When should a purchaser indemnify a supplier?

Supppliers of goods and services sometimes require their business customers to indemnify them against third party claims arising from the use of those goods and services.

IP Draughts has reviewed several contracts recently where strong indemnity terms have been included.  This seems to be a trend; IP Draughts doesn’t recall so many contracts having such strong terms in the past, but maybe his memory is failing.  Recent examples to cross IP Draughts’ desk have included the terms of business of two companies that provide IP strategy services, and the master services agreements of several CROs – Clinical Research Organisations – that provide services supporting the clinical development of pharmaceutical products.

Professional services

Whether any indemnity is included in a commercial contract is a matter of commercial policy, which may be informed by practice in the relevant industry sector.  For instance, the standard terms of engagement of Anderson Law LLP do not ask clients to indemnify the firm against third party claims arising from the use of any legal advice that the firm provides to the client.  Perhaps we are behind the times in using a very simple engagement letter.

By contrast, IP Draughts has recently advised a client that wanted to consider some tax advice that a top 4 accountancy firm had prepared for another organisation.  Before being given access to this advice, the client was required to sign a 6-page letter of indemnity that included terms such as the following:

You might think that requiring a 6-page indemnity before being given access to some basic tax advice is overkill; I couldn’t possibly comment.

Intellectual property licensing

IP Draughts has for many years included in licence agreements drafted for universities a provision under which the licensee indemnifies the university against claims by the licensee’s customers and others.  A rationale for such a provision is that the licensee is the one that is developing commercial products and that has a business relationship with its customers; it is inappropriate that a university, funded by the public purse, should be exposed to this type of commercial risk.

By contrast, many commercial software licence agreements include a provision in which the licensor indemnifies the licensee against claims from third parties alleging infringement of intellectual property.

Thus, there is not a single approach to indemnities in IP licensing transactions; it all depends on the circumstances of the parties, relevant industry practice, and the individual deal.

Technical and project management services

Coming back to the example of CRO agreements, a recent agreement included the following indemnity:

Customer shall defend, indemnify and hold harmless CRO, its Affiliates and their respective officers, directors, employees and agents (“CRO Group”) from and against all Losses arising from Claims arising from or related to …Customer’s or any other person’s use, consumption, sale, distribution or marketing of such Study Materials

This indemnity was qualified in the situation where the liability could be shown to have resulted from the CRO’s default.  The general principle, though, is that the CRO seeks an indemnity in respect of downstream use of the pharmaceutical product in respect of which the CRO provided services.

Similarly, in some terms that IP Draughts reviewed recently, a supplier of IP strategy services included the following provision:

The Client shall indemnify Supplier and each of its partners and associates (each of the foregoing an “Indemnified Person”) against any and all actions, claims, losses, liabilities, damages, costs, charges and expenses which it or they may suffer or incur in any jurisdiction or which may be made or taken against them relating to or arising out of or in connection with, directly or indirectly and to the extent lawful, the consulting services or any Indemnified Person’s role in connection therewith … save, in each case, to the extent that the same shall have resulted from a breach of the terms of the agreement by Supplier or from any Indemnified Person’s fraud, negligence or wilful default or a material breach by any such Indemnified Person of any law applying to such person.

In IP Draughts’ view, there is no overwhelming logic that says that service providers should be indemnified by their clients.  There is a point of view that professional indemnity insurance is there to deal with the remote risk of third parties suing a service provider, and therefore indemnities should not be needed (assuming the service provider is insured).

Provisions of this kind seek to allocate risk in a particular way.  Equally, IP Draughts has seen consultancy agreements prepared by investors on behalf of spin-out companies where the risk allocation is in the other direction, and the client company seeks an indemnity from the consultant in respect of liabilities arising from the use of the output of the consultant’s services.  IP Draughts has always thought such a provision to be harsh and inappropriate when dealing with individual academics, and that including such a provision reflects a particular mindset among some investors, based on a mathematical approach to risk analysis that is out of place when dealing with technology start-up companies.

