Contract management is the process of managing contract creation, execution, and analysis to maximize operational and financial performance at an organisation, all while reducing financial risk. Organisations encounter an ever-increasing amount of pressure to reduce costs and improve company performance.
Introduction to Contract Management
The installation of complex distributed systems that use packaged software, client services and other new vendors place new pressures on the service delivery function and service support functions. Business emphasis is changing from the development of systems to their delivery and support. Meeting service agreements and external contractual requirements are vital.
To manage this emphasis change, you must understand how to use Service Procurement, Contract and Service Management best practices, procedures, methods and techniques. Especially those that relate to contract management. Clearly these are key for the consultant to watch.
With such insight you will be able to help improve the effectiveness and efficiency of your organisation products and services, thus enhancing the quality of advice and other Assignment deliverable’s you give your clients.
Whilst there are many aspects to contract management, this section just highlights the issues of performance monitoring, contractual issues and contract management for service support and delivery.
Contracting for Services
Buying packages, products or other outsourced services (such as IT/IS, Finance, credit risk, accounting, production etc) will result in a more formal relationship between the customers and the service providers. If you deal with an external supplier who provides goods or services, then you will need to negotiate and implement a contract.
The contract should define:
- the legal responsibilities
- the specification of the services to be provided
- the standards required from the services and the means by which performance is measured.
Individual contracts will vary according to the types of services being procured and the arrangements for their supply. Contracts for the provision of operational services such as running a service desk or data centre require different performance measures and charging methods from those required for developing new systems or a complete outsource of your accounting department.
Always negotiate terms; don’t work to suppliers’ standard contracts.
Contract Definition
A Contract is an agreement that binds the parties.
Firstly the “agreement”: An agreement is not always interpreted as signifying that the two parties have formally declared that they are of a common mind on the relevant issues. In some cases behaving in such a way as to appear to assent, is taken by the courts to be evidence of the agreement.
Typical examples of where – without formally signing or stating agreement – the parties could be assumed to agree include such things as requesting connection to gas/electricity/telephone services. In such situations agreement to
terms of supply might be assumed.
Limitations
Sometimes the law may limit the terms of an agreement. For instance, prior to 1979, the Sales of Goods Act allowed for the specific exclusion of statutory terms in a contract, but the Sales of Goods Act 1979 changed that position. If the contract you are involved with incorporates issues covered by specific legislation, you should always check the current position.
Note also that a contract is never valid if it contravenes the law of the land. It is important therefore that those drawing up a contract are aware not just of specific laws, but common law and equity (i.e. the whole body of legal rules in this country). The Supplier Manager must be able to critically evaluate a proposed contract and will therefore be aware of these issues.
Secondly “binds the parties”.
This is often taken to mean “enforceable at law” and whilst that is true it is not always a practical definition.
The problem arises when you ask yourself if a court would really make an order compelling the other party to perform their part of the contract. It is often more usual for a court to make an order to pay damages arising from non-performance.
The important thing with a contract it is that places a legal obligation on both parties. If this obligation does not exist then the agreement is not a contract.
Offer and Acceptance
Be clear as to the point at which a contract is made.
An offer intimates a willingness to be bound by the proposition: acceptance of it creates the contract. An ITT for instance is not an offer. If it were then the first company to tender could get the contact. An ITT is an invitation to treat-
in layman terms “make me an offer”.
Contract Types
Having decided that an agreement is a contract you may then meet a number of types. This arises because of the wide variety of issues that can be the subject of a contract, e.g. employment, the supply of goods, the supply of services.
Choosing the right type is vital if you wish to ensure the supplier delivers to expectation. The contract you choose will help you and your supplier to agree on cost and performance risks which are placed on the contractor as well as you as the customer.
There are two main contract groups–fixed price and variable price (cost reimbursement). Within these types, there are many different flavours. We have chosen to illustrate the most common of these.
Fixed Price Contracts
This type of contract requires the contractor to successfully perform the contract and deliver conforming supplies or services for a price that you have both already agreed to, “upfront”.
Here a ‘once and for all price is negotiated and agreed. The price paid does not depend on how much time is actually spent on the work.
If it costs the supplier more than they expected, they still get the amount originally agreed upon. If it costs them less, they make more profit.
Note that your suppliers will expect to make a profit. You will need to negotiate on the value of the contract to your organisation.
With ethical accounting (can you believe it, yes there is such a term – sometimes known as open accounting) you each share your expectations on what is a reasonable profit. Note doubt that as the customer you focus on”lowering expected profits to reasonable levels”. Beware about “unfair terms and conditions as you try to do this.
Whilst fixed price contracts can be very beneficial if your company is going through rapid changes or is undefined (perhaps through inadequate management) you might suffer a major loss in flexibility.
