What is a Third-Party Contract?
What is a third-party contract? A third-party contract, as the name suggests, is a contract between one party to a business transaction and a third party that is not part of that transaction. The most common situation where a third-party contract is used is when a party is required to indemnify another party for damages. An example would be an insurance company, which assumes the risk of certain events occurring in the future, by agreeing to indemnify the insured against those risks.
Indemnification contracts have become common in construction , where general contractors require that subcontractors indemnify them for damages caused by the subcontractors on the project. It becomes a hot topic in commercial lease negotiations where the landlord typically requires the tenant to indemnify the landlord for anything arising out of the use of the space by the tenant. The same can be true for licenses of intellectual property, where the owner of patent, trademark or copyright requires that the licensee indemnify the owner of the IP for damages that may result from the licensees efforts to use the IP.
Crucial Components of a Third-Party Contract
The basic elements of a contract include the parties, the subject matter, their mutual consent, the legal capacity and authority of the parties to contract, and legal consideration. The main elements are:
Parties. The parties are the people involved in the contract and the businesses or individuals with whom the two people are entering into an agreement. In other words, parties can be you and another person. Or the parties can be you and a corporation or organization. This is important because the names on the contract represent the agreement that the parties mutually agree to terms with one another about.
Obligations and Rights. Obligations are what the parties must do, and rights explain what the parties are required to do for one another in the contract.
Essentially what the parties agree to is critical to the contract, and if the parties agree to something and don’t hold up to their end of the deal, the contract is not legally binding. Therefore all parties are legally bound to what was agreed upon when the contract was signed. That means when you entered into a contract with the restaurant on who was responsible for the bill, you are now required by law to pay the $200 bill that you agreed to!
Mutual Consent. Both parties must agree to the contract in order for it to be legally binding and enforceable. Essentially, if both parties do not mutually agree to the contract and what it states, then the agreement is not legally enforceable. The contract can be verbal or in writing.
Legal Authority. The obligations must be legal and lawful in order for the contract to be legally enforceable. If they are not lawful or legal, there is no contract. To be legal, the parties must have the capacity and authority to enter into a contract with one another. That means an individual cannot legally enter into a contract with a person under the age of 18, as he or she is under legal age and does not have the capacity and authority to sign a contract. And if the parties do not have legal authority, there is no contract.
Legal Consideration. Legal consideration means something of value is exchanged, including anything of value such as money, goods, services, or other consideration that is sufficient to support the parties’ promises. As an example, the restaurant that you go to at night offers to sell you dinner for $200, and then you dine at their restaurant and enjoy a wonderful meal. The restaurant gave you a nice dinner, and you, in turn, gave them the $200 that they agreed upon initially.
Advantages of Third-Party Contracts
In addition to the risk management benefits surrounding third-party contracting, there are other ways that organizations can save time and money by relying on contracted vendors to outsource some of the tasks they need to accomplish. Outsourcing can often improve the efficiency of how your organization operates, since vendors are typically experts in their given field and can rely on their previous relationships with other companies to streamline the processes and give you high-quality results in a relatively short turnaround.
One of the best examples of this comes in the form of technology. When it comes to things like IT support, telephone systems, security and other components, it’s almost always better to outsource those needs to a third party that specializes in the area. When your business tries to take on any of these projects in-house, it can be incredibly time consuming and expensive for companies of all sizes.
Instead of trying to bend over backwards to fit each new service in with all of your other electronic needs, you can hire a third-party vendor to handle all of that work for you. This outsources many complicated tasks and puts them in the hands of qualified experts. Not only does this save you time and energy in hiring, training and retaining highly-skilled employees, but it can also reduce your overall costs. These vendors have existing contracts with other companies – their ability to bundle their services from multiple entities into one contract with you makes it easier for you to get a discount because they’re guaranteed a certain amount of work from you.
So, whether you’re outsourcing a specific project or hiring a third party as a full-time solution, third-party contracts provide you nothing but benefits.
Risk Factors and Notable Issues
The most obvious risk in outsourcing is that of non-compliance. If the third-party fails to comply with applicable laws and regulations, it could impact you. By way of example, take online marketing and data gathering of personal information – which has received considerable press these days. If a company markets or uses information collected in such a way that affects your company and it does so without complying with the relevant legal and regulatory requirements, or the terms of your contract with them, the regulators will come to you.
Lack of direct control over collateral activities can undermine the desired outcome. If the and its function do not line up, you may lose the ability to affect how the other person operates and suffers consequences accordingly. For example, if a customer service team is in a different region from the product team it serves, a culture clash may make it difficult to serve certain customer requests.
Third-party contracting relationship requires an understanding of how conflicts are resolved, whether they arise during the contractual process or subsequently. A contract only works well if the parties are happy throughout the relationship. Once tensions reach an irreparable level the relationship falls apart and so does the associated business opportunity. As the U.S. Department of Defense states, "the best defense contract is one where both the government and contractor are satisfied."