As mentioned already, IP Draughts is seeing a trend towards service providers seeking strong indemnities from their clients and customers.   He wonders whether this trend is based on anything more than herd instinct. Over the years he has seen many other instances of changes in “standard” contract wording that appear to be based on general trends and little more. Examples include confidentiality obligations that require orally-disclosed information to be confirmed in writing, royalty terms in patent licence agreements that limit royalties on patent applications to application that are no more than X years old,  and audit clauses that limit the right of audit to a year or two after the payment was made.

Readers, are you aware of any compelling reason why indemnities by customers are becoming more prevalent in commercial contracts?  Or is IP Draughts’ perception based on a random blip in the contracts he has seen, and not part of a wider trend?  And do we need these provisions or are they another example of unnecessary complexity in contracts?

Indemnities that go round in circles

IP Draughts has commented before on the inappropriate use of indemnities.  One of the issues that comes up is that indemnities are often drafted in dense, complex language that makes it difficult to understand their meaning.  Many people reading contracts are put off by this complexity.  If the indemnity looks reasonably even-handed on initial reading, the temptation is to assume that it will be okay, and avoid the headache that comes with close textual analysis.

Consider the following example, from a template consultancy agreement that IP Draughts was asked to review and update last week.

Each party shall save, indemnify, defend and hold the other party harmless, from and against all claims, losses, damages, costs (including legal costs) expenses and liabilities in respect of the loss of or damage to property or personal injury including death or disease to employees in connection with the performance of the Agreement, or in connection with any Company product that results from the Consultant’s performance of services under this Agreement, except to the extent that such claim, loss, damage, cost, expense, liability or personal injury is caused by the negligence or breach of duty (whether statutory or otherwise) of the other party. 

At first sight, this wording may look reasonable.  It is drafted in a mutual, even-handed manner.  Each party indemnifies the other in respect of performance of the contract.  There is a carve out if the other party has been negligent.  What could be wrong with this?

Let’s leave aside the problem of the bloated, US-style drafting – as if the terrible trio of indemnify, hold harmless and defend weren’t bad enough, this clause has a fourth evil sibling in the form of “save” – where has that sprung from and what on earth does it mean?  Instead, let’s just focus on the general intent, so far as one can be gleaned.

IP Draughts’ best guess as to what the drafter wanted to say is that a party performing an activity under the contract indemnifies the other party against liabilities arising from that activity.  Even to say this creates issues, such as what happens if one party produces a report and the other party uses the report, leading to a liability to a third party.  Is the “performance” that gives rise to the liability the writing of the report or the use of the report?  In IP Draughts’ view, clauses of that kind (although quite often seen) are fraught with difficulty.  If a clause in this general ballpark is required, IP Draughts much prefers one that carves up liability based on liability arising at the location of the activity (eg someone is injured by an explosion at a factory) or alternatively a carve-up based on who is to blame.  Generalised indemnities based on a party’s performance rarely seem to provide for a clean split of legal responsibility.

But the clause doesn’t even say this.  It doesn’t say A indemnifies B in respect of liability arising from A’s performance.  It says, in effect, A indemnifies B in respect of “the performance” of the Agreement.  It also says (because the clause is mutual and expressed as “each party” indemnify the other) that B indemnifies A in respect of “the performance” of the Agreement.  So, ultimately, who indemnifies whom?

Sure, there is a carve out at the end of the clause, an exception to the indemnity where the other party (ie the one not indemnifying) has been negligent or in breach of duty.  So, let’s say A produces a report and is negligent when doing so.  The report is used in the design of a product, the product is defective and a customer is injured.  Under this clause, A indemnifies B for performance by A or B.  B has not been negligent so this indemnity stands.

At the same time, B must indemnify A, because the clause is mutual.  But A has been negligent (and we are assuming this negligence has caused the defect and the third party liability), so ultimately B doesn’t have to indemnify A.

So B wins the indemnity?  Perhaps, assuming that a sane judge would follow this fantasy logic rather than throw out the entire clause as meaningless.

There are other glimmerings of meaning in the clause.  The reference half-way through to Company products resulting from performance of the Consultant’s services suggests that some thought was given to liability that might arise downstream from the use of the results produced by the Consultant.  But the clause doesn’t make clear whether the Company or the Consultant should take legal responsibility for such liabilities.

