspects of the MSA before signing it.
    • The assumption that a written or electronic version (Word, Google Docs, etc.) of an MSA will be read more carefully by the customer than a drop down may not be correct. I would take a bet on that though.
  • An example of a key term the customer needs to understand is the change order process – something I build into MSAs. The contract not only requires a signed change order to modify a SOW, but also sets out a process to be followed to get there.
    • The risk of not having a strict process is that people working on the project (and possibly low-level people at that) may decide on a substantive change without bothering with approval or even informing management. If the customer decides it is in its best interest to claim the change is binding, my client has a major problem. It may have to choose between a loss of margin on the project or making the customer angry.

Negotiation

  • Presenting a drop-down contract indicates unwillingness to negotiate.
  • If changes were to be negotiated, the contract would have to be converted to another format and then marked up, so a “written” agreement would still be required.
  • A contract provided in Word, Google Docs, or Apple Pages indicates room for compromise.
    • The Client does not have to accept every, or even any, proposed change.
    • If negotiated properly, my client will explain why the Ts and Cs are what they are;
    • The customer can make a rational risk-versus-reward determination based on the facts;
    • If the parties cannot negotiate a win-win contract, should they do business together?

Adaptability

(c) Can Stock Photo / photography33
  • Assume, hypothetically that the MSA requires my client to modify deliverables that fail to meet the specifications, but no time limit is given:
    • The customer may come back with a proposed time limit.
    • Following further discussions, the customer may retreat to a requirement that my client make its “best efforts” to match the deliverable to the specifications. “Best efforts” is a tough requirement.
    • My client may then come back with “commercially reasonable best efforts.”
  • A drop-down license does not provide a method to negotiate purposely ambiguous, but effective, compromises.

For creative content, among other types of deliverables, a drop-down SOW is not practical. A drop-down MSA is even less so, as any needed changes requires the parties to begin working with a separate document anyway. That is the only way valid negotiations, compromise and purposeful ambiguity can be introduced.

An additional article: 6 Elements of Good SOWs is available here.

Marking Information “Confidential” When it is Not

Many startups, especially those in high-tech, are very concerned about keeping their confidential information safe. Such a company should start with a well-drafted NDA, though that is not always the case.

What They Do.

I have noticed that these companies, with or without a proper NDA, tend to “protect” their IP by marking all their presentations, internal and external memos, etc., as “Confidential”.

The Risk

I was lectured on this topic by an attorney when I was running the M&A and Competitive Intelligence Groups for DSC Communications Corp. As I am not an attorney, and this is a quasi-legal issue, I want to provide proper attribution to John Roberts, Esq. of New Counsel PLC – http://www.newcounsel.com.

If a startup marks everything “Confidential”, necessary or not, it runs a significant risk. This is especially true if it adds “Confidential” or “Proprietary” to its slides and memos automatically by placing the word(s) in its MS Word or MS PowerPoint templates as a header or footer. How many of us have been guilty of that?Confidential Stamp

Assigning the terms where they are not really needed, “dilutes” (not the proper legal term) the effectiveness of the notice everywhere. If there is a dispute, the other side would produce materials marked confidential that should not be. It would argue that the start-up was not giving notice of confidentiality, but slapping the words on documents without proper evaluation or a fixed, rigorous policy.

The Solution

The lesson is not to use “Confidential” or “Proprietary” in templates, or at all if inappropriate. Mark as Confidential only presentations or memos presenting information that must be kept proprietary. Include essential business data and/or IP where there is significant risk if the information is misused or distributed to third parties. When in doubt the start-up should consult with counsel on whether information should be treated as confidential or not.

Three Things Not to Do When Negotiating

As this newsletter progresses, the subject of good negotiating skills is going to come up again and again. That is because I so often see people giving away the farm and their first born for no good reason. Many of the suggestions I will make are not original to me. I took the Karrass negotiating course and so should you if you are going to do much negotiating. It’s informative, useful, and a lot of fun!

This article is for more major agreements. Your day to day transactions may not require this level of sophistication. My suggestion is to use these techniques for any contract that is strategic to your company – strategic alliances (especially OEM agreements), core development agreements, master sales or services agreements that can make or break the company, and M&A transactions.

Effective Agreements does provide negotiation support as one of its services.

