I received the following inquiry from a reader:
As you know, goods or services can be purchased by means of purchase orders issued under a master contract or by POs that aren’t issued under a master contract—I’ll refer to the latter as “stand-alone” POs. They can be issued for one-off purchases or on a regular basis as part of an ongoing relationship.
When you have a master contract, the general terms—in other words, everything that doesn’t relate to deal-specific matters such as product and price—are contained in the contract; the purchase orders issued under the contract contain just the deal terms. Furthermore, the general terms in a master contract are negotiated. By contrast, when you buy something using a stand-alone purchase order, the general terms are contained in the PO along with the deal terms, and those general terms are determined unilaterally by the purchaser rather than negotiated.
So what’s your take on the general terms in a stand-alone PO as compared to those in a master contract? Should they be equally comprehensive, or should those in a stand-alone PO address fewer topics more concisely and more evenhandedly?
Currently, the general terms in my company’s master contracts aim to be comprehensive, but those in our stand-alone purchase orders are shorter. One big reason for that is that including general terms in a PO makes demands on the supplier. Because the general terms in our stand-alone POs won’t have been negotiated beforehand with the supplier, they’re a source of delay, in that the supplier has to read through them and, after having done so, may balk at one or more of the general terms. And the longer the general terms are, they greater the likelihood of delay, and the greater the risk that the supplier will decide that given the extra one-sided verbiage, they’d rather not do the deal. Sometimes we end up having to negotiate; other times we agree with the supplier that if any conflicts arise, we’ll resolve them according to the Uniform Commercial Code.
This is of great interest to me because our legal department has prepared a new set of general terms for our stand-alone PO that essentially mirrors the general terms in our template master contract. That means the new set of general terms is comprehensive and one-sided in our favor. It’s also three times longer than the general terms we currently use for stand-alone POs. I’m torn between wanting to protect our company by using a comprehensive set of general terms for all our transactions versus wanting to use a shorter set of general terms so as to expedite our stand-alone PO transactions, most of which are low-risk. I’d be interested to hear what you think.
I don’t have direct experience with this issue, but here’s my first-principles take on it:
I can understand wanting to have the same general terms apply to purchases under a master contract and purchases under stand-alone purchase orders: your concerns as a purchaser are the same in both contexts.
But you have to consider the transaction costs. With a master contract, the parties have decided that they’ll be doing enough business together to warrant incurring up-front the transaction costs involved in negotiating a master contract. By contrast, with a stand-alone PO, you’re dealing with a single transaction—it would presumably not support the same level of transaction costs.
For purposes of illustration, here are a couple of hypothetical scenarios with make-believe numbers:
Acme and AlphaCo negotiate a master contract for Acme’s purchase of widgets from AlphaCo. In negotiating the general terms they incur $10,000 of transaction costs. They anticipate that Acme will purchase $1 million of widgets over the life of the contract.
By contrast Acme and BetaCo elect to have Acme purchase widgets from BetaCo using stand-alone POs. Acme orders 1,000 widgets for $10,000, using a purchase order that contains the same general terms as it used in the master contract with AlphaCo. The order placed with BetaCo is worth 1% of the expected value of purchases under the master contract with AlphaCo.
BetaCo’s transaction costs could well be less than Alphaco’s: with a one-off transaction, not as much would be at stake, so BetaCo might well be willing to accept some general terms without any haggling. But it wouldn’t be reasonable to expect the transaction costs incurred by Betaco to be 1% of the transaction costs incurred by Alphaco—the time it takes to read and understand the general terms would be the same for both transactions.
And it wouldn’t be realistic to expect that just because it’s a one-off transaction, BetaCo will accept all the general terms without negotiation. After all, a supplier that’s willing to give concessions in each one-off transaction could soon find itself with a portfolio of unfavorable contracts.
And it pretty much follows that if a comprehensive set of general terms in a stand-alone PO causes BetaCo to incur disproportionate transaction costs, closing the deal would cause Acme, too, to incur additional transaction costs as it engages in discussions with BetaCo.
So it may be that for the deal to make sense, the general terms in any stand-alone PO issued to BetaCo would have to be significantly shortened and made less one-sided so as to reduce BetaCo’s and Acme’s transaction costs.
Of course, BetaCo’s transaction costs could well be reduced drastically the next time Acme submits a stand-alone purchase order. But that assumes that the same BetaCo personnel are handling the second PO as handled the first. And more to the point, in handling the first PO, it would be risky for BetaCo to assume that it would in effect be able to amortize its transaction costs over the course of future purchases: for all it knows, Acme’s first PO could be its last.
So I’m sympathetic to the notion that for purposes of stand-alone purchase orders, it make sense to cut back a set of general terms used in a master contract and make them less one-sided, even though they reflect legitimate concerns.
I’m sure readers will have their own practical—as opposed to theoretical!—take on this.
Standard purchase-order terms will always favor the buyer, for obvious reasons. From the buyer’s perspective, how buyer-favorable you want to make your terms depends on how many suppliers actually read them, and how time-sensitive your orders typically are. If you often place orders at last minute and your suppliers tend to read the terms, your standard terms should be fairly even-handed. On the other hand, if many suppliers accept your terms without comment, and there’s typically time to hash out differences with vendors who object to terms, then your standard terms should be extremely buyer-favorable.
