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Business seems to be going well, but are your processes really performing as well as you think? Could there be bottlenecks you’re not aware of, or milestones you’re missing? And can you be sure you’d spot the ‘rogue contract’ that could spell serious trouble down the line?

Our Top Ten Key Performance Indicators (KPIs) will save time and cost – and keep you in control.

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Cash flow problems? No worries, squeeze your supplier

Financial times may be tight, but if you want to keep your cash flowing, the answer’s simple: get your customers to pay up promptly and hang on to that cash for as long as possible. If others have to pay the price, so be it.

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Is your contracting playbook an information manual or a dynamic tool that can evaluate negotiation options? This article shows how interactive intelligence can boost the power of your playbook, helping you achieve better negotiated solutions – and more collaborative contracts.

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To view the supplement click here.

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Social responsibility in supply chains remains a hot topic because of recent events like the fires in Bangladeshi factories. While sourcing companies need to have ethical norms in place for suppliers' behavior, they must be drafted in such a way that they balance the protection of their reputation, their business relationship with the suppliers - and avoid any negative legal consequences.

All of this starts with the language of SCCs. Several companies have been accused of drafting their SCC in such general terms that it was basically useless. Other companies are very much in favor of precisely formulated codes, which they see as more effective and legally enforceable. However, the issue is not so black and white.

Keep it as precise as possible…or not?

The conventional economic rationale pushes contractual parties to formulate contractual terms as precisely as possible to prevent any disputes and litigation.1 However, there may be a strong case for avoiding complexity and leaving some aspects of the contractual relationship either unregulated, or regulated in a more open manner.

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A few reasons why

  • Company's size matters - Small and medium-sized companies often produce less elaborate and precise SCCs than large companies. Why?
  • They may not have the resources to invest in corporate social responsibility (CSR);
  • They may not be in a negotiating position to impose CSR requirements on their business partners;
  • They have primary interests that are simply closer to their domestic location.
  • Or, most likely, they think they don't need to, because the attention in the CSR area remains focused on large multinationals.
  • The purpose of SCCs - SCCs are usually a part of supply chain contracts. However, their aim may be to communicate goals and values to their business partners, rather than explain them to a judge at some point in the future; to motivate ethical behavior rather than to enforce it. In that case, broader interpretations are appropriate.
  • Keeping the contract flexible – If the SCC uses standard terms it may be difficult to amend them, and they may require things not relevant to the specific deal. In extreme cases the requirements in an SCC may become a deal breaker. Keeping the wording more open allows the parties to interpret and adjust the content to the changing regulatory environment, their business needs and unforeseen events without the need to renegotiate.
  • Crossing boundaries, crossing cultures – A more generalized format will also allow the same wording to be used in various jurisdictions and help to overcome any differences in the parties' cultural and legal understanding of the issues in question. For example, the age limit for what constitutes child labor can differ across countries, especially those that are not signatories to the respective International Labor Organization (ILO) Conventions.
  • Requirements that cannot be controlled - The controllability and verifiability of corporate CSR performance and contribution to sustainable development can be a major problem. Some companies try to work through this burden by introducing specific goals for their suppliers.

For example, from 2009 and without any legal pressure, Verizon Communications Inc. has required its suppliers to reduce the energy efficiency of network components by 20%.2 Because this is a measurable feature, the wording of the respective contractual requirement can be precise.

Alternatively, it may simply not be possible to effectively control or quantify compliance with some requirements. In such cases, more general wording works better. For example, ArcelorMittal requires its suppliers to “…to maintain effective policies, processes and procedures to manage their environmental impact…”3

  • Is there a threat of legal sanction? SCCs tend to be more specific where there is a specific underlying legal regulation or threat of a statutory sanction. This occurs mainly in relation to topics regulated by (supra)national law.

For example, the REACH Regulation prescribes detailed rules for the obligation to register chemical substances in products marketed in the EU.4 Because legal enforcement is stricter, the buyer has to make sure the supplier understands precisely what is expected.

On the other hand, in the climate change area, EU companies are not subject to any specific rules on emission reduction in their supply chains, therefore SCCs in this context tend to be more broadly drafted.

SCC language may influence suppliers' behavior

As discussed above, parties may have valid reasons for leaving SCCs vague. However, any vagueness opens up room for ambiguous interpretation and thus casts doubts on the applicability of the underlying contract law and enforceability of the terms. Such doubts undermine the notion of the binding nature of the terms, which is an important incentive for compliance, even if the parties do not actually intend to use the formal enforcement mechanism.

This corresponds to the philosophy that “the binding force of the law is an idea in human minds”.5 People align their preferences and morals to the model behavior prescribed by legal norms. If suppliers suspect that a provision would not be enforceable, the level of compliance may be lower. On the other hand, if suppliers face strict obligations, they may fear legal and relational consequences and hide any non-compliance.

Therefore, when drafting SCCs, companies should weigh the advantages of broad language – ie its flexibility, wide application, and accent on relational tools - against the advantages of precise language in relation to proactive management of legal risks and perception of SCCs as legally binding. To do that they must be aware how the language of the SCC would be interpreted should a dispute arise, and how specific it would need to be, for it to be formally enforceable.

What would the judges say?

Disputes over SCCs rarely come to the courtroom. However, while the attention of media, NGOs and customers remains fixed on the ethical performance of international suppliers,  sourcing companies need to know if their CSR requirements are actually enforceable or not. In order to be enforceable, an SCC must form a part of a contract and cannot be too ambiguous.

