Contracting Excellence Journal

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Without a doubt, contracts are the most important risk avoidance management and mitigation tools organizations sign. Ironically, many top executives know little about contracts and how they work to support the organization’s goals. Instead, many choose to delegate the responsibility for identifying and managing those risks to others often with few, if any, questions asked.

Realistically, when we manage the contracting process, most of us will not have immediate and unlimited access to outstanding legal counsel. So, it’s critical to realize that the only safe path to avoiding major risks throughout the contracting process is to detect hidden surprises before they appear.  Which means the inability of CFOs to ask the right questions can have serious consequences for the supply chain contracts they are expected to comment on or approve. As Peter F. Drucker has noted:

“The most serious mistakes are not being made as a result of wrong answers. The true dangerous thing is asking the wrong question.” 

So, let’s look at three common scenarios where the “right questions” too often do not get asked. The specific focus is on warranty rights, extra compensation demands (claims) and delivery delays. 

Scenario 1 – how to get full warranty rights as stated in the contract

The problem

Warranty rights are valuable but can be lost if not fully understood. To get the greatest benefit from your commercial transactions, you must have a well-defined method to determine whether warranty rights exist and calculate the extent of those rights.

Do we have a claim?   Let’s say you are the procurement manager, buyer or supply chain manager and you discover that system, component or service you purchased is defective, or does not work properly or shipment was delayed.  Your first question should be, do we have a claim against the supplier? 

The solution – don’t step into the quicksand!

You must avoid hidden traps when making or dealing with warranties. When crafting or asserting warranties, ask yourself the right questions and in the right order to stay on track. When dealing with warranties or warranty claims, key questions would include:

  1. What is the warranty’s scope?
  2. When does the warranty expire?
  3. Was there a breach of warranty?
  4. Was notice provided as required?
  5. When must the remedy take place or be done?
  6. What remedy applies to repaired or re-performed work?
  7. How will the remedy affect cost, schedule or other work?
  8. What is the value of the warranty work to be performed?
  9. Were all important discussions and decisions documented?
  10. Were subject-matter experts and management kept apprised?
  11. Does the contract permit “self-help” as a remedy, and if so when?
  12. Have we done (or did we) do everything necessary to preserve our remedies?

These questions are powerful because they force you to follow a defined path that addresses your issue in a predictable and process-focused manner.

Scenario two – how to deal with extra, unexpected compensation claimed in the contract’s scope of work

The Problem

Let’s say you are a supply chain manager and are asked to analyze some serious claims arising out of a contract that your organization recently negotiated. Although a well-crafted scope of work or scope of supply will reduce claims for additional compensation, claims for “extras” are inevitable. You need to know how to evaluate claims in a disciplined and methodical manner.

The Solution - establish specific rules (protocols) for dealing with new demands

A good risk manager has clear protocols for dealing with changes. Moreover, not all changes constitute “extra work” justifying extra charges. The key to success is to have a well-defined method for dealing with such challenges.  

Again, it’s essential to ask the right questions, including:

  1. Was “extra” work performed?
  2. Was “extra” work authorized?
  3. Was notice provided as required?
  4. Are the charges properly documented?
  5. Will the “extra” work affect the schedule?
  6. Was the “extra” work due to error or inefficiency?
  7. Are the “extra” charges consistent with the contract?
  8. Are certain of the charges barred by the contract terms?
  9. Were all important discussions and decisions documented?
  10. Were subject-matter experts and management kept apprised?
  11. Is the organization at risk for apparent authority claims or liability?
  12. Have we done everything necessary to preserve our remedies?

These questions may seem like common sense, but as an old saying goes: Common sense is not so common.

Scenario three is about delayed delivery

The Problem:

Even if your contracts contain a well-defined delivery schedule for performing the work or supplying the goods, expect delays. In addition, contractors or suppliers may file delay claims against your organization based on real or alleged delays or interference. How you deal with those claims as an organization can affect the bottom line.

