Exclusive Contracts – The Plus Side

Sometimes a buyer or seller can benefit from an exclusive contract. This is true for product and service agreements alike. The former are covered here.

Here are some examples where exclusivity is of value to the seller:

  1. High Development or Specialization Costs. Does the seller need to develop specific functions for the customer that are unlikely to interest anyone else? If so, the seller has two choices:
    1. Gain exclusivity as a supplier, at least for a period of time, so that the cost of development or specialization is more likely to produce an adequate return on investment; or
    2. Charge a one time development fee, often called a Non-Recurring Engineering fee (NRE). The buyer would have to develop the new features covered by the NRE is the work is not performed by the seller. The buyer would take on an expense (and it may be more expensive for the buyer to perform the work), and it would also assume the risk of failure inherent in a development effort.
  2. High Cost of Sales. If the item in question has a long sales cycle, requiring significant effort and expenditure on the seller’s part, exclusivity should be sought. It is the investment in time and money that the seller must recoup. Its only alternative would be to charge a much higher price. The buyer may accept a period of exclusivity in place of a higher per unit cost.

With any of the above exclusivity choices, the buyer is likely to seek mutual exclusivity,
and the seller will have to consider it carefully.

There are also times when seeking an exclusive buyer might make sense for the seller. Has the seller lost interest in selling the particular product? Having the buyer re-sell it as part of a strategic alliance provides a path to the market at a low cost. Giving the buyer/re-seller exclusivity is worthwhile, as no sales would be made without the arrangement. (More information on strategic alliances is available here.)

It is likely that the issue of mutual exclusivity will come up in this case as well.

There are reasons that a buyer would agree to an exclusive contract with one seller, and there are reasons a seller might agree to sell exclusively to one buyer. In any case exclusivity should have a price – it is not something that should be given lightly or cheaply. See how Effective Agreements can help with these and other complex contract issues on our website.

The Purchase Order That Wasn’t

This morning, there was an article in the Proformative Member Digest that peaked my interest. (Wayne Spivak, What Do You Do When the Purchase Order Terms Are Outrageous.) The writer had received a Purchase Order from a client to look over. The vendor’s PO contained 20 pages of terms and conditions. Many of the conditions were ridiculously harsh, including an indemnity clause, insurance requirements, confidentiality clauses, and other major subjects that do not have any place in a PO.

The point I made was that the vendor had really sent a Master Sales Agreement disguised as a Purchase Order. This is not all that uncommon. Here are points to remember if you are ever in the same situation, some of which were in my reply to Wayne’s Post:

There are things to be said for a Master Sales Agreement. It locks in the terms and condition for a period of time, usually a year or more, so that they do not vary with every purchase order.
A Master Sales Agreement is a major document that should be negotiated at a high level by knowledgeable experts. It should not be disguised as a simple Purchase order.
Negotiating an MSA may be time consuming. You are investing time you will not have to spend later. If the process drags on too long, that tells you something about the reasonableness of the people on the other side (assuming you are being reasonable.) If there is continued insistence on onerous Ts&Cs, perhaps you have chosen the wrong party with which to deal. Unless the vendor is sole source for what you need, you should move on or at least carry on parallel negotiations.
Somewhere on the other side is an advocate for doing business with you. Make sure that person knows that the deal will go south if whoever is incorporating those onerous requirements is allowed to control the process.

This is pretty egregious example of a purchase order from Hades, but they are out there.

Sales_contract_Louvre_AO2753

This is a sales contract – a purchase order from 2600 BCE

Electronic Health Record (EHR) Contracts

The contracts to obtain Electronic Health Records (EHR) systems are just as difficult to understand as any other large software system deployment agreement.

The deployment of EHRs is mandated, and medical practices of all sizes are implementing systems. Others are finding that their original vendor is not living up to expectations Doctor on EHR System(which may mean being unable to meet the second stage functions the doctors must show to get government subsidies) and are looking to switch vendors. In either case, a complex software license agreement must be executed between the vendor and the user.