In summary, the clause is meaningless.  The words look familiar and organised differently they might have meaning.  Someone skim-reading the clause might assume the meaning from having read other, similar clauses.

The lessons, in IP Draughts’ view are two-fold:

1. Omit indemnities from contracts unless you have a very clear understanding of what you are trying to achieve.
2. Try to avoid or minimise the very convoluted legal language that is commonly seen in these types of clause.

Recently, IP Draughts has seen a number of contracts where the Consultant or service provider seeks an indemnity from the customer in respect of the use made of results, eg in the customer’s products.  This is  a theme to which IP Draughts will return in a later posting.

Government procurement in IP contracts: a dreadful waste of money?

What is the purpose of a Government procurement office?  Silly question – to save money, of course.  According to the home page of the UK Government Procurement Service, its mission is simple:

Savings for the Nation

Our role is to provide procurement savings for Government and the UK public sector, including Health, Local Government, Devolved Administration, Education and Not for Profit organisations.

Note the repetition of the word “savings” in both the title and the text above.  The focus of procurement offices, in IP Draughts’ experience, is monetary.  Yet as all good commercial managers and commercial lawyers know, the price is only one part of a negotiation.  Value for money can mean getting a high-quality product or service at a higher price than for a comparable, medium-quality or low-quality product.  Other factors such as brand reputation, user-friendliness, product reliability, service levels, and compatibility with other products, may also affect the market price.

Ah, but procurement is about much more than price, the procurement manager may cry.  It is also about defining responsibilities and allocating risk, through suitable contract terms.  And it is certainly true that the contracts prepared by Government and other procurement organisations tend to be weighty affairs with detailed provisions about performance, warranties, indemnities, financial penalties (however dressed up to make them legally enforceable), insurance obligations, termination rights, and so on.  IP Draughts recalls negotiating a 350-page contract produced by the UK Ministry of Defence, which was full of these kinds of terms. This approach is not confined to the public sector.  Some large commercial companies have procurement departments that produce lengthy and one-sided contractual documents.

Yet for all their training and professionalism (and some are very skilled at negotiating contracts), procurement managers have a limited perspective on the supply of goods and services.  They cannot guarantee that, through their efforts, a supplier will provide the desired product or service.  All they can do, ultimately, is point to a contract that requires the supplier to do so.

For some types of supply, this approach may be sufficient.  If a supplier of bulk products – office chairs, say – doesn’t perform its obligations, the contract can be cancelled, penalties enforced, and a new contract placed with another, eager supplier at a price that reflects the size of the order.  The consequences of failure are usually limited.  In the worst case, some personal injury claims may be made for back injury due to faulty chair design, but this risk may be low and the liability contained.

With other types of supply, including some IP-related supplies, this kind of procurement approach is deeply flawed.  In all procurements, before a supplier can be selected and contract terms negotiated, someone needs to decide upon a specification for the products or services, and on selection criteria for potential suppliers.  In practice, the way these criteria are framed tends to favour large suppliers over small suppliers, but that is another story.

With complex procurements, these preliminary stages take on a much greater significance than they do for routine supplies.  Defining clearly in advance what is required, finding a supplier whose capability and commitment you trust, setting a price mechanism that enables them to make a reasonable profit, and working closely with them to ensure that the project is managed and completed successfully: these factors may be critical, and the detailed contract terms irrelevant.

If any of these critical factors is absent, the contract is likely to collapse.  This may result in adverse consequences that cannot be compensated by the application of financial penalties or other onerous contract terms, even assuming that the fault can be laid at the door of the supplier.  Familiar examples from newspaper reports include:

• NHS Direct withdrawing from supplying the “111” non-emergency health telephone service because the price was too low for the work involved;
• The provision of language interpreters in the English courts, where Government switched to a single procurement contract with a large supplier and promptly lost more money than they saved, because interpreters didn’t turn up for trials and court hearings had to be rescheduled; a House of Commons committee concluded that the Government had not been an intelligent purchaser of services and the result was “chaos” in the court system
• numerous examples of expensive IT procurement contracts that failed, sometimes due to changing (or ill-thought-out) specifications or requirements

In IP Draughts’ experience, many IP-related contracts fall into this category, i.e. what is required is intelligent purchasing, and collaboration between purchaser and supplier, not onerous contract terms.  Government departments sometimes pay lip service to this idea.  IP Draughts recalls, during the negotiation of the 350-page contract referred to above, a civil servant telling him that the MOD took a “partnership approach” in its dealings with suppliers.  IP Draughts bit his tongue to avoid saying what he really thought, which was that this was complete bollocks, as evidenced by the ridiculously one-sided, antagonistic, and patronising contract terms that they were discussing.

