Contract Disputes - Prevention is Key! (But what happens if that doesn't work?)
Contract disputes can range the continuum of disagreement from mundane differences of opinion to material breaches. If you're a procurement professional, I hope a contract dispute doesn't happen to you, but it will if it hasn't already. To help, here are some terms and tips relating to contract disputes.
To avoid contract disputes, you, as a procurement professional, must ensure that:
1. the contracts you negotiate with vendors are on your contract templates;
2. the terms and conditions of the contract are clear and unambiguous;
3. the roles and responsibilities of the parties are well-defined; and,
4. for each obligation, undertaking, representation, warranty, or "promise" under the contract, there is a corresponding remedy.
If items 2 and / or 3 aren't achieved, disputes will inevitably arise. That's bad enough. It's when you don't do item 4 well that disputes caused by items 2 and / or 3 can really get out-of-hand. If that happens, it will waste a lot of time (and, possibly, money) for a lot of folks. The reason is because when there is a breach of contract--and no remedy--the parties then have to not only negotiate through the dispute, they have to negotiate through an appropriate remedy. Sure, it takes more time on the front end your you, but define remedies for each breach to avoid pain later on. For example, if your vendor warranties that its deliverable to you will not violate anyone's proprietary rights, you need to have an "infringement indemnification" provision as a remedy. If you didn't, and the vendor breached its warranty, then what? Yeah, a dispute on top of a dispute.
In some cases, remedies can take the form of monetary damages. Remember that it's against public policy to demand punitive damages under a contract--remedies under a contract can only be compensatory or "make you whole." It's the courts' job to "punish," not yours, and courts will strike anything that looks like punitive damages (such as penalties). That's why whenever you read contract language relating to monetary damages, the language will read something like "...as liquidated damages, and not as a penalty..." Even if you include that magic language, but the amount of the liquidated damages starts looking more punitive than compensatory, a court will figure that out pretty quickly. A court will look to determine whether the liquidated damages were reasonably ascertainable at the time of the breach, measured by a fixed or established external standard, or by a standard apparent from documents upon which plaintiffs based their claim. Stated simply, make sure that the amount of liquidated damages does nothing more than cover your loss.
In summary, a cardinal rule for contract drafting is always, always, always develop a remedy for each material breach. That doesn't mean you need to address every "technical" or "simple" breach--just the "material" breaches.
Breaches
OK, what's a breach? It's basically a failure to perform a contract without "legal excuse." Breaches can be "simple" (sometimes called "technical") or "material." Here's the difference... As defined by the venerable Black's Law Dictionary, a "material" breach is a "[v]iolation of contract which is substantial and significant and which usually excuses the aggrieved party from further performance and affords a right to use for damages." Anything that's not a material breach is a simple breach. An example is if a contract calls for the vendor to include your PO number on invoices the vendor submits to you. Another way of looking at a simple breach is that you received pretty much what you bargained for, and the breach doesn't frustrate the purpose of the contract.
If the vendor fails to do that, it's a "simple" or "technical" breach. If you try to terminate a contract for that simple breach or bring a claim for such a breach, you probably need to re-think your profession. It's accepted that contracts cannot be terminated based on a simple breach. You may be entitled to some damages, but they're probably insignificant. Just in case there are some folks out there that would do something like bring a cause of action for a simple breach, many contracts will distinguish, for example, termination for cause only in the case of material breach (so as to not permit termination for a simple breach).
Waiver / Forbearance
If your vendor fails to perform without a "legal excuse," such as force majeure, and you repeatedly fail to assert your rights, your contract has likely been amended (yes, without a writing) based on that pattern or practice, and you have thus waived your rights to make a claim of breach. The thought is that if you don't care, then it must be OK, so you can't cry about it later. The technical term for that is "waiver." Sometimes, in the process of conducting business, it takes a while to get around to doing something--including asserting your rights. That's why most contracts contain a waiver provision somewhere near the bottom of the document. A waiver (also called a "no waiver") provision says something to the effect that, if the customer fails to assert its rights, it doesn't mean that it can't later. You need one of these provisions in your contract template.
Forbearance is a one-time legal excuse for a party to breach (via non-performance) a contract. For example, if the vendor comes to you and asks your permission to be late on something, your agreement is called "forbearance" and is basically a promise not to terminate the contract or bring a claim associated with the breach. It doesn't give the vendor permission to do it (be late) over and over, but just for that one time only. If the breach is significant enough, you should document it in a letter to the vendor, stating something to the effect that the vendor has breached the agreement, that you are agreeing to forbearance, and so on. Those letters are nice to have if you do need to make a claim at a later point for another reason (it shows that you played nice, but the vendor still managed to screw things up).