This was my inquiry. Our negotiated contracts govern the PO and any conflicting general terms. We were not modifying PO terms to override a master contract.
Our current PO terms issued w/o a master contract are usually accepted w/o comment (perhaps because they’re too benign) but it’s a good bet that suppliers who have accepted the PO terms w/o comment, will take notice because the draft terms are 5 times longer and more detailed and one-sided. So they may not accept them or ask to negotiate them or to enter into a separate agreement.
You need to ask yourself, what is the likely upside of —
1. having “killer” terms in your PO that, in theory, give you an advantage if a dispute should arise later, but that require negotiations resulting in delays getting business done;
versus
2. having “fair and balanced” (sorry!) terms that let you get business done promptly.
Putting it another way, which is more important to you: Achieving a win for the legal department in a hypothetical future dispute? Or achieving a real, present-day win for the operations folks?
Good comments above. A few further thoughts:
Your reader doesn’t mention the process for incorporating the one-off terms into the contract. Are the terms intended to be “small print” on the back of a form? Do the terms fit onto the back of a one-page form and are they still legible? Are the terms always sent with the PO or are they merely referred to and incorporated by reference? Are the POs emailed or posted? Does the supplier sign and return the PO? How often does the supplier respond with their own quotation with terms of sale attached? Does the purchaser ever accept the supplier’s terms? How “cute” is the purchaser about making sure that it wins the “battle of the forms”, or do the seller’s terms sometimes get incorporated, perhaps inadvertantly, into the contract? How often does the supplier query the terms of the PO? Does the purchaser accept these queries or use their bargaining position to insist on terms at or very close to the original PO terms?
Although some of the above questions are not directly relevant to a drafting decision as to how detailed or one-sided the PO terms should be, I think they are relevant to the larger, strategic question of how best to handle one-off POs. I find some clients focus just on the terms without sufficiently considering the practical aspects of how those terms will be incorporated into the contract. Eg have Jim and Vera in accounts been trained to reject a returned PO that is countersigned by the seller but which has written above the countersignature the words “subject to seller’s terms and conditions and not those overleaf”.
If I were advising a client on this question, I would want to understand the detailed process as well as the balance of power with suppliers before commenting on how one-sided the terms should be.
Answers to Mark’s questions:
Are the terms intended to be “small print” on the back of a form? Current terms are back of PO; about Arial font size 8; double column; 1.4 pages; New terms have same format except 6.5 pages.
Do the terms fit onto the back of a one-page form and are they still legible? See above. Legible – yes.
Are the terms always sent with the PO or are they merely referred to and incorporated by reference? Sent with every PO. We are reviewing our sending options given potential increase in content size. The trend or precendent for referencing terms instead of attaching is unclear to me.
Are the POs emailed or posted? Some are posted on a supplier network site; some are faxed; some are sent EDI.
Does the supplier sign and return the PO? Some return a PO acknowledgement. Others just process the order.
How often does the supplier respond with their own quotation with terms of sale attached? Don’t know for sure.
Does the purchaser ever accept the supplier’s terms? Rarely if ever.
How “cute” is the purchaser about making sure that it wins the “battle of the forms”, or do the seller’s terms sometimes get incorporated, perhaps inadvertantly, into the contract?
A double edge sword – The new comprehensive terms give a stronger position in “battle of the forms” but it could also cause suppliers to introduce their terms when they didn’t before and create a “battle of the forms” or to delay order while conflicting language is resolved.
How often does the supplier query the terms of the PO? Not very often with current terms.
Does the purchaser accept these queries or use their bargaining position to insist on terms at or very close to the original PO terms? Depends on leverage; products; replacement suppliers. First position is stand firm with ours. Balance of power varies. Impact on direct materials POs poses biggest concern.
Is the baseline presumption that these ‘long terms are necessary’ discussions start from really true? In short, what’s really wrong with simply relying on the default UCC terms (presuming a sale of goods)? They may not be one-sided, but they generally lead to fair results and don’t come with gobs of transactional costs as discussed above. Sure — In any one example the result may be bad for one or the other, but in the larger scheme over time the UCC default rules are very unlikely to lead to unfair results (based as they are on a thousand years of commercial law and practice that preceded them).
Which is a long-winded way of agreeing with D.C.’s point — Aren’t these fights usually more about the ego of the bigger party’s lawyers than anything else?
6.5 pages of Arial 8 point sounds to me like a recipe for eye strain. I don’t really see the point of making it “small print” at that length, other than to reduce global deforestation if the terms are printed out by every supplier.
Even 1.4 pages sounds to me like some work needs doing to prune back to a single page.
But it sounds like John’s company is in a strong bargaining position. I suppose a calculation needs to be made as to whether the advantage of having more favourable and detailed terms, that are identical to the terms used for one-off deals and that may be accepted by some suppliers without question, outweighs the disadvantage of having individual negotiations with some suppliers who object to the new terms but were okay with the old ones.
I am reminded of the 350 page agreement that a Government procurement department proposed to one of my clients a few years ago. That negotiation was fun…(?)