In this video I share 5 contract terms that you should know. Remember, this isn't legal advice (and it's good to get some of that prior to any contract) but understanding common procurement terminology will help you manage your supplier relationships more effectively.
It has been a long time since I did AS Level Law aged 17, and I remember contract law being the less interesting part of the course. However, some of it is still relevant to my job today. For a contract to be legal, certain conditions have to be met. There are 5 conditions to fulfil before you can say that your contract can be legally entered into.
1. There must be an offer
There must be an offer and an acceptance. If I don’t offer you something, there is no contract. If you don’t accept it, there is no contract.
I can’t contract you to do something that you don’t want to do because you haven’t accepted my offer. You’re within your rights not to sign a contract with a supplier if the deal isn’t right for you. Just like you would stand your ground with those door-to-door sales people, you can stand your ground with a supplier on your project too.
There’s often back and forth at this point (as there should be) as you refine the offer into something that you can both live with.
2. There must be consideration
This means that something has to be exchanged. Your project suppliers offer you goods or services and you pay them money in exchange.
It doesn’t have to be money. You could give them goods or services back, or exposure to your client base or something else that you both agree to. But there has to be some give and take.
Again, there’s negotiation to be done here. Once you’ve agreed on the offer you might go back and forth on the consideration (the fee) that you are willing to pay, and how this will be structured: all in one go, payment phased over the life of the project and so on.
3. There must be legal capacity
I expect this varies from country to country, but the people entering into the contract must be legally able to enter into an agreement. I remember reading about a case where a toddler had accidentally purchased some expensive stuff online through random button pressing on a parent’s device (it happens) and the case concluded that the family didn’t have to pay as the toddler didn’t have the legal capacity to enter into a contract. I think they had to return the goods though – getting your child to purchase all your supplies is not a legal method of getting resources for your project for free! I’ve looked but I can’t find a citation for that case – if you know of one, let me know and I’ll update this article to reference it. I did find this one where a 3 year old bought a car on ebay, but the case didn’t go to court for contract law to be tested.
You may have capacity in law, but you may not have capacity in terms of your company’s due process. For example, perhaps only Directors can sign contracts above a certain value, or you can only enter into a contract in certain circumstances or with certain providers. While I’m not sure that would hold up in court, it would definitely get you into hot water at work, so make sure you check your company’s contract signing policy and get advice from your Legal team. That will avoid you entering into any deals and contracting the company in ways that they would prefer you didn’t.
4. There must be legal purpose
This simply means that the subject of the contract needs to comply with the law.
In other words, you can’t contract someone to steal for you. Or do anything else illegal. But you wouldn’t do that anyway, would you?
5. There must be intention
There must be the understanding on both sides that this agreement could be enforced by a court if it came to it. You must go into the contract understanding that it is legally binding and that you intend for it to be so. You aren’t signing up to something on a best endeavours basis, or without realising that it’s a legal document.
This is all broadly common sense, but it’s there to protect businesses and individuals.
I don’t know if these are the same conditions enshrined by your local laws, but for UK and US laws these seem to hold true. What’s the situation where you are? Drop a note in the comments to let us know!
Project procurement is full of jargon – it can seem like a totally different language at times. Here are 7 contract terms that you should know.
A waiver is where you voluntarily surrender an option under the contract. It’s a concession. You ‘let the supplier off’ the term because it suits neither of you to carry it out. This could be, for example, in the situation where enforcing a contract clause or requirement would turn out to be prohibitively expensive for both parties, or is no longer needed.
This is another way of explaining a guarantee. It’s where you need assurance from your supplier that the terms of the contract are going to happen. Warranties tend to be limited by time, so it would be unusual to get one that lasted a lifetime. Just like with your dishwasher at home, your supplier will probably provide a warranty period.
Warranties are contractual – it’s not a best-endeavours guarantee. As a result, if the contract isn’t delivered as you expect you can call on the warranty and get compensation.
Warranties are a good negotiating point for developing the contract. You could work with both parties to get an extended warranty added into the contract if you felt it would be worth it.
A claim is a request for compensation. It has to take place according to the terms of the contract, so your contract should specify how you can make a claim and what sorts of claims are going to be appropriate under this agreement. In other words, it’s a type of dispute that you can resolve through negotiation together.
