Risk Management 360: Contracting, Part II: What Should Be In Your Contract and How to Deal with Adverse Terms from the Other Side

In their years working with life sciences companies – large and small – Medmarc’s risk managers have evaluated numerous medical devices and pharmaceuticals as well as their manufacturing and distribution operations and FDA compliance histories. From these experiences, our team of risk managers has developed a unique perspective on this innovative and growing industry. Life sciences companies operate in a heavily regulated and litigated environment. Through studying these companies’ successes, and their missteps, the authors of this series have discerned common trends that can influence a company’s products liability exposure. This series will discuss these trends and what companies can do to manage the products liability risks they create.

Contracting, Part II: What Should Be In Your Contract and How to Deal with Adverse Terms from the Other Side 

Introduction

In the first of this two-part series on contracts, we looked at the importance of contracts for life sciences companies, and detailed how a lack of or inadequate contracts can make companies especially vulnerable to products liability.

In this second part, we enumerate the most important terms for life sciences contracts and how to deal with oppressive terms from the other side—evaluating your bargaining power and knowing when to push back.

What Should Be in Your Contract?

Although each contract will be different depending on the work contemplated and the relationship of the parties, there are some basic terms that are very important to include in life sciences agreements. Some of these are outlined briefly below.

Responsibility Matrix

One of the most important items that should be in your contracts is a responsibility matrix. This is an effective laying out of which party is responsible for what. It can take the shape of a table, bullet points, or a narrative, but should include every contemplated procedure and eventuality and allocate responsibility for each among the contract parties according to their mutual understanding. In addition to the basic functions involved in the production of the product, the party or parties responsible for product testing, record keeping, complaint handling, and recall coordination should also be identified.

Term & Termination

Two more important contractual items are the term and termination provisions. “Term” refers to the duration of the agreement, or how long the parties wish to be bound by the terms agreed upon. The parties will need to decide the best way to measure duration, and then agree on the appropriate one and express it clearly in the agreement. The agreement’s term may be expressed as a function of time, amount of sales, or completion of a particular scope of work. Two examples of how the term of an agreement may be expressed are provided below.

Time

The term of this Agreement (the "[Initial] Term") commences on the Effective Date and continues thereafter until [DATE]/for a period of [NUMBER] months/years, unless and until sooner terminated as provided in Section XX.

Project

The term of this Agreement (the "[Initial] Term") commences on the Effective Date and continues thereafter until the [completion of the Services/delivery of the Products] as set forth in this Agreement, unless and until terminated as provided in Section XX.

Next, the agreement should include a provision for the termination of the agreement. How and when will the agreement end? Can the parties terminate early, and if so, what are the procedures for doing so? The termination provision should also consider whether there is a right to renew the agreement, and whether renewal should be automatic, upon the meeting of certain conditions, and with or without a price adjustment.

Risk Transfer: Indemnification & Insurance

For business organizations, risk transfer is accomplished primarily in two ways: (1) indemnification by contract; and (2) insurance. Indemnification is the mechanism by which one party “indemnifies” the other for specified claims, losses, and expenses. Insurance transfers risk from an insured to an insurer.

Indemnification

Perhaps the most important provision in a contract—at least from a liability perspective—is indemnification. Indemnification is the process whereby one party—typically the “at fault” party— agrees to indemnify the other party from costs that may be incurred because of that loss, whether in the form of attorneys’ fees, damages awards, or both.

The need for indemnification can perhaps be best illustrated with an example. Imagine a contract manufacturer makes plastic tubing for a ventilator OEM. As a result of the contract manufacturer’s error, the tubing bursts at high temperatures. In lawsuits for resulting bodily injury as a result of the burst tubes, plaintiffs sue the entity appearing on the product—the OEM. With effective indemnification language in the contract between the contract manufacturer and the OEM, the OEM can require that—as the contract manufacturer’s defective component was the source of these suits—the contract manufacturer undertake and pay for the defense of the OEM. In the absence of such language, the OEM may have to incur the costs of defense and damages itself, despite the fault originating with the contract manufacturer.

There is a “common law indemnification” which can be imposed on the parties in absence of explicit indemnification language, but it can be difficult and expensive to obtain and leaves significant uncertainty that can be better resolved in contract. For instance, in the absence of adequate indemnification language, the would-be-indemnitee, relying on common law causes of action to seek indemnification, may not be not be able to obtain certain types of reimbursement. For instance, attorneys’ fees are commonly excluded from common law indemnification remedies, though they can be a huge part of the cost of defending a claim. The would-be-indemnitor, in the absence of effective indemnification language, may not be able to cap its liability, reduce its liability by incorporating materiality qualifiers or liability caps or deductibles like thresholds or baskets. For these reasons, it is invaluable to include clear and thoughtful indemnification provisions in your contracts.

The breadth of indemnification can vary and should be decided among the parties. In a narrow indemnification, the indemnitor may only indemnify the other party for losses arising solely out of its own negligence or wrongful act. A more intermediate level of indemnification would be structured with the indemnitor indemnifying the other party for losses arising out of or caused in whole or in part by the indemnitor’s negligence. The broadest type of indemnification, which should generally be objected to, would make the indemnitor responsible for all losses, however caused. Many state anti-indemnity statutes limit the degree to which such provisions may be enforced, but contracts from the other side should still be scrutinized for the inclusion of this language.

