Contract and Contract Management
Contract and Contract Management
Contract is defined in short as an agreement between two or more parties enforceable under the law. A contract is a legally binding agreement between the parties identified in the agreement to fulfill all the terms and conditions outlined in the agreement. A prerequisite requirement for the enforcement of a contract, amongst other things, is the condition that all the parties to the contract accept the terms and conditions described in the contract. Historically, this was most commonly achieved through signature, but in many jurisdictions – especially with the advance of electronic commerce – the forms of acceptance have expanded to include various forms of electronic signature. Party/parties awarding the contract are known as the purchaser or employer. Party/parties agreeing to execute or perform the contract are known as the supplier or contractor.
Contracts are of several types. They are normally classified as supply contracts, service contracts, management contract, transport contract, sales contracts, purchase contracts, design and engineering contract, training contract, maintenance contract, civil contract, and erection contract etc.
Contract life cycle management is defined as the process of systematically and efficiently managing contract creation, execution and analysis for maximizing operational and financial performance and minimizing risk. Contract management life cycle is shown in Fig 1
Fig 1 Contract management life cycle
A contract life cycle has two distinct phases namely pre signing phase and post signing phase.
The pre signing phase consists of activities before the signing of the contract. The activities in this phase are dominated by the purchaser/employer. There is no supplier/contractor in this phase but there are bidders. One of the bidders becomes supplier/contractor after the award/signing of the contract.
The activities involved in this phase are identification and approval of a requirement, preparation of a tender document, issue of invitation to the tender, issue of tender document to the bidders, receipt of the bid documents from the bidders, preliminary evaluation of the offers, clarification meetings if necessary, receipt of revised bid if necessary, final bid evaluation along with comparison statement, selection and the approval of a bidder for the contract, preparation of the contract document along with the successful bidder and signing of the contract document with supplier/contractor after taking the required approvals.
The contract document is to be prepared very carefully since it is the guiding document for both the parties during execution as well as in case there is a dispute between the purchaser/employer and supplier/contractor. The contract document should include as appropriate the following.
- A definition of what is to be provided and requirements to be met
- Scope of supply and services and bill of quantities
- Specifications for supplies and services
- An agreed level of supply and services and mechanism for payment reduction if not met
- Means to measure performance
- Pricing mechanisms and payment terms including where appropriate, milestone payments, penalties, and incentives/rewards etc.
- Fixed price contract, if not, then price variation and escalation mechanisms
- Force majeure clause
- Progress review mechanism
- Acceptance strategy and test plan
- Ownership of assets and intellectual property
- Dispute resolution procedures
- Change control procedures
- Invoicing arrangements
- Communication mechanisms and routes
- Agreed exit strategy and agreed break options if needed
- Premises (where the goods/services will be delivered)
- Documents to be given along with supplies
- Sub contractor/vendors approvals and details
- Authorities responsible for contract operation
- Obligations of the purchaser/employer
- Legislations applicable and place of jurisdiction
Complex contract documents are often necessary for large construction projects which also include among other things, a detailed technical specification and demonstration of performance guarantees.
Standards and norms of behaviour
Standards and norms of behaviour expected between the parties entering into a contract are as given below.
- Honesty and fairness – Parties must conduct all the contractual obligations and business with honesty and fairness and avoid any practice which gives one party an improper advantage over another.
- Accountability and transparency – All the actions of the parties during the pre-signing and post signing stages are to be open, clear and defensible and all parties must not engage in collusion, hidden commissions and other anti-competitive behaviour.
- No conflict of interest – A party with a conflict of interest is to declare and address that interest as soon as the conflict is known to that party.
- Rule of law – Parties will comply with all legal obligations.
- No anti-competitive practices – Parties are not to engage in practices that are anti-competitive.
- Intention to proceed – During pre-signing phase, parties should not seek or submit tenders without a firm intention and capacity to proceed with a contract.
- Co-operation – Parties will maintain business relationships based on open and effective communication, respect, and trust. The parties will also adopt a non-adversarial approach to dispute resolution.
After a contract has been signed, there are a number of matters that should be addressed to provide the foundation for successful contract management. An early step is to ensure that sufficient resources and senior management support are available to manage the contract. It is equally important to understand both the contract provisions and contractual relationships at the outset. In the case where the contract manager has been involved in the pre signing phase of the contract then it is expected that the contact manager already has knowledge of issues relevant to implementation.