Claims administration is the process of reviewing and agreeing on claims. You’re discussing whether you (or the supplier) has a valid point. If you do, you’ll use the change control process to potentially amend the contract as necessary to allow the claim to be met.
You might also hear this referred to as a default. When there’s a contract breach it means that a requirement of the contract has not been met.
In severe cases (a material breach), the party who didn’t do the breach can be released from the contract. This often relates to non-payment of fees or if the party can be shown to have broken some kind of significant contractual term. If that applies to you, the other party can walk away. You have no further hold over them and the contract is broken.
Typically this results in some kind of financial compensation and if your business was the one who caused the material breach, the other party could apply for punitive damages or fines. These can cover loss of earnings from the contract or other losses.
5. Performance Bond
Performance bonds are a way to ensure your business doesn’t suffer if your supplier doesn’t do what they promised. These can be appropriate if your project is at significant risks from the vendor failing to deliver.
They work like this: a pot of money is put aside to compensate you in case the vendor fails to achieve the terms of the contract. If they can’t deliver, you get the cash instead.
These can be hard to set up because they are particularly valuable when working with small or volatile organisations which probably don’t have the cash to lock away until the contract is completed.
6. Force Majeure
This is a contract clause you will see all over the place, from your household insurance policy to software contracts.
It simply means that if things happen that are beyond the control of the contracting parties (in particular, the party supplying the services or goods) then they don’t have to compensate you – they can be released from their contractual obligations.
Examples of things that are beyond their reasonable control are extreme weather like floods, wars, terrorist attacks, hijacking and crime.
7. Change Control
OK, you’re probably very familiar with change control systems. They apply to contracts too.
Any changes to the contract need to be managed professionally and with input from both sides. Everything is normally documented within the contract, at least at high level. Sometimes the detailed change process or a change form is included as an appendix or schedule to the main contract.
Pay attention to what contract change terms apply to your contract as they can vary.
Contracts should have a glossary or definition of terms, and that can help you unpick all the unfamiliar language. Always get a lawyer to read over a contract before you sign it and make sure that everyone knows what they are getting into. Contracts support both parties, but only if you agree to terms that work for you both from the beginning!
Last time I looked at the three general types of contract that you often find on projects: fixed price, cost-reimbursable and time and materials. That’s the overview, but as you’d expect with all things budget related, there’s a lot more to it when you start to dig into the detail.
Let’s look in a bit more detail at cost-reimbursable contracts. Personally, this is the type that I find the most confusing. Fixed price (you pay what both parties agree) and time and materials (you pay for the work done at the vendor’s agreed rates) are pretty straightforward, but cost-reimbursable contracts are harder to get your head around in my opinion.
There are four types. You’ll find the most common three in A Guide To The Project Management Body of Knowledge (PMBOK Guide) – Fifth Edition, each with a snazzy acronym:
Cost Plus Fixed Fee (CPFF)
All allowable costs (that’s whatever you’ve defined in the contract) get reimbursed. Then on top of that the vendor gets a fixed fee extra payment. This is determined at the beginning of the project, normally calculated as a percentage of the project cost. Note that this means it will be based on the estimated overall project cost, so if your costs go up significantly they won’t get any more (although they will probably ask for this to be renegotiated).
Cost Plus Incentive Fee (CPIF)
All allowable costs get reimbursed. Then there’s an incentive paid based on whether the vendor has hit certain performance targets. The theory behind this is that the vendor will try extra hard to meet your needs to earn that performance bonus. The risk is that you set the performance targets against things that are too easy to achieve or too difficult to measure and you end up paying the maximum when you don’t feel as if they have really earned it.
The other twist with this type of contract is that if the project goes over the original agreed budget then you will split the extra charges with the vendor. You’ll agree the amount of the split in the contract (it’s unlikely to be 50/50). This works both ways, so if the project is under budget, you’ll give some extra back to the vendor as you’ll split the saving with them as well. It’s another incentive to do well and to keep costs within budget.
Cost Plus Award Fee (CPAF)
Again, all allowable costs get reimbursed. Then there’s an extra payment, but it isn’t as clearly worked out as in the other two cases. There are performance criteria for the vendor to achieve, and these are documented in the contract, but they are more subjective. The total fee available as an award is negotiated and documented in the contract so the vendor knows the maximum that can be achieved. Then the project team determines how good a job the vendor has done against set criteria and then determines how much of that available fee the vendor will actually get. They can’t dispute the award, so if it is lower than they would have hoped, that’s tough, and they may actually get nothing if the project team consider that their work has not been satisfactory.
