The role of a contract is to set out the roles, rights and obligations of parties in a transaction or relationship. A contract may be a useful tool in risk management if the six stages of contract management are understood. These stages include contract drafting, contract negotiation, contract approval, contract storage and repository, contract compliance and administration, contract renewals and optimisation. Poor management of contracts can result in poor planning and ill- informed buying, inappropriate pricing structure, deliberate contract manipulation, miscommunication, revenue leakages and cost overruns, scope creep and quality failures, loss of competitive advantage, loss of intellectual property, personal and brand reputation.
Increased contract risks due to:
• Increased trend to outsource non-core activities
• Companies licensing copy rights, trade marks and other intellectual property
• The evolving geopolitical, regulatory, operational environment due to globalisation
• Growing number of business affiliations due to joint ventures, partnerships and franchise
• The ever increasing speed of chance that compromises compliance A contract should have the following clauses:
• Parties to the contract are legal entities and the correct legal names (or defined abbreviated terms) are utilized throughout the contract
• Performance measures and reporting requirements are set
• Insurance requirements are specified
• limitations of liability are identified and defined given the context of the contract
• Confidentiality issues are addressed and contractor is obligated
• Termination provisions are specified and reasonable
• Dispute resolution processes are identified
Organisations should develop and implement policies that address broad risk issues related to all contracts including:
• Requirement that all contracts must be written
• Designated authority levels to negotiate and sign contracts (generally, the greater the amount and potential exposure, the greater the level of authority required)
• Requirement that all contracts be reviewed for risk management considerations prior to acceptance
• Requirement that any indemnities granted are approved
• Designated central storage areas, including who can access stored contracts and procedures to obtain copies;
• Requirement that current listings of all contracts be maintained;
• Schedule defining how frequently contracts should be reviewed for both performance and risk management issues;
• Archiving procedures for expired contracts, including how long they will be retained.
i. Contract performance
Contract terms are statements by the parties to the contract as to what they understand their rights and obligations to be under the contract. They define the content of the ‘offer’ (or counter offer) which becomes binding once accepted by the other party. There are a number of important distinctions in regard to types of contract terms.
Express term is a term that is directly acknowledged and stated by both parties. They consist of the direct promises made by either party to the other, and they are binding. Implied terms can also arise from statute, customs from business interaction or by the courts for example, it is implied that the goods supplied should conform to the description or sample. Similarly, it is implied that goods supplied should be of satisfactory quality and fit for purpose.
A number of express terms may be inserted to define key aspects of contract performance, in regard to quality, payment and time.
Testing inspection and acceptance clauses
There should be a clear acceptance procedure where the contract involves the supply of goods and services. The contract should envision and explain what will count as “acceptance” of the goods or services, and accordingly what will count as satisfactory “delivery” of goods and services. Inspection and testing clauses may be used to stipulate:
• That the buyer is not legally bound to accept delivery of goods (which may imply the transfer of possession, title and risk) before inspection and/or testing of the goods to ascertain that they conform to specification and are fit for purpose
• That the buyer is to be allowed a reasonable time to inspect and test incoming goods. A related acceptance clause may stipulate the right of the buyer to reject goods for various reasons, such as quality defects or lateness of delivery (i.e. stating that ‘time is of the essence’ of the contract).
A range of clauses may be used to support performance management, especially in outsource contracts, to ensure supplier performance of specific KPIs and critical success factors. Here are some examples.
• A rights of inspection clause, giving the outsourcer rights of access to inspect the supplier’s premises, processes or performance to monitor compliance
• A schedule performance clause, making it a condition of contract that certain tasks (e.g. systems maintenance or data back-up in an IT
outsource contract) be performed according to a defined schedule, or within defined timescales or response times
• Penalties for specific non-performance (e.g. liquidated damages), and incentives for performance or improvements (gain sharing arrangements, bonus payments).
Payment
The contract must specify the amount (or a method for calculating an amount) and timing of payments. Clauses relating to payment may involve incentives for a party to comply with its obligations in the form of increased rates or agreed one-off payments, rights to withhold payment where obligations have not been fully complied with, or provisions that payments be made in segments subject to specified conditions being met. This way a party can match its obligations to pay for goods or services with the actual provision of those goods or services so that it does not bear the risk of having paid, or being required to pay, for goods and services which are not provided, or which do not meet standards or specifications agreed between the parties. Payment mechanisms will often be expressed to coincide with a milestone date or a milestone event.
