Analyzing vendor and supplier contracts.

Contractual relationships between group practices and outside vendors cover diverse topics from specialized topics such as hazardous waste disposal and computer maintenance to such minor matters as janitorial services. In most instances, these contracts are executed by the medical group without the benefit of legal review. These agreements form an increasingly significant way by which a medical group operates its business, and, therefore, a group's revenues are increasingly committed to these types of arrangements. While the use of legal counsel in these situations may not be cost justified in every instance, groups should carefully scrutinize these agreements in order to provide some protection to the interests of the medical group.

Certain basic principles can be applied to the analysis of these contracts.

Preliminary Considerations.

The basic principle overriding all others in analyzing vendor or supplier contracts is that the agreement should contain a clear expression of the obligations of the parties. Are the ideas clearly expressed, and are the types of services that the group expects to receive accurately described? Reading the contract carefully with this principle in mind is the most important step in protecting the position of the group.

Another basic consideration is to critically evaluate the bargaining power of the group in the proposed relationship. Often, contracts will be typeset in fine print, giving the impression that the only option for the group is to sign, accepting what is offered on a "take it or leave it" basis. Such typeset agreements are almost uniformly designed to favor the vendor, not the medical group. Groups must determine their bargaining power in these situations and identify major concerns they may have concerning the relationship and the document. To the extent that the vendor needs the group's business, it will more than likely try to accommodate reasonable requests made by the group for modifications to the agreement. It is important for the group to determine what benefit it brings to the situation and to be prepared to propose reasonable changes in light of its bargaining position with the vendor.

Determining the Obligations

of the Medical Group.

For vendor contracts, the primary obligation of the group will be to pay for the services that are rendered. The main issues to consider in this area are how the payment obligation is expressed and when payment is required. Whether the obligation is expressed as a flat sum, a fee based upon volume, or a charge determined by a formula, the group must be convinced that the charge it will be paying is clearly expressed. Otherwise, the group runs the risk that later disputes will develop concerning the appropriate payment to be made. The timing of such payment is equally important. In order to live up to its obligations, the group must know when its payment will be required.

Some vendor contracts may require the group to perform certain services. Again, the overriding principle is one of clarity of expression. In order to avoid later dispute, obligations of the group must be clearly understood and expressed in the agreement.

Obligations of the Vendor.

The primary obligation of the vendor is to provide some type of service or product. This focus is exactly the opposite of a managed care contract, where the group provides the services and is subject to extensive provisions regulating performance. For a product or service contract, the group must determine, with equal care, whether the obligations of the vendor are clearly expressed. Where timely performance is critical for the group, response time must be clearly specified. Phrases such as "reasonable efforts" or "prompt performance" must be avoided, as it is impossible to determine whether these vague performande standards are being met.

Another important consideration is to separate the salesman's indications of the type of performance that can be expected from what is expressly set forth in the agreement. In reviewing the contract, sales "hype" should be totally ignored, and the group should determine by review of the contract language itself whether the obligation of the vendor matches the expectations of the group. Disputes often arise because of a failure to separate talk from binding obligations. Extra care in determining what the group will receive in return for its money will often avoid disappointment, or will reveal that the vendor or supplier is unwilling to make the necessary quality or time commitments.

Term of the Agreement.

The term of the agreement should be clearly set forth in the contract. In most instances, the group will need time to evaluate the quality of the product or service being provided, and the contract should only last a reasonable amount of time for that determination to be made. Under these circumstances, a term of six months usually provides a sufficient time for the group to evaluate the service or product. A longer period will provide more benefit to a service provider who desires to obligate the group to continue to use the provider's services.

Another provision found in the term section is an automatic renewal clause. These clauses renew the contract automatically at the end of the current term, unless the parties affirmatively act to not renew the agreement. While there is nothing inherently wrong with automatic renewal clauses, the time for giving notice for nonrenewal should not be long. Otherwise, the renewal notice date may pass without the group taking action, causing an inadvertent renewal of the contract for an additional term. A 30- to 60-day advance notice should be sufficient in almost every circumstance. The group should keep track of renewal dates so that contracts are not inadvertently renewed without evaluation of contract performance.

Termination.

The termination clause will set forth the circumstances under which the group may terminate the supplier before the end of the contract term. Termination clauses are important, as otherwise the group will be obligated to pay for the services for the entire length of the contract term without regard to their quality. Because the group will often only be providing payment for the services or goods it receives, these clauses are less important to the vendor, and detail sufficient to provide protection for the group will often be absent. In reviewing a termination paragraph, the group should determine under what circumstances it may terminate the relationship for cause. Cause can be defined in a variety of ways. It is important, however, for the contract to allow for termination by the group for a wide variety of circumstances, including failure of the vendor to perform in accordance with performance standards that are set forth in the agreement or failure to perform in a timely fashion. Without a clear statement that failure to fulfill obligations undertaken by the supplier will give rise to a right to terminate the agreement, it will be impossible, or at least legally risky, to terminate agreements for cause prior to the expiration of their term.

Groups should also realize that a standard provision concerning the ability to terminate because of bankruptcy of the vendor is not enforceable under the federal bankruptcy law. Federal bankruptcy law expressly prohibits the termination of a contract solely because of the filing of a bankruptcy petition by a party. As long as services are being provided in accordance with the requirements of the contract, the filing of a bankruptcy petition will not allow a group to terminate the agreement.