These types of contract are used extensively by NASA. As they say in their contracting guidelines, you can’t standardise the performance factors. What’s important on one project is not important on another: early delivery of a weather satellite might be good to help monitor natural disasters more quickly, but early delivery of a planetary probe means nothing because the window to launch it only occurs every couple of years. Therefore in that case early delivery may actually cost money as the probe would have to be stored somewhere. Performance measures should be tailored to the contract and project and, as the NASA guidelines recommend, based on outcomes not outputs.
The final cost-reimbursable contract doesn’t get used much according to Wikipedia. It’s:
Cost Plus Percentage of Cost
In this contract, the allowable costs are covered as you would expect, and the vendor also gets a payment based on those costs. This is calculated as a percentage of their overall cost. So, as they spend more, their fee goes up. See the problem? There’s no incentive to keep costs low. It’s also not that attractive to project teams who have to pay the increasing costs, plus the increasing contractor fee. It’s not surprising that this type of contract is specifically prohibited for U.S. government procurements (its banned in 16.102, the section on Policies if you want to confirm this for yourself, on page 403 of a 1889-page Federal Acquisition Regulation document, or you could just trust me!).
So those are the 4 types of cost-reimbursable contracts. You probably won’t come across all of them, but it’s good to know that they are out there in case you ever do need to use them or a supplier tries to get you to go for one and you aren’t convinced it is the right thing for your project. As with all procurement matters, get specialist help if you are dealing with contracts and legalities: it is very easy to tie yourself and your company into a contract that isn’t clear and that doesn’t serve your best interests so if in doubt, get your in-house counsel to look it over.
Appropriate Contracting is a term used by Michael Cavanagh in his book Second Order Project Management (Gower, 2012). He defines it as “the application of common sense to a commercial relationship”. In other words, it’s not really about money, but it is about making sure that the contracts you enter into with suppliers are fit for purpose and will help you achieve your objectives.
Consider a project where you buy software from a vendor. You go out to tender and you receive pitches from a number of companies. You choose the cheapest. The contract is tied up, with tight clauses around payment terms and schedules. You shake hands, everyone is pleased, and the project starts.
Six months in, you realise that the project scope needs a significant change in order to be able to accommodate the needs of the users. At the time of signing the contract with the software supplier, you hadn’t finished the requirements analysis and were not exactly sure how they would be using the project’s deliverables. Now you know, and you want to change the scope.
The vendor says no.
This is an example of inappropriate contracting – where the money side of things takes so much emphasis over a trusting, working relationship where both parties are working successfully together to achieve the end goal.
A trusting relationship does not mean that you don’t have a contract at all. Of course not. You should always enter a legally binding contract with suppliers on projects, as this gives you both additional protection should the worst happen. But as Cavanagh says in his book, “major contractual issues rarely occur between parties who have long experience in dealing with each other”. Trust is built up over a long time (and this goes for project managers with their teams too – in fact trust is one of the major attributes of a good project leader).
The better your relationship with the vendor, the more likely it is that you can work effectively together. This starts with the bid process. How the vendor operates at this point will give you an insight into what they will be like to work with when the real work starts.
So what is an appropriate contract?
Cavanagh says that an appropriate contract has the following attributes:
For this last point, any processes can be included as a contract schedule.
“First and foremost,” writes Cavanagh, “the contract should be establishing a framework for success.” He says that in order to achieve this the contract should cover these four areas:
1. Scope and goals (what the contract is about)
3. Performance indicators
4. Rights and remedies (what happens when things go wrong and what options both parties have if performance targets are not met).
Cavanagh says that the ‘meat’ of the contract is in the first three points, but project managers (when they are involved in negotiations) and legal teams spend a lot longer on negotiating point 4. This is counter-productive. If you skip over the scope and goals, who does what, and how success will be measured, you have every chance of needing those rights and remedies because it won’t be at all clear about what the vendor is supposed to actually do. “Rather than managing the risk,” Cavanagh says, “the contracting process itself becomes a source of risk.”
How appropriate are your contracts?