As a rule, a firm-fixed-price contract is suitable for products and services that are described in sufficient detail to ensure each party has a clear and complete understanding of the requirements and risks.
We suggest that due diligence is absolutely critical here for the supplier and customer Be aware also, that your supplier may be very unwilling to work with you if their profit levels sink too low. This is one of the major areas of concern that is
affecting the large outsourcing PFI and PPP deals lasting 5 to 10 years.
You may consider specific clauses in the contract to help you be more flexible. You could make price adjustments where costs fluctuate frequently either up or down. You could consider implementing incentives to the fixed price to reward good performance. You could also impose provisions to deduct for poor performance.
You must look at the whole supply and service chain. Does your potential supplier also have sub-contractors? If so then consider the risk change.
During the negotiation, the potential supplier may constantly point out the high risk of performing certain contract activities. An example might be where fix rates and times are being set for a service desk. After the contract is awarded
the supplier then uses a fixed-price subcontract to shift that risk to the supplier’s supplier – a subcontractor.
You can see this happening in any internal Support and Delivery function where internal SLA (OLA) are not defined between development and support staff. Poor service results and it is not the development team who got the
requirements wrong in the first place who is responsible!
Variable Cost Contracts
In these “cost reimbursement” contracts you allow for payment of all incurred costs. This helps the supplier by reducing their cost and performance risks.
They may only need to meet “best efforts to complete the contract. These often apply for systems development where there is uncertainty for example changing needs, function creep, Infrastructure upgrades and risks, new issues affecting Continuity, SLA Capacity and Availability, obtained.
Here the uncertainty makes it difficult to ensure a fair and reasonable price is Typical variable types include:
- Time and Material Contracts
Where it is not clear at the onset of the contract, exactly how long it will take to provide the specified materials. The contracted rate is therefore on a “per diem” basis. This can involve payment of all incurred costs. We suggest
you set a predetermined total at the outset. - Cost-sharing (based on performance)
Where you and the contractor agree to split the cost of performance in a predetermined manner. No fee is given. - Cost-plus-fixed-fee
This allows payment of all incurred costs within a predetermined amount plus an agreed-upon fee which will not change. - Cost-plus-incentive-fee
Here you agree on an adjustment of the fee (either up or down) using a predetermined formula based on the total allowable costs in relation to total targeted costs. - Cost-plus-incentive-fee- penalty
Just like an SLA, a contract may specify financial and other consequences if the supplier does not deliver in accordance with the specified standard. A contract may specify that if system uptime is not 99.5%, then for each .5% of downtime, the service provider’s fees in the next month will be reduced by a fixed percentage. It is not a good idea to include such penalties in either an SLA or a contract unless you know your legal position. Some remedies will not be enforceable, and may even impact upon the enforceability of other contracts or SLA clauses and schedules. - Cost-plus-award-fee
You negotiate a base fee with an award fee which depends on a mutual and agreed judgmental evaluation by you and the supplier, for example, did implementing those ITIL problem management procedures actually increase uptime and overall performance whilst reducing our costs?
Some other variants - Short term contracts (up to three years)
Usually, imply higher service charges. However, they can provide more flexibility in situations where requirements are likely to change. - Long term contracts
Normally result in lower service charges but increase the risk of overdependence on one source of supply and may make it difficult to re-test the services effectively.
Critical Terms and Conditions
The critical terms and conditions in the contract will be those which express the terms of reference, which were drawn up as part of the PID, Statement of Requirements, Business Case or equivalent.
They will cover in specific terms:
- what the supplier will do (and will not do)
- what deliverables are required and the details of those deliverables
- the standard of performance required
Always remember that the vaguer the terms the less ‘enforceable the contract. Some words are, by their nature, fuzzy but may be capable of clearer definition.
Specification checklist
For instance, consider the meaning of “to a high standard”, or “within a short period of time”, how could these be made more specific?
Contract Contents
Contracts consist of:
- Clauses setting out the legal responsibilities of the respective parties.
- Schedules setting out the operational and administrative processes for the life of the contract. Schedules form part of the contract and equally bind the parties legally (provision is made for clauses to prevail only to the extent of any conflict with schedules).
Clauses
- Hardware: Consider the arrangements for ownership of hardware assets.
- Software: Software may be provided by yourselves, and/or by the contractor, and/or by a third party already licensing to you, to the contractor or to both. It is essential that you set out clearly the licensing and support
arrangements for software provision during the term of the contract. - Warranties and Representations: If you were hiring consultants, you must define the skills needed to meet the service requirements. Always secure the legal protection of provisions covering general duties of care and specific obligations.
