The Contract and the Sale of Goods and Supply of Services

From a commercial and contractual perspective, there is a big difference between agreements for the sale of goods and supply of services.

Contracts for the sale of goods and services agreements are similar in that they both place legal obligations on contracting parties and require consideration.

However, they are dramatically different when it comes to:

  • The laws governing both sales of goods and services agreements
  • The rules governing partial and complete performance
  • Remedial measures required when the contractual obligations are not met.

In drafting offers and contracts and their terms and conditions you need therefore to pay special attention to what the deliverables are in your agreements: services or goods.

If you use the wrong set of terms and conditions, you can unnecessarily lose a lot of value along the lifecycle of your contract.

Especially, when it comes to liabilities, warranties and liquidated damages or other wording.

The Difference Between the Sale of Goods and the Supply of Services

A service is intangible, often instantly ‘perishable’ (reply to a query, training session, consult), and is not storable or transferable. Otherwise, it most probably is a ‘good’.

A ‘good’ – as we will see below – may be a tangible property or an intangible one (in the case of software.

An example where this distinction between services and goods caused and still causes difficulties is software.

When service tax was introduced on created software this caused many problems and confusions.

In which category do the deliverables of software belong and is the software a good or a service?

The discussion was and still is whether ‘canned software’ like PC software or on-premise applications sold off the shelf like SAP, Oracle, etc. are ‘goods’.

It would become a ‘good’ provided it has the attributes thereof.

You therefore need to look at:

  1. The use of the software
  2. It being capable of being bought
  3. It being capable of being transferred, delivered, stored, and possessed.

If the software, whether customized or non-customized satisfies these three attributes, it most probably is a good.

A simple rule is that in general goods, tangible or intangible, must be deliverable.

With the trend to move all software system functionality into the cloud, it has become easier.

The name given to many of such cloud applications – ‘Software-as-a-Service’ (‘SAAS) – tells the complete story.

There is no ambiguity anymore about SAAS. It is a service and therefor you need to apply the terms and conditions of a software-as-a-service agreement.

In drafting offers and contracts and their terms and conditions pay special attention to the above distinction. Do not only look at the words used.

For instance: delivering spare parts is often described as a ‘service’.

However, spares are (tangible) goods so the terms and conditions applicable (like warranty) should be those of a contract of the sales of goods.

We need to look good at the deliverables when we are writing our proposal or drafting the contract.

The Services Agreement

A services agreement is a contract between two or more parties agreeing to the performance of an express task or service.

Much like a contract for the sale of goods, a contract for services specifies the service to be performed and sets an agreeable standard of completion for these services.

Service agreements also provide the terms for failure to deliver the service or to meet the specified standard, as well as allowances for force majeure (acts of God etc.).

Some rights are statutory in laws and need not to be mentioned in contract:

  • That the supplier will carry out the service with reasonable care and skill
  • That the work will be carried out in a reasonable time (unless the timeframe has been specifically agreed)
  • That the work will be carried out at reasonable cost (unless cost has been specifically agreed).

However, I recommend you always included them in your services agreements and define what ‘reasonable care’, ‘reasonable timeframe’, or ‘reasonable cost’ actually means for the specific services you want to deliver.

If only to prevent long discussions or even conflicts and claims when things go wrong.

Service level agreements (SLAs) are becoming increasingly common in many service-, outsourcing and software agreements.

They define specific key performance indicators (KPls) that can be used to assess the performance of the supplier.

Parties can agree in the SLAs that failure to meet the agreed service levels or KPls can then result in an obligation on the supplier to ‘repair’ service delivery and a decrease of the price paid by the customer.

The SLA will describe:

  • How you will measure the performance in question.
  • Whether the effort and cost required to measure the performance are justified by the benefits of measuring it.
  • What should happen if performance is too late or inadequate.

But you should be careful whether focussing on KPIs will actually improve overall service delivery or simply concentrate the supplier’s mind on meeting such KPIs to the detriment of service in other areas.

A Contract for the Sale of Goods versus Services

A contract for the sale of goods (also known as a ‘contract of products’) is not different from a supply of services agreement in that it is an agreement between two or more parties agreeing on the sale of goods.

The quantities of goods, the price per unit, total price, as well as terms of payment (generally upon delivery) are specified within the contract.

Contracts for the sale of goods also have terms regarding failure or default by either party.

