Technology contracting in uncertain times – tips for buyers and suppliers

We have read countless legal articles recently about how a contract’s “force majeure” clause or the doctrine of frustration could allow suppliers or buyers to get out of their existing contract.

But this time of pandemic crisis and response provides a great opportunity to put in place new contracts for products and services that businesses need now and will need when business conditions are improved.

What advice should suppliers or buyers have in mind when negotiating new contracts? Or re-negotiating existing contracts where conditions have changed so that it is unfairly burdensome or impossible for parties to comply with their contractual obligations?

This article will highlight several contracting issues for both buyers and suppliers which are relevant in all market conditions. These are:

• understand the term of the agreement;
• negotiate appropriate payment terms;
• customise the specifications;
• right of termination for convenience;
• consider each party’s liability; and
• have a properly-crafted force majeure clause.

Understand the total term of the agreement

Here’s a short and sweet one to get us going: 

Buyers will likely get a better rate from the supplier, but should take care when signing multi-year contracts. The swift pace of change in technology and market conditions can mean buyers on longer contracts are locked into with outdated solutions that could be replaced with more efficient options. 

A rule of thumb is, no more than three-year contract terms; or one year terms for as-a-service arrangements.

Appropriate payment terms

Conventional logic would suggest that, except for upfront or ongoing licensing fees, buyers shouldn’t agree to pay in full or in part for services not yet delivered. 

A common approach in these circumstances is to contract for work to be done in stages or phases, and continue to the next stage only after you are satisfied with the quality and outcomes from the previous stage. From a buyer perspective, this is a completely understandable approach.

But these are anything but conventional times, and both sides may need to give concessions so that buyers and suppliers can cross our Australian prime minister’s metaphorical “bridge”, together.

In tougher times, suppliers should consider:

• offering a service “hibernation” mode, where the buyer continues to pay, say 20% of the normal fee for up to six months, but with the supplier’s service offering similarly pared back;
• asking for part-payment in advance, to fund upfront expenses or reduce a risk of a buyer’s non-payment; or
• shortening payment terms, say seven days instead of 14 days. Cash is king, as they say. Buyers who can help particularly their smaller suppliers should even consider offering shorter terms. For example, Brisbane City Council will (on a permanent basis) pay suppliers, who employ less than 20 people, within 7 days.

In return for a buyer’s flexibility on payment terms, suppliers could consider offering say, a reduced fee for early payment, or 12 months of service at the price of 10 months. 

On sufficiently large arrangements, requiring the buyer to provide security such as a bank guarantee or personal property security (PPS) charge.

Customise the specifications

The standard wording in supplier contracts requires the supplier to ensure the product or service is as described in the supplier’s Documentation. But unless the buyer is buying bog-standard, off-the-shelf IT products or services without customisation, the buyer will only achieve its expected benefits if the products or services also meet the buyer’s business requirements or technical specifications (Specifications). 

Buyers should review the supplier’s Documentation for the product or service accurately reflects your commercial and technical requirements; if not, write your own Specifications and include them in the agreement. Then verify that the applicable obligation or warranty clause in the agreement requires the supplier to deliver products or services which satisfy the Documentation and the Specifications.

If it later turns out that the products or services do not meet the Specifications, it will be essential to have included these Specifications in the contract to help in making out a claim for breach of contract. 

This approach also protects a supplier from its buyer’s spurious claim for breach of contract, where the buyer may have been unable to use the product or service in an undocumented way or differently to the Specifications.

Termination for convenience

Commercial contracts will usually provide for circumstances when which a party has a right to terminate “for cause”, such as the other party’s breach of an essential term or an insolvency event.

But what if the supplier or buyer may want or need to bring the contract to an early end. This could be for a number of reasons, including:

Unlike some jurisdictions, Australian law does not generally provide that a supplier (including agents or distributors) is entitled to receive certain payments on termination. 

Early termination payments (ETFs) can be negotiated into the contractual arrangement. But take care, as the ETF amount must be “a genuine pre-estimate” of the cost or loss that the supplier will suffer due to the early termination. Otherwise, the ETF could be unenforceable as a penalty. 

For suppliers, in return for the buyer’s early termination right, you might want a moratorium on termination during the initial period (to provide time to recover upfront costs that you might otherwise have spread over the life of the contract) or a right to recover specific types of up-front costs, of standing-down or redeploying personnel, or of bringing third-party contracts to an early end. 

A note about early termination: there are a number of related issues to consider with early termination generally, including unfair contract terms; the “ipso facto” reforms in the Corporations Act 2001 (Cth) about automatic termination of a commercial contract upon a party’s insolvency; whether there is an implied obligation to act in ”good faith” when exercising a right of termination; or the Franchising Code of Conduct’s timing and content requirements for a franchisor’s termination notice. These are specialised issues for which you should seek legal advice.

