Incorporating by reference: key risks

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Many organisations have global supply arrangements or framework agreements with key subcontractors and suppliers. 

By way of example:

  • Suppliers often have global partnering arrangements with other large suppliers.  In this context, a purchase order or letter agreement may simply incorporate by reference the terms of the relevant global contract.
  • Framework arrangements are very common in the public sector.  These are often set up with a pro-forma call off as a schedule.  The call off is usually intended to be a free standing agreement, but often incorporates either specific provisions or the entirety of the framework terms and conditions.

These arrangements are very common, but in our experience, there is a risk that only cursory attention is paid to the agreement terms which are being incorporated.

The problem is that incorporating terms generally in this manner can lead to inconsistency and lack of clarity as to the parties' rights and obligations.  Certainly there is guidance from the Court of Appeal to the effect that, in this situation, "surplus", "insensible" or "inconsistent" provisions should be "disincorporated", "rejected" or ignored as "surplusage".  The difficulty with such an approach is that it requires careful analysis and interpretation in accordance with established principles; the risk is that parties get their interpretation wrong and end up in litigation, as happened with BAe and Northrop Grumman.

In that case, Northrop Grumman agreed to licence software to BAe with provision of separate support and assistance. In order to avoid having to copy out verbatim the relevant text, the licence agreement provided that:

"This Agreement shall be governed by the terms contained within the "Enabling Agreement for Design Services and Task Work, Version 2, dated March 2010".

That Enabling Agreement happened to be made with a different BAe entity.  It provided, amongst other things, for a right of termination for convenience to apply to all purchase orders.  The key question for determination by the Court of Appeal was whether the licence agreement was a form of purchase order and should also be subject to a right of termination for convenience.

As an initial point, the court held that using the term "shall be governed by" did not have a materially different effect from stating that provisions from an agreement were "incorporated in[to]" the licence agreement.

Turning to the relevant provisions of the licence and Enabling Agreement, the Court held that where the latter is a clearly inconsistent with the licence agreement, the licence agreement should prevail and "appropriate manipulation" should be applied.  Thus for example, it was evidently the intention of the parties that they alone should be able to enforce the licence agreement, not the BAe entity that was a part to the Enabling Agreement.

As a matter of construction, the licence agreement fell within the requirements set out in the Enabling Agreement for a purchase order.

But Northrop Grumman argued that by its nature, the provision of software, training and support was one indivisible supply which was inherently unsuitable for early termination for convenience.  The Court of Appeal disagreed and concluded that delivery of software was to be in two tranches and support was to be delayed precisely so that BAe could terminate for convenience either before the second tranche of software was released or before support commenced.

Key learning points:

  • A significant amount of time and money was expended by both parties in trying to resolve whether a relatively common clause applied on the facts.  With the benefit of hindsight, it would have been best to deal with this expressly in the licence agreement or to have carried out a review of the Enabling Agreement and stated that, for example, the licence agreement will be interpreted as being a purchase order for the purposes of the Enabling Agreement.
  • It is probably worth asking, do you really have to incorporate by reference?  Whenever possible it makes sense to avoid the risk of ambiguity by setting out terms in contract rather than incorporating by reference.  This is clearly best advice when preparing public sector framework agreements with a detailed pro forma call off contract attached as an annex or schedule.
  • We recognise sometimes, for whatever reason, be it the need for speed or inability to lawyer every small contract, incorporation by reference is the only practicable way to go.  Perhaps a counsel of perfection in these circumstances, but we would urge against doing so blindly. The risks in doing so may be mitigated by raising awareness of the key provisions, possibly through training or a summary of them.