Every company buys and licenses products and services from third parties, who are called vendors or suppliers. The terms that govern those purchases are vendor contracts. While that basic concept is not complicated, vendor contracts can present complex business and legal challenges. This post explains the basics around the formation, scope, and terms of vendor contracts.
How a vendor contract is formed
The law says a contract exists when there is an offer, an acceptance, and value. The value part is not an issue with vendor contracts, so we’ll leave that out for now.
Whether your company has a binding contract with a vendor depends on whether there has been an offer and acceptance. If a vendor made an offer to your company (“We’ll license you this software for $50”) and your company accepted (usually by clicking “I Agree”), there’s a contract. Acceptance can even happen by the vendor’s performance. If your company asks the vendor to send the company ten reams of paper, the vendor can accept by shipping the paper.
The traditional concept of a contract is a document with the word “Agreement” at the top. The vendor and customer outline terms for a single purchase or license and then sign the document.
But did you know that vendor contracts can be formed orally with no signature? Courts regularly find that when someone makes an offer and the other side accepts, there is a contract even with no written terms. Vendor contracts do not require a signature. Your company may be entering into contracts when it agrees to an offer in an email, when it allows the vendor to begin performance, or when it sends out a purchase order. All those can be contracts.
The most common contracts cover a single purchase, but many companies also use a contract format called a master agreement. Say your company plans to purchase some equipment from the vendor but you don’t know exactly how many you’ll need and when. With the master agreement, you negotiate the broad commercial and legal terms at the beginning. Then, when you need the equipment, you issue a purchase order with just the quantity and delivery location. You don’t have to renegotiate the contract every time, making it a smoother and simpler way to contract with your primary vendors.
The three ways to scope a vendor contract
The scope of rights and obligations in vendor contracts depends on the category of purchase. All vendor contracts fall into three main categories: purchase of goods, purchase of services, or license of rights.
Purchase of goods
A law called the Uniform Commercial Code governs the purchases of goods in the U.S. All 50 states passed this law with very little variation. The UCC, as it is called, sets out terms for how the rights and obligations work if there is no contract. These are known as gap-fillers. If the contract identifies the rights and obligations, the gap- fillers from the UCC do not apply. But if the parties only agreed on the price and quantity, the UCC would supply the rest of the terms.
Purchases of services
Purchases of services are subject to the general contract laws of the state, not the UCC. One common form of service contract is called Software as a Service, or SaaS. In these contracts, the vendor does not sell or license the software. Instead, the vendor provides the customer the service of allowing the customer to use the vendor’s software systems.
License of rights
The third category of vendor contracts is a license. In these contracts, a vendor doesn’t sell a good or service. Instead, it allows the customer to exercise rights restricted under intellectual property laws. Let’s look at copyright law. That law provides that the author of a written work, like software, has exclusive rights to distribute and display it. When the vendor offers a customer a license, the vendor is not selling the customer a physical product. It is licensing the rights granted by the copyright law.
There is another way that companies characterize vendor contracts. Some companies divide vendor contracts into two main categories — direct and indirect.
Direct vendor contracts are any purchases of goods and services that go directly into the goods sold. If you were selling shoelaces, direct purchases would include the material for the string and the plastic for the eyelet.
Terms: The anatomy of a vendor contract
Vendors and customers form contracts in many ways and formats. Yet most written vendor agreements include the same legal provisions and usually in the same general order.
Part 1: Business terms
The first part of each vendor contract usually outlines the business terms including:
- Name of the customer
- Name of the vendor
- Specific obligation of each party, with details around the good, the service, or the license
- Payment terms
Part 2: Legal concepts
This section usually begins with the representations and warranties section. Representations are facts that are true today, while warranties are facts that are true in the future. The contract parties use this section to make promises about the quality of the products and services, their rights to sign the contract, and their compliance with applicable laws.
After the reps and warranties (as we call them) usually comes the confidentiality and indemnity provisions. In the indemnity, a vendor agrees to reimburse and defend the customer if a third-party files a claim against the customer because of the product, services, or other acts of the vendor.
Part 3: How to handle problems
The last part of the vendor contracts then describes what happens when things go wrong. The contract will talk about when each party can terminate, whether they’ll use litigation or arbitration, what law will govern the dispute, and a lot of other legal boilerplate.
Vendor contracts are a necessary and important part of running any company. Companies have a lot of opportunities to save money and mitigate their risks by negotiating advantageous vendor contracts. They also put the company at risk when they don’t. Make sure you are taking care with all your company’s vendor contracts. Learning about their formation, scope, and terms is an important part of that effort.
Ironclad is the #1 contract lifecycle management platform for innovative companies. L’Oréal, Staples, Mastercard, and other leading innovators use Ironclad to collaborate and negotiate on contracts, accelerate contracting while maintaining compliance, and turn contracts into critical carriers of operational business intelligence. It’s the only platform flexible enough to handle every type of contract workflow, whether a sales agreement, an HR agreement or a complex NDA. The company was named one of the 20 Rising Stars on the Forbes 2019 Cloud 100 list, and is backed by leading investors like Accel, Y Combinator, Sequoia, and BOND. For more information, visit www.ironcladapp.com or follow us on LinkedIn and Twitter.
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