Contract Clauses

Know your contract – not knowing causes problems! This page lists common clauses found in contracts, their basic meaning and purpose, which party benefits, and the clause’s importance. The descriptions and references provided are brief and simple in nature. Contact us for additional information or assistance with your situation.

Acceptance

Acceptance is often defined in terms of time and location and usually in connection with inspection. Be aware that acceptance may occur at buyer’s facility, after inspection, after test, and buyer may have up to 60 days to complete inspection and acceptance before the product is deemed accepted by default. Acceptance is also one part of the revenue recognition test and could cause financial disruption to your organization.

Assignment & Subcontracting

Buyers want to know that you are performing a significant portion of the work on a contract or at least providing value-added services. While there are limitations on pass-through charges governed by the FAR, this clause is not intended to prevent the purchase of raw material, the use of contract labor, or the use of vendors for manufactured assemblies.

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Buyer’s Property

Buyer furnished property must be returned or destroyed (as appropriate) upon completion of the contract.

Changes

The buyer may make changes to the quantity and schedule at any time and seller may request an equitable adjustment in price or other consideration. Changes to the specification, SOW, drawing, product revision, etc may be addressed in this clause, but are often addressed as part of quality (often a separate document or set of clauses).

Code of Ethics (standards of conduct)

FAR 3.10 states that contractors shall adopt a code of ethics or standards of business conduct. Primes or larger contractors will ask to confirm that you have your own code of ethics or that you agree to adopt and abide by their code of ethics.

Compliance with Laws

The contract itself is one set of rules and there are a number of laws and regulations to apply to businesses including the Foreign Corrupt Practices Act (FCPA), Occupational Safety and Health Administration (OSHA) rules, export and import regulations including the International Traffic in Arms Regulations (ITAR) and Export Administration Regulations (EAR), Environmental Protection Agency (EPA) reporting requirements, and various state and local requirements. By signing the contract, you agree to abide by all laws that govern your business.

Confidential & Proprietary Information

Confidential information may be addressed in the contract, in a separate document such as a Non-Disclosure Agreement (NDA) or Proprietary Information Agreement (PIA), or both. We recommend the use of a separate document as outlined in “The Anatomy of a Non-Disclosure Agreement.”

Conflict Minerals (human rights)

Conflict minerals, or 3TG (tungsten, tin, tantalum, and gold), are those minerals mined in conditions of armed conflict and human rights abuses, mostly in the eastern provinces of the Democratic Republic of the Congo (DRC). Conflict minerals attention in contracts resulted from Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act whereby publicly traded companies are required to report on the use of such materials in products sold. Organizations such as EICC and GeSI formed as a response to industry needs for collaboration and standardization of reporting. Their collaborative effort, Conflict Free Sourcing, provides a forum for industry feedback and resources for training and reporting.

Counterfeit Parts (new materials)

Detection and Avoidance of Counterfeit Electronic Parts clauses started showing up in defense contracts in late 2010 in anticipation of a formal change to DFARS. Essentially, manufacturers must buy electronic components directly from manufacturers (OCM) or franchised (licensed) distributors, not from wholesalers or independent distributors who purchase excess and obsolete inventory. This rule originated because of faulty components sold by Hong Dark Electronic Trade found on the P-8 and F-35, among other aircraft. Read DoD’s Counterfeit Detection Program Instructions.

Disputes

Disputes result from delays, errors, miscommunication, and missed expectations and may be resolved through legal action or arbitration. Due to costs and delays associated with legal battles in the court system, many companies opt to resolve disputes through arbitration and may require this as a condition of your contract. Arbiter’s rulings may be binding and have the full effect of a court of competent jurisdiction. Know if your contract requires arbitration before, or in lieu of, judicial proceedings, and know the place of arbitration, especially in foreign contracts. The American Arbitration Association and the Association for International Arbitration are two organizations that provide information on arbitration and may be directly referenced in your contract.

Financial Records & Audit

Customers want confidence that your invoices and reports are accurate and may ask for audit rights to support invoices or other claims for payment. Terminations, stop work orders, and other claims for adjustment

See also “Seller Financial Review” below

Force Majeure

From the French or Latin for “superior force” or “chance occurrence,” this clause allows for excusable delays for acts of God, government, Mother Nature, or other factors beyond the contractors control.

Governing Law

Much like the state of incorporation is important for tax and liability reasons, so is governing law important to contract craftsmanship. The laws of each state vary and interpretation of contracts depends upon the state of governing law. If not specifically addressed, Article 9 of the UCC states that location of the debtor determines the governing law.

