What is a Long Term Agreement?
A long term agreement is an enterprise level agreement with a vendor or supplier. It’s an agreement that is generally longer in duration than a typical purchasing agreement and has some or all of the following characteristics. The term may last from 3 to 10 years. A significant upfront commitment is typically required and often a significant minimum annual commitment (as opposed to a commitment for minimum payments) is required each year over the term. There is often a significant up-front service fee (that can range from six figures to multi-seven figures) that is payable regardless of usage over the 3-10 year period. The upfront service fee usually entitles the company to certain services of corresponding value each year over the term, including professional services (e.g., dedicated project management and consulting), annual education/training services, strategic planning services, etc.
Long term agreements are used frequently when companies are migrating to new technologies, networks or platforms. For example , in wireless communications, multi-year, enterprise-level long term agreements are common. The fundamental reason is that deploying the technology and/or migrating to a new network platform involves significant costs in the first year. In many cases the long term agreement requires a prepayment of services that are expected to be incurred over the term. For a long term software as a service (SaaS) agreement, the SaaS provider cannot normally make a capitalizable investment (for hardware or software) without a long term commitment. Likely the most common use of long term agreements is in long distance telecommunications where companies typically have long term agreements with their local telephone carriers. Other possible areas (including voice and data) include:
Long term agreements also are used in other contexts (e.g., labor negotiations, government contracts, real estate development, strategic alliances, joint ventures, etc.), but the largest number of long term agreements are for the reasons outlined above.
Advantages of Long Term Agreements
Long term agreements benefit both parties in several ways. For example, long term agreements can provide the landlord with stability in terms of the ownership and operation of a particular facility. If the landlord’s practice specialties include surgery centers, the medical office building is an important portion of the business. Therefore, the stability of the operation of the medical office building pursuant to the long term lease, along with continuity of physician users, creates an environment that is attractive to the landlord in order to promote it to other prospective tenants. Second, the long term agreement ensures the tenant can be present on the property for many years to come at a predetermined cost. This can be especially important in the event that rents in the market increase drastically.
The tenant similarly benefits from the long term agreement. First, the tenant has the opportunity to organize its operations within the facility, permit the appropriate government approvals including certificates of need and other approvals with respect to the professional corporations owning, leasing, or operating the facility, and interact with the landlord regarding modifications to the space and leasehold improvements without the concern of having to move to a new location after one or two years. In addition, if an expansion is reasonably necessary for the facility, the rent for the space can be pre-established.
Elements of a Long Term Agreement
The essential terms of a long term agreement include the items discussed below. A long term agreement is an agreement that will last for a period of time (as opposed to a "one-shot" contract) and reoccurs each time work is required. Given that long term agreements will last for a long time, it is important that they be reviewed and updated on a regular basis (e.g., every two to three years).
Scope of Work – States what work will be performed under the term of the agreement. It should address the types of services that will be provided by the contractor. Term – This specifies how long the agreement will last. Given that this type of agreement can last quite a while, it sometimes makes sense to include a termination provision that allows either party to terminate the agreement at any time. This is particularly important when the agreement covers basic services (e.g., janitorial services or maintenance/repair services), because costs associated with these services can go up or down over the years, and a long term agreement with no flexibility may "trap" the parties in an agreement that no longer suits its needs.
Renewal – Usually long term agreements do not automatically renew: the parties are required to re-negotiate prior to the expiration of the term. However, when drafting these type of agreements there often is the question of whether the contract can be extended beyond the term. "Extension" refers to extending the term and does not imply that the work will end. The agreement must be carefully drafted to ensure that it addresses this issue.
Payment Terms – As stated above, party’s budgets fluctuate from year to year. For this reason, a long term agreement generally cannot contain fixed prices over the entire term. Rather, annual budgets usually are prepared that set pricing for each year of the agreement.
Negotiating a Long Term Agreement
When entering into a long term agreement, there are important factors to consider to help ensure you negotiate a contract that is fair and reasonable to you.
• Duration of the Agreement. The basic term of the agreement should be for as short a duration as possible, consistent with any business or operational requirements. A long term agreement provides the other party with an advantage, as no adjustment to their pricing, compensation, or other terms will be considered until the expiration of the full term of the agreement. Companies often propose that you commit to a long term under the guise of giving you a lower price and providing some stability in pricing. But longer terms are generally not in your best interest, unless you are getting an extraordinarily good deal on your pricing. Just because a company proposes a long term agreement does not mean that it is likely to give you a better price. The reality is that you need to look at the price being offered and negotiate for what makes sense. If the company pressures you into a longer term, you should agree to that term, but only if you are getting a discount at a comparable level, consistent with the duration of the agreement.