The problem is that many of the EHR license agreements are skewed toward the vendor and they are being executed by the users without a full understanding of onerous terms built into the agreements or beneficial terms left out. A few examples will suffice in this blog entry:

  1. Fee structure. Having seen the marketing information, the doctor may assume that all of the necessary fees are spelled out or that everything is obtained for one large fee. Unless the contract specifies, there are many elements that are needed that may cost extra. For example:

    • Telephone help desk support

    • Maintenance

    • All new software releases, including bug fixes and simple updates

    • Some training and implementation services

    • Creating/maintaining interfaces with other office systems

    • Transition services for moving to a new system (more on that below)

  2. Service Level Agreement. With most large software installations there is a Service Level Agreement (SLA). The SLA determines what the system being “down” means, how long the system may be down each time, how often the system can be down, etc. Penalties for excess or too frequent down time may be stipulated. Many of the EHRs lack any kind of SLA. What will the user do if the system is down 10% of the time, and the provider is not obligated to fix the problem for free or pay for the time lost?

  3. Divorce. Changing to a new vendor can be almost impossible. The agreement may not stipulate that the data can be produced in any standardized format. In some licenses, the vendor has possession of the data in the system, not the doctor. Ownership of the data is a matter being debated in the legal community and courts. There is very unlikely to be a term requiring the vendor to help in the transition to a new vendor for a fixed fee.

Buying any large software package requires care, and there are many specialized terms and conditions that must be reviewed and understood. Electronic Health Record systems are not an exception to this rule. The purchaser of the license should get help with the negotiation of the license agreement from a knowledgeable third party.

High-Tech Nondisclosure Agreements

High-Tech nondisclosure agreements present unique difficulties to the high-tech enterprise. Its intellectual property rights are its greatest asset. Consider:

1. Some large companies will place language in the nondisclosure agreement (NDA) that claims ownership of any intellectual property produced by the smaller company during the term of the agreement. This is rare, but I have seen it. Executing the nondisclosure is a questionable business decision. Should management take the risk or find a less rapacious customer/partner?

2. The nondisclosure agreement has a term (the time that it is in effect), but also has a clause that protects each parties confidential information for “x” years after termination of the agreement itself. This is a two edged sword. A longer period of confidentiality works for you, but it also extends the time you must be careful with the other party’s confidential information. This can prove burdensome. If your technology will be out-of-date in three years because of the development cycle in your industry, three years of confidentiality after termination will do.

3. In the Nondisclosure agreement, there is always a list of items that are not considered confidential. For example, information that turns up in the public domain, but not because of anything either of the parties did. There is one exclusion that is not always included that should be: if the receiving party develops something that is contained in the disclosing party’s confidential information without reference to that confidential information. You do not want to discontinue a project or otherwise hobble your development team because the disclosing party has developed something first, as long as you are honest. If you circulate the disclosing party’s confidential information to your development team with instructions to duplicate the intellectual property (IP) in question, you face may face problems your low ethical standards deserve.

(Be careful if the exception is for something developed by people that did not have access to the other party’s IP. If you are a small company, you may not have a large enough development group to create a “Chinese Wall” between projects.)

All NDAs are important. High-tech companies’ nondisclosure agreements may be just a little more difficult to negotiate and finalize. Effective Agreements can help.

Drafting Commercial Contracts: The Problem

Too many companies drafting commercial contracts focus solely on the legal necessities, “winning” the negotiation and covering all of the possible risks.

None of the above are bad things, though achieving all of them is unlikely in a fair transaction. My arguments are that there are practical situations that must be taken into account as well and that a masterful document will not serve if it is drafted without the commercial realities considered. Some of the terms may not be as strong when you are done, but they will work to both party’s advantage.

Drafting Commercial Contracts: Examples of Built-In Problems:

  1. Payment terms are on acceptance of a service or deliverable. This only works if “acceptance” is defined and codified carefully in advance. If there is to be an acceptance test, it should be agreed to in writing before the relevant contract is signed. The hardest part is often determining against what standard the service or the deliverable will be measured.Complicated-Agreement
  2. Parts of the commercial contract do not tie. One example would be where what is being purchased/sold is separate from the pricing schedule. The item is described in one place, but not called exactly the same thing in the pricing section. While this may not kill a deal, it can introduce confusion.
  3. Indemnifications are not parallel or at least equitable. Common practice seems to be for the drafter to make the indemnification unilateral for the first pass. All this accomplishes is a delay; few companies will actually accept a unilateral indemnification. The indemnification for intellectual property infringement, for example, may be unilateral. But, the drafting party should not ignore indemnifications for which it should be responsible, such as violation of confidentiality, death, or injury.
  4. Non Disclosure requirements are clumsy. These often have unworkable terms. One is that information must be marked confidential, with oral information reduced to writing and stamped accordingly. Assume the companies work together on the project for six months. How many times will this provision even be remembered? My preference is that whatever could be reasonably assumed to be confidential information is confidential. This reduces the record keeping burden tremendously.

