Ten Things To Consider When Reviewing a Vendor Contract

Founders and operators of any growing business inevitably need to review and negotiate contracts with various outside service providers and vendors.

Most large and established vendors, such as AWS, Google or Salesforce, have standard boilerplate contracts that are NOT negotiable.  However, for many other vendors, especially those providing custom deliverables or services, it’s important to review and negotiate the terms of the engagement to ensure they fit your needs and expectations.  

Even in situations where it’s not possible to negotiate terms, it’s always good to review (or have your counsel review) the terms to ensure you understand how the contract works and avoid any surprises in areas such as payment timing, late fees, exclusivity provisions, termination, IP ownership, or automatic renewals.

Below is a list of common areas to review before you sign a vendor contract:

1. Pricing, Invoicing & Payment Terms

Pricing is typically one of the first business terms that is negotiated and agreed upon in a typical vendor contract.  How pricing is defined typically varies depending on the type of good or service being provided.  

For an existing product or service, pricing is typically based on cost per unit being delivered, or for software service, is often based on a cost per license/seat (whether one time or more likely, monthly or annually based on a subscription fee), and may also include upfront “initiation” or other start up fees/costs.

For custom work or services, fees are often billed on a Time & Materials (T&M) basis, such as an hourly, weekly or monthly rate per resource or FTE (Full Time Equivalent), although in some instances vendors may promise to provide a deliverable or service at a fixed rate per deliverable/project/service provided.

In addition, you should also be aware of the applicable payment terms.  Monthly invoicing (on a calendar month basis) is most common, although the timing of the payment (eg how long you have to pay, such as “Net 30”, and whether there are upfront or guaranteed payments) should be carefully reviewed.

 

2. Description of the Product or Services; Acceptance Criteria

Any contract should provide a good description of the product or service being provided.  For contracts with standardized products and services, this should be pretty straightforward.  

However, for custom or non-standard services or deliverables, including work for hire by contractors, ensuring the contract has a good product/service/deliverables description is extremely important to ensure both parties have the proper expectations on what is being provided.  A robust, accurate and complete description of the work also enables the parties to know if delivery was complete or incomplete, avoiding potential disagreements over scope after the fact.

Often these details are scoped out in a Statement of Work (or “SOW”), usually in the form of a detailed standalone exhibit separate from the main contract or agreement terms, which contains additional information regarding what the deliverables will be, how they will be delivered or provided, and applicable timelines or deadlines.  

In addition, for custom work or for products being delivered, it’s a good idea to include acceptance criteria and/or inspection rights to address how and when a deliverable or good is deemed “accepted” based on the agreed upon specification or description.  

 

3. Term of the Contract & Renewals

Another important area of a contract that is sometimes overlooked is the term of the contract (eg how long it lasts) as well as provisions relating to the term, such as the right of a party to terminate early, and whether and how a contract may renew.  

Parties entering into a contract do so because they expect the business relationship to succeed.  Yet in many cases the business relationship doesn’t work as expected, and a common question attorneys deal with in these situations is “how do I get out of this contract”?  

For this reason, while you should always expect and plan for the relationship to be successful, its also good to think about an “exit” strategy in contracts (eg. how and whether you can terminate a contract early) to avoid ongoing cost and risk. 

In addition, you should also be aware of any automatic renewal clauses in vendor contracts – in many cases customers get tripped up where they are stuck with a contract (and its costs) where it renews for an additional term they did not want. 

 

4. Scope of Rights

For contracts that provide a standard service or product, how you may use a product or service is usually straightforward and any use restrictions that might apply are typically not negotiable. In those cases, the most important thing is to make sure that you understand the use restrictions, if any, and are comfortable that they fit with your business requirements.

However, for a custom service or deliverable, especially those products or services that you expect to be incorporated into your own product or service, you should pay extra attention to the scope of rights to use that service or deliverable.  Ideally your rights to use the deliverable extend to the uses you expect to offer in your own product or service that incorporates that deliverable, so depending on how you are using the deliverable, you should carefully review any restrictions in areas such as field of use, rights to sublicense/subcontract, rights of others such as end users or affiliates to use the deliverable, rights to use vs rights to distribute, and rights to create derivative works from the deliverables.

 

5. IP Ownership

In addition to understanding what rights you have to use or distribute a deliverable or service, it’s also important to understand what, if any, intellectual property (“IP”) rights (eg copyrights, patent or trademark rights) you are being granted in the deliverable or service being provided.  

For standard products or services, you typically would NOT expect to have any IP ownership rights, other than a non-exclusive license to use that product or service.  

For custom products or services, especially those that are being used within your own product or service, you may need to be sure that you own IP rights in the deliverables to be sure that you own all rights in your own product, as well as ensuring you are neither ‘blocked’ from further development nor precluded from offering similar or the same service to other customers.  Generally, agreements should provide for an assignment of such rights to the company paying for the service or product (in some cases including an assignment of any copyrights under the “work made for hire” doctrine in the US), but this is something you should review carefully with your legal counsel, as in some cases a contractor or vendor may carve out certain rights. 