The termination provision of a contract should also be closely examined to determine what effect it will have on the respective rights of the parties. A group should determine the extent of its continuing obligations to accept services. Continuing financial obligations should also be reviewed carefully.

Finally, termination paragraphs may contain a provision that allows either party to terminate the agreement without a reason (without cause) upon the giving of notice to the other party. The notice period may vary from 30 to 90 days. These provisions are usually very favorable for the interests of the group, allowing it to avoid the sometimes difficult task of establishing cause for termination. If this type of clause is not present, it should be requested in the negotiating process.

Disclaimer of Warranties

and Representations.

A vendor contract should provide qualitative standards for performance on behalf of the vendor or supplier. While the law may imply certain warranties in these contexts, the contract language should contain sufficient protection for the group. Often, however, vendors or suppliers of services and goods will use the warranty and representation section to insert significant disclaimers of warranties. These disclaimers should be reviewed carefully and a determination should be made whether the disclaimer give the group no protection at all concerning the quality or scope of services or goods to be provided. To the extent the supplier is unwilling to stand by the quality of its goods or services, reevaluation of the appropriateness of that particular supplier should be made.

Indemnification.

Indemnification clauses may require a group to reimburse a supplier for any loss the supplier suffers through a third party because of the actions of the group under the agreement. Indemnification clauses are designed to help parties obtain reimbursement for losses that might not otherwise be covered by their insurance. The problem with these clauses is that a group that agrees to make the indemnification will, in some contexts, be agreeing to make these payments without being reimbursed by its insurance policies. Groups should not agree to these obligations without checking with their insurance carriers.

Where the group is unable to have the clause removed, however, it should insist that the clause also require the vendor to indemnify the group. In a contract that only requires the group to make payments, however, there is little risk that the actions of the group will give rise to an indemnify event, and a greater likelihood that group will be entitled to receive the indemnifying payments based upon the actions of services provided by the vendor. These clauses should be closely evaluated with respect to their language, potential lack of insurance coverage, and the protection that they may or may not afford groups from the services or goods provided by vendors.

Legal Requirements.

The group should determine that the services or goods to be provided by the vendor will be provided in accordance with all applicable laws, statutes, and regulations. In addition, the contract should explicitly state that the provider of services or goods has all necessary licenses, permits, or other approvals to provide the services. These representations and warranties should be set forth in contract. In addition, in areas where permits and licenses are particularly critical, such as in the biomedical waste area, contact with the appropriate regulating authority will provide additional assurance that the vendor is, in fact, fully licensed under state law.

Restrictive Covenants.

Restrictive covenant provisions in contracts will prohibit the group from doing business with a similar vendor or supplier for a period after termination of the contract. These provisions are rarely justified. In a physician's employment agreement, the covenant will protect the good will and practice of the group; here, the group is being asked to restrict its future selection of suppliers of services. Any such restrictions on the ability of the group to conduct its affairs should be avoided.

Arbitration.

As an alternative means of dispute resolution, a contract may contain an arbitration clause. Groups should recognize that while arbitration clauses keep the disputes out of the courts, arbitration is not an inexpensive way to resolve disputes. The same type of testimony and discovery costs that have created large litigation costs can also be found in the arbitration context. Selection of the arbitrators in the contract should be examined to ensure fair selection from an appropriate pool of qualified individuals. In addition, rules for the arbitration should be specified as being under existing state arbitration law or under rules of the American Arbitration Association.

Miscellaneous Provisions.

Each contract signed by the group will invariably contain a number of "boilerplate" provisions that govern the parties' relationship. While these provisions often do not need to be negotiated, an understanding of their meaning is useful. A summary of these provisions follows:

* "Entire Agreement." The entire agreement clause means that there is no other agreement between the parties, except as set forth in the contract. Marketing materials and presentations not explicitly incorporated into the contract are not binding obligations of the vendor. Any legally binding obligation must be set forth in the contract or in an exhibit attached to the contract.

* "Amendment." Contracts often contain a provision that says the contract may not be amended except by a writing signed by both of the parties. Without such documentation, it will be impossible to establish any later modification of the agreement.

* "Choice of Law." Contracts will also contain a choice of law provision. Often, the home state of the vendor or supplier will be selected for the laws that will govern the interpretation of the agreement. Generally, it is preferable to have the laws of the groups' home state apply, although for most contracts it is difficult to tell in advance whether the laws of another state will be more favorable to the group on any given subject.

* "Assignment." The agreement will also likely contain a provision that prohibits the assignment of the contract to a third party. It is important that the contract not be assigned to a third party that is not originally selected by the group. All of these contracts, therefore, should contain a provision that prohibits assignments.

* "Severability." Often, a contract will contain a clause that states that in the event any portion of the contract is held to be unenforceable, the other provisions will remain intact and enforceable against the parties. This provision protects the integrity of the contract, even though one of the provisions may be deemed unenforceable. Generally, these clauses are of benefit to both parties.

Contractual arrangements have come to govern nearly every aspect of the operation of a group practice. While each contract will cover a different subject and will, accordingly, be drafted in a different fashion, it is clear that in all of these circumstances, it will be the group that will be responding to a preprepared, well-thought out arrangement proferred by the vendor party. A basic understanding of contractual provisions is imperative in negotiating a contract that will be successful for the group. By employing the principles of analysis set forth in this article, groups can use a more systematic approach in evaluating, modifying, and enforcing various arrangements with third parties.