Government Clauses (incorporated by attachment or reference)

Flow-down clauses from a prime’s (or other higher tier’s) contract are often incorporated by reference and may be on a separate document. FAR and DFARS clauses change on a regular basis and it is impractical to duplicate all of the clauses in a contract. Be sure that all referenced documents and clauses are reviewed as part of your contract review clauses and look for these references on the PO, in the terms and conditions, and in the SOW or other documents. Incorporated clauses have the full effect as if they had been directly included in the contract.

Indemnity

Talk to your attorney about indemnity – this is a serious clause and can have profound impacts on the liability of your organization.

Indemnity is a promise to pay the cost of possible damage, loss, or injury and can reach to indirect parties such as end customers, users, and others who otherwise have no privity to your contract. Indemnity may be addressed as part of a warranty clause and needs to be addressed by your organization from the buyer’s and seller’s perspectives to ensure you have maximum protection and minimum liability.

Inspection

Customer inspection is common in some industries, and may be required only for initial deliveries, random testing, or all deliveries. Contracts often state that inspection will be unobtrusive, occur during normal business hours, and that the contractor will provide a suitable place for the customer to inspect the goods. This is often referred to as “source inspection” and may be required by your customer and the end customer (such as the Government).

Insurance

Insurance is a risk mitigation tool, and in terms of contract clauses, is a requirement for performing work at the customer’s location. Certificates of insurance may also be requested to prove you are responsible bidder and have sufficient liability and workmen’s compensation coverage. Work with your broker to execute policies specific to your industry, business size, and needs, and note that some contracts will have minimum limits of coverage and may require waiver of subrogation and naming your customer as an additional insured. Both of these requirement usually require review by an underwriter and may cause an increased premium.

Intellectual Property

Read our resource page on intellectual property.

Invoices & Payment

Invoice requirements are often limited to standard commercial practices (as outlined below), but may require submission through an electronic portal, submission by mail in duplicate, or no submission at all (pay from receipt). Invoices should include at least the following items:

  • Date
  • Unique Invoice Number
  • PO or Contract Number
  • Line Item Number
  • Part Number & Description
  • Quantity
  • Unit Price
  • Extended Price
  • Taxes
  • Shipping & Handling
  • Other Fees

Payment terms may be listed in the contract, on the face of the PO, or both. If they differ, know the order of precedence (see below), and do not assume that terms most favorable to you automatically apply.

Offset Credits

Offset credits, or industrial participation, are credits received from a foreign country for buying goods or services in that country. The credits are used by the contractor (or higher tier contractors and primes) in fulfulling their contractual obligations to purchase a minimum amount of goods and services from a host country in exchange for a contract with the foreign government. For example, India’s purchase of P-8 aircraft from Boeing requires Boeing to purchase the equivalent of 30% of the value of the contract in goods and services from qualified Indian businesses. Boeing has the option of purchasing these goods and services directly or accruing credits from its suppliers who purchase goods and services from India. Note that offset requirements vary from country-to-country, may be limited to certain types of goods and services, and may be limited to purchases from certain qualified companies and organizations. The offset credits may also be achieved through technology transfers and other foreign investments.

Order of Precedence

The order of precedence defines which document (or clauses) take precedence in the case of a discrepancy or dispute. Contracts consist of multiple documents and duplication of clauses is common, especially when negotiations lead to deviations from boiler plate terms or original specifications. When confusion arises, use the order of precedence to determine which document governs. A sample order of precedence is:

  • Purchase Order or Delivery Order
  • Record of Negotiations
  • Blanket Agreement
  • Specification
  • SOW
  • Standard Terms and Conditions

Packing & Shipping

Contracts silent to packing and shipping requirements generally rely upon best commercial practices. Electronic items require ESD packaging, wood pallets must be made of a certain grade of wood and treated for international deliveries, styrofoam peanuts are prohibited in many facilities, and some items may require air-tight sealing, packaging for long-term storage, or MIL-SPEC packaging.

Publicity (Release of Information)

Winning awards causes marketing departments to create press releases or update promotional materials. Note that many contracts require prior written approval to release the name of the customer, program, or platform. Even mentioning the customer or using their logo in a list of customers may be a direct violation of the contract. Work on classified programs cannot be released for obvious reasons, but what may seem innocuous to you might be key to your customer’s confidential marketing strategy. Always ask permission first – this is not an area to ask forgiveness later.