If an intelligent and collaborative approach to purchasing is followed, it is unlikely to be accompanied by aggressive contract terms that assume a kind of master-and-servant relationship.  Examples of contracts in which intelligent purchasing is required, in IP Draughts’ experience, include:

• Contracts to run academic training courses, eg for medical students
• Contracts for the provision of specialist technical services, eg research and consultancy, or the development of “state of the art” products
• Contracts for the provision of legal services

IP Draughts is not sure why Government procurement departments seem, increasingly, to be proposing very one-sided contract terms for these types of project.  But they do seem to be doing so.  Some recent contracts with the UK Department of Health have been particularly one-sided.  He suspects it is a mixture of factors, including:

• increasing use of procurement departments, and political pressure to reduce costs
• a lack of discrimination between projects that suit onerous terms and those that don’t, combined with a general trend towards longer and more one-sided contracts
• it is easier for Government departments to manage the contract negotiation process than it is to manage the earlier stages of defining requirements, choosing good suppliers, etc.  The former is a process that can be reduced to a measurable system; the latter is sometimes a very complex task that requires skills that are not always present in Government departments

Is this your experience or is IP Draughts being unfair on procurement departments?

10 tips for successful contract negotiations

Some of the following points touch upon negotiation techniques, but the main thrust of this article is about the process for conducting successful negotiations.  Being professional and having an efficient process can be just as important, if not more important than some of the softer skills of negotiations.  Regrettably, the process is sometimes dismissed as a bureaucratic detail by the impatient negotiator.