- Limitation of Liability: This sets out the reciprocal arrangements for limiting financial liability for defaults under the contract. The effects of a service failure on the business could be considerable with severe financial
consequences. - Intellectual Property Rights (IPR) indemnity: The contractor should fully indemnify you of any infringement of any third party IPR.
- Force Majeure: This sets out to relieve both parties from responsibility for events beyond their control. There is considerable contractor sensitivity in contracts, given dependencies on sub-contractors and other suppliers, such as telecommunications operators.
- Termination: State in what circumstances the contract should be terminated. For example, there may be a change of ownership of the contractor, which may be unacceptable. Consider the consequences of termination, such as how continuity of service could be maintained.
- Confidentiality: Sensitive information will flow from one to the other and both parties
must accept quite stringent confidentiality obligations. - Loss of Data: It is important that the contractor if at fault, accepts responsibility for lost data and is able to reconstitute that data.
- Transfer and Sub-Letting: Consider the rights to re-assign a contract if you are taken over by (or take over another organisation.
Schedules
- Interpretations: Expressions used throughout the contract must be defined to avoid misunderstanding. Beware of technical jargon.
- Description of Service: These schedules are constructed as you go through the procurement process. You may get the information from the requirements and proposals. They should describe the function, features and scope of the service and may even include service level agreements (SLAs).
- Timetable/Implementation: Times of start and delivery of the service
- Acceptance: The acceptance procedures and criteria. Define the actions that should be taken if the contractor fails to meet these criteria.
- Charges: What is involved and how much?
- Variation of charges: This schedule should describe how charges will vary and what factors should be taken into.
- Performance of the service: Measures of performance and targets applied to the overall package of services and related remedies.
- Invoicing and Payment: The invoicing procedure and the structure of the charges should be set
out in a schedule. - Audit of Service
The typical three types of audit include:
• that discharging any statutory or accounting obligations.
• that looking at the processes used
• that looking at the quality of the service provided. - Change Control: The schedule should define how changes are requested, the procedures to accept or reject changes and the procedures for making a formal amendment to the contract or agreement.
- Your own obligations: You may have specific obligations affecting the contractor’s ability to deliver service. These must be set out as well.
Contract Placement
Responsibility
Much of the information given in the preceding topic (Contract Types) is concerned with the form and legality of a contract. Many of those issues will be addressed by your procurement function. They may have the responsibility of authorising, negotiating the terms of the proposed agreement and creating the contract. It is important, however, to realise that they need the support and active participation of the Consultant.
Potential Problems
You will need to identify potential problems which may cause the premature cancellation of a contract (the walkaway points). These need to be thought about whilst drawing up the contract. It is obviously better to prevent the situation arising wherever possible.
It is worth noting, that a contract is still binding even if you subsequently realise that it is a poor bargain. One area to look for is where a contract overlaps with an existing contract. For example, a consultant is already under contract to his/her own company. Does your contract conflict with any of those conditions?
Most suppliers operate their own “Terms of Business”. It is not unusual to find that some of those terms conflict with a proposed contract. If so, be prepared to negotiate a compromise. Failure to do so may cause a dispute at a later date.
Preventative Action
Having isolated potential problem areas the next thing is to decide how to prevent the problems arising. You can do this by applying a preventive action planning process. This means that you:
- List all the potential problems.
- Look at each and assess the impact of that problem arising. How severe would that be? Would it cause some annoyance, major disruption, and premature termination of the contract?
- Now think about the likelihood of the problem arising. Much time and effort can be wasted trying to prevent things which are actually highly unlikely to occur.
- Finally, concentrate your effort on those issues which are potentially very severe and very likely to happen.
Contract Termination
There are four ways to terminate a contract; performance, agreement frustration or breach.
Termination should be considered the last resort: before “untying the bond the effective PM will try and remedy before terminating.
The most obvious way to terminate is by non-performance. If you and a consultancy firm make a contract under which the consultancy firm performs a service and you then pay for it, then when the service has been performed and you have paid the contract is “discharged”. The key factor is “performance or non-performance”.
Performance v Non-Performance
The general rule is that performance must exactly meet what the parties have agreed to do, so that if somewhat less is done, or something different, then the supplier may not be entitled to payment. There are exceptions to this rule. The
most likely ones within an consulting environment being:
- Entire or Severable Contracts, i.e. does the contract have to be completed in its entirety.
- A contract to complete a “full study of the current methods of recording sales enquires” where the person conducting the study does not investigate the current process or provide more than one alternative solution may be considered dangerously incomplete,
- However if the Consultant delivered his recommendation five minutes late in a presentation then, as the effect on a new system would be very marginal anyway, does it really matter?