Quality Control

Customers demand quality in the products and services they purchase from your organization. ISO (or other) quality standards are requirements in many contracts. There are industry-specific standards that may apply to the product or service being purchased and certification may be a requirement for award or follow-on work.

Seller Financial Review

Big contractors want to be certain that small(er) contracts are financially stable and able to perform the contract (“responsible”) and often ask for access to financial records, audit reports, and rights to audit records themselves or through a third-party. As a small(er) contractor, be prepared to support your claim as a responsible bidder, but do not think you must share everything or even allow the customer direct access to your records. Reviewed or audited financial statements will aid your argument, and due to the confidential nature of financial records, most contractors will agree to allow a third-party to audit records and provide a report of findings. You may still be required to provide copies of annual financial reports (reviewed, audited, or internally prepared) as part of contract compliance.

See also “Financial Records and Audit” above

Severability

Severability provisions state that if parts of the contract are held to be illegal or otherwise unenforceable, the remainder of the contract should still apply. Some severability clauses will state that some provisions to the contract are so essential to the contract’s purpose that if they are illegal or unenforceable, the contract as a whole will be voided. In many legal jurisdictions, a severability clause will not be applied if it changes the fundamental nature of the contract, and that instead the contract will be void.

Stop Work Order

A stop work order directs the contractor to stop all identified work immediately – part or all of the original contract. Such orders typically last for up to 90 days and may used to deal with schedule issues elsewhere in the program, funding, or customer changes. While often temporary, stop work orders may turn into terminations. Most contracts allow for necessary administrative and safety expenses to stop work, re-start, and/or file claims for adjustment. When the order turns into a termination, you are dealing with the stop work order and termination clauses of your contract. Note notification periods for claims for adjustment in both clauses.

Survivability

Most contracts and agreements inherently expire either due to completion of performance or a defined expiration date. Expiration of the contract does not nullify certain aspects of the agreement such as non-disclosure of information and compliance with laws. Survivability simply means that certain clauses live on when part of the agreement appears to be complete or expired.

Taxes

FAR 29 states simply that the Government does not pay taxes to itself on any products or services that it purchases. If your contract is with a commercial entity, a foreign government, or a state or local government, different rules may apply and remember that taxes in general may includes duties, fees, and VAT. Know who is responsible for filing and paying the appropriate taxes.

Termination

Termination comes in two flavors: Convenience and Default. While the effect of stopping work is the same, the claims allowable by the seller and remedies available to the buyer are quite different.  As with any claim for adjustment, note the required notices and filing times.

Termination for Convenience

Termination for the convenience of the customer (the Government) is because the Government changed its mind (ran out of funding, changed priorities, etc.) and is no reflection on the quality or quantity of work performed by the contractor. Contractors can claim reimbursement for costs incurred (whether work is complete or delivered or not) through the time of termination. Allowances are made for stopping work in a safe manner, canceling orders, and other administrative tasks necessary to terminate the contract. Profit (usually the portion thereof related to the amount of the claimed work) must be expressly allowed in the contract. Some contracts expressly disallow profit or fee in terminations for convenience and only reimburse actual costs incurred.

Termination for Default

Breaches of contract may lead to termination for default. Your rights and claims as a seller are limited and you may incur additional liability and expense for the customer to re-procure the defaulted goods and services. In other words, you may be responsible for your incurred costs to-date and your customer’s costs to re-procure the goods and services they initially contracted with you.

Warranty

Talk to your attorney about warranty – this is a serious clause and can have profound impacts on the liability of your organization.

Warranties can be express (written in the contract – words or promises) or implied (assumed part of the contract – merchantability and usage of trade). Your warranty liability is defined as much by what is not written in the contract! The UCC statute of limitations in §2-725 states that an action for breach must be commenced within four years after the cause of action has accrued – an important example how a default time for warranty can be implied.

Good warranty clauses expressly deny other warranties:

THE REMEDIES SET FORTH ABOVE SHALL BE THE BUYER’S SOLE AND EXCLUSIVE REMEDY AND THE COMPANY’S ENTIRE LIABILITY FOR ANY BREACH OF THE LIMITED WARRANTY SET FORTH IN THIS SECTION. THE COMPANY MAKES NO WARRANTY, WHETHER EXPRESS, STATUTORY OR IMPLIED, WITH RESPECT TO PRODUCTS INCLUDING WITHOUT LIMITATION ANY WARRANTY OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE, NON-INFRINGEMENT OR OTHER WARRANTY OF QUALITY.

World Congress 2013 – Efficient Contract Review for Effective Compliance