The same applies to the provision that implements SCC into the contractual text. Courts will interpret the code and contract in two steps: first identify the parties' intentions and then, if they cannot be determined, establish the meaning that a reasonable person would assign to the document in question.6

For example, Article 14.2 of the Verizon Australia Supply Agreement7 reads as follows:

“Buyer is committed to conducting its business in an ethical, legal and socially responsible manner. Buyer expects its suppliers to share this commitment and has therefore established a Supplier Code of Conduct set forth at which Company agrees to adhere to.”

Should the suppliers understand the words “agrees to adhere to” as accepting an obligation to comply with the code, or merely that they support the values expressed in it? And can Verizon take a dispute to the court successfully if necessary?

Parties' intentions

To answer the above questions, the first step is to determine the intentions of the parties. This is easy if there is a declaration regarding the effects of the code in the contract's preamble or in some pre-contractual documents. If that is not the case, we should look into the circumstances of the contract.

For example, does Verizon request suppliers to sign the code before concluding the contract? Does it state anywhere that compliance with the code is a prerequisite for any business relationship? If yes, then Verizon's intention would clearly be to establish binding obligation.

The conduct of the parties provides further help. In the code, Verizon reserves the right to audit suppliers' compliance. It is important whether the company actually conducts such audits and how it reacts to any negative findings.

If the supplier can prove that the company knew about any non-compliance but did not act upon it, the court could rule that Verizon did not intend to cause a binding effect. And conversely, if the supplier follows the code, accepts regular audits and implements corrective plans that are imposed, the court could deduce that he/she considers the code binding.

Parties' conduct is closely connected to the establishment of contractual practices, which may be examined when interpreting a contract. Therefore, it is relevant to gather information about the parties' previous dealings. Did they include a similar document in their previous contracts and how did they treat it?

International implications

Objective test

If there is no clear evidence of parties' intentions, then the so-called objective test is conducted.

There is no standard wording of SCCs or their incorporation of contractual clauses that would be recognized internationally. It is a question of companies' style and policies. Therefore, neither the common meaning nor the objective test of a reasonable person will help much, as in the sea of various approaches we cannot determine a common meaning of the clause as the reasonable person's view differs significantly across jurisdictions.

Furthermore, the nature and purpose of the contract does not help us either, as one of an SCC's main characteristics is that it is disconnected from the subject matter of a contract. The main objective of the contract – i.e. to have goods delivered – can be achieved without assigning a binding effect to the code.

More guidance can be derived when interpreting the provision in the light of the whole contract. From a structural point of view, the placement of a provision within the text suggests how great a value parties assign to it, and therefore helps in interpreting the contract and the code. There are five general rules for structuring a contract:

1.  General provisions should be placed before special provisions;

2.  More important before less important provisions;

3.  More frequently utilized before less frequently utilized provisions;

4.  Permanent before temporary provisions; and

5.  Miscellaneous provisions should be placed at the end of the body of the agreement.8

We should also look at the actual text of the code. The preamble states that “…Verizon's suppliers and their agents and permitted subcontractors shall support Verizon's core values by conducting business with integrity, by treating others with respect, by striving for performance excellence and by accepting accountability for their conduct.” The words “support” and “strive for” point towards soft obligations, ie obligations to exercise best efforts rather than to achieve full compliance. The expression “accept accountability” also does not suggest that the obligation would be absolute.

Finally, contra proferentem interpretation is followed, ie that an ambiguous provision should be interpreted against the party that drafted it.

If you took the time to study both Verizon's SCCs and the respective contract carefully, you would find that in essence all the interpretation rules used in international contract law point towards the unenforceable character of the analyzed provision.9 The conclusion would have to be that suppliers have the obligation to invest efforts to support the values of Verizon; however, possible non-compliance with the code would not constitute a breach of contract.

So…which language to choose?

The precision of language in SCCs has wide implications on their actual and legal effects. It is not a general truth that precisely formulated codes are better than broadly formulated ones. But it is true that wrongly chosen language can undermine the goals of SCCs your company wishes to achieve and may possibly put the company in danger of negative legal consequences.

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Businesses across the world spend an incredible amount of time and therefore money trying to get Confidentiality or NDAs in place with their numerous prospective customers or suppliers before they can even start talking to them about buying or selling their products or services. As I was reviewing yet another NDA recently, I thought there must be a simpler and better way of addressing the issue of establishing the principle of confidentiality for disclosures made during the course of routine sales negotiations for products and services.

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The focus on indemnities and limits of liability in the IACCM Most Negotiated Terms1 survey, year after year, suggests that for many of us the primary role of the contract remains as a weapon (enabling us to punish the guilty) or an insurance policy (limiting our exposure if we make mistakes). 

Are those two objectives in line with creating business value? If they are, can we (realistically) achieve them through our current contracting focus?

To ask a wider question, given the time, money and emotional energy invested in creating and negotiating agreements, isn't it about time our organizations started to get their money's worth?

What is your contract for?

To assess the value delivered by our contracts and contracting process, we first need to identify why we have them in the first place.

In many organizations, the necessity of a written contract to underpin each commercial relationship is taken for granted. When asked, businesses and public sector organizations will cite risk management and value maximization as key drivers for the contracting process.

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When it comes to how we manage risk and maximize value, however, there are many divergent approaches. IACCM's research1 illustrates in Figure 1 that our negotiation focus does not necessarily line up with our objectives.


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