Most manufacturing companies rely heavily on “supply chain” vendors to keep the business running. A breakdown in even a single link in the supply chain can be devastating to a business. In the wake of the recent pandemic and the subsequent failure of at least 10% of small businesses nationwide, it is vital for a company to have a firm grasp of the terms and conditions of its vendor contracts.
A vendor contract details the rights, obligations, and consequences for the parties involved. Although each vendor contract needs to be tailored to the unique products or services being provided, there are several key provisions that are included in most vendor contracts.
- Scope of Services/Products: A description of the products or the scope of services to be provided is a key element in any vendor contract and should include a clear, detailed account of their timing, delivery and location, if applicable. Be specific. Many vendor contracts do not contain enough detail in the description clause which hampers the likelihood of either party being held accountable if a discrepancy should occur.
- Payment Terms: Every vendor contract should contain a payment terms clause outlining how and when payments will be made. Details of the payment terms should also include the structure and method of payments, the amounts being paid, to whom the payments should be sent, and the due dates. If there will be any penalties or fees assessed for late payments, the amounts and conditions for those charges should be explicitly listed.
- Indemnity, Disclaimer, and Limitation of Liability: In a vendor contract, the indemnification clause often states that the vendor must compensate the purchaser for losses, damages or liabilities incurred as a result of the vendor’s failure to perform. However, many contracts also include a disclaimer of warranties and limited liability clause with a cap for monetary damages and potentially an exclusion of special, indirect, consequential and/or incidental damages. Adding a limitation of liability clause can decrease uncertainty and help justify an indemnity clause. Many companies assume they are protected and will be compensated by a vendor for damages if a contract has an indemnity clause; however, the disclaimer and limitation of liability sections often drastically limit the effectiveness of an indemnification clause. It is important to carefully review these provisions with your attorney and insurance agent.
- Business Continuity: A business continuity plan includes a vendor’s procedures established to maintain critical business functions and operations in the event of an unplanned service interruption and during disaster recovery. The requirement for a vendor to have a business continuity plan should be included in the vendor contract. The vendor contract should allow the purchaser to request and test the business continuity plan of the vendor on a regular basis.
- Service Level Agreement: The service level agreement (SLA) clause, common in technology fields and third-party contracts, defines the level of service that the vendor is required to provide. This section should also include how these services will be measured and reported as well as the penalties and remedies if the expected level of performance is not met. The SLA clause should give the purchaser the ability to terminate the contract if the vendor fails to meet the SLA over a defined period of time.
- Right-to-audit: The right-to-audit clause is added to the vendor contract in order to grant the purchaser the right to have measurables like the vendor’s quality, pricing, finances audited. The right-to-audit clause can mitigate the risk of vendor fraud. It is helpful if the right-to-audit also allows the purchaser to conduct its own audits including regular visits to the vendor’s facilities and an annual request for compliance paperwork.
- Termination: The termination clause in a vendor contract should clearly define what can trigger termination of the contract by either party as well as the specific details of a how a termination will proceed. Adding a remedies section to the termination clause allows more flexibility for the purchaser to terminate the contract and still recover damages. However, remedies should be carefully researched by a professional to ensure they meet legal standards.