Litigation Prevention Dispute Resolution Negotiation Mediation Litigation Arbitration Courts Development of Commercial Law Basic Legal Considerations The Purchase Contract Letters of Intent Special Legal Considerations Inspection Rights Rights of Rejection Title and Risk of Loss Warranties Evergreen Contracts Order Cancellation and Breach of Contract Liquidated Damages Provision Special Considerations (cont’d) JIT Contracts Honest Mistakes Patent Infringement Restraint of Trade Laws International Considerations Contracts for the International Sale of Goods Foreign Corrupt Practices Act

1. 17-1
Chapter 17
Contract Formation
and Legal Issues

2. 17-2
Key Concepts
• Litigation Prevention
• Dispute Resolution
» Negotiation
» Mediation
» Litigation
» Arbitration
» Courts
• Development of Commercial Law
• Basic Legal Considerations
• The Purchase Contract
• Letters of Intent

3. 17-3
Key Concepts
• Special Legal Considerations
» Inspection Rights
» Rights of Rejection
» Title and Risk of Loss
» Warranties
» Evergreen Contracts
» Order Cancellation and Breach of Contract
» Liquidated Damages Provision

4. 17-4
Key Concepts
• Special Considerations (cont’d)
» JIT Contracts
» Honest Mistakes
» Patent Infringement
» Restraint of Trade Laws
• International Considerations
» Contracts for the International Sale of Goods
» Foreign Corrupt Practices Act

5. 17-5
Litigation Prevention
• The best way to deal with legal disputes is
to avoid them in the first place!
• Daily activities of supply managers are
subject to two major areas of the law:
» Law of Agency
– Supply professionals act as agents for their firms
» Law of Contracts

6. 17-6
Why Most Business Firms Utilize Litigation Only
as a Last Resort
• Contractual disputes are usually resolved
more effectively using negotiation
• A lawsuit almost always alienates a good
supplier
• The outcome of any court case is usually
uncertain
• Litigation is expensive

7. 17-7
Dispute Resolution
• When attempting to resolve a dispute, it
pays to keep in mind six considerations:
1. Time
2. Money
3. Complexity/Formality of Method of Dispute
Resolution
4. Stress
5. Visibility
6. Damage to the Relationship

8. 17-8
Dispute Resolution
• Five Options exist to resolve a dispute:
» Negotiation
» Mediation
» Litigation
» Arbitration
» Courts
• Most disputes are best resolved through
negotiation and compromise

9. 17-9
Mediation
• If negotiation fails, the disputants can
consider mediation
• Mediation involves introducing a third-
party into the discussion
• The mediator’s role is to listen,
sympathize, empathize, coax, cajole and
persuade
• One thing the mediator may not do is
decide anything
• If the disputants confer decision-making
authority on a third-party, we are now
talking about arbitration

10. 17-10
Litigation
• Some maintain that if a commercial
dispute reaches litigation, the disputants -
- regardless of the outcome -- have
already lost
• In litigation, costs tend to be maximized
» Recall: time, money, formality of method,
stress, visibility, and relationship damage

11. 17-11
Arbitration
• Arbitration vests the decision-making
authority with the arbitrator
» Purchase orders often have arbitration clauses
» It is critical to employ an impartial arbitrator
» A good source in the U.S. is the American
Arbitration Association
• The arbitrator will hear testimony and
study evidence from both sides, then
make a decision based on the facts

12. 17-12
Courts
• Litigation may be brought to state or
federal court.
» Lawsuits heard by judge or jury.
» Relevant court rules govern procedure.
» Relevant rules of evidence prescribe what may
or may not be presented.
• Best to avoid destructive legal disputes
whenever possible.

