Drafting IT contracts that work
Diana J.P. McKenzie, chair, information technology practice group at Neal, Gerber & Eisenberg LLP (Chicago), examined the core details of IT contracts, offered strategies for drafting favorable contracts and provided insight into current trends in “Contractually Speaking: Drafting IT Contracts that Work” on Tuesday at the Healthcare Information Management Systems Society (HIMSS) annual meeting in San Diego.
External factors, such as the state of the economy, impacts contractual terms, said McKenzie. Vendors are more likely to agree to concessions when the economy is in a decline. Currently, the number of vendor concessions, such as warranties, is falling compared to the early, recessionary part of the decade.
McKenzie explained the significance of a number of commonly used, misunderstood contractual terms. For example, representation and warranty are not interchangeable. A hospital must prove a material breach of a representation, but the vendor is in breach of the contract if it does not follow the warranty.
Most IT contracts use a multiple of fees paid as the limit of liability; however, a few exceptions can protect the buyer. Exceptions worth seeking include indemnification, breach of confidentiality provision and repudiation of vendor, which holds the vendor to a contract if it attempts to back out of a fixed fee implementation.
Levels of effort vary from reasonable, which is implied in law to best efforts, a very stringent standard. One of the more popular options is best commercially reasonable efforts, which is not a defined legal standard and should be avoided, said McKenzie. Instead, McKenzie prefers tier-one efforts, which are defined as the efforts used by top-end vendors in a specific industry.
Another recent trend is the push of date-based payment over performance-based payment, said McKenzie. A hospital can protect itself by asking for a deferral of date-based payments if the acceptance fails to meet established standards.
Other common payment terms include holdbacks and true-ups. A holdback retains payments until certain events occur, and a true-up redistributes payments based on vendor efforts. Hospitals should limit true-ups because it could force the buyer to pay for an implementation prior to completion. McKenzie recommends that hospitals ask vendors to drop interest on late payments from 12 to 18 percent to 6 to 9 percent. Another worthwhile request is the all-fees clause, which states that there are no additional software implementation fees.
Other trends include the expansion of the “force majeure” event, which excuses a party’s failure to perform in the event of unexpected circumstances beyond reasonable control. Vendors are attempting to broaden the definition of force majeure from weather and fire to acts of terrorism and labor shortages. The clause gives the vendor a complete out, so its use should be examined carefully, said McKenzie. Also, force majeure should not be included in a disaster recovery contract.
McKenzie concluded the session with some advice for drafting contracts. She recommends that hospitals:
External factors, such as the state of the economy, impacts contractual terms, said McKenzie. Vendors are more likely to agree to concessions when the economy is in a decline. Currently, the number of vendor concessions, such as warranties, is falling compared to the early, recessionary part of the decade.
McKenzie explained the significance of a number of commonly used, misunderstood contractual terms. For example, representation and warranty are not interchangeable. A hospital must prove a material breach of a representation, but the vendor is in breach of the contract if it does not follow the warranty.
Most IT contracts use a multiple of fees paid as the limit of liability; however, a few exceptions can protect the buyer. Exceptions worth seeking include indemnification, breach of confidentiality provision and repudiation of vendor, which holds the vendor to a contract if it attempts to back out of a fixed fee implementation.
Levels of effort vary from reasonable, which is implied in law to best efforts, a very stringent standard. One of the more popular options is best commercially reasonable efforts, which is not a defined legal standard and should be avoided, said McKenzie. Instead, McKenzie prefers tier-one efforts, which are defined as the efforts used by top-end vendors in a specific industry.
Another recent trend is the push of date-based payment over performance-based payment, said McKenzie. A hospital can protect itself by asking for a deferral of date-based payments if the acceptance fails to meet established standards.
Other common payment terms include holdbacks and true-ups. A holdback retains payments until certain events occur, and a true-up redistributes payments based on vendor efforts. Hospitals should limit true-ups because it could force the buyer to pay for an implementation prior to completion. McKenzie recommends that hospitals ask vendors to drop interest on late payments from 12 to 18 percent to 6 to 9 percent. Another worthwhile request is the all-fees clause, which states that there are no additional software implementation fees.
Other trends include the expansion of the “force majeure” event, which excuses a party’s failure to perform in the event of unexpected circumstances beyond reasonable control. Vendors are attempting to broaden the definition of force majeure from weather and fire to acts of terrorism and labor shortages. The clause gives the vendor a complete out, so its use should be examined carefully, said McKenzie. Also, force majeure should not be included in a disaster recovery contract.
McKenzie concluded the session with some advice for drafting contracts. She recommends that hospitals:
- Avoid shorter, less precise contracts.
- Use specific dates or date-based time references for vendor obligations.
- Check to make sure formulas work.
- Closely scrutinize the definitions of the following terms: solely, estimate, may, goal and could.