Vendor Agreement Overview
Vendor contracts are essentially written agreements between your company and an entity you are purchasing products, services or materials from. They specify the details of the transaction and are intended to establish a binding agreement that lays out all parties’ obligations and protects your interests.
The details included will depend on the nature of the arrangement. For example, if you are writing a contract for computer supplies, you will want to ensure that any hardware or software you purchase is covered, as well as any warranties on that equipment. You may also want to include a clause that outlines how issues will be handled should they arise with the supplier , just in case you receive defective or otherwise problematic products.
The contract can also be written to ensure that your company will protect your intellectual property if your supplier has access to any confidential information about your products or processes — though this typically requires separate coverage in an intellectual property agreement.
This is also where you will want to stipulate payment information — what the costs will be, how you will pay your vendors, and when they will be paid. In many cases, this also includes contingencies, where payment is based on terms such as shipment or delivery.
What Does a Vendor Contract Need to Cover?
Vendor contracts, sometimes called vendor agreements are essential for any business that relies on external suppliers for the goods and services they need to operate. An experienced business lawyer can help you prepare an effective contract that serves your interests by establishing a clear expectation for how you and your vendors will transact business and handle any disagreements.
Every vendor contract should contain some standard elements including terms and conditions, delivery schedules, payment terms and confidentiality provisions. As well as establishing these terms and conditions, vendor contracts can also be drafted to establish guidelines for the advertising of your company by your vendors. This type of provision may be particularly important for businesses that rely on their reputation as part of their business model, such as a luxury brand.
"The Terms and Conditions of the agreement govern how your company and the vendor will work together."
Terms and Conditions
The Terms and Conditions of the agreement govern how your company and the vendor will work together. These terms must be carefully chosen. If you’re working with an international vendor, you need to consider whether the terms will hold up in the country where your vendor is based. You need to consider the time and date of delivery and what might happen if the vendor fails to meet this deadline (i.e., may you burn through a retainer he agreed to in advance?) The Terms may also address the scope of work performed by the vendor and its employees.
Delivery Schedule
When will the vendor deliver the goods or services? Where will they be delivered? Which party is responsible for shipping costs? How should the products be shipped? An established delivery schedule protects your business from future problems. For example, if you are a bakery that needs to receive a regular supply of flour, your vendor will be responsible to fulfill the order each week. However, if you don’t establish a schedule, the vendor could decide to be lazy, leaving your business without the ingredients you need the following day or to decide to raise the cost of delivery or to even stop taking your orders altogether. If you have a 10-year contract and only realize the problem in year 5, the resulting loss in revenue can be catastrophic.
Payment Terms
Your contract needs to establish the payment terms for the goods and services being provided by the vendor. When are you required to pay the vendor? When does the contract become official? Are there any additional costs or expiration dates? Will the vendor be providing financing to your business? Is your order guaranteed for a certain time period? Can the vendor guarantee that they can fill the order? These terms should be crystal clear when both parties sign the contract.
Confidentiality
Most vendors are granted some access to confidential or proprietary information about your company. This includes passwords, usernames, employee information, financial data, trade secrets and more. You may want to require the vendor to sign a non-disclosure agreement in addition to the Terms.
Forms of a Vendor Contract
There are several types of vendor contracts that differ significantly in their structure and the protection they provide.
• Fixed-price contracts are generally the most advantageous for the client company. These contracts determine an exact price for the product or service at the onset of the engagement, and do not change throughout the duration of the contract. These contracts also put nearly all risk on the vendor, who cannot adjust the cost once it’s been agreed upon. For example, an IT services company may agree to a fixed-price contract to develop a new software system for the client company instead of billing by the hour. The vendor will be at a loss if unexpected problems arise during the software development process. While this type of contract can result in a larger loss for the vendor, its upside is that the vendor retains any extra profit for developing the software more efficiently. It also incentivizes the vendor to do the job correctly, because the vendor will not be able to make up the cost on future billings.
• Cost-reimbursement contracts are the polar opposite of a fixed-price contract. In this case, the client agrees to pay the vendor an agreed-upon fee plus all of its costs associated with the work. These agreements can include some sort of limitation on the total amount of money that will be paid out over the life of the agreement. For instance, if a client is purchasing products from a third-party vendor, the vendor may agree to a cost-reimbursement contract that allows the client to be billed for the vendor’s incremental costs such as shipping, labor and materials on top of a per unit cost of the product itself.
