Agreement Payment Terms

Are you concerned about when you get paid for your product or services? You should be, as the payment terms affect the profitability of the transaction.

The longer the period between the sale and when you get paid, the more working capital required to maintain your business. Working capital is never cheap, whether or not you have to borrow any part of it. There is an internal lost opportunity cost for money tied up
in accounts receivable – it cannot be used for growing the business.

I advise my clients to try to make invoices payable upon receipt. It is not a point you win all the time, but for the small company in particular, it is worth a try. After that we try for thirty day terms as opposed to forty-five days, and so forth. Some of the large companies will try to impose forty-five, sixty or even ninety day terms. Sometimes the point is negotiable and sometimes not, but the small company needs to push hard on this point.

If an agreement’s payment terms are not drafted carefully, they can cost you money and/or cause unnecessary confusion. A client’s salesperson recently sent me a Statement of Work attached to an email. The SOW said the client’s customer would pay $2,000/month for the client’s services. The salesperson wanted to emphasize that $2,000/month was a really good price. The email mentioned that the fee was actually payable annually up front. If it were not for that comment, I would have ignored the payment terms. The customer could have paid in monthly installments rather than a lump sum up front, no matter what had been negotiated before. Even with very low interest rates, $24,000 spread over twelve months is worth less than $24,000 right now.

Close attention should be paid to the payment terms to prevent confusion and to conserve working capital as much as possible.

Work Stoppage and Delay Fees

What are work stoppage and delay fees?

Assume you are a service provider and you are taking videos of clients’ products for their websites. You have camera people, production staff, voice over talent and other staff all ready for the day’s shoot, and you have booked the studio for the day.

What happens if the Client prevents the work from going forward on time? Perhaps the product to be shot does not arrive in time to be assembled properly. Or the client decides on one more script edit at the very last minute.

It does not matter if the client stops the work arbitrarily or if work grinds to a halt because

the client failed to meet its obligations on time; you, the service provider, are going to feel the pain.

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What is needed is protection in the form of work stoppage and delay fees in the Statement of Work (SOW) executed with the client:

  1. A provision passing on the unavoidable costs incurred because of the delay; and

  2. A significant hourly fee for the time the work is delayed.

This is a fair arrangement. The hourly fee provides an incentive for the client to keep to the schedule it agreed to. The charge for unavoidable incurred costs is clearly fair. If the service provider can take steps to reduce those costs, it is obligated to do so, so the client pays only for what costs the service provider could not postpone.

Perhaps these provisions do not fit every arrangement, but work stoppage and delay fees payable by the client can be important protection for the service provider.

Contract Termination For Convenience

Termination for convenience is like having the other side pick up their football and go home. If you are the seller or service provider, a unilateral termination for convenience can bring a lucrative arrangement to a sudden halt.

Assume you have a deal to provide services to a customer. The Master Services Agreement would set out the terms and conditions and there would be a Statement of Work (SOW) for each project or portion of a project. Now, the buyer terminates either one for convenience:

  1. What were your up-front costs in preparing to perform the services? Are there set-up costs, targeted development, or just costs of deploying resources? In other words, do you incur a lot of costs in the early days in the hopes of having reduced costs when you perform the services down the road?

  2. Did you hire extra people or enter into a subcontract with them? What can you do with those people if the customer terminates early for convenience?

If the customer just cuts off the business on a corporate whim, you will suffer financially.

There are some ways to protect against damage from early termination:

  • Do not agree to termination for convenience at all.

  • Insist that the termination cannot occur before a certain amount of the work has been performed.

  • Set it up so that the buyer has to pay to terminate, perhaps on a sliding scale over time.

  • Have a long period of notice required before the termination so you have time to adjust and hopefully replace the business.

Early termination by the other party is a serious matter that should be negotiated carefully in any agreement.

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.

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.