Negotiating contracts for the sale of goods

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Corporate Update

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What’s your price? How many can you send? When can you deliver? These are the questions that first come to mind when negotiating a contract to buy goods. While those key elements form the core of any transaction, they are far from the only considerations that should be addressed in a robust contract for the purchase and sale of goods. Particularly when entering into a long-term relationship, parties should unpack those three key questions as well as address a number of other issues before signing on the dotted line.

Finding the right price

Pricing plays a pivotal role in the success of any business. However, the price of goods may not be static over the life of an agreement, particularly in a long-term relationship or where custom goods are being ordered. In those situations, the parties must be clear about whether prices can change and what boundaries apply to any price adjustments.

For example, price increases may be forbidden, or may be permitted at any time or only at pre-determined intervals, or may only be permitted in extraordinary circumstances (e.g., change of law). Changes may be capped, either by a negotiated rate (e.g., 2% per year) or with reference to an external benchmark (e.g., not to exceed CPI). The supplier may be required to provide evidence of increases in its own costs to justify an increase in the price charged to the buyer. The buyer may even insist that prices can move both ways — up or down — in response to external changes in costs. Whatever the case may be, the contract must clearly define if and how pricing can evolve over time.

Quantity matters too

Quantity may be particularly relevant to both price (where volumes may drive discounts) and to delivery timing (where production capacity may constrain lead times). Parties must therefore specify any limits on order quantities and describe the consequences for price and delivery time of any material changes to orders. In longer-term arrangements, a buyer may agree to provide purchase forecasts to assist the supplier in planning its production. The buyer may even request that the supplier hold a dedicated “safety inventory” to ensure that it can respond to sudden spikes in the buyer’s demand. Before agreeing to such concepts, a supplier should clarify what happens if the forecasted demand never materializes or the safety inventory is never used.

In some circumstances, the supplier may be forced to take the risk of managing its own production planning to meet the buyer’s demand.  In other situations, particularly for “must have” or “just in time” supply chains, the supplier may be willing to share in the risk by agreeing to “take or pay” minimum purchase commitments or to other forms of compensation if the supplier’s inventory expires or becomes unmarketable.

Timely delivery is critical

Stating a delivery date is a good start, but may not be the end of the story. Parties should also indicate whether those delivery dates are firm, address how and when a deadline date can be moved, and specify what happens if a deadline is missed. Where deadlines are intended to be firm, the contract should say so and may also include “time is of the essence” language. Where more flexibility is intended, the contract may state that the supplier will “use reasonable efforts to deliver” by the deadline (rather than “shall deliver”).

Even where deadlines are firm, a supplier may be excused for delivering late as a result of an event of force majeure or some other “excusable event” (e.g., the buyer failing to approve specifications on time). Despite their importance, such force majeure and excusable event provisions are sometimes relegated to the last few pages of boilerplate in a contract. However, they deserve the parties’ specific attention, as many business are now learning as they scramble to determine whether COVID-19 is included in their force majeure provisions. Ultimately, some delays will not be excusable. A comprehensive contract will spell out the consequences of inexcusable delays, which can range from a right of the buyer to receive discounts or liquidated damages to a right of the buyer to terminate all or the delayed part of its order.

Other important issues

If price, quantity and timing were the only issues that mattered, every contract would fit on a cocktail napkin.  That is clearly not the case. Here are some of the other key issues to consider in a contract for the purchase and sale of goods:

  • Payment terms: When does the buyer have to pay? This is an obvious corollary to the pricing question. Simply stating “net 30” or something similar may not be sufficient. For example, when does the 30-day clock start ticking: upon shipment, delivery, transfer of title, complete of inspections, other? The contract may also state consequences of late payment, which could include interest on overdue amounts or a right of the supplier to suspend future shipments.
  • Order documentation: What is the mechanism for placing orders? Purchase orders are commonly used, but they can introduce confusion if they include terms that supplement, or worse yet, contradict the terms of the main contract. To avoid a “battle of the forms”, parties should be clear about what form of PO is permitted and how any inconsistencies with the main contract are to be resolved.
  • Transfer of title: When does the buyer actually take ownership of the goods? Buyers will typically want title to transfer as early as possible in the process (e.g., as soon as the goods ship). The supplier may have a very different view, preferring to see title transfer only once they have been paid in full. Sometimes the compromise is to permit the supplier to take a purchase money security interest in the goods until they are paid. However, granting a PMSI to a supplier may create other issues for a buyer who has agreed to deliver clean title to its customers or to grant first priority security to its lenders.
  • Risk of loss: Who bears the cost of loss or damage of the goods? While risk of loss may shift to the buyer at the same time as title transfers to the buyer, that is not always the case. For example, a buyer may want to take title as soon as goods are ready to ship, but may insist that the supplier bear the risk of loss until those goods are delivered. If the goods are then damaged in transit, the supplier may be responsible for the cost of replacing goods that the buyer owned at the time they were damaged. Whoever bears the risk of loss at any given time should ensure that they have adequate insurance that covers the risk of loss.
  • Importation: If goods are crossing an international border on their way to the buyer, who is the importer of record? The importer of record must attend to customs clearance matters and may also have to pay duties and/or taxes at the time the goods cross the border. The contract should be clear about which party acts as importer of record and about whether pricing includes or excludes duties and taxes that are imposed at the time of importation.
  • Inspection and acceptance: Does the buyer have the opportunity to inspect goods on arrival? Such inspections may simply involve counting boxes and looking for obvious damage, or may follow much more detailed technical protocols to verify that goods perform to specification. The contract should capture what type of inspection will be done, how much time the buyer has to complete it, and what happens if the goods fail the inspection. To narrow the scope for disputes, it is always best to tie inspections to specific, objective, measurable criteria (rather than using subjective language like “the buyer is satisfied with the goods”).
  • Warranties: What warranties do the supplier offer? Warranty provisions must state how long a warranty lasts and what it covers. The provisions should also say what is not covered, which may include situations where the buyer does (or fails to do) something that voids coverage, and may also include disclaimers of implied warranties (which can arise under statute, like the Ontario Sale of Goods Act, or under international treaties like the UN Convention on Contracts for the International Sale of Goods). Where a supplier is combining parts and materials that it has sourced from third parties to make the goods it is selling to the buyer, the supplier may also want to clarify if it is passing through third-party warranties (such that the supplier’s warranty excludes issues covered by a third-party warranty) or if the supplier’s warranty “wraps” any third-party warranties (such that the supplier must remedy issues even if its own suppliers breach the third-party warranties).
  • Limitation of liability: What is the extent of the supplier’s potential liability under the contract?Commercially reasonable parties accept that a supplier should not have uncapped liability for any and every breach of a contract. Contracts for the sale of goods therefore typically include a liability cap for the benefit of the supplier. That cap may be a fixed number (e.g., “not to exceed $1 million”), may be determined with reference to other variables (e.g., “not to exceed amounts paid in the previous 12 months”), or even a combination of both (e.g., “not to exceed the greater of $1 million or the amounts paid in the previous 12 months”). It may also be appropriate to exclude certain types of indirect, consequential, special or punitive types of damages. This type of exclusion ensures that while the supplier may be on the hook for damages directly caused by its breach, it cannot be held accountable for every knock-on effect of its breach. For example, if a third tier supplier is late in shipping $10,000 of bolts to a subcontractor working on a $10 million project, and the prime contractor suffers huge delay damages as a result, it may not be appropriate to flow those damages all the way down to the bolt supplier.

Whether trading in commodity materials or complex systems, buyers and sellers can address these issues and many others in a carefully negotiated contract. By taking the time to do so, parties can allocate risk before signing the contract, minimize confusion when interpreting the contract, and avoid disputes if things do not go exactly as hoped.

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