• Time and materials contracts are hybrid arrangements that consist of a fixed cost plus all of the vendor’s costs, plus a fixed markup on its labor at the current rate charged. These agreements are designed for projects of short duration where it is difficult to foresee the level of effort required to complete the project. A client seeking the development of new software system may enter into a time and materials contract with a third-party IT provider instead of a fixed-price contract, where the vendor will provide hourly services for system modification at a fee of $150 per hour, plus a $100 per hour labor rate.
Advantages of a Vendor Contract
By establishing clear expectations and legal protections, vendor contracts can provide a solid foundation for business relationships and help ensure long-term success. While not every company is required by law to have a written agreement with every vendor, doing so is a best practice. Even companies that are required to have contracts under federal or state law should have a formal written agreement in place. In short, these agreements are crucial to managing risk and protecting valuable assets.
The following are among the specific advantages of implementing vendor contracts:
Risk Management – In an ideal world, vendors would never fail to meet their obligations. Disputes would never arise. All relationships would function smoothly and without error. Unfortunately, this is not reality. The reality, however, is that having a written agreement in place can significantly minimize risk and limit liability exposure. For example, a contract may detail what happens if a vendor fails to deliver a service or product as expected. It may make clear what recourse the vendor has when the buyer is in default. It might even address how, when and where the buyer can file lawsuits, mediation or arbitration.
Clarity – One benefit of a written contract is that it clarifies obligations of each party. If there is no agreement and a dispute arises, it may be more difficult to determine who was responsible. Without a clear understanding of who was responsible for damages, it may be difficult or impossible to collect any compensation.
Not only do written contracts help to clarify expectations in business arrangements, they can also help to clarify communications. The reality is that businesses may communicate in different ways, and not all communications about important matters are accurate. Written contracts clarify what has been agreed to, and what has not been agreed to.
Legal Protections – Contracts are legally enforceable agreements. Some oral or implied agreements may also be legally binding, but contracts are the surest way to definitively establish the rights and obligations of parties. Contracts can also be extremely useful in court if there is a dispute about the agreement.
Relationship Building – Strong relationships are an important part of every business. Having a formal written agreement can help to engender a level of trust and respect on both sides. By clearly defining expectations, the contract can ensure that everyone involved has the same understanding about how the arrangement should work. As a result, everyone understands their responsibilities, making it more likely that the business relationship will flourish.
Common Vendor Contract Issues
Not knowing your business case and not understanding the big picture are some straight-forward mistakes companies make when dealing with vendor contracts. But the problem is compounded by a tendency to panic when you think you have to move quickly. So the result is that you are signing a much more vendor-friendly agreement than you should be. A vendor contract review can help to prevent this. Other common mistakes that companies make involve costs. Many times, companies do not know whether their costs are reasonable or how to calculate them. A cost analysis helps with this. Another cost-related issue is that many companies enter into multi-year agreements and do not include sufficient flexibility for future changes that could lead to unexpected additional costs. A vendor contract review can help to add in the necessary flexibility for, i.e., changes in quantity, changes in volume, more or less access. For example, when you buy new technology, whether on a ten-year schedule or ten-week schedule, consider the need to scale up or scale down and include in the agreement that option for flexibility .
One of the biggest challenges faced by a company when drafting or reviewing a vendor contract is that many vendor contracts have "no fault" clauses. They indemnify the vendor by stating that the customer has to cover all liabilities. Vendors try to limit their own liability, but often do such a poorly because they are relying on legal boilerplate that they do not understand. A well-structured contract addresses liability issues by talking about "material" breaches. These should be defined and restricted to specific areas of breach. From a services standpoint, not meeting the agreed-upon Service Level Agreement (SLA) such as uptime, response time or service delivery fails can become a material breach. Vendors use no-fault liability clauses to deal with SLAs. They basically say that if the SLA is not met, you still have to make the payments and that saves the vendor money, but at the same time it costs the customer for failures that should be caught and fixed. As a customer, you want to make sure that your services are actually being provided and the vendor is not being allowed to avoid liability for a failure to do so.
