Bryce Giddens and Teresa L. Johnson

Imagine you’re bidding for the exclusive solid waste collection franchise in the city of Springfield. The request for proposal allows bidders to take exceptions to the city’s form franchise agreement included as part of the bid package. You know that the fewer exceptions you take, the more favorably the city will evaluate your proposal. To maximize your chances, you decide not to take any exceptions, even though some of the contract language could be problematic. The city awards your firm the contract, and you sign it as written.

Fast forward a few years. The landfill that accepts Springfield’s garbage increases its tip fee. Tip fees are listed as a pass-through cost under the contract, so you apply for a rate adjustment. Without it, the increase in disposal costs will go right to your bottom line, eroding your already-low margin and threatening to push the waste collection contract into the red.

The city council rejects your request. This comes as a surprise — aren’t disposal costs supposed to be a pass-through? City staff point you to a sentence in the waste collection contract that reads, “All rate increases are subject to the approval of the city council in its sole and absolute discretion.” Your attorney confirms that the language means what it says: although the contract allows the hauler to apply for a rate adjustment if disposal fees increase, it doesn’t obligate the city to actually grant it. You scratch your head and wonder, “How did that get in there?”

The above example illustrates a common dilemma faced by haulers when bidding on or negotiating agreements for the collection of solid waste, recyclables and organics with cities, counties, joint powers authorities or other public entities. On the one hand, even if the contract is not competitively bid, the hauler has a short-term interest in accepting the public entity’s contract with a minimum of comments. The desire to win the bid, minimize transaction costs and appear responsive to the entity’s needs, combined with the entity’s often superior bargaining position, all incline haulers to accept the contract as written.

On the other hand, the contractor’s longer-term interests may be better served by pushing back on the contract provisions that present the most risk. As the above example shows, the provisions defining the scope of services and the amount of compensation aren’t the only ones with financial consequences for the hauler. By not negotiating the contract effectively, the contractor runs the risk that hidden costs will render the contract less lucrative than expected, or even unprofitable. At the same time, contract terms that are ambiguous or don’t reflect the parties’ intent are recipes for future disagreement, which can damage the parties’ relationship and be costly to handle.

Striking a balance between these competing short-term and long-term interests is key to successfully managing the contracting process. This article examines several key provisions commonly found in solid waste franchise agreements and the pitfalls haulers may face by not addressing them at the time the contract is made.

Rate Adjustments

Most businesspeople wouldn’t dream of signing a contract that doesn’t assure them the right to get paid for the services they perform. But such provisions aren’t uncommon in solid waste agreements. The reason is that solid waste haulers operate in a highly regulated environment. Typically, the rates that contractors can charge a city’s residents and businesses for collection services are established (or are subject to caps that are established) by the city council. The contract sets forth the methodology for adjusting rates over time and in response to specified events such as changes in law, but the adjustments must be approved by the city council before they take effect.

However, if the contract states that the adjustment is subject to the discretion of the city council, then the city council is not contractually required to approve it, even if the adjustment is of the type called for by the contract and has been correctly calculated. Some contracts even are more explicit, expressly stating that the city council may reject an otherwise permissible rate application.

Such provisions can have serious implications for the hauler. Instead of a contractual entitlement to a rate increase, the hauler is at the mercy of the city council, which may have little sympathy for the hauler’s complaints that failure to approve a rate increase will cost it money. For these reasons, the contract should clearly express the hauler’s contractual entitlement to a rate adjustment if certain triggering events occur. The hauler may be required to make a reasonable evidentiary showing to qualify for the rate adjustment — for example, confirming the occurrence of the triggering event and demonstrating its effect on the hauler’s costs — but once that showing is made, the city’s role should be ministerial.

Exclusivity

A critical part of any franchise agreement is the section defining the scope of the hauler’s exclusive right to collect solid waste. This provision is vital to the hauler’s business because it defines the hauler’s ability to exclude competitors from the service area. Ideally, this provision will clearly define each materials type (solid waste, recyclables, organics, etc.), specify whether the hauler has the exclusive or non-exclusive right to collect such materials, and carefully circumscribe the exceptions to the contractor’s exclusivity (such as self-hauling, or charitable donation of source-separated recyclables).

Unfortunately, exclusivity provisions frequently fall short of these standards. Part of the problem is historical. Many city ordinances have not been updated to reflect developments in the waste industry, such as the segmented nature of the marketplace, with different types of haulers operating in different niches, or advances in diversion programs and technology, as a result of which materials formerly designated as “refuse” or “garbage” may now be classified as “recyclables” or “compostables.”

Language from such ordinances frequently carries over to the franchise agreement, raising interpretive issues. Is source-separated food waste that is destined for composting a “recyclable,” and therefore exempt from the hauler’s exclusive right to collect “refuse”? Does the hauler’s exclusivity include collection of construction and demolition debris from debris boxes, which contain a mixed waste stream of recyclable and non-recyclable materials? Lack of clear answers to these questions undermines the protection afforded by exclusivity.

