How warehouses can avoid the contract trap
Tuesday, July 19, 2016
Until a few decades ago, agreements between logistics service providers and their customers were seldom governed by any long-term agreement. The International Warehouse Logistics Association (IWLA) developed a standard contract early in the last century and has revised that agreement to comply with the growth of electronic communication.
In more recent years, agreements have been developed that are longer term with more detailed language about performance. In some cases, the need for a contract began with the warehouse operator, because the banker would not finance construction or costly equipment without some assurance of stability.
Cynics claim contracts actually serve only two purposes:
- A device to deceive the bankers who want the security of a long-term contract
- An enrichment for litigating lawyers
In the days before the rise of physical distribution, logistics and supply-chain management, the general traffic manager was the prime purchasing agent for both transportation and warehousing. Before deregulation, most transportation was governed by published tariffs, and the traffic manager's job was to negotiate a special tariff with low commodity rates.
Warehousing was usually a smaller purchase than transportation, so the traffic manager tended to treat both in the same fashion. Long-term agreements for either transportation or warehousing were virtually unknown at that time, so the traffic manager treated his suppliers as commodity vendors, with primary emphasis on favorable rates.
The standard agreement developed by IWLA was generally recognized as an acceptable guide to the relationship between the warehouse provider and the customer.
Why have an agreement?
As the expansion of warehousing services became more complicated and costly, bankers who financed the service providers expansion demanded some assurance that the business would not be suddenly lost. At the same time, the buyer wanted some assurance of continuity. The contract was designed to provide comfort for both the buyer and the seller.
Common sense indicates it is not possible to force adversaries to collaborate. If the relationship between buyer and seller becomes toxic, orderly separation is the best way to solve the problem. Therefore, agreements always have a practical method of termination.
The service disconnect
A key problem with most contracts between operator and shipper is that the best of lawyers cannot force a provider to give really good service. In his biography of Apple founder Steve Jobs, author Walter Isaacson describes a dispute between Apple and its logistics provider, Airborne Express.
The dispute started as a personal grudge match between Jobs and Airborne. Jobs wanted to terminate the agreement because he did not like the service, and one of Apple's managers resigned in protest.
In another dispute between a consumer products manufacturer and a major logistics service provider, consultants on both sides earned massive fees by developing and attacking briefs to describe the process of negotiating the agreement. Similar briefs were written to support the service provider's pricing formulae.
The consulting report included substantial detail about labor, capital expenses and information technology. All of this was designed to prove that the provider's pricing was "commercially reasonable."
I suspect far more money and energy was invested in this dispute than the one between Apple and Airborne. In both cases, the big winners were the lawyers.
The IWLA standard warehousing agreement
The "Standard Contract Terms and Conditions for Merchandise Warehouses" serves several purposes. First, it conforms generally to the Uniform Commercial Code (UCC), which is used in much of the world.
Of the 21 sections of the standard contract, the most important is Section 11, which deals with liability and limitation of damages. English common law is the basis for defining the liability of a "bailee for hire."
The bailee is responsible only for that degree of care which a reasonably prudent owner would exercise. If a tornado, earthquake, fire or other calamity were to destroy the property placed with the bailee, the shipper's insurance would pay for the loss. The only exception would be a case when the owner could prove that the bailee was negligent.
Even when the operator is liable, the contract provides a way to limit that liability to a ratio of the value of goods in storage. Warehouse operators who sign an agreement that changes the liability limitations of UCC could lose their liability insurance coverage.
An equally important clause is Section 1. This defines how and when the agreement is accepted, and how it is terminated.
Section 19 of the standard agreement gives the warehouse operator the ability to apply a lien on stored merchandise if the fees have not been paid.
The value of separating legal matters from service
The best way to avoid litigation is to have separate documents: the legal contract and a statement of work (SOW). The contract should be devoted to a description of liability, the term of agreement, and an orderly method for termination. Everything else, including pricing and performance standards, should be in the SOW that is developed by the operator and the customer.
The SOW should be altered as conditions change, and its details should not be subject to litigation. The ultimate remedy, when the contracting parties cannot agree to changes in the SOW, is an orderly termination.
When either the buyer or seller fails to comply with conditions in any of the agreements, there should be a cure period to remedy the deficiency before punitive action is taken. A detailed description of the termination procedure is the best way to avoid a lawsuit. In some cases, binding arbitration may be required instead of litigation.
Separation of assets from services
Most of the earliest contracts between warehouse operators and their customers dealt with protection of investment in assets. Perhaps the customer wanted a new warehouse constructed, and available service providers were either unable or unwilling to accept the risk of investing in the real estate. The contract provided protection in the event that the agreement was terminated before the warehouse building was paid for.
One way to control the risk of capital investments is the development of a separate agreement for real estate and capital equipment. If the parties need to terminate, the customer might retain the capital equipment and real estate.
Preparing the scope of work
The SOW should provide a detailed description of the work to be performed. This includes order profiles, hours of operation, key performance indicators (KPIs), verification of inventory and order cycle times. Within the warehousing organization, there needs to be involvement from every member of the executive team who may be involved in serving the client.
The SOW should be a living document, one that is subject to change when either party finds that conditions have been altered. Pricing should be specifically tied to the shipper’s specification. Whenever the specifications change, an adjustment of pricing should be expected.
Both shipper and provider should insist that any oral agreements should promptly be reduced to writing. There should be a procedure for inserting these in the appropriate section of the SOW.
If continuous improvement is expected, the SOW should provide a procedure for rewarding the service provider for innovation, and possibly for penalizing the provider when performance falls below an agreed standard.
Developing a model set of agreements
Here is a brief outline that could serve as a model in the development of three primary agreements.
1. XYZ Corporation, a warehouse service provider, will provide services to the buyer, ABC Corporation. These services will begin on or about Aug. 1, 2016, and will continue until terminated. Accountability, acceptance and termination will be in accordance with the IWLA Standard Contract Terms and Conditions, which is part of this agreement.
2. Services provided are described in the Statement of Work (SOW) that is attached to this contract. This SOW will be subject to alteration by either party as conditions change. In the event that buyer and seller cannot agree to changes in the SOW, the primary agreement is subject to termination under the procedure outlined in the agreement.
3. Real estate and capital equipment, described in detail, shall be purchased by one of the two contracting parties, based on the amortization schedule. These capital investments must be acquired by the buyer in the event of termination.
The spirit of warehousing agreements
The origin of warehouse agreements was the need to protect the warehouse provider's investment and to provide reasonable assurance of continuity.
However, there is no agreement that can effectively force unhappy parties to work together. Therefore, the contract must provide for an orderly separation. Ideally, that separation protects the investors and avoids litigation. In order to accomplish this, there must be a detailed termination procedure as well as a procedure for disposing of capital assets.
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