Especially when it comes to too late delivery or issues related to the goods itself (defects, quality, liability, intellectual property).

Provision for unforeseen circumstances that prevent the completion of the contract (“act of God” or “Force Majeure”), (product) liability, and warranties are more the focus here.

This is also where contract wording starts to really deviate form services contracts.

Incoterms for Sales of Goods

Another term you will find often in sales of goods – and not supply of services – agreements is the Incoterms.

The Incoterms or International Commercial Terms are a series of pre-defined commercial terms published by the International Chamber of Commerce (ICC) relating to international commercial law.

They are widely used in International commercial transactions as the use in international sales is encouraged by trade councils, courts, and international lawyers.

A series of three-letter trade terms related to common contractual sales practices, the Incoterms rules are intended primarily to clearly communicate the tasks, costs, and risks associated with the transportation and delivery of goods.

Incoterms help you to define respective obligations, costs, and risks involved in the delivery of goods from the contractor to the customer.

The Incoterms rules feature abbreviations for terms, like FOB (“Free on Board”), DAP (“Delivered at Place”), EXW (“Ex Works”), CIP (“Carriage and Insurance Paid To”), which all have very precise meanings for the sale of goods around the world.

International Chamber of Commerce

However, the Incoterms as such do not constitute the contract or govern law itself.

Also, Incoterms do not define how and where titles transfer, and the Incoterms do not address the price payable, currency, or credit items.

A common mistake people make is to confuse transfer of title or ownership (not part of Incoterm definitions!) with transfer of risk (under Incoterm).

Transfer of title and ownership needs to be addressed separately in the agreement from the Incoterms.

The transfer of ownership can also take place long after the risk was already transferred to the customer.

Often suppliers link title transfer to the moment they have been 100% paid by the customer.

Incoterms can NOT be used for delivery of labor-based and other services (training, or where ownership is not transferred like reports, documents, etc.).

Obligations, Terms, Conditions, Deliverables

As within any other agreement there are four main categories of provisions in sale of goods and supply of services agreements:

  • Obligations – specifying specific actions that either party must do, or is prohibited from doing. These might include, for example, an obligation to provide services to a certain standard (e.g. ‘serviceable condition’) or make no more than two copies of any software supplied. Remember that an ‘obligation’ for one party is generally a ‘right’ for the other party, so ‘obligations’ can be rewritten as ‘rights’ for the other party.
  • Terms – setting out the legal terms relating to the relationship. Limits and exclusions of liability, assignment, entire agreement, and other ‘boilerplate’ terms would fit in this category. A term of a contract can refer to any provision of the contract. These are terms that are not obviously either warranties or conditions. If an innominate term is breached, the injured party’s right to terminate the contract, as a result, will be determined by:
    • The seriousness of the breach,
    • The particular circumstances around the breach
    • The effect of the breach on the parties’ ability to complete the performance of the contract.
  • Conditions – There are some terms that are so fundamental to the purpose of the agreement that if they are breached, the contract cannot continue. These are described as conditions because the performance of the contract is conditional upon those terms being fulfilled. Breach of a condition would entitle the non-breaching party to terminate the contract and would relieve the non-breaching party of its obligations under the contract.
  • Warranties and other terms – while important, are less essential to the fundamental purpose of the agreement. Breach of one of these terms, described as ‘warranties’, can be remedied and the parties can continue in the performance of the contract as before. The remedy may involve a practical resolution for the breach, and possibly the payment of damages to the injured party. The key distinction between warranties and conditions is that while a breach of condition enables the non-breaching party to terminate the contract and to claim damages, a breach of warranty entitles them to damages only.
  • Deliverables – these will be the specific products or services to be delivered under the agreement.

In some environments where I worked – especially in engineering-driven companies – there surprisingly was a lot of confusion about what a ‘deliverable’ actually is.

The issue is that project managers also use the word ‘deliverable’.

This is the definition you can use to distinguish the two:

  • The overview of Contract Deliverables in the sales of goods and supply of services agreement is a comprehensive list of all things that the person paying for the product or service expects at the end of the contract.
  • The Project Deliverables are a more finite overview of the specific milestones or achievements expected during the life of a project, which would fall within an agreement.

So Contract Deliverables are more comprehensive, while Project Deliverables are more specific.

So be careful and for instance exclude documents to be used as milestone evidence etc. ! Also be careful with wording like ‘other deliverables’: also those need to be clearly defined.

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