 Let’s assume you are a vice president of procurement at a large organization, and in charge of global procurements and supply chain management. Supply chain disruptions are a risk that every executive is expected to manage. You discover that delay claims are being filed against the organization. You first need to know how these types of claims are being handled by employees that report to you and whether or not they are well trained to deal with delay claims.

The Solution - only you will protect your interests

Not all claims for delays are compensable. Knowing how to evaluate the validity of delay claims is crucial. To be successful in business, you need to know how to evaluate such claims and protect your interests. This includes asking the right questions in correct timing. 

Such questions might include: 

  1. Did a delay occur?
  2. What or who caused the delay?
  3. How does the contract allocate risk of delay?
  4. Were the notice requirements complied with?
  5. Has supporting documentation been provided?
  6. Could the delay have been avoided or mitigated?
  7. Are the alleged damages correctly calculated?
  8. Are the alleged damages barred by the contract?
  9. Were subject-matter experts and management kept apprised?
  10. Were all important discussions and decisions documented?
  11. Is the organization at risk for apparent authority or claims/liability?
  12. Have we done everything necessary to preserve our remedies?

Bear in mind that the issue of who is accountable for delays is essentially a question of risk allocation. The perennial question is always: Who should bear what risks? This has nothing to do with who has the most money or deeper pocket. As a broad proposition, the person who is best able to manage the risk should be the one to be handling the risk and absorbing the consequences should such risk occur.

Embrace the contract, make sure it’s clear!

The whole purpose of a contract is to create certainty and predictability by clearly articulating the parties’ respective rights, roles and responsibilities. Each party assumes certain risks and liabilities according to its ability to bear these risks and its tolerance for those risks.

But too often, we imperfect managers get in our own way!  That’s why the perfect contract is not yet written and likely never will be.   We are imperfect creatures; everything we do, contractually or otherwise, is by extension, imperfect. There are always two sides to every contract (coin), but we try to make the “pancake” as “flat” as possible in the interests of clarity. Any language around including “code” is likewise imperfect. Of course, we never abandon our campaign against ambiguity: the hobgoblin of all contracts. 

Finally, within it all, we are tasked to strive for the best clarity possible and leave no stones unturned in our warranties, scope statements, and delivery scheduling.  If we ever connect with intelligent alien life, maybe you’ll want to be on the team negotiating the first interstellar contract. No doubt our alien visitors will have soldiers, bankers and lawyers eager to negotiate. In the meantime, practice on earth!

ABOUT THE AUTHOR

X. Paul Humbert is President of The Humbert Group, LLC, and provides consulting services regarding process improvement and transactional matters. He is a lecturer at Rutgers Graduate School of Business, where he teaches contract management to supply chain MBA candidates. Paul is a frequent public speaker and has authored several books for use in contract development and implementation, project management and process improvement endeavors. They include: 

Playbook for Managing Supply Chain Transactions with Desktop Tools, References and Sample Forms: Explains a well-defined methodology for entering into and managing supply chain transactions. 

Contract and Risk Management for Supply Chain Management Professionals: Addresses how to enter into and manage contracts to maximum advantage while controlling and minimizing commercial and execution risks. This book is being used by three universities as a course text. 

Model Contract Terms and Conditions with Annotations and Case Summaries: Provides model contract language with annotated explanations and suggestions, together with summaries of actual litigated cases.

What CFOs (And Future CFOs) Need to Know About Supply Chain Transactions and How Their Risks Should be Managed: Provides CFOs and future CFOs all they need to know about the challenges and risks of supply chain transactions and how they can best be managed.

How to Analyze and Negotiate Warranties for Goods and Services: A Primer for Lawyers and Non-Lawyers Alike: Learn how to analyze, structure, negotiate and manage warranties, while avoiding the pitfalls. This book has been widely acclaimed by both academics and practitioners.

Topics: contract /commercial management, risk management, contract management

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