Six "Gotchas" Hiding in IT Contracts

Updated: Jan 18, 2021

Supplier contracts include vague and confusing language, making them difficult and time-consuming to evaluate. Sometimes they exclude clauses that would protect customers from future price hikes or outline requirements for an audit. Because of this, the contract often exposes IT buyers to substantial financial risk, but you do not have to be a lawyer to identify and mitigate these risks.

These are the six areas we assess for risk or “gotchas” in every supplier agreement, regardless of the vendor.

1. Price Transparency

A lack of price transparency makes it impossible to determine if the deal is competitive in terms of individual product pricing, scope change fees, and annual support fees.

Many suppliers do not provide full price transparency in their deals, claiming they “do not share certain information with their customers”. This is simply not true. If the expectation is clearly communicated as a requirement of the deal by the buyer upfront, the supplier will provide transparency.

To achieve price transparency, ask your supplier to supply all the specific information listed in the chart above.

2. Renewal Rights

It is essential to understand the renewal terms to protect you from surprise price increases when the initial term of the contract expires. Clear renewal rights will help you save on and forecast future costs.

Suppliers make a lot of money on renewals, and therefore try to omit renewal cap details. This gives them greater flexibility to hike prices down the road. We caution clients that the absence of renewal terms in a contract does not mean the supplier will not increase prices; it just means you have no protection.

Vendors may attempt to justify high renewal increases by pointing to the Consumer Price Index (CPI), the value added, or some combination of both. If based on CPI, make sure the contract clarifies which CPI will be used to calculate the increase. Further, some suppliers will honor the renewal cap only on the products that are part of the order, if the quantity and list of products are not reduced. Bottom line: most renewal increases can be negotiated if there is leverage, so don’t be misled by suppliers that state these fees are standard and non-negotiable.

3. Price Holds

Price holds honor a negotiated discount for a specified amount of product and period of time. These are useful if you lack a high level of confidence regarding your demand and want to start with a conservative deployment. They help customers lower the initial financial layout and protect against future price increases.

Make sure to inspect your deal to see if you have protection for fees in excess and check for any built in price premiums or high purchase minimums that must be met to qualify you for the price hold protection.

The takeaway: you should never be forced to pay more per unit for increasing your volume, but it is incumbent upon you to prevent it from happening.

4. Change in Control

This contract clause stipulates what happens to your hardware, software, and services rights if you acquire, merge with, or divest a company.

The two primary items to inspect are your divestiture terms and assignment rights. The divestiture clause outlines a period of time – usually 6 to 12 months – during which a divested entity is allowed to continue operating under the agreement after its spun off.

Assignment language dictates whether you have the ability to transfer the agreement and purchases in connection with a merger, acquisition, corporate reorganization, or sale of your assets. A lack of assignment language can be a problem if the ability to move licenses in connection with reorganization does not exist.

We urge clients to negotiate assignment language that lets you share products and payment obligations with the other entity in the event of an M&A or divestiture. Make sure all contingencies and conditions are reviewed and understood.

5. License Rights

This area of the contract describes how you can legally use the software being purchased in accordance with the supplier’s requirements and restrictions. Sometimes suppliers include restrictions that are easy for customers to break inadvertently, triggering costly noncompliance fees in an audit.

For example, some contracts stipulate that any individual that accesses the software, directly OR indirectly, must be licensed. In other contracts, vendors will award a competitive purchase price but will set usage restrictions to limit how you can use the product. License rights are unique to products and specific suppliers. We encourage clients to scrutinize these terms to make sure they are understood and communicated to stakeholders before the deal is signed.

6. Audit

Compliance audits are a huge revenue source for suppliers. To help avoid noncompliance, boilerplate audit clauses must be negotiated to eliminate “gotchas” and include more advantageous contract language. We look for answers to the following list of questions when inspecting this section of a contract.

We counsel clients to request the audit notice be no less than 45 business days, and the audit frequency on large strategic investments, no more than once in 2-3 years. Audit payments should be due in no less than 60 days, which allows time to review and dispute audit findings. Make sure the contract does not terminate service and support while you’re negotiating the audit settlement or obligate you to pay fees based on list prices. And finally, the contract should designate the cost of the audit to the supplier, not the customer.

In our experience, there is at least one “gotcha!” in 90% of the contracts we see. We recommend that the entire deal team shares the responsibility for understanding and mitigating risk in supplier contracts and hires outside expertise if time or expertise is in short supply.

Brady Carlson is an Analyst and Tanya Lutsyuk is a Principal Analyst at ClearEdge Partners.

This blog post was inspired by the webinar Top Gotchas in an IT Contract. You can access the full recording to this webinar below. To learn more about this subject, download our whitepaper or contact your ClearEdge representative.