Some common types of payment arrangements are:
• Fixed price: A fixed amount for the entire contract. This is typically for straightforward contracts for goods or services.
• Variable price: The price is calculated on the basis of a formula. This is suitable for use in longer-term contracts or where the contract costs are likely to vary due to factors beyond the contractor’s control. The most common example is for a first year price to be stated in the contract, which will then be increased by a fixed rate (such as a consumer price index or other indicator) for future years.
• Variable quantity: Allows for a maximum contract price to be agreed with such factors as labour rates, overheads and quantities also being agreed by the parties (e.g. Ksh.1200 per hour, up to Ksh. 1,000,000). This payment regime is generally used where the level of labour effort required under the contract cannot be estimated with certainty.
• Incentive payments: These are extra payments which are generally tied to achievement of performance measures. These can be useful to encourage the contractor to achieve desired outcomes within a nominated time. Common timing arrangements for payments are:
• Full payment upon completion: Payment upon successful delivery of all contract deliverables. This is suitable for straightforward contracts for goods or services.
• Progress payments: These are periodic payments, usually tied to time (e.g. monthly).
• Milestone payments: These are progress payments based on certain events or deliverables being achieved. This is a useful mechanism for ensuring that contracts are planned, progressed and delivered or performed on track
Time of performance
Express stipulations as to time of performance (such as dates of shipment, transfer or delivery) are normally treated as conditions in commercial contracts and other contracts where time lapse could materially affect the value of the goods.
Such time stipulations are generally treated as part of the essential description of the goods, and are governed by implied terms in relation to sale by description of the Sale of Goods Act. However, it is common to note expressly that ‘time is of the essence of the contract’, so that the buyer can insist upon the delivery date specified in the contract. In such cases, if there is a delay in performance, the injured party may treat it as breach of condition and pay nothing (and also refuse to accept late performance if offered).
Subcontracting and assignment
Since buyers have a key interest in assuring the quality of the goods Produce A or the so services performed, by suppliers, they will generally not want the supplier to hand over the contract to a third party least without the opportunity to pre-qualify and approve the subcontractor. The original supplier will remain liable for any failures on the part of the third party, but the risk may still be unacceptable to the buyer.
The general rule is that a contract can be assigned or subcontracted unless it is evident in all the circumstances that a supplier was specifically chosen for its unique qualities (and it would therefore not fulfill the buyer’s intentions to have the work done by another party).
A subcontracting and assignment clause may be used to prevent any assignment or subcontracting without prior written consent. A typical clause might be as follows.
‘The supplier shall not assign or transfer the whole or any part of this contract, or subcontract the production or supply of any goods to be supplied under this contract, without the prior written consent of the buyer.
Liquidated damages
Liquidated damages are fixed damages agreed upon by parties to a contract which apply if a specified event occurs. The fixed damages agreed to must be a genuine pre-estimate of the loss likely to be suffered as a consequence of that event occurring, or a lesser sum – in other words, liquidated damages cannot be used as an “inflation” mechanism. If a liquidated damages clause applies in relation to a breach by a party of a provision of an agreement, the compensation to be paid to the party that suffers of that breach is a fixed sum or a sum determined in accordance with a fixed formula, rather than a sum determined in accordance with the normal rules of contract. This provides some certainty since the party who is responsible for performing a particular obligation knows exactly what amount will be payable as damages if it fails to meet its obligations; the recipient of the liquidated damages knows exactly how much it will recover if the specified event occurs
Force majeure clauses
The general rule is that, unless otherwise agreed, a party which fails to perform its contractual obligations is in breach of contract and liable for damages – whatever the excuse for non-performance. The legal doctrine of ‘frustration’ was designed to reduce the severity of the general rule, by allowing for genuinely good excuses for non-performance.
The purpose of majeure (major force) clauses is to release the parties from liability in circumstances where their failure to perform a contract results from circumstances which were unforeseeable, for which they are not responsible, and which they could not have avoided or overcome. Examples of such circumstances include ‘act of God’; flood, earthquake, fire, storm and other natural physical disasters; war, revolution, riot or civil disorder; general industrial disputes (not limited to the employees of the supplier or its subcontractors); and so on. Such circumstances do not automatically frustrate or end a contract, but may cause late delivery or non-delivery for which liability needs to be waived.