Here is an example of a boilerplate, broad indemnification provision:

[Buyer/Seller/Mutual] Indemnification. Subject to the terms and conditions set forth in Sections XX (Exceptions and Limitations on Indemnification) and XX (Indemnification Procedures), [Buyer/Seller/each party] (as "Indemnifying Party") shall indemnify[, hold harmless,] and defend [Seller/Buyer/the other party] and its officers, directors, employees, agents, affiliates, successors, and permitted assigns (collectively, "Indemnified Party") against any and all losses, damages, liabilities, deficiencies, claims, actions, judgments, settlements, interest, awards, penalties, fines, costs, or expenses of whatever kind, including [reasonable] attorneys' fees, that are [incurred by Indemnified Party/awarded against Indemnified Party [in a final [non-appealable] judgment]] (collectively, "Losses"), arising out of any third-party claim alleging: . . .

Insurance

In addition to contracting, the other most important risk management mechanism life sciences companies can employ is ensuring that they have sufficient insurance and that the parties with whom they are transacting also have sufficient insurance. Your contract should include not merely the requirement that the other party carry insurance, but should be specific about carriers, types of insurance, and amounts of limits. For instance, you may want to require that insurance only be purchased from carriers with a certain financial rating. Additionally, you will want to secure from the other party annual certificates of insurance, verifying the current standing of the policy in the types and amounts required. Ideally, the other party will name you as an “additional insured,” giving you more direct access to the policy limits.

Notice

Another provision worthy of inclusion in your contracts is one addressing the parties’ respective obligations to notify the other party or parties of specific events. For example, a notice provision might stipulate that in the event of an FDA inspection or enforcement action, the party that is the subject of such inspection or action must promptly notify the other party or parties. A common notice provision requires parties to notify the others in the event they become aware of a product being involved in an adverse event or receive a user complaint that meets a certain threshold of potential seriousness (perhaps in severity, degree of injury, or likelihood of being a repeat issue).

Merger Clause

A merger clause, also called an integration clause, is language in a contract that states that the contract itself is the complete agreement of the parties. Without a merger clause, it may be difficult to determine whether subsequent terms—e.g., terms and conditions affixed to a purchase order or those discussed orally—form part of the contract or not. These subsequent terms may conflict with the agreement’s terms, and an expensive “battle of the forms” may be necessitated to determine the mutual intent of the parties and what terms are binding. A merger clause prevents this confusion by making the agreement to which it is a part the definitive word of the parties, regardless of subsequent terms.

A merger clause may be formed like this:

This Agreement, [together with other documents [names of documents] incorporated herein by reference] and all related exhibits and schedules,] constitutes the sole and entire agreement of the parties to this Agreement with respect to the subject matter contained herein, and supersedes all prior and contemporaneous understandings, agreements, representations, and warranties, both written and oral, with respect to such subject matter.

Dealing with Terms from the Other Side

When negotiating a contract, there will inevitably be terms from the other side that may not be as appealing to you. The first step in negotiating these terms is determining how much bargaining power you have. Leverage in contract negotiation for life sciences companies is influenced by several factors. Among them, the uniqueness of your offering (i.e., are you the sole source for the particular product being sought, or one of dozens of comparable suppliers?) and your risk tolerance (i.e., how willing and able are you to accept more risk in exchange for a larger potential upside?). The relative size of the parties to one another and the respective size of their contracting departments also affects bargaining power as the larger party may have more resources to devote to a contract’s negotiation and effecting an advantageous agreement.

Regardless of your respective bargaining power, there may be some terms from the other side that are unacceptable, even if that means losing the relationship. These should be determined at the outset. Some terms that are at least worthy of pushback if not categorical “dealbreakers” are:

• Unilateral or overly broad indemnification obligations. For example, a provision specifying that one party is required to indemnify the other party for all claims and losses arising out of a product’s use, howsoever caused, including by the other party’s own negligence.
• Termination without cause. A provision that gives one party the right to terminate the agreement without sufficient cause or notice should be carefully examined and the related risks weighed.
• Lopsided responsibilities. If one party is deemed responsible for items outside of its control, like the testing and assurance of a component for which it was not responsible, this term should be objected to as it opens the door for significant liability.
• Exclusive-remedy provisions. While these can be favorable in that they reduce contract costs, most often parties will want to preserve their ability to recover all costs incurred because of a breach and not want those remedies limited in type or dollar amount.

Of course, there will be times that one might accept unfavorable terms in light of the desirability of the partnership or transaction. If this is the case, the party accepting unfavorable terms should calculate and understand the costs of worst-case scenarios and obtain robust insurance to cover those scenarios to the extent possible.

Conclusion

Contract negotiation should be approached seriously and with the understanding that the terms contained in one’s agreements can have serious reputational and financial implications. Even smaller organizations should not assume that any given agreement must be accepted without negotiation and should endeavor to push back on the most objectionable provisions, as detailed above. Inclusion of the terms enumerated in this article will help life sciences companies make the most of their business relationships and best protect them from adverse outcomes.