- Prevention of Performance. The contractor or Supplier may be prevented from completing some work because a preceding task has not been completed. If this happens then he could sue and get a reasonable sum of money for the work already done, such as:
- Attending tender board meetings, review meetings, etc.
- A typical example would be a contract programmer unable to write code because the programme specifications have not been approved.
- Acceptance of Partial Performance. The restaurant produces the meal but the desert did not arrive.
If the meal was eaten then it could be implied that the contractor has completed the contract. - Substantial Performance. A partner who performs his obligation defectively, but substantially, can enforce the contract
- A contract programmer writes a validation program. The validation works for most situations but owing to a coding fault does not work to full specification. In such a situation the contractor could sue for payment but with a deduction equal to the cost of putting right the defect. If however the validation resulted in loss to the customer then there is a sound case for damages.
The Service / Contact Consultant must be aware that it is not the whole contract which is enforceable in its entirety, but the obligation(s) within the contract.
Agreement to Vary the Contract
Your procurement people are probably the only people who should do this, however, a Consultant could do it by needed. Consider the examples forservices:
- Discharge by Agreement. A contract is a bond. You and the Consultant contractor can, by agreement, untie the bond. If A agrees to give up his rights and in turn B agrees to give up his rights, then the contract is at an end.
- Vary the Contract. The contract states that the Supplier must produce a double room with “en suite bath”. It is then decided that the client will have a single room with “bath down the corridor past the bar”. In this situation a substitution is being made. This could be defined as a discharge; more likely it will be a variation. What the implications will depend on the formality and consideration.
- Formality tends to relate to contracts of guarantee or the “disposition of land”.
- Consideration, (accord and satisfaction) is more likely to concern the Project Consultant. Three contract programmers produce a program. The programmers charge £245,000. The Project Consultant, worried about a budget overspend, would rather not pay this amount. However, the Project Consultant needs help on another suite of programs. So instead of paying the £245,000 he offers to engage the programmers for a further three months writing the suite of programs. The PM could be said to be ensuring accord and satisfaction. Both parties are happy. However, the previous contract is discharged and a new one is in
place. - Contracts may also be difficult to discharge for reasons of frustration. Frustration because the subject matter is destroyed”. … we lost the program specifications:
- Because the specialist is ill/dead.
- Because the subject matter is “unavailable”. “We are almost complete on the full study: there will be a small delay, just bear with us
- It is illegal. “We expect you to work all hours of the week”.
- It is radically different. “We recruited you as business development Consultant looking after these key accounts, however, before you start that, we need to ensure you prove yourself; we, therefore, want you to work in the photocopying department for half the salary.
The project Consultant must be aware of “breach of contract”.
- A breach occurs when either party fails to perform any obligation within the contract.
- A breach can be due to “non-performance, defective performance or non-truth of the statement”. A breach may be “anticipatory or actual”.
Any breach entitles the innocent party to sue for damages (see above “non-performance”).
There are many other situations the PM needs to control. The intention should be to keep the contract going unless there are very good reasons to discharge it.
The Project Consultant will always try to remedy the failure. There are six specific remedies. Each remedy should be approved by consultancy services even though the PM is responsible for successful completion.
The remedies include:
- Rescission. A contract programmer is hired to produce a program for “fast recovery restarts of the x system; a maximum time of thirty minutes is allowed. The program never allows restarting in less than three hours. During
this time all are locked out. If the PM rejects the program on the grounds of non-performance, quality etc., then the ownership will return to the programmer. The PM will need to decide whether this is acceptable. If not, what can be done? - Damages. Put the injured party in the same position as if the contract had not been performed. A supplier asks you for a vital piece of information to be delivered from Glasgow to Luton. Without this information, he cannot perform the job. The team leader says he will sort it out. The information arrives one week later. “I did not know it was that important,” says the Team Leader. As a result, the supplier misses a major milestone and is unable to complete his task. Worse still he had another contract lined up which has now been lost because of the delay. In this situation, the supplier could sue for damages. How much would depend on “What for” and “How Much”, any market rules, taxation, mitigation etc.
- Specific Performance. A court can order a defendant to perform a promise. This would be enforceable in some situations. A consultant to return manuals, and other documentation.
In others such as a contractor service contract, it would not be enforceable (infringement or liberty) “you will work till midnight and get me that report on my desk by tomorrow, or else!”
- The injunction “No comment on our policies or this particular project must be made to third parties”.
- Quantum Meruit. “The contractor’s lack of progress has prevented us from implementing program x on April 1”. We, therefore, see no reason to continue with these contractors.
- Other Remedies include “Claims in Quasi-Contract and Extinction’.
Covering Actions
The Consultant by documenting actions and using common sense will prevent these issues arising.
Conclusions
Contract Management is about providing the services that users should demand and providers seek to supply.