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www.mccarter.comMcCarter & English, LLP
Proceed with Caution -Critical Terms of Sales Agreements
Dror Futter
© 2015 McCarter & English LLP, all rights reserved
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ME1 20531909v.1
Disclaimer
� Tell me you did not see this coming …
� Disclaimer– This presentation and these materials are for informational purposes
only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem. The opinions expressed in this presentation are those of the author alone and may not reflect the opinions of the firm or any other attorney.
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Why Do Contract Terms Matter to Startups?
� Impact your business– Cash Flow
– Pricing
– Costs
– Revenue Recognition
� Impact the Value of Your Company– Diligence by potential investors and acquirers is very likely to include
a review of the terms of all material contracts
– Restrictive and unfavorable terms may be used by an investor or acquirer to negotiate down a proposed valuation/purchase price
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Note
� This presentation is written from the perspective of the Startup as a Supplier. If the Startup is the customer in the relevant agreement, many of the issues discussed “cut both ways” but not all.
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Payment Terms/Earliest Invoicing Date
� Agreements Need to Specify Payment Dates
� Typically this is phrased as Net X, which means payment no later than X days after invoicing
� Supplier will generally want Net30. Larger Customers have pushed for Net60 and even Net90
� Agreement needs to be clear when is the earliest date that Supplier can invoice Customer
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Multiple Orders Under a Single Contract
� Agreements often provide that multiple orders can be placed by the submission of Purchase Orders by Customer
� Important to make it clear that any supplemental terms on the Customer’s Purchase Order will not apply
� Supplier should reserve the right to reject Purchase Orders. Potential reasons for rejecting invoices:– Customer is in breach of the Agreement with respect to prior orders
– Customer’s credit profile has changed and Supplier may want to consider requiring cash pre-payment or be unwilling to sell at all
– Customer may not have sufficient inventory to fulfill the order within the requested timetable
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Calculating Royalties
� When the purchase price is a royalty rather than a fixed price, it is important to specify the basis for the royalty calculation
� Often this is phrased as a percentage of Customer’s revenue
� The Agreement should specify what is excluded from “revenue.” Examples: taxes, insurance, shipping charges, and returns
� The Agreement should specify whether the royalty is based on amounts payable to Customer or amounts received by Customer. – Difference in who bears the risk of non-payment. Amounts payable =
Customer has to pay royalty even if its customer never pays. Amounts received = Customer only has to make payment if it has received payment from its customer
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Defining Specifications in a Performance Warranty
� Products are commonly warranted to function “in accordance with their specifications”
� It is often very unclear where you can find these “specifications”
� Product documentation and sales materials are usually poor sources of specifications because they often include a great deal of additional information and more sales-oriented content
� Ideally, specifications should be in a clearly identified document stating precisely what a product will do and any minimum configuration required to support the proper functioning of the product
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Disclaiming and Conditioning Warranties
� Supplier should attempt to disclaim any warranties it is providing in situations where the issue results from actions of the Customer or Third Parties. Examples:– Modifications of the product by the Customer
– Damage to a product by the Customer or usage outside of its proper operating environment
– Uses by the Customer of the product or service outside of its intended purpose
– In the context of online services, issues arising from delays or drops in Internet connectivity
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Disclaiming and Conditioning Warranties (cont’d)
� The Agreement should also disclaim certain warranties implied by law. If you fail to do so, the Courts will add these warranties to anything you agreed to.– Example: “The warranty of merchantability and fitness for a particular
purpose.”