These are only a handful of examples in which drafting commercial contracts poorly wastes time and money for both parties involved.

The International Sales Agreement – Some Differences

Negotiating an international sales agreement requires additional care and work to be accomplished successfully.

  • The foreign sales agreement, even if no strategic alliance is created, will be based on a different level of trust and personal comfort than a domestic one.
  • The costs of structuring an international sale are high. This means that encouraging, if not obligating the other party to multiple sales with a Master Sales Agreement would be worthwhile.International-Strategic-Alliances-Flags
  • Unlike the normal domestic sales contract, the international sales contract relationship may morph into an international strategic alliance.  It may be to your benefit to to encourage the longer term sales relationship.
  • That means the negotiations  will be that much different as well.

Foreign Accounting and Taxes

It always amazes me when someone goes for even the most basic international contract and fails to take into account the differences in accounting rules and especially in taxes. I have been involved in a transaction where the definition of an accounting term was paramount to the deal. The contract presented by the foreign company had the definition in three places, none of which was understandable by our team and each of which had major tax implications one way or the other. They should have used an expert such as an international accounting firm.

Listening More Carefully

Nuances in the negotiation may influence the final terms of the sales contract. Understanding what the other party, who may be speaking English as a second language, requires concentration. I once saved a deal – actually an M&A transaction {Link}, but the point is a good one – where the deal almost fell apart due to an argument about inventory turns (a measure of how fast investment in inventory is showing a return). Because I was free to listen, I heard something that indicated the ratio was calculated very differently in the country in question, and put the parties back in synch.

The international sales agreement is rarely a simple document to negotiate. Special care should be taken and additional expertise involved in accomplishing such a relationship.

The Escalation Procedure

An escalation procedure commits people on both sides of a contract dispute to meet and attempt to resolve it without costly arbitration or litigation.

Here is how this procedure might work, using a 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 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.
  • If the project managers cannot resolve the issue 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 highly motivated to resolve the issue before this point. The Escalation Procedure Meetingprocedure again requires very busy people to find time to meet, and sets a time limit on their deliberations.
    • The vice presidents should have a firm understanding of the importance of the project in question.
    • They probably have the required authority to make changes that will alleviate the problem without further review.
  • Finally, if the other initiatives have failed, the CEOs of the companies have to meet.
    • This puts tremendous pressure on the project managers an vice presidents to resolve the issue themselves. Otherwise, the CEO is forced to take a meeting he or she would rather avoid.
    • The CEOs are able to make the tough decisions that may be required to fix the damage.
    • CEOs like to get deals done, and they will be motivated to find common ground in order to avoid appearing as though they failed

If the escalation procedure is unsuccessful, the normal litigation process begins.

Obviously this procedure in not a panacea. However, sometimes the escalation procedures work, avoiding costly litigation. A small company should consider this as a useful tool for placement in its major agreements.

If the Nondisclosure Was a Hassle, Wait Until the Definitive Agreement

If you have trouble negotiating the nondisclosure agreement, you will have equal or greater difficulty achieving the definitive agreement(s).

When a mutual NDA was sent to my client, the other company was well-protected while the definition of my client’s confidential information was limited to pricing and financial information. Nothing protected the client’s intellectual property, including methodologies and trade secrets. The damage was done by one sentence out of several pages of nondisclosure language, and it took a couple of readings to spot.

When faced with this kind of heavy-handed dealing, the seller or service provider must Nondisclosure-impasse-means-troubleconsider the implications:

  •  The other side’s attorneys are running the show, and they are more interested in achieving dominance than in a mutually beneficial business arrangement.
  • It is not jut the attorneys – the company management believes that the negotiation must be “won”, whether the resulting business terms are fair or not.