A force majeure clause should:
• State the events that will constitute force majeure, as relevant to the industry or market
• Oblige either party to notify the other if force majeure events have occurred which may materially affect the performance of the contract
• State that a party will not he considered in default of its contract obligations, as long as it can show that full performance was prevented by force majeure events
• Provide for the contract to be suspended for up to 30 days, if performance is prevented by force majeure for this period
• Provide for the termination of the contract, by mutual consent, if the force majeure event continues to prevent performance for more than 30 days (with provisions for transfer of work done so far, in return for reasonable payment).
A very simple clause might he as follows.
‘Neither party shall be regarded as being in breach of its obligations if it can show that it was prevented from performance by any circumstances of force majeure which arose after the date of the contract. Such circumstance may include, but is not limited to, war and other hostilities; terrorist activity, revolution, riot; earthquake, flood or other natural disaster, and industrial disputes (not limited to the employees of the parries or their subcontractors).’
Warranty Clauses
Warranty clauses govern the rights and obligations of the contractor and the acquiring entity in relation to defective goods and services. They serve to promote a minimum standard of performance. A warranty clause allows one party to vouch or promise to the other that a certain thing or fact will remain true (for instance, that some item will remain in working order). Warranties are usually accompanied by a requirement for the person giving the warranty to compensate the party relying on the warranty, if the warranted “fact” turns out to be incorrect.
Insurance
Insurance is a means of protection from financial loss. It is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. An entity which provides insurance is known as an insurer, insurance company, or insurance carrier. A buyer will usually wish to confirm that the supplier has the ability to pay compensation in the event of any indemnities or legal claims arising against it, and will usually make it a requirement of the contract that the supplier has the necessary insurances to cover them.
A comprehensive indemnity and insurance clause might .be as follows. ‘Without prejudice to any other rights or remedies available to the Buyer, the Supplier shall indemnify the Buyer against all loss of or damage to any Buyer property to the extent. Arising as a result of-the negligent or willful acts or omissions of the Supplier or Contract Personnel in relation to the performance of the Contract; and all claims and proceedings, damages, costs and expenses arising or incurred in respect of:
(a) Death or personal injury of any Contract Personnel in relation to the performance of the Contract, except to the extent caused by the buyer’s negligence;
(b) Death or personal injury of any other person to the extent arising as a result of the negligence or willful acts or omissions of the Supplier or Contract Personnel in relation to the performance of the contract;
(c) loss of or damage to any property to the extent arising as a result of the negligence or willful acts or omissions of the Supplier or Contract Personnel in relation to the performance of the Contract.
‘The Supplier shall at its own expense effect and maintain for the Contract Period such insurances as required by any applicable low and as appropriate in respect of its obligations tinder this Contract. Such insurances shall include third party liability insurance with an indemnity of not less than (KSh. 2m) for each at every claim.
Intellectual property protection
Intellectual property rights are legal rights over certain intellectual creations. Such rights may be protected by legislation (e.g. copyright, patents, registered designs, trademarks), or may be protected under case law or common law (e.g. trade secrets, unregistered trademarks, confidential information).
Where it is likely that the activities under the contract will give rise to the development of intellectual property by either the procuring entity or the other party to the contract, the position of ownership and access to those intellectual property rights – as well as future use must be considered.
Example
All Intellectual Property Rights developed by, the Contractor and used in the performance of the Contract which do not vest in the Client shall be vested in the Contractor. The Contractor hereby grants to the Client a royalty free, worldwide, non-exclusive license to use the same.
Copyright in all documentation and Intellectual Property Rights in all other items supplied by the Client to the Contractor in connection with the Contact shall remain the property of the
Client to the extent that they are in the ownership of the Client.
The Client hereby grants the Contractor a non-exclusive, non-transferable license to use the entire Intellectual Property Rights owned (or capable of being so licensed) by the Client required by the Contractor or any of its employees, subcontractors or agents to provide the Services. Any such license is granted for the At-at-ion of the Contract solely to enable the Contractor to comply with the obligations of this Contract.
The Contractor shall reimburse the Client’s reasonable costs incurred in complying with tire provisions of this Clause.