Guiding Principles for Drafting a Third-Party Contract
There are several important factors to take into consideration when drafting a third-party contract. First and foremost is how many parties are involved. A one-on-one contract is much easier to draft than one that involves multiple parties. When more than two parties are involved, there is more potential for confusion and litigation. Even though multiple parties are involved, the ability to simplify the contract is key. For instance, you should strive to have a single party responsible for each single obligation to be performed under the contract so that there is no misunderstanding about who must perform that obligation. With multiple parties, it is often unclear who a third party can bring a lawsuit against when a third-party does not fulfill its obligation under the contract. That is why simplicity and clarity are paramount.
The terms of a contract also play an important role. It is crucial in a third-party contract to include precise terms in the negotiations so that there is no room for interpretation by the parties. Ambiguity in terms can lead to disputes between any of the parties. Terms can be clarified by using numbers to denote amounts , specific times of delivery and place of performance in the contract. If a particular term is unclear, it is always better to negotiate an amendment to the agreement as opposed to leaving the unclear term in the contract.
If there is a delay by any party to meet its obligation under the contract, it is necessary to include penalties to protect the other parties’ interests. It is also important to include exceptions to the penalties, such as the event of a natural disaster so that a party does not have to breach the contract due to circumstances beyond its control. All parties would benefit from the penalties in order to encourage performance of the obligations in the contract.
In conclusion, there are several good strategies to use when drafting a third-party contract. The biggest factors to consider are how many parties will be included in the transaction and the terms of the agreement. In a third-party transaction, clarity is always preferable over ambiguity. It is also important to include penalties for failure to meet obligations under the terms of the contract, but the parties to the contract must be mindful to include exceptions to those penalties so that they can continue to operate without the penalties becoming an obstacle.
Legal Terms and Positions to Consider
When creating third-party contracts for your investment property, you also need to be mindful of some relevant real estate laws (depending on your local jurisdictions). It is prudent to seek legal advice before signing any agreement.
q) Which Act: You should familiarize yourself with the Commercial Tenancies Act or the Residential Tenancies Act in regards to standard clauses, dispute resolutions procedures and other obligations, such as dealing with security deposits and how to terminate lease agreements.
q) Apartment size: Fair Trading has a set of guidelines available regarding the minimum internal sizes of a rented apartment. Apart from looking at the internal area, check that the layout is suitable and doesn’t have any dead areas where furniture cannot be placed.
q) Agent or tenant: Most state governments specify that an agent/landlord must provide a tenant with a copy of a relevant legislation (such as fair trading) at the time they enter into the agreement.
You are required to be registered for goods and services tax (GST) if you have a GST turnover of $75,000 per year. Read more on GST obligations at dotcom.
You may also be required to register for pay-as-you-go withholding (PAYGW) by the Australian Taxation Office (ATO) if renting to friends and family or able to resolve a dispute with a non-registered entity through mediation. Read further on PAYGW obligations at dotcom.
Examples of Third-Party Agreements in Various Fields
The way in which third-party contracts are used can vary by industry. Here are some examples:
Technology. A software company may have many relationships with other companies for various purposes. For example, a cloud software company may have:
• distributor agreements with channel partners who resell its software to end-users.
• service provider agreements with companies that host its software.
• software development agreements with third-parties that provide software enhancements to its own software to differentiate it from competitors or provide more comprehensive services to its customers.
• terms of service and end-user license agreements with its end-users who will use the software.
Manufacturing. For many manufacturers, third-party contracts are key components of their businesses and the products they offer. Areas for third-party contracts include:
• raw materials that go into the product.
• sub-component parts that are manufactured by a third-party.
• products that are resold as part of a package deal with the manufacturer’s own products.
• distribution agreements (which could involve multiple parties) that are responsible for getting the product to customers.
• transportation of the product to customers.
• outsourcing either product manufacturing or some part of the manufacturing process.
Services. There are many ways in which a services provider could work with third-parties. Examples include:
• outsourcing of its service to a third-party that can do it less expensively or more effectively.
• referral arrangements with a third party that receives some compensation for referring the service provider’s services to end-users.
• reseller arrangements with companies that resell the service provider’s services to end-users.
• reseller arrangements where the end-user purchases both the services and products of both the service provider and the third-party.
How to Guarantee Effective Third-Party Contracts
Strategies for ensuring success with third-party contracts include the following: First, it is important to review on a continuing basis whether the third-party contract is still the best apparent option for achieving the goals of the company. Situations can arise where the benefit of the third-party service provider can be achieved through other means, such as by insourcing the service that the third-party service provider is providing.
Second, the internal processes for monitoring the third-party services should be established . For example, with an IT outsourcing partner, there should be a service level agreement that includes metrics for reviewing performance periodically, and assessing whether the third-party partner is meeting the company’s needs.
Third, a company should ensure that it maintains direct lines of communication with third-party providers. For example, the company should not rely upon intermediaries for its communications with third-party providers. By communicating directly with its third-party providers, a company can ensure that its voice is being heard, and that it understands how the provider is executing the services.