1. If it doesn’t seem right, don’t do it. Over the years, IP Draughts has come to trust his instincts: if the deal (or the other party) smells rotten, it probably is.  If people are asking for things that don’t make sense, or if they bluster when asked for information about their organisation or ultimate owners, there is probably a hidden agenda.  Sometimes, the client’s commercial leader is so keen to make the deal happen – so close to the action – that they don’t realise that there is a strong fishy smell.
2. Keep it simple and conventional. Overly-creative deal structures are fraught with difficulties.  In IP Draughts’ experience, the parties who come up with them tend to believe that, through persistence and imagination they have found a win:win solution that addresses everyone’s stated concerns and removes a difficult roadblock.  Yet the structures often require much more extensive legal drafting than the commercial parties realise when they dream up the structure.  IP Draughts recalls a joint venture and licensing structure that Elan Pharmaceuticals presented to one of his clients about a decade ago.  His summary of it took up about 6 pages of text, and involved colour coding different parts of the deal structure (loan, licensing, share ownership, control, etc) to make it comprehensible to his commercial colleagues.  IP Draughts much prefers to see simple, straightforward deals that everyone understands, even if they don’t achieve all the subtle advantages (eg tax or liability) that are obtained by more complex arrangements.
3. Agree the main elements of the contract before drafting a written contract – work, price, etc.  But only the main elements – don’t get bogged down in details.  If you are using a term sheet, it should be no longer than 2-4 pages.  If it gets any longer, tear it up and start again, focussing only on key points.  If presented with a lengthy term sheet that has pages of IP-related definitions, push back and go for something much simpler, or go straight to drafting and negotiating the final agreement.
4. Involve your lawyers. Successful contracts are a team effort.  Choose high quality, user-friendly lawyers and involve them at an early stage.  They bring useful skills, such as clear and accurate recording of the commercial terms of the deal, and they may have experience that will assist you in the negotiations. They are well-placed to fill in any gaps that you may have left in your commercial discussions, and to point out any issues, eg that the proposed terms do not comply with company policy or are illegal.  You may also need other professionals in the team (eg scientists, accountants) and similar comments could be made about effective use of their skills.
5. Manage your lawyers. To get best value from your lawyers, and best value for money, you need to give them proper instructions and guidance.  Some lawyers, if left in a vacuum of instructions, will take every point, and push it to the nth degree until told to stop.  This may be counter-productive for the deal, and is almost certain to involve wasted expenditure.  It may be tempting to “leave it to the lawyers”, particularly if they have more experience than you of the type of transaction.  But that is no excuse for abdicating responsibility.  Ultimately, the client takes the commercial decisions about what goes in the contract, not the lawyer.  This is a good and valuable division of labour.  You will get far more value out of your lawyers if you manage them effectively.
6. Manage your colleagues. In some organisations, the commercial leader will seek input from colleagues in different departments, eg finance, sales, patents, tax.  This may result in a shopping list of terms that the organisation requires, which the commercial leader must propose in the negotiations.  That is fine as far as it goes, but someone – usually the commercial leader – will at some point need to bargain on some of the requested terms, and may need to make concessions.  There may be an internal negotiation on the terms, just as important as the external one with the other contracting party.  Separately, there may be an issue of the other contracting party seeking to “divide and rule” by having discussions with other people within the commercial leader’s organisation.  The commercial leader needs to ensure that the organisation speaks with one voice and can take rapid decisions.
7. Think a few steps ahead. Some commercial leaders don’t plan ahead; others are very good at planning.  If you want to hold a negotiation meeting on a particular date, think backwards to how long before the meeting a draft agreement must be prepared, and whose approval or input will be needed for the draft. If you want to involve a particular lawyer in a meeting, make sure they are  available before booking flights for yourself to attend the meeting.  If you need to have the agreement signed by a particular date, think about whether there needs to be a Board meeting to approve the agreement and how much notice is required to hold a Board meeting.  None if this is rocket science, but mistakes of this kind happen sufficiently often to make it necessary to make these obvious points.
8. Give yourself time and space to negotiate the final contract. Sometimes, a client’s commercial representative is so eager to get the deal done that they make concessions too early (assuming that the other party will reciprocate), or take other unwise decisions.  For example, he may have heard his opposite number agree with him that both parties want to get the deal done quickly and will work at full speed to make it happen.  But while, for the client, that means turning around drafts in 24 hours, for the other party it may mean turning around drafts in 2 weeks.  Turning a draft around in a very short space of time may be technically possible but can lead to mistakes or points being overlooked.  Nor is it necessary to decide things instantly, except perhaps in the last rounds of negotiations when the issues have narrowed and been rehearsed internally.  On a similar theme, don’t call people up, unannounced, and expect them to negotiate the contract terms (or accept this from the other party), at least not if lawyers are to be involved.  This approach to negotiating may be fine for a certain kind of spontaneous free spirit, but for busy lawyers it can be immensely irritating, particularly if they aren’t prepared for the discussion.
9. Try to understand the other party’s point of view. Try to work out what the other client wants from the negotiations.  Ask lots of questions.  Don’t assume they have the same objectives as your organisation.  One example is what working quickly means, as mentioned earlier. Another example that IP Draughts has encountered is  where the parties to a proposed collaboration have fundamental, and irreconcilable objectives in relation to IP ownership and use.  Because the parties didn’t spend time discussing these objectives, but moved straight to detailed drafting, these differences only became apparent after several rounds of drafting, with each party proposing subtle changes of language that did nothing to address the other’s fundamentally different point of view.
10. Don’t lose focus when you think the deal is done.  There is an understandable tendency, when the last negotiating point has been discussed, agreed, and struck from the list, for parties to relax and start making assumptions about the contract process.  IP Draughts was involved in a contract recently where the client assumed, based on the other party’s comments about urgency, that the other party would sign the agreement and return it within 24 hours.  The commercial leader was away for a few days and was not pleased when she returned to the office to find that the contract was no further forward, and indeed the other party had found a number of further drafting points that they wished to discuss.  If it is important, try to discuss and agree everything, down to when the final version will be prepared for signature, who will be signing it and when.  Similarly, if you don’t intend to involve your lawyers in the signing of the agreement, you need to manage the signing process with the same attention to detail that the lawyers would bring.  Basic points like signing in the right place, filling in the signer’s name and job title, dating the agreement, etc, can and do get overlooked.