Sourcing teams are assuming increasing responsibilities in the contracting process, playing a central role in managing an array of issues, including legal, operational, financial, and information security risks. In an effort to streamline contracting lifecycles and reduce legal costs, companies often prefer legal counsel to focus on complex issues around intellectual property rights, indemnification, or regulatory compliance. This often leaves important unresolved issues to be negotiated by the sourcing team.
Fortunately, by focusing on certain terms of outsized impact that arise across deals, sourcing departments can contribute significantly to managing their companies’ risk profiles.
Auto-Renewals: When Does Your Contract End?
As we’ve previously written, auto-renewal provisions are commonplace, appearing as boilerplate language in many contracts. This omnipresence can easily cause such terms to be overlooked.
Most auto-renewal terms provide for successive renewals unless one party provides the other with a nonrenewal notice within a specified timeframe prior to expiration. If a customer misses the notice deadline, it may find itself locked into another year of receiving and paying for products or services that it no longer needs or wants.
This is not to say that auto-renewal terms are always undesirable. Such terms can increase stability while reducing administrative inconvenience. Some companies believe that rejecting auto-renewal is always the safer approach, but contracts that automatically expire can lead to disruption of important services if not carefully managed.
Sourcing teams should determine:
- Whether the agreement automatically renews;
- How much advance notice is required to prevent renewal;
- The duration of each renewal term;
- Whether and what pricing changes may occur upon renewal and how much advance notice is provided; and
- Who is responsible for tracking renewal deadlines.
While many auto-renewal provisions start with the same nonrenewal notice period for both parties, customers sometimes successfully argue that the vendor should provide more notice of nonrenewal, giving customers the opportunity to procure a replacement vendor.
Termination Rights: How Does Your Contract End?
In the negotiation phase, most contracting parties are in a positive place, focused on the value of the agreement rather than what happens at the end of the relationship. Establishing an initial exit plan and procedures for updating that plan is equally important, as it can prevent serious issues down the road.
As we’ve noted, termination provisions implicate numerous practical concerns, including operational flexibility to move away from underperforming vendors or to adopt emerging technologies, changing budgets, shifting regulatory guidance, maintaining vendor relationships, and business continuity.
Sourcing teams should understand:
- Termination for convenience rights and considerations;
- Whether there are other specialized termination rights (e.g., for regulatory concerns, force majeure events, or data security incidents);
- Whether termination fees are payable and in what situations;
- What happens to prepaid amounts (e.g., forfeiture or pro-rata refund);
- Whether any purchase orders survive termination of the main agreement; and
- Whether the vendor must provide transition assistance and, if so, the specifics of such assistance (e.g., service limitations, pricing, and duration).
Termination rights can be particularly important for critical services, for services in rapidly evolving areas, and in long-term relationships where plans and priorities may evolve substantially over the course of the relationship.
Price Increases: What Will You Pay Tomorrow?
Initial fees are a critical part of a company’s decision to move forward with a given vendor. However, the focus on initial pricing should not overshadow the price at year two, year five, or beyond.
While some contracts provide for annual price increases based upon clear mechanisms such as the inflation rate or a fixed percentage of the prior year’s fees, others permit vendors to increase fees without specificity or to peg the increases to unknown amounts such as “then-current rates.” Where a contract anticipates a multiyear association, these increases can have a significant impact.
Sourcing teams should evaluate:
- When prices may increase (e.g., only upon renewal, upon notice from vendor, or with per-year or per-term limitations);
- How price increases are determined (including whether such increases are capped);
- Whether price increases are consistent across renewal terms or may change over time; and
- Whether the customer has termination rights that mitigate this risk.
For a liability cap, instead of limiting their focus solely to the headline number, sourcing teams should consider:
- Which types of damages are subject to the cap;
- Which types of damages are carved out of the cap;
- Whether multiple liability caps apply and, if so, to what they apply (e.g., super caps for confidentiality or data-security breaches);
- Whether service-level credits apply to the cap or are excluded from it; and
- Whether costs of cover or other transition costs apply to the cap or are excluded from it.
Helping the business understand these contours can be helpful to its long-term financial planning, as even seemingly small annual increases can compound over time.
Liability Limitations: Are You Covered?
Limitations of liability can pack a powerful punch into a few sentences or paragraphs. They can essentially trump other provisions, especially when problems arise, and they can appear similar but come in different forms. These provisions should be handled carefully and escalated when in doubt.
Sourcing teams should pay attention to these points:
- Exceptions to the limitations of liability can be as or more important than the amount of the liability cap(s).
- Limits on the type of liability (e.g., consequential damages) and limits on the amount of liability can have different exceptions. For example, a party may be willing to concede that consequential damages should be available for a breach of confidentiality but still push for a cap on the amount of that liability (unless another exception, such as willful misconduct, applies).
- Similarly, for purposes of clarity and certainty, some specifically listed liabilities (such as certain documented costs of a data breach) could be deemed direct damages for purposes of the relevant liability limitation.
The acceptable liability framework can vary depending on the particular circumstances and risks. Instead of simply asking the legal lead whether a contract or a particular liability provision is “OK,” the sourcing professional should explain their assessment of potential risks and how such liabilities can be allocated or mitigated.
Stepping Back
The above pointers are not intended to circumvent the legal department, but rather to help sourcing departments become better partners with the legal department and the business. Sourcing teams that grasp these nuances can better spot issues and opportunities to efficiently and effectively drive the contract negotiation process.