Grid Law founder David Walker reflects on a client’s recent legal dispute to clarify a question frequently asked by micro business owners: Is a purchase order legally binding?
This question was the key issue in a dispute I was recently involved in and if you Google the answer, it appears to be a resounding “Yes”.
However, that’s not strictly correct. A purchase order can be legally binding, but only if it forms part of a legally binding contract.
This was the point we were arguing over. My client (Company A) formed a joint venture with another company (Company B) so they could work in partnership on a project which included the installation of some new equipment in the end user premises.
Company B insisted on receiving a purchase order from Company A so Company A simply sent an email saying words to the effect of “Please accept this email as a purchase order for [NAME OF PROJECT] for [CONTRACT PRICE].”
The two companies started work on the project but there were problems from the very outset. Company B seriously let my client down because the quality of their work was poor. They ordered the wrong specification parts for the equipment so it never functioned to its full capacity and their time keeping was atrocious so the project over ran.
Read more of David’s contracts articles:
- How to deal with unfair business contracts as the owner of a small company
- A definitive contract review checklist every business owner needs to read
As you can imagine, the whole project was a complete disaster and it’s not surprising the end user refused to pay the full contract price.
As the two companies were working in partnership, my client offered to share the loss with Company B, but Company B wasn’t happy with that. Despite all the problems they caused, Company B wanted to be paid in full!
Their justification for this was that my client had issued a purchase order and they believed this was a legally binding contract and conclusive proof they should be paid.
We refused to pay the full amount they were claiming and so they threatened to sue my client for the balance.
Part of my defence was that the purchase order, on its own, was not legally binding. Also, the end user had changed the scope of the project almost straight away and that meant the terms of the contract between my client and Company B also changed. The purchase order was never updated and was therefore it was completely irrelevant.
We weren’t disputing the fact that the two companies had worked together, but as claimant, the burden of proof was on Company B to prove their case.
In order to win, Company B had to prove what the terms of the contract were, that they had fulfilled their obligations under the contract and as a result they should be paid. They simply couldn’t do this and as a result, their claim failed.
So, if you use purchase orders as part of your ordering process, how do you ensure they’re legally binding?
First, you have to remember that using a purchase order isn’t compulsory. The most important thing is to have a legally binding contract and there are five essential elements of this:
- One party must make an offer to the other;
- The other party must then accept the offer;
- There must be some form of consideration i.e., payment;
- The parties must intend to be legally bound by the contract; and
- There must be sufficient certainty within the terms of the contract.
As long as these elements are all present, it doesn’t matter if the contract is made verbally or in writing. However, unless it is a very simple arrangement it’s always a good idea to have a written agreement or use standard terms and conditions of business.
When used properly, a purchase order can help ensure all of these elements are present.
When a purchase order is issued, it is a formal offer from the purchaser to purchase specific products or services on specific terms. It will therefore usually accompany the purchaser’s standard terms and condition of business and will contain the following information:
- A unique purchase order (PO) number;
- The names and addresses of the purchaser and vendor;
- A clear description of the products or services being purchased;
- The price of the products or services, any delivery fees and VAT if applicable;
- The delivery date or commencement date of the services; and
- The payment terms (if they’re not already specified in the terms and conditions).
The vendor can then formally accept the purchase order and a legally binding contract is formed.
Looking back at my dispute, you will see there was another problem with Company A’s purchase order. There wasn’t sufficient certainty within it to be a formal offer which Company B could accept.
Another mistake I often see with purchase orders is that they’re confused with invoices. A purchase order is not an invoice. As explained above, the purchase order is a formal offer to enter into a contract. An invoice is a request for payment.
A purchase order will therefore always precede an invoice, but they may contain very similar information. A purchaser may even require the vendor to quote the purchase order number on their invoice before making payment.
Read back over some of David’s most popular legal articles:
- Does a handshake form a legally binding contract?
- Are statements made during contract negotiations legally binding?
- Standard terms and conditions: Why they’re the unsung saviours of your business
If you’re the vendor and you don’t quote the purchase order number on your invoice, it could delay payment.
To finish up, I’m sometimes asked by clients whether they should use purchase orders as part of their ordering system.
This is a question I can’t answer as it’s a personal choice. All I can do is offer this advice.
Purchase orders can be useful from an administrative perspective. When each contract has its own unique PO number, it can make record keeping much easier.
However, if you’re going to use purchase orders you must use them correctly and ensure they form part of a legally binding contract.
Remember, when you issue a purchase order you’re making a formal offer to the vendor. Your offer must contain all the terms of the contract and sufficient information regarding the products or services for the vendor to be able to accept it.
This means the purchase order will likely accompany your standard terms of business. If these aren’t acceptable to the vendor, and the vendor insists on doing business on their terms (which is the case for many small businesses), the vendor will be making the offer. You will then have to accept their offer so there is no point issuing a purchase order.
If you have any questions about purchase orders or contractual disputes please feel free to email me at email@example.com and I’ll happily answer them for you.
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