Drafting a Vendor Contract
Before entering into a contract with a new vendor, a business should, among other things, consult legal counsel and other relevant experts from the appropriate departments within the company. This will help identify the terms that should be contained in the contract. The contract itself should be prepared clear and unambiguous. The law favors the enforcement of contracts as a reflection of the mutual will of the parties, and thus unclear language may be interpreted against the party that drafted the contract, or in favor of the party claiming that the language is ambiguous. Among the types of terms that should be considered when preparing a vendor contract are: Contract duties, obligations and performance Indemnification Insurance Remedies for breach Confidentiality and trade secrets Warranties Intellectual property Audit rights Dispute resolution
Amending Vendor Contracts
Vendor contracts should not just be static documents that are ignored once signed. Vendors, your business needs, and the law can and do evolve. Some of your vendor contracts may contain clauses that require compliance with certain federal laws, state laws, or county ordinances. You may sell your business and have a new owner of your business now subject to laws not applicable when the contract was signed. Perhaps there are additional federal regulations you need to comply with now. Maybe you learned from experience with a vendor that a contract provision is not being adhered to and needs to be updated. All of these are examples of situations in which your existing vendor contract may need to be updated.
One of the key purposes of vendor contracts is to serve as a road map of what happens if something goes wrong and a party to the contract has not followed the terms or conditions of the contract. Perhaps the contract becomes impossible to follow. This can occur because of changes in applicable law. If the contract you have with the vendor does not require the vendor to follow applicable law, this can present problems. Or maybe it was not apparent at the time the vendor contract was signed that the applicable law would change. In such a case, the vendor contract may need to be updated to ensure that both parties to the vendor contract have a clear understanding of the applicable law as it stands now and the obligations each party has.
Perhaps, through experience, you learned that a vendor contract with one of your vendors could be improved to provide additional protection for you. For example, recent changes in the law may have changed the extent to which a vendor can be liable for a data breach involving your customers’ private information, but your vendor contract may not be updated to reflect the latest changes. In this case, you may want to consider updating the vendor contract. In other instances, where the vendor contract does not contain its own liability provisions, you learn, through a separate contract with another vendor, what some of those provisions should be. For example, the vendor contract you recently signed with another vendor requires insurance coverage for errors and omissions by the vendor and appropriate liability limits. In contrast, the vendor contract with your earlier vendor probably will not contain insurance and limits obligations. In this circumstance, you may want to consider updating the vendor contract with your earlier vendor.
Regardless of the reasons, each vendor contract should be reviewed regularly in case it needs to be updated.
Vendor Contract Dispute Resolution
Dispute resolution clauses are common in vendor contracts, particularly those involving partnerships and joint ventures. The most common dispute resolution mechanism is alternative dispute resolution (ADR). This may include mediation (negotiated settlement) or arbitration (the neutral decision maker settles the dispute).
This may seem like an unnecessary clause in a vendor contract, however, it can be a key for both parties in the event of an issue that requires some form of conflict resolution. A dispute resolution clause in a vendor contract could eventually save both parties time and money if a conflict arises due to a misunderstanding between the parties about the provisions of a contract. It can provide a structure to handle the dispute without damaging the relationship.
There are a couple of possible solutions that can be included in vendor contracts. First, note that virtually any form of negotiation or settling could be put in the dispute resolution clause. Parties may draft their vendor contract to specify how to resolve a disagreement either through arbitration or mediation (or identify any form of analysis between these two systems). Most international vendors use an arbitration clause because a mediator cannot issue a decision that is binding on both parties. A mediator does not have power to enforce their decisions , which is what discourages some people from using this form of dispute resolution. However, it is important to note that mediators cannot be called out to the contract unless there is a mutual agreement to employ one.
Additionally, the parties may specify the location of a dispute resolution hearing, and identify specific procedural requirements to the provision. This can often involve both parties agreeing to the dispute resolution procedures in good faith, or the parties may agree to specific time limits for each stage of the dispute resolution process. If the parties’ move to court, it may be set up like any other civil case. The dispute goes before a judge to be settled (often with the hopes that the parties will also be able to work out their issues and settle without involving the judge).
If a dispute arises, the parties should try to determine whether the dispute can be resolved without the courts. Once courts are involved in the matter, the proceedings can become more expensive and protracted.