Even if the underlying ordinance cannot be changed, it is essential to ensure that the exclusivity provision in the franchise agreement is clearly drafted and protects the hauler’s interests. Otherwise, competitors may have an opportunity to enter the market, forcing the hauler to spend time and incur legal fees to protect its rights.

Liquidated Damages

Liquidated damages provisions require the hauler to pay the city certain amounts for specified breaches of the franchise agreement, such as missed collections, late submission of reports, collecting outside authorized hours, failure to respond quickly to customer calls, etc. By monetizing the contractor’s failure to perform, such provisions hold the hauler’s feet to the fire and ensure that it doesn’t cut corners in performing its core obligations under the franchise agreement.

Since liquidated damages provisions directly affect the bottom line, the hauler will want them to be clearly drafted, so there’s no room for doubt whether the contractor is required to pay or not. Where appropriate, the contractor also will want to receive prior notice and an opportunity to address the situation before liquidated damages are imposed. The likelihood that the hauler will be found in violation is much greater if liquidated damages are assessed for “failure to clean up spills,” rather than “failure to clean up spills within one business day after notice of the spill by the city or a customer.”

A key aspect of such provisions is the city’s ability to retroactively charge the hauler for violations. While some retroactivity is necessary — by definition liquidated damages can only be assessed on past events — the city should have an obligation to bring the violation to the hauler’s attention reasonably promptly after becoming aware of it. Doing so allows the hauler to address the problem on a timely basis, and avoids a situation where the city suddenly decides to assess damages for a violation that’s been ongoing for years. This goal can be accomplished by making liquidated damages subject to a lookback provision, whereby the city only can assess liquidated damages within a certain period of time after they occur, or after the city becomes aware of them. After all, the purpose of liquidated damages provisions is to incentivize the contractor’s good performance, not to provide a windfall to the city’s general fund.

Indemnification

The franchise agreement will inevitably require the hauler to indemnify the city — that is, to defend the city against the legal consequences of the hauler’s actions, and to compensate the city for any losses it sustains as a result. For example, if the hauler negligently injures a pedestrian, and the pedestrian sues the city on the theory that the hauler is the city’s agent, the indemnity clause will require the hauler to defend the suit and be responsible for any damages. This seems fair, since the city would not have been exposed to the lawsuit were it not for the hauler’s negligence.

The difficulty is that many indemnities are overly broad. In a typical formulation, the hauler indemnifies the city for all liabilities “arising out of or relating to the hauler’s performance of or failure to perform its obligations under this agreement.” While affording maximum protection to the city, such an indemnity is problematic for the hauler because it isn’t limited to harms that are the hauler’s fault. All the city needs to do to make out a colorable indemnity claim is to assert a relationship — however tenuous — between the contractor’s performance or non-performance, and a harm suffered by the city. For example, if a suit is filed challenging the process by which the city awarded the contract to the hauler, the city could claim that the suit “relates to” the hauler’s performance and is therefore indemnifiable — even though the suit has nothing to do with the hauler’s actions.

A more balanced indemnity would ensure that the hauler remains responsible for the consequences of its own conduct, but nothing more. For example, the hauler could indemnify the city for liabilities caused by the hauler’s negligence, willful misconduct, violation of law or breach of the franchise agreement. Such a provision fully protects the city from the consequences of the hauler’s actions, but also protects the hauler from indemnity demands that have no connection to its activities.

Conclusion

Solid waste haulers devote considerable time and energy to developing business models and operating plans and to ensuring that the business deals they’re entering into pencil out. Haulers would be well advised to make equally sure that the terms of that deal are reflected in the contract that is signed, without any uncompensated, hidden costs.

Bryce R. Giddens is an associate of and Teresa L. Johnson is a director of Howard Rice Nemerovski Canady Falk & Rabkin, PC, a San Francisco law firm. They frequently represent solid waste, recyclables and organics haulers in negotiating franchise agreements with public entities, as well as in other transactions such as acquisitions, bank and bond financings, and other commercial agreements.

RELATED STORIES:

• Contract Intact: Crafting a Service Agreement that Will Protect Your Firm

• Crafting Waste Contracts

Sidebar: Want to Know More about Effectively Negotiating Collection Contracts?

Bryce R. Giddens and Teresa L. Johnson will be speaking at the “Traps for Unwary Collectors When Contracting with Public Entities” WasteExpo conference session. The session will take place from 1:45 p.m. to 3 p.m. on Tuesday, May 10, and is part of the Municipal Collection Track.

For complete information on the 2011 WasteExpo conference program and other show events, visit www.WasteExpo.com.