Don’t Start A Strategic Alliance with a Document

So very often, two companies work a strategic arrangement this way: the CEOs talk about the type of relationship, one says, “I’ll have my attorney create the first draft…but it will be very fair” and that document becomes the starting point. Why?

  • When the parties negotiate, they may be arguing about wording before the concepts are properly agreed, as the draft is unlikely to be all that fair
  • One party is playing catch up
  • You are paying someone to draft a document when you do not know if you can reach an agreement on the key terms
  • If the CEOs talked and came up with a general idea of what the relationship would look like, well and good, though my bet is that if you had each of them write down what was agreed to, the lists would differ
    LAdy Pinching Through Piece of Paper
    © Can Stock Photo / ivector

    significantly and lack any detail required to make it work.

The solution:

  1. Lock the principals, subject matter experts, and the negotiating teams in a conference room with a flip chart (and coffee and sweet rolls.)
  2. Include the principals at the beginning to handle the top most issues, but not for the detailed Ts and Cs.
  3. Have the two negotiating teams hash out every detail needed to make the relationship equitable to both parties and workable in the real world.
  4. Avoid errors of omission that could otherwise arise by using an outline covering all of the terms that belong in it.
  5. Even if he/she has been in the room, the person responsible for reducing the agreement to writing should take the pages from the flip chart and use them.

The strategic alliance is a special case, so some of the next two sections apply and some don’t. For example, it is always best to have a negotiating strategy going in, but the strategic alliance may be so amorphous at this early stage that a plan just is not practical. Conversely, some other types of agreements would benefit from a white-boarding session at the beginning and some would not.

Don’t Negotiate Without a Plan

This especially applies to the final negotiations on the written agreement.

Going into a negotiation without a negotiating plan is implicitly a decision to “wing it.” Perhaps that works for you in your personal life (it doesn’t in mine), but do you want to place the company at risk through the lack of simple preparation?

“Winging it” implies an unfocused approach to concessions given, compromises sought, necessary concessions from the other party, and to creating an organic whole agreement so the parts of the contract work together. What if you are winging it and the other side is well prepared with a thought-out negotiating strategy?

The Solution

A negotiating plan must be prepared that sets out the critical elements:

  1. What will be conceded when and for what in return
  2. The critical “must haves”
  3. The critical “must NOT haves”
  4. A list of the “nice-to-haves”
  5. Those terms that can be traded for other more important terms as the negotiations progress – the trading chips
  6. Arguments to make for your position on each issue
  7. At what point you would walk the deal. Anyone who negotiates without a clear notion of when they should abandon the deal, based on the “must haves” and “must not haves” will lose. The other side will detect the lack of room to maneuver, and will take full advantage of it every time, scoring concession after concession. Perhaps that point cannot be identified for inclusion in the plan. That is acceptable if the negotiator has permission and the absolute right to terminate the negotiation when he/she deems it necessary

The entire negotiating team described in the next session will need to update the negotiating plan, to reflect the negotiations to date, at least once a day in long negotiations and at every break for shorter ones.

Do Not Negotiate Alone

Multi-tasking may be the rage, but it does not belong in a negotiation.

The solution:

Four People at Conference Table
Four people negotiating around table

The proper negotiating team has three people (not counting attorneys – their number depends on the type of transaction.)

  1. The negotiator, who must focus on what he/she is saying and what to say next, while remaining aware of the negotiating plan
  2. Someone who just listens! This is the person in the best position to pick up on nuances in what is being said (or reflected in the other party’s body language.) He/she is also free to think several steps ahead, consider the whole picture and track the negotiating plan. When this person has a brainstorm – or panics – he/she slips the negotiator a note or calmly calls for a brief recess.
  3. The person that just takes notes. This does not mean notes on every back and forth. Only the actual terms that are agreed to or are specifically tabled for later negotiation needs to be recorded.

These rules may be difficult for the small company to follow, but they are more critical to them. Many small companies can be decimated by one badly negotiated agreement.

The Contract With a 500-Pound Gorilla

Whatever the size of your company, eventually you will be dealing with a contract with a 500-pound gorilla for the first time – a very large multinational, or just a company that is much larger than your previous clients/ customers. This is a good thing, as it means your business has grown.

