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The Basics of Customer Contracts

CFOs, controllers, and business owners recently gathered to discuss the basics of customer contracts. Joseph D. Gustavus of Miller Canfield joined us to provide information on this topic.

Defining the Contractual Relationship

It is important that a signed agreement exists between your company and the customer. Without it, a battle of the forms may happen. Each side can claim their contract documents and other supporting documentation should govern. Don't let a customer purchase order (P.O.) or RFQ define the relationship to your disadvantage.

In the event of a disagreement, deciding which terms apply can be tricky, but many times it will depend on who is able to best demonstrate that their contract documents constitute the offer. Typically the side that is most persuasive at characterizing their terms and conditions as an offer, which can only be accepted "as is," will have their terms applied.

In addition to P.O.s, P.O. confirmations, quotes and other such documents, external evidence can be used to further define the contractual relationship between your company and your customer. This may occur when vague contract terms are used, or there are aspects of the relationship left undefined. For example, (a) promises made via e-mail (i.e., delivery dates or specifications) may be binding, (b) promotional content on your company's website that may be construed as warranties, or (c) PowerPoint presentations made by your sales team, or instruction manuals, may be considered.

Your past dealings with customers and performance may also play a role in defining the contractual relationship with your customer. Your company's prior track record with the customer in question, other customers, and conduct early on during the course of performing the current contract could be taken into consideration.

When it is clearly shown that your company's terms and your customer's terms cancel each other out, general contract law may come into play.

Protection of Intellectual Property (IP)

Intellectual property (or IP) includes items such as trade secrets, copyrights, trademarks, patents, and "know how."

The company needs to protect its IP during the pre-contract phase. If IP needs to be developed prior to being awarded a job, there is a risk the customer could give the production work to a competitor, pay nothing to your company for your time, and then claim it as their own IP to use with other vendors.

With regard to intellectual property contract terms, remember that a nonexclusive IP license is NOT a sale, but an exclusive IP license IS essentially a full or partial sale of your IP. In addition, make sure your company includes verbiage to have control over the derivatives, improvements, or other alterations to the IP, or you may lose or be deemed to have released your rights in the IP. Also, make sure that when the contract concludes with the customer, the license expires as well. When writing the terms of the contract, detail them to the specific product/IP rather than using general terms.

Protect Yourself from your Sales Team

Education, education, education. The sales team should be well educated on how and what can be offered and presented. Enforce a strict policy that the sales team is not authorized to sign anything on behalf of the company. Your company may want to include verbiage such as "all documents not valid until authorized by..."

On the flip side, make sure the person representing the customer company has the authority to sign documents. Having this policy in place allows your company to decide issues and roles earlier in the deal rather than later. It also shows your company is a mature corporation watching out for both sides with excellent contract control.

Achieving "Acceptance" of Goods or Services

It is important to have clearly defined specifications in your company's acceptance and rejection processes. Include a limited period of time and verbiage indicating that commercial use of the goods or services will be considered "accepted."

Without a well defined acceptance and rejection process, the customer can take control over this and specify that the goods or services aren't accepted until they have given signed acceptance. This could last indefinitely, delay payment from the customer, extend the warranty, and extend the period of time for training and implementation services.

Termination for "Customer Convenience"

The effect of contract termination should be well defined. The contract should cover customer purchase of inventory on-hand at termination, recoupment of start-up or capitalized costs, and a clear definition of what constitutes termination. For example, lack of customer orders for an extended period of time should be considered one means of termination.

Additional Thoughts

Make sure all individual participants are aware of the contract terms and who has authority to bind and make changes.
Your company must protect itself against increases in the prices of raw materials. Failing to do so could result in your company having to absorb those increased costs. Consider an established index method for price fluctuations.
Clearly define all general or performance warranties, and limit them to a period of time.
Contracts should clearly define and then limit customer remedies for damages.
Obtain perfected security interests in goods sold, to the extent possible.
Define dispute procedures: Law to follow, location, and forum.
DO rely on conspicuous contract terms and conditions, follow policies and operate consistently.
DO NOT rely on oral agreements, or inadvertently change agreements by sending out emails or letters.

Special thanks to Joseph Gustavus of Miller Canfield for sharing this information.

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