Terms and Conditions: Contracting for Economic Certainty

by Josef Keglewitsch and Laura Hult, Schottenstein Zox & Dunn Co., L.P.A.

Given the difficult economic times, we are all looking for ways to improve the bottom line. Even after combating some of the more traditional problems that erode profit such as raw material costs, machine rates, and labor expenses, a business’ bottom line is still subject to significant exposure if its sales terms and conditions (“T&Cs”) are deficient. T&Cs can be one of the most valuable defenses to economic uncertainty and dealing with financially distressed customers. Unfortunately, more often than not, T&Cs create more ambiguity than they eliminate. Highlighted in this article are some of the most common deficiencies, all of which represent ideal opportunities for shifting risk and lowering exposure in customer relationships.

Warranties: What You Say AND What You Don’t Say About Your Products
T&Cs need to be drafted in a way that both you and your customers know what you are representing as to the quality of your product and what you are not representing. Express warranties (what you are representing) are only created when you do something affirmative. Implied warranties, on the other hand, are automatically a part of your contract with your customer unless you do something to limit or exclude them. Your T&Cs need to be carefully crafted so that both you and your customer know which express warranties are in the contract, and which implied warranties are not in the contract.

It is important to keep in mind that a warranty is not simply limited to any written warranty, but will include certain warranties implied by the law unless properly disclaimed. Unknowingly, you can be assuming a warranty obligation that is dramatically broader than what you have put in black and white. For example, the implied warranty of merchantability is part of your contract with your customer unless you do something affirmative to get rid of it. Implied warranties not only provide that your product is fit for the ordinary purposes for which the product is to be used, but also can be expanded depending on how long the supplier has been dealing with the customer and what the supplier should have reasonably known about how that customer would use the products.

The best way to avoid liability for an express warranty is not to make one in the first place. Unfortunately, that also is the best way to avoid selling your products. After all, you make an express warranty every time you adopt specifications, say something orally about your product, or point to a sample or model. Having done one or all of these things, you have created customer expectations that your product will comply with the representations made. One option is to live with the liability assumed by these representations. Your other option is to disclaim or at least limit those express warranties to the ones you think you and your product can live up to. Unfortunately, this is a very tricky course to navigate because there is a strong public policy against disclaiming representations you make to generate business. Therefore, any disclaimer of an express warranty must be crafted very carefully.

Here, form can be as important as substance. Unless a disclosure of warranties is properly formatted to be “conspicuous,” it can be void. And, if an express warranty has vague or imprecise language, it can result in a warranty so broad as to undermine any disclaimers. The takeaway is that this is not an area of law that is friendly to suppliers. Unlike most contract law, where courts will look at what you and the customer agreed upon, this area is rife with minefields for the unknowing. Do not be in a position where you are held responsible for warranties that you did not make or even know existed.

Remedies: What Is My Exposure?
Even if warranties are properly addressed, unless the T&Cs limit the buyer’s remedy to repair, replace, or return the product for the purchase price, the scope of recovery can become rather broad and include the costs of repairing products of which it is a component, the cost of procuring substitute goods, and similar obligations. This exposure could be broadened further by the indirect, special, and consequential damages discussed below.

T&Cs often limit recovery to “repair of defective goods, replacement with conforming goods, or repayment of purchase price.” Ideally, these options are identified as “the buyer’s exclusive remedy.” However, if your T&Cs don’t disclaim indirect, consequential, or special damages, you are leaving the door open for much more significant exposure. The reason that most suppliers don’t exclude these types of damages in their T&Cs is because they do not know what these other damages mean or the wide range of expenses covered by these types of damages. Indirect damages include reasonable charges, expenses, and commission incurred in covering any other reasonable expense related to the delay of delivery or sale of defective goods. Consequential damages include any loss resulting from the general or particular requirements of your customer that you knew or should have known about. For example, if you deliver defective products to a manufacturer, there is a strong argument that you should have known that defective goods would cause a disruption of production and, consequently, loss of profits. Special damages can include anything that flows from the error and encompass more remote damages if you’ve had a long relationship with the customer. In an economic downturn, customers are going to be watching the bottom line as closely as you are, and you cannot afford to be stuck with bills for lost profits, downtime, personal injury, and property damage. If your customers are large operations, these are the kinds of claims that can reach a magnitude that may result in having to shut the doors.

Late or non-paying customers are an all too common theme in today’s business landscape. Getting out in front of issues with financially distressed customers is absolutely critical in this climate. All too often, T&Cs fail to provide some basic tools a vendor can use to deal with a delinquent customer, such as the assessment of late fees (to ensure that customers do not start to use the supplier as a bank) and the ability to recover all costs of collection (including attorneys’ fees). Don’t be in a position where you have to ask yourself Is it worth getting paid what I am owed? You have already upheld your end of the contract; you should not have to pay to get them to uphold their end.

Surprises are not only bad for the bottom line, but can be injurious to your relationship with the customer. The phone call after a shipment of late or defective goods may never be welcome, but it can be less rancorous if you have been clear about the extent of your financial liabilities from the start. In addition, you can point out that you include these limitations in T&Cs with all your customers, thereby protecting your financial viability in these uncertain times. This means that customers may have to eat some of the costs that flow from error, but it also means they have a supplier they can depend on to keep producing the products they need.

Fine Line Between Adding Value and Increasing Exposure
Rarely is a vendor-customer relationship quite as simple as “I make – you buy.” Often, the supplier plays an active role in developing specifications for the products and perhaps even in tooling development. These value-added services can mean getting and keeping the business, but also represent an additional source of risks for a supplier.

This sometimes blurry line between adding value and increasing exposure raises key questions. Who owns the tooling or product design? Whose problem is it if there is a design defect? What if a third party sues because there is an intellectual property infringement with respect to the design? The lack of a clear-cut answer to these questions can be a source of friction with a customer. Far worse, any ambiguity can represent inadvertently assigning intellectual property or proprietary rights to another party or finding oneself in the cross-hairs should a customer be pursued for claims related to tooling or a product design the vendor helped (even marginally) develop.

While there is no standard way to answer these questions because every relationship is different, vendors need to get out in front of these issues in their T&Cs. What should be consistent, however, is that you should only be held responsible for those facets of the project over which you had some control and, frankly, for which you are paid.

The Takeaway
As businesses are becoming increasingly concerned with the financial health of their vendors given the economy, they are beginning to run the numbers on how much it would cost them if their suppliers go under or their custom-made products cannot be made. As a result, companies appear to be becoming more collaborative recently because both sides of the table have a vested interest in keeping each other’s business viable. As these dialogues spring up, they may present a great opportunity to clarify the nature of the obligations within even existing relationships and to ensure your T&Cs reflect that understanding.

Tightening up business terms and shrinking exposure are the low-hanging fruit of cost-cutting. They are steps rather easily taken when considered against the backdrop of more dramatic approaches, such as workforce reductions and benefits cuts. Giving T&Cs a thoughtful review is always important, but is an absolute must in these difficult economic times.

Josef Keglewitsch [(614) 462-2279; jkeglewitsch@szd.com] and Laura Hult [(614) 462-1109, lhult@szd.com] are attorneys with Schottenstein Zox & Dunn Co., L.P.A. More can be learned about Keglewitsch, Hult, and their firm at www.szd.com. The firm has included a special program under MAPP’s Legal Assistance Program to review and revise T&Cs – learn more in the “Legal Business” section of the MAPP website.