As a startup manufacturer, vendor contracts (also known as vendor agreements or supplier agreements) are one of the most common types of agreements you are likely to encounter.
A vendor contract governs the sale of goods between two companies. A manufacturer may have a contract with its supplier for materials, or with a retailer for the sale of its own products. These agreements are useful for setting expectations between parties before sales occur. However, boilerplate clauses in a contract can cause trouble if the parties interpret them differently, and can even lead to litigation.
...even a few words in the contract can transfer large risks to a manufacturer.
Many startup companies simply look at the price of the goods in a proposed vendor contract and sign it. This is unwise because when you sign a contract, you agree to be bound by every term in the agreement and some terms can be detrimental to a small company in the event that things go wrong.
As exemplified below, even a few words in the contract can transfer large risks to a manufacturer. Accordingly, manufacturers should understand each paragraph and make changes to protect itself. The following are some basic vendor contract negotiation rules of thumb.
Foundational Principles of Vendor Contracts
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To avoid costly misunderstandings, clarify any ambiguous terms in the agreement, particularly related to the price and quantity of the goods, payment deadlines, shipping and delivery methods, manufacturer’s warranties and the contract’s start and end dates.
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Pay attention to confidentiality provisions that may require certain information not to be disclosed to the public. If a startup’s employees have access to confidential information, they should be aware of the scope of the confidentiality clause and know that they must not discuss confidential information with friends or post it on social media. If a startup owns intellectual property related to its products, a paragraph in the vendor agreement should require the other company to keep all IP confidential and clarify that the startup maintains ownership of its IP.
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Consider hiring a lawyer to review the contract if language in the agreement is unclear.
Beware of an “Indemnification Clause”
Many vendor contracts will include an “Indemnification Clause” that transfers the vendor’s risk and legal defense costs to the manufacturer in the event an accident occurs. In effect, an indemnification clause can make a startup-manufacturer liable for any damages caused by its product, even if the vendor’s own mistake or negligence caused the damages.
For example, if a vendor mishandles and breaks a product before selling it, and the broken product injures a customer, an indemnification clause may require the startup-manufacturer to compensate the customer for his injuries.
An indemnification clause that transfers a vendor’s risk to a startup-manufacturer is especially dangerous because the startup’s liability insurance policy may not protect it against damages that a vendor causes. This is because liability insurance policies generally only protect an insured against harms caused by its own negligence. Using the prior example, the startup-manufacturer would need to pay its own legal defense fees and compensate the injured customer even though the vendor broke the product.
An indemnification clause that transfers a vendor’s risk to a startup-manufacturer is especially dangerous...
Each state has different rules regarding how to interpret an indemnification clause. In many states, a few words can change whether a startup-manufacturer is responsible for a vendor’s negligence. For example, in New York, the following language is sufficient to create this obligation:
“[Manufacturer] shall defend and indemnify [Vendor] for all claims arising from the Product.”
In contrast, California requires an indemnification clause to include additional words for a startup-manufacturer to be held responsible for a vendor’s negligence, such as:
“[Manufacturer] shall defend and indemnify [Vendor] for all claims arising from the Product, including all claims arising from Vendor’s own negligence.”
If a startup company sees an indemnification clause in a vendor contract that might hold it responsible for the vendor’s negligence, it should either ask the vendor to remove the clause entirely, or alter the agreement to ensure that each party is responsible for its own negligent acts. One way to accomplish this is to change the indemnification clause into a “Mutual Indemnification Clause”, stating:
“[Manufacturer] and [Vendor] agree to mutually indemnify each other against any and all claims arising from the product.”
Conclusion
Receiving a vendor contract is exciting for a startup and a sign you are on the right track. However, you need to take the time to read and understand the Contract before signing it. Furthermore, if an “Indemnification Clause” transfers risks to the manufacturer, ask the vendor to remove it or change it into a “Mutual Indemnification Clause”.
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[Jed Bernstein focuses his practice on defending manufacturers, suppliers and distributors against product liability claims. He defends companies located internationally and in the United States against a wide range of personal injury and property damage claims.]