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Acceptance Testing
� Customers may ask for the right to perform “acceptance testing” on products delivered to them
� More common in situations of customer product development instead of off-the-shelf
� Supplier cannot recognize the sale revenue until the end of the acceptance test period
� Important to:– Limit the duration of acceptance testing; and
– Make it clear that if a product is not rejected by the end of the applicable acceptance testing period, it is deemed accepted
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Most Favored Nationals Clause (“MFN”)
� An MFN Clause is an attempt by Customer to make sure that it will always get Suppliers lowest price
� Typical MFN Clause states that Customer’s price will be lowered if Supplier offers a lower price to another customer
� Impact can be mitigated if the clause is limited to:– Other customers purchasing similar volumes, under similar terms
– Specific markets
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Source Code Escrows
� When licensing software from Startups, Customers may require that the Supplier deposit a copy of its source code in escrow
� The most critical element of an escrow agreement is the conditions under which Customer can request a copy of the escrowed code. Release from escrow should not be a remedy for an ordinary breach by Supplier. It should be limited to situations where the Supplier fails to respond for a prolonged period of time/ceases to operate/enters bankruptcy
� The escrow agreement should limit what the Customer can do with the code if it is released from escrow (example: use limited to servicing existing customers) and provide that the code remains subject to all relevant confidentiality obligations.
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Exclusivity
� Customers may try to lock up a Supplier by requiring exclusivity and preclude Supplier from selling to other customers
� This should be avoided because it limits the markets open to Supplier
� If exclusivity is required, it should be narrowed as to:– Duration
– Geography
– Market
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Caps on Liability
� Cap on the maximum a Customer can claim from Supplier under the Agreement
� Generally Suppliers should be able to get a complete exclusion of consequential/indict damages– Example: Software fails, brings down Customer’s production line
� All other liabilities can generally be limited to a dollar amount, usually pegged to sales over a give period– Example: Liability limited to all amounts paid by Customer to
Supplier during the 12 months before the claim
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Caps on Liability (cont’d)
� Customers may insist on exceptions to the cap. Common exceptions:– Gross negligence
– Breach of Confidentiality
– Intellectual Property Infringement
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Liquidated Damages/Penalties/Service Credits
� Customers may ask for “liquidated damages” (specified dollar payments), penalties or service credits, instead of or in addition to the damages they suffer as a result of breach
� Most often raised in the context of late delivery, delayed warranty/maintenance, or service downtime
� If they cannot be avoided, important to cap the maximum amount that can be claimed per incident/per year. Also, preferred to offer credits against future amounts due rather than cash payments
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Data Privacy/Protected Health Information
� Various State, Federal and International laws and regulations govern a party’s handling of personal information with respect to healthcare specifically (HIPAA) and data privacy generally
� These requirements typically include– Heightened confidentiality obligations
– Requirements for documented procedures for safeguarding the relevant data and securing and limiting access to the devices where the data will be stored.
� Given potentially significant penalties for non-compliance, it is important to understand what compliance requires
� Increasing trend by healthcare, insurance and financial services customers to impose data privacy language on all Suppliers, even those that will not have access to personal information
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Shipping Terms
� When shipping product, the parties need to determine– Where/when the sale takes place (where Supplier makes it available
for Customer’s carrier or where Supplier’s carrier delivers it to Customer)
– Who handles export/import matters and customs clearance
– Who handles insurance
– Who is responsible for import taxes
� There are actually 2 questions– Who handles
– Who pays
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Shipping Terms (cont’d)
� There are standard terms (under the Uniform Commercial Code (UCC) and Incoterms) used as “short hand” to describe the allocation of these responsibilities – Examples: FOB, Ex Works
� See http://en.wikipedia.org/wiki/Incoterms for an informative summary
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Assignability
� Customers will often try to limit the Supplier’s right to assign the Agreement without Customer consent
� This clause can become a major issue when a company is being acquired
� This clause gives the Supplier comfort that it can prevent transfer of the Agreement to an unreliable new Supplier. However, it can also be used by the Supplier as leverage to renegotiate the Agreement in return for consent to the assignment
� If the clause cannot be eliminated, the Agreement should always specify that Customer’s consent may not be unreasonably withheld
� Supplier should try to get an exception for an assignment made in connection with the sale of the company
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