Informal Dispute Resolution
The first thing to remember is that if you have to break out the contract to handle a disagreement with a vendor, the relationship is likely already strained and rapidly going downhill. When my customers come to me with a disagreement, I ask them to please first work things out with the vendor before I have to get involved. If the customer and vendor can't work it out, I like to include a provision in my contracts that require the parties to submit the disagreement to their VPs, who then have thirty days (or whatever is appropriate) to work it out. Most of the time, cooler heads at the VP level prevail. If you use this type of provision, be sure that it excludes certain appropriate obligations in your contract. For example, if there's been a breach of confidentiality, I don't want there to be a requirement that VPs noodle on it over thirty days. Instead, I want to run to court and get an injunction against the vendor to stop the leak.
Mediation
Mediation is the next typical step in an escalating dispute. Basically, mediation is where a third-party gets the disputing parties together and tries to work things out. Be mindful that working things out doesn't necessarily mean fair. The job of the mediator is to get the parties to agree, even if it means convincing one party to cave into the other party's demands. Mediators don't care (sorry, mediators) about fairness, they care about agreement. A good benchmark of success for a mediator is that both parties came to an agreement and each party walked away equally unhappy. That's the best case scenario. The good news is that the agreement isn't binding. If you have second thoughts, you can take another shot at the dispute.
Arbitration
If mediation doesn't work, sometimes contracts require arbitration. There are two types, non-binding and binding. No-binding arbitration has been termed to be "testing the waters of litigation." In non-binding arbitration, it's very much like going to court, with discovery and all of the other procedural matters that take place. After presenting the parties present their cases, the arbitrators render an advisory opinion. If one party felt that they could go to court and win, but get clobbered in arbitration, they probably won't be going to court since arbitration is a good predicator of a courtroom result. Similar to mediation, the parties can take the opinion or leave it.
Binding arbitration is exactly that, the opinion rendered by the arbitrators is binding on the parties. No appeals, nothing. That's why I never, ever agree to binding arbitration (unless it's an international contract--which is another story). I'll agree to pretty much anything else relating to dispute resolution but never binding arbitration. If I don't like the result of informal dispute resolution, mediation, non-binding arbitration, I want my day in court.
Going to Court (or at least threatening to)
The reason arbitration was so popular back in the day is that it was faster and less expensive than going to court. Those days are over. Courts throughout the country have cleared their dockets over the last few years and going to court can happen very quickly. Also, legal professionals have infiltrated the field of arbitration, and prices ain't what they used to be. So, the advantages of arbitration are gone and the advantages of going to court include my right to appeal.
Governing Law
At a stalemate? The vendor wants their choice of law to govern the contract and you want yours? A happy medium is NY (oldest and best established trade law in the country) or IL (then next oldest and best). But remember, governing or choice of law is only that--it's the law that the contract will be interpreted under. Keep in mind that a court in one state can apply the laws of another state. You have to specify in your contract not only the governing law but the venue. So, if you want your state's law to apply and your state's venue, you should specify both in your contract (in your governing law provision).
To avoid contract disputes, you, as a procurement professional, must ensure that:
1. the contracts you negotiate with vendors are on your contract templates;
2. the terms and conditions of the contract are clear and unambiguous;
3. the roles and responsibilities of the parties are well-defined; and,
4. for each obligation, undertaking, representation, warranty, or "promise" under the contract, there is a corresponding remedy.
If items 2 and / or 3 aren't achieved, disputes will inevitably arise. That's bad enough. It's when you don't do item 4 well that disputes caused by items 2 and / or 3 can really get out-of-hand. If that happens, it will waste a lot of time (and, possibly, money) for a lot of folks. The reason is because when there is a breach of contract--and no remedy--the parties then have to not only negotiate through the dispute, they have to negotiate through an appropriate remedy. Sure, it takes more time on the front end your you, but define remedies for each breach to avoid pain later on. For example, if your vendor warranties that its deliverable to you will not violate anyone's proprietary rights, you need to have an "infringement indemnification" provision as a remedy. If you didn't, and the vendor breached its warranty, then what? Yeah, a dispute on top of a dispute.
In some cases, remedies can take the form of monetary damages. Remember that it's against public policy to demand punitive damages under a contract--remedies under a contract can only be compensatory or "make you whole." It's the courts' job to "punish," not yours, and courts will strike anything that looks like punitive damages (such as penalties). That's why whenever you read contract language relating to monetary damages, the language will read something like "...as liquidated damages, and not as a penalty..." Even if you include that magic language, but the amount of the liquidated damages starts looking more punitive than compensatory, a court will figure that out pretty quickly. A court will look to determine whether the liquidated damages were reasonably ascertainable at the time of the breach, measured by a fixed or established external standard, or by a standard apparent from documents upon which plaintiffs based their claim. Stated simply, make sure that the amount of liquidated damages does nothing more than cover your loss.
In summary, a cardinal rule for contract drafting is always, always, always develop a remedy for each material breach. That doesn't mean you need to address every "technical" or "simple" breach--just the "material" breaches.
Breaches
OK, what's a breach? It's basically a failure to perform a contract without "legal excuse." Breaches can be "simple" (sometimes called "technical") or "material." Here's the difference... As defined by the venerable Black's Law Dictionary, a "material" breach is a "[v]iolation of contract which is substantial and significant and which usually excuses the aggrieved party from further performance and affords a right to use for damages." Anything that's not a material breach is a simple breach. An example is if a contract calls for the vendor to include your PO number on invoices the vendor submits to you. Another way of looking at a simple breach is that you received pretty much what you bargained for, and the breach doesn't frustrate the purpose of the contract.