13. 17-13
Development of Commercial Law
• National Conference of Commissioners on
Uniform State Law (NCCUSL)
» Uniform Sales Act
» Uniform Commercial Code (UCC)
– Determines rights on basis of fairness and
reasonableness in light of accepted business
practices
– Topics treated throughout the rest of the chapter
reflect the provisions of the UCC where applicable,
as well as the provisions of earlier laws not
displaced by the code

14. 17-14
Basic Legal Considerations
• Status of an Agent
» Agent - a person who, by express or implied agreement,
is authorized to act for someone else in business
dealings with a third party
» A “purchasing agent” is not a legal party to his or hers
business transactions, but rather serves as an
intermediary.
» Law requires the agent to be loyal to the employer
» Law permits the employer to hold its purchasing
agent(s) personally liable for any secret advantages
» A buyer operates under two types of authority
– actual authority
– apparent authority

15. 17-15
Basic Legal Considerations
• The Purchase Contract
» Agreement
» Consideration, or mutual obligation
» Competent parties
» Lawful purpose
» “The Written and the Spoken Word”

16. 17-16
Offer and Acceptance
• Purchase order constitutes a legal offer
• Supplier’s quotation usually constitutes
an offer
» Agreement does not exist until the supplier
accepts
– Called a “meeting of the minds”
• Uniform Sales Act law requires
acceptance of an offer in terms that were
identical with the terms of the offer
» Mirror image concept

17. 17-17
Battle of the Forms
• Occurs when the terms of acceptance
differ from the terms of the offer
• Terms of Acceptance are automatically
incorporated into the contract, unless one
of three conditions exists:
1.They materially alter the intent of the offer
2.The offerer objects in writing
3.The offer explicitly states that no different
terms will be accepted

18. 17-18
Consideration
• A valid contract must also contain the
element of obligation
• Most purchase contracts are bilateral
• Important point is the “mutuality of
obligation”
• Statements regarding material quantity,
price, delivery, and so on must be specific
enough to bind both the buyer’s firm and
the supplier to definable levels of
performance

19. 17-19
Competent Parties
• A valid contract must be made by persons
having full contractual capacity
• A contract made by a minor, an insane or
intoxicated person is usually entirely void
or voidable

20. 17-20
Legality of Purpose
• A contract whose purpose is illegal is
automatically illegal and void
• A contract whose primary purpose is
legal, but whose ancillary terms is illegal,
may be either void or valid

21. 17-21
The Written and the Spoken Word
• A contract is not a physical thing
• It is a relationship which exists between the
parties
• A written document is evidence of the
contract
• Oral contracts are more difficult to prove
facts
• Law requires some agreements to be in
writing
• Written evidence supercedes all prior oral
evidence
• All data to be included as part of the contract
should appear above the agent’s signature

22. 17-22
Letters of Intent
• Letters of Intent and Memorandums of
Understanding – precontracts to cover
informal agreements.
• LOI’s can be used as a planning document
to order materials with long lead times,
special tooling, or unique design work.
• A preliminary agreement with open issues
to be resolved.

23. 17-23
Special Legal Considerations
• Inspection rights
• Rights of rejection
• Title
• Warranties
• Order cancellation
• Breach of contract
• JIT contracts
• Honest mistakes
• Patent infringement
• Restraint of trade laws
• Product liability

24. 17-24
Inspection Rights
• The law gives a reasonable period of time
to inspect material after it is received
• If the buying firm raises no objection to
the material within a reasonable period of
time, he or she is deemed to have
accepted it
• Industry practice usually sets the standard
for “reasonable” time

25. 17-25
Rights of Rejection
• A buying firm has the right to reject
material that:
» Does not conform with the terms of the
contract
» Is an overshipment
• Rejection requirements:
» Notification must be sent to the supplier
» The nature of the defect or default must be
specified
» The buying firm is not legally bound to return
the material
» The buying firm is obligated to protect and
care for the material in a reasonable manner

26. 17-26
Title and Risk of Loss
• From a legal point of view, the question of
which party has title to purchased
materials is normally answered by
defining the F.O.B. point of purchase
» F.O.B. origin shipment: buying firm becomes
owner when the material is loaded into the
carrier’s vehicle
» F.O.B. destination: supplier owns the material
until it is off-loaded at the buyer’s receiving
dock

27. 17-27
Title and Risk of Loss
• Liability for goods not determined by title
passing.
• UCC designates Risk of Loss for
conforming goods passes at the FOB
point.
• Risk of Loss for nonconforming goods
does not pass until seller delivers
conforming goods or buyer accepts
nonconforming tender.