The problem comes when the gorilla insists that you sign its sales or service document rather than your own. The problems that may result include:

  • The document doesn’t fit your business because it is a one size (or one type of vendor) fits all;

    500-Pound Gorilla
    © Can Stock Photo / cthoman
  • There are sections you could live with, if only they could be tweaked.
  • Some provisions are toxic and cannot possibly be agreed to.

Generalizations are risky here, as no two contracts will be alike. However, there is some advice I can share regarding the different issues, based on my experience.

  • The document doesn’t fit your business. I see this all the time with a client who prepares high-quality videos for companies to post on their websites. Very large companies send them their standard agreement for software providers, not creatives. Almost nothing fits. My favorite is when the document is rife with onerous confidentiality restrictions on the customer’s information. As the whole purpose is to make that information very public, those sections must be deleted. To address this:
    • Try getting the salespeople to have a frank discussion with the people they are dealing with at the company and explain the problem. Often, they will find that major changes are expected.
    • There are times that a section has absolutely no applicability to your business and it is safe (after taking great care to confirm your understanding with counsel) to leave it in. Sometimes in my example above, there are large sections protecting Personally Identifiable Information (PII), a requirement of the utmost importance for some companies. As there is no possible way for my client to get to PII, having no access to the company’s systems or facilities, the COO sometimes chooses to leave the requirements in.
  • The Sections You Could Live With if they Were Tweaked. If the client or customer is serious about wanting to enter into an equitable arrangement, they will expect to negotiate some points. Work with someone who can help you with corrective wording. Sometimes you will be told that modifications to some sections require lengthy legal review. Then you must consider accepting the risk versus losing the deal, which is what they are really saying – they are not going to wait.
  • The toxic provision you cannot sign. One of my clients received an NDA from a prospective strategic partner that made everything discussed between them – ever – the sole intellectual property of the prospective partner. My client, rightly, walked when the prospective partner would not give. There are several elements to this issue:
    • If there is a section that is that onerous (and ridiculous) you have to delete it. You may well find out the other side just puts it in knowing it will be deleted.
    • Their legal department may put in such provisions in the hope that someone will miss them and sign the agreement with them still in there.
    • The other party may really be insisting on onerous, one-sided terms.
500- Pound Gorilla Behind Bars
© Can Stock Photo / cthoman

If any of the three reasons immediately above is true, ask yourself “is this a company I really want to do business with?” If the legal department just wastes your time, as in the first sub-bullet, or acts like a bully and is a bit unscrupulous, as in the other two, they are not acting in a vacuum. The management team is likely to show the same behavior. Such companies do not make good customers, suppliers or allies.

Just because you are dealing with your first 500-pound gorilla does not mean you cannot negotiate a reasonable contract. If you need help, get it. But don’t just blindly accept terms that you will regret later because you don’t know what is and is not acceptable and how to negotiate for what you need.

A Master Sales Contract Referring to a Missing Document

Effective Agreements worked with a company, revising their Master Sales Contract template. The client readily admitted that the current template was a contract the vice president of business development had brought over from a company where he was previously employed. (Note: although we are not attorneys, we recognized there might be copyright and confidentiality issues. We pushed the company to involve legal counsel.) After covering

Upset Executive
© Can Stock Photo / lisafx

most of the issues in drafting a new contract template, we noticed a provision that all maintenance and repair would be provided according to the company’s “written Maintenance and Repair Policy.” Of course, when we asked if the company had any such document, the answer was “no.”

This missing document caused significant consternation.

In the first place, the contract template had been used with customers for some time before Effective Agreements was brought in. That meant that a lengthy policy had to be written quickly, before a customer had a repair issue. Writing such a document is not a simple task. A combination of technical knowledge, writing skills, and business acumen are required. Effective Agreements could oversee the project and examine the final product for clarity, but a technical writer had to do most of the drafting. It was also necessary to determine how the maintenance process would actually work, which meant pulling engineers off their current assignments to be interviewed. The head of engineering was loath to have his people diverted to create a document. But even that was not the biggest issue.

Motherboard Repair
© Can Stock Photo / MnyJhee

The client’s management had never tackled the key question of whether the maintenance program would be a cost center or a money maker. The need for the written policy made this decision urgent. Effective Agreements aided the company in crafting a tiered level of support with appropriate pricing for each tier. That made the maintenance and repair document more complex, adding to the time needed to draft it, but changing a cost center into a new source of income for the company.