If the vendor fails to do that, it's a "simple" or "technical" breach. If you try to terminate a contract for that simple breach or bring a claim for such a breach, you probably need to re-think your profession. It's accepted that contracts cannot be terminated based on a simple breach. You may be entitled to some damages, but they're probably insignificant. Just in case there are some folks out there that would do something like bring a cause of action for a simple breach, many contracts will distinguish, for example, termination for cause only in the case of material breach (so as to not permit termination for a simple breach).
Waiver / Forbearance
If your vendor fails to perform without a "legal excuse," such as force majeure, and you repeatedly fail to assert your rights, your contract has likely been amended (yes, without a writing) based on that pattern or practice, and you have thus waived your rights to make a claim of breach. The thought is that if you don't care, then it must be OK, so you can't cry about it later. The technical term for that is "waiver." Sometimes, in the process of conducting business, it takes a while to get around to doing something--including asserting your rights. That's why most contracts contain a waiver provision somewhere near the bottom of the document. A waiver (also called a "no waiver") provision says something to the effect that, if the customer fails to assert its rights, it doesn't mean that it can't later. You need one of these provisions in your contract template.
Forbearance is a one-time legal excuse for a party to breach (via non-performance) a contract. For example, if the vendor comes to you and asks your permission to be late on something, your agreement is called "forbearance" and is basically a promise not to terminate the contract or bring a claim associated with the breach. It doesn't give the vendor permission to do it (be late) over and over, but just for that one time only. If the breach is significant enough, you should document it in a letter to the vendor, stating something to the effect that the vendor has breached the agreement, that you are agreeing to forbearance, and so on. Those letters are nice to have if you do need to make a claim at a later point for another reason (it shows that you played nice, but the vendor still managed to screw things up).
Informal Dispute Resolution
The first thing to remember is that if you have to break out the contract to handle a disagreement with a vendor, the relationship is likely already strained and rapidly going downhill. When my customers come to me with a disagreement, I ask them to please first work things out with the vendor before I have to get involved. If the customer and vendor can't work it out, I like to include a provision in my contracts that require the parties to submit the disagreement to their VPs, who then have thirty days (or whatever is appropriate) to work it out. Most of the time, cooler heads at the VP level prevail. If you use this type of provision, be sure that it excludes certain appropriate obligations in your contract. For example, if there's been a breach of confidentiality, I don't want there to be a requirement that VPs noodle on it over thirty days. Instead, I want to run to court and get an injunction against the vendor to stop the leak.
Mediation
Mediation is the next typical step in an escalating dispute. Basically, mediation is where a third-party gets the disputing parties together and tries to work things out. Be mindful that working things out doesn't necessarily mean fair. The job of the mediator is to get the parties to agree, even if it means convincing one party to cave into the other party's demands. Mediators don't care (sorry, mediators) about fairness, they care about agreement. A good benchmark of success for a mediator is that both parties came to an agreement and each party walked away equally unhappy. That's the best case scenario. The good news is that the agreement isn't binding. If you have second thoughts, you can take another shot at the dispute.
Arbitration
If mediation doesn't work, sometimes contracts require arbitration. There are two types, non-binding and binding. No-binding arbitration has been termed to be "testing the waters of litigation." In non-binding arbitration, it's very much like going to court, with discovery and all of the other procedural matters that take place. After presenting the parties present their cases, the arbitrators render an advisory opinion. If one party felt that they could go to court and win, but get clobbered in arbitration, they probably won't be going to court since arbitration is a good predicator of a courtroom result. Similar to mediation, the parties can take the opinion or leave it.
Binding arbitration is exactly that, the opinion rendered by the arbitrators is binding on the parties. No appeals, nothing. That's why I never, ever agree to binding arbitration (unless it's an international contract--which is another story). I'll agree to pretty much anything else relating to dispute resolution but never binding arbitration. If I don't like the result of informal dispute resolution, mediation, non-binding arbitration, I want my day in court.
Going to Court (or at least threatening to)
The reason arbitration was so popular back in the day is that it was faster and less expensive than going to court. Those days are over. Courts throughout the country have cleared their dockets over the last few years and going to court can happen very quickly. Also, legal professionals have infiltrated the field of arbitration, and prices ain't what they used to be. So, the advantages of arbitration are gone and the advantages of going to court include my right to appeal.
Governing Law
At a stalemate? The vendor wants their choice of law to govern the contract and you want yours? A happy medium is NY (oldest and best established trade law in the country) or IL (then next oldest and best). But remember, governing or choice of law is only that--it's the law that the contract will be interpreted under. Keep in mind that a court in one state can apply the laws of another state. You have to specify in your contract not only the governing law but the venue. So, if you want your state's law to apply and your state's venue, you should specify both in your contract (in your governing law provision).
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