All businesses conduct indirect procurement. For some, indirect procurement consists of purchasing office supplies from an outside vendor. For others, indirect procurement involves the outsourcing of customer relationship management, order processing, and other services. Unlike direct procurement, which comprises the bulk of a business’ sourcing activities and involves purchasing raw materials needed for the production of certain goods and services, indirect procurement is the sourcing of goods and services that indirectly facilitate business operations.
Even though each company’s level of indirect procurement varies, each company can benefit from strategic language in indirect procurement contracts. After carefully assessing company needs in terms of quantity, quality, timing, price, and other variables, business leaders should negotiate with procurement providers (hereinafter “providers”) to ensure the contract terms protect production interests and ensure operational cohesion. To do so, business leaders should pay special attention to the areas of representations and warranties, indemnification and limitation of liability clauses, fulfillment terms, and termination rights.
Representations & Warranties
Representations are factual statements that a provider makes about the provider’s operations and include the provider’s capabilities, among other things. Most importantly, companies should ask for representations that affirm the provider’s ability to perform under the contract and any special promotional statements the provider made.
Warranties are like representations, but they are more like factual promises than statements. In the indirect procurement context, critical warranties include what form and state goods will arrive in or how services will be performed. Companies may benefit from warranties regarding cost savings plans (especially in outsourcing scenarios) and performance standards such as delivery/performance guarantees involving certain dates and times, speeds, etc. Warranties may also concern the performance of other third party vendors involved in the procurement process on the provider’s end. Warranties are crucial to a strong indirect procurement contract.
Indemnification and Limitation of Liability
What happens if the provider breaches the agreement or the company has to procure substitute goods and services? Indemnification clauses may provide for reimbursement to the company in the event of a contract breach or other scenario. Limitation of liability clauses, on the other hand, work to protect the provider in cases of breach. Business leaders must be careful in agreeing to wide limitation of liability and narrow indemnification clauses.
Fulfillment terms are the primary promises in a procurement contract. They spell out what goods or services will be delivered or performed as well as when, how, where, by whom, and everything in between. Carefully crafting clear and methodical fulfillment terms will help protect the company in cases of breach and also ensure a smooth procurement process between the parties. Business leaders will need to work with many internal stakeholders to map out a company’s own production process to craft optimal fulfillment terms. Although difficult to prepare for and draft, accurate and specific fulfillment terms are necessary not only to inform the provider how to perform, but also to hold the provider to the particularly-desired performance. The more elaborate the production process, the more costly the indirect procurement will be; however, providers can provide cost savings for the company (by providing the goods or services more cheaply than the company itself could). Cost savings incentive plans should be worked into the agreement in relation to fulfillment terms to encourage adherence.
Lastly, business leaders may benefit by reserving broad or preemptive termination rights. Commonly, provider contracts include terms that allow the providers to cure any contract breaches, essentially allowing for second-chances. Although in some indirect procurement circumstances this may be acceptable and beneficial, in others, it may not. Depending on the importance of the indirectly-procured goods or services, business leaders may have significant reasons to reserve the right to terminate an agreement at the earliest instance of trouble, thus allowing the company to find a replacement provider before business operations are substantially interrupted and sales are lost.
If you are a business leader considering indirect procurement, you should work with an attorney to structure your contract in accordance your specific needs. This article was sponsored by Vlodaver Law Offices, LLC, an experienced business solutions and transactions law firm in the Twin Cities. If you would like a free legal consultation, contact us.