The lessons are obvious:

  • Do not use a contract from a previous company as your master sales contract template
  • Make sure what any documents referenced in your master sales agreement actually exists
  • Have written maintenance and repair policy, drafted so the service will be a profit, and not a cost, center.

Read about Effective Agreements’ contract template services.

The Escalation Procedure

An escalation procedure commits people on both sides of a contract to meet and attempt to resolve disputes without costly arbitration or litigation. If there is no procedure agreed to in the initial document, the parties may find it difficult to work out a process to resolve major problems when they are already at odds. Putting a workable escalation procedure into the contract itself establishes the framework to be used if and when it is needed.

Man Holding aprt two huge boxing gloved hands
© Can Stock Photo / focalpoint

I discussed escalation procedures with attorney Phillip Cannatti of Lehtola & Cannatti the other day. I could not understand why this kind of process isn’t used in more agreements, particularly in service contracts. Phillip agreed. He pointed out that the attorney’s focus should be on keeping their client out of litigation, and this kind of procedure could further that goal.

Here is how an escalation procedure might work, using a master service agreement as an example:

  • First, the project managers must meet on the issue. If you failed to name project managers on both sides with equal authority, you did not get the original agreement right. The chances are that the project managers would meet quickly on a major issue anyway, but the escalation procedure has time limits (such as five business days) that force two very busy people to address the issue quickly and personally.
    • Project managers usually have a good perspective on what has happened to date.
    • They also should have a firm understanding of any technical and/or business issues.
    • It is also probable that the project managers will have a good handle on what the costs would be to make changes to the project, through a change order process (yes, you need a change order process – I have written about it before), and can present a plan to their respective management teams.
  • If the project managers cannot resolve the issue in the allotted time, the appropriate vice presidents from each firm become involved. Note that this is not an optimal outcome for the project managers, so they will be motivated to resolve the issue before escalating it. The procedure again requires very busy people to find time to meet and sets a time limit on their deliberations, say ten business days.
    • The vice presidents should have a firm understanding of the importance of the project in question.
    • They should have the authority to make changes that will alleviate the problem without further review, increasing the probability of the dispute ending here.
  • Finally, if the other initiatives have failed, the CEOs of the companies must meet.
    • This puts tremendous pressure on the project managers and vice presidents to resolve the issue themselves. Otherwise, the CEO is forced to take a meeting he or she would rather avoid.
    • The CEOs can make the tough decisions that may be required to fix any damage or choose to part ways.
    • CEOs like to get deals done, and they will be motivated to find common ground to avoid appearing as though they
      Business People arguing at table
      © Can Stock Photo / endotune

      failed.

If the escalation procedure is unsuccessful, a mutually-agreed termination may result, or there can be a provision providing for mediation and, if necessary, arbitration. Your attorney may prefer litigation in place of mediation and arbitration.

The procedure does not have to be more detailed than that. The time limits are important to prevent things from spiraling out of control. The rest should be based on experience and common sense.

Obviously, the escalation procedure is not a panacea. If the companies just cannot agree on anything, there may be no solution. However, sometimes the escalation procedures work, avoiding costly arbitration or litigation. Particularly smaller companies should adopt this as a useful tool for placement in all its major agreements.

Intellectual Property Protection: 7 Warnings

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The Concern

A surprising number of people enter the phrase “Free Intellectual Property Agreement Template” into search engines. The thought of someone using so important an agreement acquired in this manner is a cause for concern.

Someone searching for an intellectual property agreement probably intends to accomplish one or both of the following:

  • Protecting existing intellectual property while taking part in a commercial transaction or transactions with another party; or
  • Agreeing with another party to create or share intellectual property without any other commercial arrangement.

A template downloaded from the Internet would require careful modification by someone knowledgeable about intellectual property arrangements in Circuit Boardgeneral to protect the party’s intellectual property (IP) in a commercial transaction. Using it as is, or modifying it without sufficient understanding of the issues could be very risky. Your IP may be your most valuable asset – it is not worth the risk to fly blind.

A joint development agreement or a cross license for intellectual property are outside of the scope of this article. They are very specialized arrangements requiring extensive legal counsel and the advice of someone used to negotiating such arrangements.

For commercial relationships, the intellectual property agreement should be as protective as possible while still allowing the commercial transaction to proceed smoothly.