 

6. Data, Data Privacy & Data Ownership Rights

Data, including privacy issues and ownership rights, has become increasingly important, especially the treatment of any potential liability and risks around certain kinds of data, such as personal information from customers or employees of a company, which are subject to regulations in the EU and in certain states such as California and Massachusetts.  

To the extent your vendor provides a service that uses or operates on data sourced from your company, you should be sensitive to how they are using and protecting such information, especially if the information being operated on involves personally identifiable information (including personal health information) regarding your own customers or users. 

In instances where a vendor is using or operating on personal information of your customers or end users, we suggest conferring with your legal counsel as to whether additional provisions, including a data processor addendum or “DPA” document, is required to ensure compliance under applicable data privacy laws.  Similarly, in some instances, you may be required to enter into a Business Associate Agreement for the safe transfer of personal health information between you and a vendor or supplier of health-related products.

7. Support

These days, especially with Software as a Service (“SAAS”) or other ongoing services, the “support” you receive with respect to a product or service is as much a part of the “service” as the actual product or service itself.   

As would be expected, larger vendors with standard SAAS or other service type offerings will usually provide a standard set of service level commitments via a Service Level Agreement, also known as “SLAs”.  In many cases, the service level commitment is expressed as an uptime commitment (e.g. a certain percentage that the service is available).

Generally, the smaller the customer, or the larger the vendor, the less likely there is any wiggle room to negotiate these provisions.  But as contract value goes up, or as more customization of the services is required, vendors are more likely to negotiate these types of provisions.  

 

8. Warranties; Indemnification; Limitation of Liability

Provisions regarding warranties, limitation of liability and indemnification are very important in a contract, especially where the contract value is high, the types of goods or services may result in significant liability or risk, or your company’s ‘crown jewels’ (e.g., an algorithm, a patent filing, a trade secret) are involved.  

These provisions often appear near the end of a contract, usually in all caps and bolded text, and while non-lawyers typically avoid negotiating these provisions, having an experienced attorney review these provisions can be very important to avoid significant liability in the event there is a problem with a good or service, or if damage or injury arises out of a contract.   

While explaining the nuances of such provisions is beyond the scope of this blog, the following is a short explanation of each of these types of provisions and why they are found in a contract. 

Representations and Warranties: These are “promises” being made by one party to another that something is true as of the date of the contract (or will continue to be true during the term of a contract), which can vary from things such as representing that the product or service will work in a certain way, or may include a representation that a product or service will not infringe third party intellectual property rights or violate any laws.  

Indemnification:  Sometimes indemnification is confused with representations and warranties, as the types of risk they cover are similar.  However, indemnification is different in that it’s a form of “insurance” that a party provides to another party – to the extent there is an issue that is subject to indemnification, then the party providing the indemnification (the “indemnifying party”) is essentially agreeing to pay the other party for any loss or damage from the issue that is subject to the indemnification.  Often, this can create a situation where the indemnifying party will have unlimited liability for the issues covered, so they should be reviewed very carefully.

Limitation of Liability:  This provision limits the overall liability that one (or both) parties will have in the event of a breach or other issue under a contract.  The limit is sometimes expressed as a set dollar value, although in other cases it’s tied to how much is received or spent under a contract over a period of time.  In addition, limitations of liability are often subject to certain exceptions or “carveouts”.  

In each case regarding the above, we always recommend that you have counsel review such provisions, as in many cases there are definitions and exceptions or carveouts that can significantly affect how such provisions work and what type of coverage (or liability) the party is taking on.  In addition, to the extent a contract does NOT have such provisions, we again strongly suggest you seek counsel to understand where such provisions should be included.  

9. Governing Law; Forum & Arbitration

Hopefully, a contract that you enter never results in a dispute or litigation.  However, in some sense a reason why contracts are important is to have a document that tells the parties what happens if things DO go wrong.  

In the event things do go wrong, and litigation (or the threat of litigation) is a possibility, then understanding what law applies, and what courts the contract parties may bring an action in, is very important – different states in the US have slightly different laws and rules that may favor one party or the other. It is also important here to know whether there’s a clause that permits the prevailing party to also get its attorneys’ fees and costs reimbursed.

In addition, having the “home court advantage” (eg specifying the laws and courts of the state in which a party resides) can be helpful, especially if the other party is out of state and needs to potentially incur additional costs for travel and litigate a matter in your home state.  That said, we suggest conferring with legal counsel regarding the potential benefits (and downsides) of specifying certain governing law and forums in your contract.  

Finally, you should consider whether to include a binding arbitration or mediation clause in a contract – in some cases submitting a claim to arbitration or mediation can be less expensive the resolving a claim in court.  We suggest discussion with counsel the pros and cons of including such a provision.  

10. Other Provisions to Consider

The above contract provisions are by no means an exhaustive list of areas to be considered when negotiating a vendor contract.  In addition to the above, you may also want to confer with counsel regarding these additional provisions/areas in a contract, depending on the type of deal you are working on:

Confidentiality

Assignment

Insurance

Shipping Terms

Exclusivity/Non-competes

PR/Marketing Rights

Non-Solicits