• Periodic Reviews. With regard to pricing, compensation, and other important aspects of the agreement that may require periodic reviews, provisions should be included in the agreement that make clear that the company has no obligation whatsoever to adjust the terms of your agreement, but may do so in its discretion for any reason. In negotiations, the company may initially propose that it adjust pricing, compensation and other terms on a scheduled basis – e.g., annually. However, you should always push back on this and try to get language that makes clear that the company is not obligated to change the terms of your agreement at any time – only that it may do so at its discretion. A good reason to push for this language is that when the company engages in normal inflationary costs increases, its costs rise and so do its prices. Because it will not be adjusting the agreement terms on a scheduled basis, it can never come up with a reason that the agreement terms should not be adjusted downward should market conditions allow it or if its prices and costs go down. If you have agreed to any periodic pricing or compensation increases, this language should be in the agreement and bolstered by language that ties them to the company’s cost increase, not just the company’s inflationary costs.
• Modify Long Term Pricing and Compensation Increases. Even if the company will not agree to tie price or compensation increases to its cost increases, it may agree to a lower percentage increase as the term of the agreement continues. In addition, you should get a commitment to fix the price or compensation increases in your favor in the event that the company’s costs go down. In other words, if the company insists on an annual increase of 3%, then you should insist on a commitment to fix the increase in your favor at 2.5% for the 6th year of the agreement, and at 2% for the 7th year. Also, within these same contexts, you should also insist on a commitment to fix the increases for the last year at the same percentage as for the previous year. This will provide you additional protection.
Common Issues Confronted and Resolution Mechanisms
Despite their many benefits, long term agreements can be a source of frustration and concern, particularly when either of the parties attempts to assert control over its business counterpart. Common issues include:
"Creeping Control." As time goes on, your business partner may attempt to impose greater control over your actions or vice versa. In extreme cases, this can lead to litigation in the form of a request to "pierce the veil" and hold the parent entity liable for the acts of the subsidiary. Such action may be appropriate, but courts are reluctant to do so absent egregious conduct. Conversely, a business entity can become vulnerable to liability from the acts of its subsidiary, even if the parent did not exert control over the day-to-day affairs of the business. The best way to avoid both of these problems is to have robust policies and procedures in place, particularly those that ensure the activities undertaken are within the scope of the agreement. In addition, an annual review in which all parties address whether the business entity is acting consistent with the agreement may be beneficial.
Potential Liability for Third-Party Claims. Third parties, such as a creditor or law enforcement authority, may attempt to assert control over a subsidiary by treating it as synonymous with the parent. For example , they will try to enforce a judgment against the parent against a subsidiary and with access to the parent’s assets. It is therefore important to make clear on the face of every contract with an outside party that the party with which it is dealing is a separate and distinct entity. In addition, if a lawsuit is filed against a parent entity, steps should be taken to limit its effect vis-à-vis the subsidiary and vice versa by ensuring that the complaint is correctly directed and each entity, armed with its own independent legal representation, files appropriate motions. If this occurs, the separate identities of the two entities may be enough to prevent a court from piercing the veil.
Loss of Institutional Knowledge. The longer a contract is in place, the greater the risk that the individuals who negotiated it are no longer with the organization and/or vested interests change as the parties grow, expand, and merge with other organizations. Therefore, an annual contractual review between the parties with those same individuals can be helpful, as can processing and maintaining documentation through a carefully designed, centrally located information management system. If that is not possible, the best way to protect institutional knowledge is through a process of simple, periodic review.
Examples of Long Term Agreements
In various industries, long-term contracts are the norm rather than the exception. For instance, in the construction and engineering services industry, it is typical for contractors to receive extended commitments from major clients by way of long-term agreements. One such example would be a large construction company whereby contracts for projects are executed for five years. In this case, the contractor is virtually assured of steady work for utility companies well into the future.
Another great example is an automobile manufacturer whose operations include designing, building and selling cars and parts to retail dealers. The manufacturer will invest large sums of money developing a new car design and its components. These costs include extensive research, prototype design and testing. Once the manufacturers have completed development, they turn to long-term agreements with suppliers to provide the parts necessary to build the vehicle.