Each party’s liability

It is not unusual for technology contracts to find clauses which exclude one or both parties’ liabilities for consequential loss, and which limit at least the supplier’s liability for direct loss. In many cases, the risk for a supplier in taking on any higher liability simply isn’t priced into the contract. 

Additionally, it would be more unusual to cap the buyer’s liability, as their primary obligation is simply to pay the contract price in exchange for the goods or services.

Let’s presume that the parties have agreed that the supplier’s liability under the contract will be limited. Where should this limit be set? 

Suppliers often prefer caps that are based on a value in the contract. For example, 

• the contract value, or a multiple of it; 
• the fees paid or payable in X number of months before the liability arose, e.g. three, six or 12 months; or 
• a specified dollar amount (and usually less than contract value). 

A good question for a buyer to consider is, what is the cap amount that would cover my business’ likely loss or damage if the supplier fails to perform the contract? 

Would this be your costs of replacing the products or services? Or if your business is an online retailer, would it be the amount of lost revenue that you would otherwise have earned by using the supplier’s shopping cart or product information management platform?

A better question buyers should consider is whether the same limit should apply at all times under the contract – or is the buyer exposed to a different level of risk in particular stages or timeframes within the contract period? For example, is your risk higher during the implementation stage, while the supplier’s service is still being customised and tested?

If the risk level could change, the contract’s limitation of liability clauses will need to specify the different timeframes and liability caps to apply during each one. 

When acting for a supplier, we usually suggest that the contract wording makes clear that any cap on the buyer’s general liability excludes the buyer’s obligation to pay the contract sum. For suppliers, this helps to ensure they get paid for the services provided.

Force majeure

This is a clause that nearly everyone glosses over in contractual boilerplate. But businesses should carefully consider force majeure clauses in their negotiations, as this legal concept is only recognised within contract law. In order to later rely on it, the parties should ensure the terms have been drafted into the contract, and accurately capture the types of qualifying events and the specific consequences of a force majeure event occurring.

Force majeure, sometimes called an “act of God” or “event of exceptional circumstances”, is an occurrence of such magnitude that it is beyond a party’s reasonable control, and makes that party’s contractual obligations impossible to perform in the circumstances. Not merely difficult, impractical or more costly than anticipated (or even uncommercially so) – but effectively impossible to perform.

Where the existence of the force majeure event is made out (and sometimes this requires the occurrence to continue for at least a minimum period of time); and that the party seeking to rely on it has followed the contractual procedure including notifying of the event, then the nonperforming party will be excused from liability for not performing the contract – either at all, or for the duration of the event (depending on how the clause has been drafted).

In the Australian contracting context, typical force majeure events are often strikes or labour action, floods, cyclones and or other natural disasters. 

Yes, a pandemic such as COVID-19 can be a force majeure event, provided that this event has been included in the clause’s scope. But in present times while the parties are negotiating in a COVID-19 environment, is it reasonable to suggest that a pandemic or its flow-on effects would not be within a party’s reasonable control? Or that the effects could not be avoided or remedied by applying foresight, care and diligence? Perhaps not.

We have also seen negotiations in which a supplier proposes to include as events of force majeure their third party supplier’s business failure or non performance of a back-end contract (i.e. the supplier’s data centre host becomes insolvent or refuses to supply the hosting services). Frankly, these specific circumstances would not ordinarily be, nor should they be, unforeseen events – rather, they can and should be anticipated and planned for within a business.

It is also worth noting that, where a force majeure clause is ambiguous about either the types of qualifying events, the notice or other procedures, or the contractual consequences of the force majeure event, leaves any ambiguity, then (unless another term of the contract negates the contra proferentem rule) the ambiguity will be construed against interests of the party who seeks to rely on the force majeure provisions. 

Accordingly, a prudent approach when negotiating the agreement is to consider what events should constitute a force majeure; what are the possible impacts that such event would have on ongoing operations if contractual obligations (or say, those of critical suppliers) were suspended for months on end (as these sort of time scales are entirely possible); and what will be the legal consequences. Will the party’s obligations be suspended until the event clears? If the event persists for a prescribed time, can the affected party terminate the agreement? Will the unaffected party have a general right of termination?

These questions should be considered when negotiating your force majeure clause – only a contracting fool risks accepting the boilerplate version! 

For more information about negotiating better technology contracts as a supplier or buyer, or making changes in your existing contracting arrangements, please contact HopgoodGanim's Intellectual Property & Technology team.