What can you do if you find yourself in a difficult negotiation on the nondisclosure, before the definitive agreement is ever begun? Consider the following:

  • Be certain that the other party is one with which you want to do business. If the discussions are heated enough, it may be wiser to “fire” the client or strategic partner, as a workable deal is unlikely. I realize this is a difficult, rarely made decision.
  • Watch the other party very carefully. Attention needs to be paid to every negotiating point and each word in the draft agreements – much more than normal.
  • Assume getting to a workable business deal will take twice as long as usual, and plan accordingly.
  • Assign your most experienced negotiators to the task and have management kept closely informed.
  • Make sure that the nondisclosure and later agreements protect your intellectual property to a sufficient degree, or walk the deal.

Trying for a strong negotiating position in a nondisclosure is normal. If the other side goes well beyond that, you must consider if you wish to continue the negotiation.

International Business Negotiations

I have engaged in international business negotiations in more than ten countries around the world. Each transaction presented its own challenges.

Different Culture, Different Negotiation Strategy

  • A different culture means a different negotiation strategy. That does not mean that you should not have one. Your overall strategy may include a year of developing relationships. Eventually, though there will be a negotiation, and a negotiation strategy that takes into account all of the cultural differences between the parties will be require
  • There are companies that will help you prepare and provide guidance while you are in the foreign country. I would be very hesitant to do any kind of deal in China without consulting Pacific Rim Resources;
  • If you have employees from the country in question, use them if there are no cultural barriers to doing so. For some countries there is.
  • Read the books. There are now several books in the Kiss, Bow or Shake Hands series, some on business in certain areas and all designed to help the business person.

Business Terms

  • Try to learn as much as possible about business parameters such as accounting regulations in the other country. Do not forget that a company in Europe does not have to keep its books according to GAAP. (See a “war story” about just that issue.)
  • The European Union has a body of law that will have to be taken into account. This is a legal point to be discussed with counsel; I just know the EU laws impacted acquisitions upon which I worked.

Canada

I throw this in because Americans forget it so frequently. Canada is a foreign country, not the 51st state. You may think they do business just like us, but you would be wrong. If nothing else, remember that their legal system and way of doing business come from England, not the United States.

International business negotiations are more difficult. With proper preparation, including a complete negotiating plan, they can be approached calmly.

One Big Thing to Watch For in a Nondisclosure Agreement

Occasionally, we come up against something that we see rarely, but is of high importance. This is definitely a “forewarned is forearmed”.

The Situation

Our client had received a “standard” Nondisclosure agreement from a potential customer, along with the draft Master Services Agreement.

The Grab For the Intellectual Property

In the middle of the Nondisclosure was a full section on intellectual property. This was wrong in so many ways:

  • Any discussion on intellectual property belonged in the central document, not in the Nondisclosure;
  • The section was drafted so that, upon the client completing the assignment, the customer would own all of the intellectual property embodied in the deliverable or used to create it. The result would be that our client would give up all of its intellectual property rights in its methodologies and in its proprietary software platform;
  • The customer licensed back much of the intellectual property (should the client have been foolish enough to accept this arrangement), but the license was badly flawed, including the fact that it was subject to cancellation;
  • There was no mention of separate payment for the intellectual property. Was the fee the customer paid for the work sufficient for the intellectual property as well? To our client, the value of the intellectual property would (rightly) be nothing less than the amount required to purchase the entire company.

 Was This a Serious “Grab” for Intellectual Property Rights?

One must ask if this was actually a serious attempt by the potential customer to obtain the IP. It does not speak well of their contract process. There are three possibilities:

  1. The Nondisclosure, was the wrong document, sent in error. (What would that say about checks an balances?);
  2. The customer’s hope was that someone would sign the Nondisclosure without reading it, giving the customer the intellectual property rights for a song;
  3. Whoever sent the NDA knew that the onerous terms would be rejected out of hand, but always includes the language for some unknown reason.

The lessons here are obvious:

  • Never, ever sign a Nondisclosure without reading it as carefully as you would any other document; and
  • Beware of a wolf in sheep’s clothing!