28. 17-28
Warranties
• The UCC identifies two specific types of
warranties:
» Implied warranty – one which is read into the
contract as a matter of law.
» Express warranty – a promise or
representation that the goods, services, or
subject matter of the contract will have certain
characteristics or qualities.

29. 17-29
Warranties
• The warranties Implied by the UCC:
» Implied Warranty of Good Title
» Implied Warranty of Non-infringement
» Implied Warranty of Merchantability
» Implied Warranty of Fitness for a Particular
Purpose

30. 17-30
Evergreen Contracts
• Orders or contracts with open-ended
termination.
• Can be difficult to monitor or amend.

31. 17-31
Order Cancellation and Breach of Contract
• A breach of contract has occurred if a
supplier:
» Fails to deliver by agreed delivery date
» Fails to perform in accordance with the
contract
• The buying firm has the right to cancel
• Buying firm can also sue for damages
• Liquidated damages provisions are
common

32. 17-32
JIT Contracts
• Require higher quality
• On-time deliveries
• The following must be spelled out in such
contracts in unequivocal terms:
» Quality levels and controls
» Delivery schedules
» Inventory levels
» etc.

33. 17-33
Honest Mistakes
• Honest mistakes can happen in drawing
up a contract
• The conditions surrounding each case
weigh heavily in determining whether the
contract is valid or void
• However, a mistake usually must be made
by both parties for the contract to be
voided

34. 17-34
Patent Infringement
• The law gives a patent holder the
exclusive right to manufacture, sell, and
use the patented device for a specified
number of years
• A buying firm who engages in any of these
activities during the period of patent
protection, without permission from the
patent holder, is guilty of patent
infringement and can be sued for
damages by the patent holder

35. 17-35
Restraint of Trade Laws
• Robinson-Patman Act
» Designed to prevent price discrimination that
reduces competition in interstate commerce
• Act prevents a supplier from offering the
same quantity of a specific material to
competing buyers at different prices,
unless:
» One buyer is offered a lower price because his
or her purchases entail lower manufacturing or
distribution costs for the supplier
» One buyer is offered a lower price in order to
meet the legitimate bid of a competing supplier

36. 17-36
International Considerations
• United Nations’ Convention on Contracts
for the International Sale of Goods (CISG)
» Stipulate in the purchase order or contract
which body of law is acceptable to both buyer
and the seller
» Stipulate a mutually acceptable “choice of
forum” at which any lawsuit will be heard
• May want an arbitration clause also

37. 17-37
International Considerations
• Contracts for the International Sale of
Goods
» Acceptance of an offer
» Revocation of an offer
» Formation of a contract
» Oral contracts

38. 17-38
International Considerations
• Foreign Corrupt Practices Act
» Anti-bribery issues
» Record keeping requirements
» Penalty provisions
• Created in reply to American public
• Amendment to the Securities Exchange Act of 1934
• Objective was to curtail U.S. corporate involvement in
foreign commercial bribery activities
• Enhance the image of the United States
• Three major sections focusing on:
» Anti-bribery issues
» Record-keeping requirements
» Penalty provisions

39. 17-39
Concluding Remarks
• The most powerful tool a supply professional has to
avoid legal problems is skill in selecting sound,
reliable suppliers
• A supply manager must understand basic legal
concepts well enough to detect potential problems
before they become realities
• Finally, this chapter presents only basic legal
considerations
» Interpretations of laws may vary significantly
» Supply professionals should seek legal counsel whenever
potential legal problems arise or the opportunity to prevent
legal problems will be increased