Confidentiality clauses
Confidentiality clauses are designed to protect either party, in cases where they need to give the other party access to information about their operations, in the course of the contract. There are several types of confidentiality clauses, which vary based on what is being kept confidential – information brought out in performing the contract, information created in the course of the contract’s performance, or the terms of the contract themselves. Failure to comply with that confidentiality could lead to legal action for breach of contract and breach of confidence – and if the information was commercially sensitive or valuable, then significant damages could result.
ii. International sourcing
International sourcing is the practice of sourcing from the global market for goods and services across geopolitical boundaries international sourcing often aims to exploit global efficiencies in the delivery of a product or service these. International sourcing and trading imposes a distinct set of risks for businesses. Depending on the particular circumstances, they may include any of the following socio-cultural differences, language barriers, legal issues, logistical and supply risks, technical risk, increased security risks, exchange rate risk, payment risk, difficulties of monitoring and assuring quality, general STEEPLE factor risks in the overseas environment: political instability; nationalisation of businesses by regimes; economic instability; inflationary climates; protectionist policies (tariffs, quota etc.); poor technological infrastructure; poor education infrastructure and skilling; and so on Price and cost risks
The management of such risks will generally focus on measures such as the following.
• Proactive demand forecasting and procurement planning, taking into account realistic lead times for international supply.
• Proactive transport planning, in order to maximise the security and efficiency of deliveries, customs clearances and so on
• Rigorous risk identification, monitoring and assessment, including the regular updating of supply risk registers
• Contingency planning: developing action plans and mitigating measures for unlikely but foreseeable risk events (including, where appropriate, developing alternative local ‘back-up’ Sources of supply)
• The purchase of appropriate insurances to cover likely and/or high-impact contingencies, and the use of incoterms to establish buyer and supplier responsibilities for insurances, and liability for risk events during storage, transport and handling
• Collaborating with suppliers to minimise identified risks — and/or to help with disaster recovery and supply continuity (e.g. Toyota supporting its supply network in rebuilding after an earthquake or tsunami)
• Using third party service providers (e.g. agents, freight forwarders or logistics providers), in order to access international expertise and local offices — and share or transfer responsibility for risks
• The use of incoterms to minimise contract ambiguities; establish liability for risk, cost and insurance at all stages of transit; and establish the points at which risk passes from the seller to the buyer.
• The use of local agents or consultants, or translation and interpretation services, in negotiating and developing contracts and agreements.
• Some risks can be managed operationally: through supplier monitoring; the inclusion of grievance mechanisms in contracts and relationship management planning; insurances; the use of incoterms; and so on. art a more strategic level, sourcing professionals will need to establish policy guidelines (e.g. on ethics aid risk management) and implement ongoing environmental monitoring and research. They will also need to make key strategic decisions about the configuration of the supply network: e.g. using agents, freight forwarders, logistics lead providers, strategic alliances or local strategic business units (or divisions) to help manage international supply chain relationships.
iii. Use of model form contracts-
Model form contracts are published by third party experts (such as trade associations and professional bodies), incorporating standard practice in
contracting for specific purposes within specific industries, and ensuring a fair balance of contractual rights and responsibilities for buyer and seller.
They are often used in particular-industries to establish conditions of contract between buyer and seller which become an acceptable and familiar commercial and legal basis upon which business is usually conducted. Model form contracts can usually be adapted to suit particular circumstances and relationships.
The NEC (New Engineering Contract): The Institute of Civil Engineers has produced a model form contract, standardising terms used across the construction industry. The New Engineering Contract (NEC) is intended for use for civil, engineering, building and electrical or mechanical works. It was originally developed in the early 1990s with the aim of introducing a non- adversarial contract strategy which would enhance the smooth management of projects.
The FIDIC (International Federation of Consulting Engineers) Contract: The International Federation of Consulting Engineers (Federation International Des Ingenieurs-Conseils – FIDIC) represents the global engineering industry. It has developed a range of model form contracts for use by the construction industry worldwide, including:
• The Construction Contract (contract for construction for building and engineering works designed by the employer) or fled Rook
• The Plant & Design-Build Contract (contract for electrical and mechanical plant and for building and engineering works designed by the contractor) or Yellow Book
• The Short Form of Contract, or Green Book
• The Design/-Build-Operate (ORO) Contract
• Forms of agreement for the engagement of consultants: The Client/Consultant Model Services. Agreement (or White Book); Sub- Consultancy Agreement; and Joint Venture Agreement. .
The FIDIC contracts include clauses on risk, responsibility, liability, indemnity, insurance and force majeure