You Can Reduce Your Contracting Risks

One frustration all risk managers experience is being brought into the contract process when it is too late to reduce the risk. Only yesterday, I was asked to review a contract for the acquisition of health equipment. When I sent my recommendations back to our contract negotiator I was told “But it’s too late – we already told the supplier that the draft they approved was the final version.” The best time to negotiate contract terms and conditions is before the contract is signed! Contract law is complicated, involving numerous federal, state and municipal laws (not to mention internal policies, procedures and protocols!) that apply different conditions depending upon the type and cost of the item under consideration. Terms in the tender document or request for proposal are the starting point for most acquisition processes. The language of the tender or RFP is critical to successfully achieving a satisfactory relationship with the supplier of goods or services. The terms of the tender document, with the terms of the successful bidder’s response, are substantially the terms that will be included in the final contract. Procurement officers need to know the extent of negotiating ability they have upon receipt of bids or proposals. The variety in responses possible from bidders can often lead to very good reasons for going off in a new direction. But, straying too far from the tender specifications can quickly lead to multiple claims from unsuccessful bidders. Purchasing and Risk Management Departments must work closely with other corporate colleagues to review or create business contracts that limit the organization’s liability exposure. Well-drafted, the indemnification and insurance clauses ensure that if something goes wrong it is clear who will bear financial responsibility. The Risk Manager’s Role The importance of risk transfer requires Involving risk management early in the process. The risk manager can help examine the purpose of the contract from an ‘outsider’s perspective. Specifically - what could go wrong with the work (or product/service)? If something were to go wrong – what are the implications of that problem? “Implications” can be financial cost, a delay in using the end result (e.g. a building), negative publicity or any combination of these three outcomes. Risk manager can provide advice and consultation in structuring tender or RFP, assist colleagues in properly drafting contracts consistent with corporate policies and minimize financial risk by identifying and dealing with possible contingencies. They do this because they know that poorly prepared contracts can lead to nasty surprises. You want to enter into contracts with some assurance that the end result will satisfactorily meet your expectations. The classic risk management process is helpful in conducting a review of any proposed transaction. To avoid surprises, you need to identify risks by considering what potential downsides can arise from the project. Once this step is complete, assess the risk by determining how likely it is that something will go wrong and if it does, how expensive the problem is likely to be. The contribution of the risk manager to the contract language is central to successfully achieving risk transfer. Clearly define the circumstances under which the contractor will hold harmless and indemnify the municipality for losses arising from the supply of goods or services. If a serious loss occurs, these clauses can be analyzed word-by-word. Any ambiguity is likely to be held against you. Review and revise both the hold harmless and indemnify clauses until it is absolutely clear to you and to your procurement officer. The term “Contractual Risk Transfer” is used by risk managers to avoid saying ‘passing the buck’. The goal is to always make the party who has control over the products or services accept financial responsibility. Usually insurance does not cover problems arising from poorly-drafted contracts, negligence in the procurement process or poor performance of the work described by a contract. For example, there is usually no coverage for situations where unauthorized employees engage in work under an unapproved contract or for breach of contract claims. Poor business judgments and financial mistakes are also the responsibility of the organization. Claims arising from these errors typically must be paid by the municipality as those costs are rarely transferable to insurers or anyone else. The municipality is likely to incur all of their own costs arising from problems, plus any award to the claimant. Always use written contracts and state terms and conditions clearly. In many situations verbal agreements are legally permissible. Properly drafted written contracts, however, reduce the chance of misunderstandings in the future. Documented business transactions protect the rights of all parties to the contract. The written contract provides an audit trail and authorizes the use of funds when paying invoices. Further, if the subject of the contract becomes an adversarial issue due to a lawsuit, the contract can show the intent of both parties at the outset of the work. Written agreements ensure both parties have an opportunity to clear up at the negotiation stage any confusion or differing interpretations. The main purpose of written contracts is to prevent conflicts or litigation caused by inadequate documentation of crucial points. It is time-consuming and expensive to take issues to court for interpretation. Judges may interpret the contract differently than either party intended. The courts do not usually consider very great weight to verbal evidence as verbal statements are considered unreliable once a dispute has arisen. When contracts are vague or indefinite, or the intended performance cannot be determined, the court may rule the contract unenforceable - to the disappointment of both parties. Power does not always prevail – when one party is larger than the other it may make them feel that they can dictate contract terms and conditions. Remember that you want a contract that is enforceable. When unfair bargaining strength is used, it can become contentious later if other problems arise. It is in all parties’ best interest to avoid ambiguous language and unreasonable or unlawful conditions. Always be prepared to be flexible and to take the time required for a good result! Remember, it is important to note that any language showing a clear intention to negotiate cannot defeat an inherent duty of fairness with which the municipality must conduct themselves at all times. The trade-off is clear: the more extensive the negotiations, the more stress it puts on the municipality’s duty to be fair to all bidders.