The Intellectual Property Sections – 7 Warnings

  1. Do not download a template from the Internet and try to adapt it to your needs unless you are very knowledgeable about intellectual property and its licensing or have guidance from counsel.
  2. Be sure you know what your intellectual property is and what portion of it is really important. Often start-ups think their “secret sauce” is in their hardware design when, in fact, it is their software. As a result, they may not include the right IP protection in their agreements. A stringent software license is required.
  3. You may be selling equipment with very little software content, but be sure to draft the appropriate protection for that software anyway. Grant a (very restrictive) license in the sales contract. Again, your attorney can be sure the right terms are granted, once you determine the business aspects of the transaction. If a customer is buying the equipment, their use of the software should obviously be very limited.
  4. Remember this rule above all others: you never sell IP, especially software. You license it. While this is a legal observation, it is one that has been pounded into any business person that negotiates agreements in which intellectual property is transferred. Be certain that you do not accidentally “sell” the software, even if it is just firmware. The only exceptions are when you are selling a product line or the company. Get a good law firm involved early if either is the case.
  5. Be very careful with any IP license in your agreement. Here are some examples, learned from experience:
    1. For hardware, be sure the recipient cannot “reverse engineer” or “create derivative works” from your equipment or its embedded software. Get definitions of these terms from your attorney;
    2. Man Pointing to Flow ChartYou may have to grant your customer permission to sub-license software to its end user. Unless there are special circumstance, be sure the right to sub-license is not passed on to the end user. A special circumstance would be if you sell to an OEM that bundles your product with its product and sells the resulting “solution.” If the OEM’s customer is not an end user, but a service provider, for example, it will need the right to sub-license to its end user, which can be a complicated arrangement (you have to be able to enforce this sub-license).
    3. Make sure there is a flash screen, label or something that tells any user at any level that you created the software. The attorney will insist on this for different reasons. Here, the point is that you would be giving up a golden opportunity for brand awareness.

Even the sections of “simple” sales and marketing agreements that deal with intellectual property can be complicated and of the utmost importance. You should be certain these sections are drafted clearly and that they provide the maximum protection for what may be your “crown jewels.”

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Exiting the Business Arrangement – Plan for the “Divorce”

One of my clients contacted me in a rather agitated state after I had not heard from him in some time. A party for whom he was performing services was not satisfied with the final work product and was seeking recompense. My client agreed that exiting the business arrangement was for the best, and had offered to return a major portion of his fee in the form of a refund. He started drafting a short “settlement agreement” himself, but realized that he could not complete an effective document on his own.  Exiting the business arrangement required the agreement of the parties on several thorny issues, and my client realized that they had to be addressed and the agreements written into the document clearly and with a lot of care.

Illustrative Elements of the “Divorce”

  1. The first task that my client recognized was dividing the intellectual property (IP).  Translating the simple bullet points my client prepared into words that adequately delineated each party’s IP was a daunting task. How, for example, do you separate “specific color combinations” from “look and feel” in a legal document? It took me and the client time and a lot of back-and-forth before we were satisfied that our IP descriptions were crystal clear and defensible.
  2. The next item to address was the refund. There was a purely legal consideration here, but I had to explain it to the client well enough that he would seek counsel. The point I made was that the refund could be referred to as “liquidated damages”. Those words, I thought, might change the money into a negotiated settlement that the other side would accept in lieu of any other damages or legal action. That is how the section ended up being drafted.
  3. Finally, I realized that once the document was signed and the liquidated damages paid, the other party had to be prevented from maligning my client’s work or company – a provision critical to my client’s future business. We successfully negotiated this term.

The Lesson to Be Learned

Have you guessed where I am headed? Both parties would have been better off if the terms of exiting the business arrangement had been considered in advance and the terms placed in the original contract.

  • Defining what IP was to be owned by whom at each step in the process should have been a part of the initial agreement as it should be in every service agreement.
  • My client’s exposure could have been capped at what the other party had paid to date well before any gulf developed between the parties.
  • Both parties’ legal remedies in case of a split should have been agreed to before the document was executed and before emotions clouded the issue.

Perhaps not all of the terms of exiting the business arrangement discussed in this blog could have been covered in advance, but most could have, and that would have prevented a lot of stress, arguments, bad feelings and needless fees when the time came.