As a third example, look at a major Canadian bank who serves millions of customers. As millions of customers daily open chequing accounts to save and borrow, the bank needs numerous products to provide services to its customers. That bank enters into long-term contracts with many suppliers to supply the bank with, among many other things:
Long-term agreements can be found in every industry. Successful companies understand that a key to profitability is to use long-term agreements to assure quality and acceptable levels of service and to assure adequate supplies at prices that are more effective over the long term.
Legal Aspects of Long Term Agreements
When engaging in long term agreements, there are several legal considerations manufacturers should keep in mind to ensure compliance with federal laws. For example, the Magnuson-Moss Warranty Improvement Act governs warranties and could have important ramifications on a manufacturer’s obligations to its customer. The Federal Trade Commission enforces the Act and, in general, it is not possible to disclaim limitations of warranty or liability on a product. The Magnuson-Moss Act has an "educational purpose" by requiring that warranties that are offered to consumers be presented in a manner that enables the consumers to have sufficient information to make informed choices at the time of purchase. The scope of warranties – performance, function, service to be performed, remedies, disclaimers and limitations – must be clear to consumers so that they are able to assess the quality of the product being purchased.
In addition to a manufacturer’s warranties, long term agreements often contain additional provisions that seek to modify and/or limit a manufacturer’s liability in the event of a claim or dispute regarding the goods being sold and/or the costs associated therewith. The addition of such clauses requires careful attention. Many states have passed legislation governing the type of liability provision that may be included in a contract for the sale of goods or services. This section will discuss some of these common contract provisions.
Limitation of Liability
Contractual provisions that limit the amount of a manufacturer’s liability for loss or damages should be carefully drafted and, if possible, should allow for the collection of damages that would be recoverable by law if the clause is not present. Some statutes specifically prohibit the limitation or exclusion of consequential losses or damages arising from the sale of goods or the provision of services; however, many courts will enforce broadly drafted limitation of liability clauses to the extend agreement is not unconscionable or against public policy. Courts in some states hold that such limitations must be conspicuous, must be mutually agreed upon and must be reasonable. Other states do not require a mutual agreement, but require that the limitation be conspicuous "so that the risk of a limitation of remedies [or waiver of damages] was brought home to the buyer . "
These limitations are generally unenforceable if the loss or damage is the result of willful misconduct, recklessness, fraud or intentional or grossly negligent acts by the manufacturer. The Uniform Commercial Code (U.C.C.) states that remedies may not be varied or excluded by agreement, but may be limited to those provided in the U.C.C. For example, the exclusive remedy for breach of warranty may be restricted to refund or replacement by the manufacturer, and even be limited to parts, not labor. A wholesale distributor that did not elect to limit its remedy to refund or replacement could be required to pay damages for breach of warranty, even though the contract itself may otherwise indemnify the manufacturer for such damages. In general, an express disclaimer of implied warranties on the packaging shipper and/or invoice may be enforceable if it is sufficiently conspicuous, but it may not be sufficient to limit or exclude remedies or set forth the remedy as the exclusive and sole remedy.
Limitation on Remedies
To the extent that a contract or warranty states that a manufacturer’s only obligation shall be to repair or replace the product, that product may not be brought back to compliance by money damages. Additionally, exclusive remedy clauses should be conspicuous, specific and reasonable. Courts that have evaluated this issue have held that these clauses are unenforceable when they unfairly preclude an injured consumer from suing.
Appleton Area Sch. Dist. v. Liberty Mut. Ins. Co., 594 N.W.2d 415 (Wis. Ct. App. 1999) (construction/school roofing case); Super Tire Eng’g Co. v. Aro, Inc., 412 N.E.2d 274 (Mass. 1980), (substantial loss of profits), cert. denied, 453 U.S. 911 (1981); Quiroga v. Hasbro, Inc., 317 F. Supp. 2d 50 (D. Mass. 2004) (claim for breach of express warranty for sale of poker set).
Limitation of Consequential Damages
While damages such as lost profits, loss of use, loss of data and other indirect damages may be recoverable in any action alleging breach of contract, consequential damages related to exposure to multiple lawsuits may not be recoverable under a limitation of liability provision. In addition, the limitation of liability often does not apply to remedies regarding patent infringement actions.