Contract management includes negotiating the terms and conditions in contract and ensuring compliance with the terms and conditions, as well as documenting and agreeing on any changes or amendments that may arise during its implementation or execution.
Contract management is the process that enables both parties to a contract to meet their obligations in order to deliver the objectives required from the contract. It also involves building a good working relationship between the contracting parties. It continues throughout the life of contract and involves managing proactively to anticipate future needs as well as reacting to situations that arise.
One of the key aims of contract management is to obtain the services as agreed in the contract and achieve value for money. This means optimizing the efficiency, effectiveness and economy of the service or relationship described by the contract, balancing costs against risks and actively managing the purchaser/employer and supplier/contractor relationship. Contract management may also involve aiming for continuous improvement in performance over the life of the contract.
The critical success factors which are essential for good contract management as well as for its successful completion are given below.
- Good preparation – An accurate assessment of needs helps create a clear output-based specification. Effective evaluation procedures and selection ensures that the contract is awarded to the right and capable contractor/supplier.
- The right contract – The contract is the foundation for the good relationship between the two organizations entering into contract. For achieving good relationship, the contract should include aspects such as allocation of risk, the quality of service required, and value for money mechanisms, as well as procedures for communication and dispute resolution.
- Single business focus – Each party needs to understand the objectives and business activity of the other party of the contract. The purchaser/employer must have clear business objectives, coupled with a clear understanding of why the contract will contribute to them. The supplier/contractor must also be able to achieve their objectives, including making a reasonable margin.
- Contract performance management and contract administration – Effective governance of the contract performance ensures that the purchaser/employer gets what is agreed and to the level of quality required under the contract. The performance under the contract must be monitored to ensure that the purchaser/employer continues to get value for money.
- Relationship management – This is an essential aspect for the successful contract management. Mutual trust and understanding, openness, and excellent communications are as important to the success of an arrangement as the fulfillment of the formal contract terms and conditions.
- Continuous improvement – Under continuous improvement, a supplier/contractor improves in price, quality or quantity of service under contract as the contract proceeds. Where possible, these are built into the contract terms.
- People, skills and continuity – There must be employees in the contracting organizations with the right interpersonal and management skills to manage the relationships on a peer-to-peer basis and at multiple levels between the organizations. Clear roles and responsibilities should be defined, and continuity of key employees handling the contract should be ensured as far as possible. A contract manager (or contract management team) should be designated as soon as the contract becomes operative.
- Knowledge- The employees who are managing the contract must understand fully the contractual items in every aspect and also should know the contract documentation inside out. This is essential if they are to understand the implications of problems or opportunities that may arise over the life of the contract.
- Flexibility – Management of a contract normally requires enough flexibility on both the sides and a willingness to adapt the changes in the terms of the contract to reflect a rapidly changing environment. Problems are bound to arise that could not be foreseen when the contract had been awarded.
- Change management – Contracts are to be capable of changes (to terms, requirements and perhaps scope) and the relationship should be strong and flexible enough to facilitate it.
- Proactivity – An effective contract management is not reactive. It aims to anticipate and respond to organizational needs of the future.
If contracts are not well managed then there is a possibility that any or all of the following things may happen.
- If one of the party is not managing the contract well then the other side will take control of the contract implementation. This results into unbalanced decisions that do not serve the contractual interests.
- Decisions are not taken at the right time and sometimes not taken at all.
- New business processes do not integrate with existing processes, and therefore fail.
- Employees in both the organizations fail to understand their obligations and responsibilities.
- There are a large numbers of misunderstandings, disagreements and underestimations.
- There are too many issues that get escalated inappropriately.
- The progress of the contract slows down and there seems to be an inability to move forward.
- The realization of the intended benefits is absent.
- Opportunities to improve value for money and performance are missed.
In case the mismanagement continues for a long time then ultimately the contract becomes unworkable. There are several reasons why organizations fail to manage contracts successfully. Some possible reasons are given below.
- The contract is not drafted properly.
- There are inadequate resources which are assigned for an effective contract management.
- The teams assigned for the contract management in the two contracting organizations do not match each other in terms of either skills or experience or both.
- The wrong people are put in place, leading to personality clashes.
- The context, complexities and dependencies of the contract are not well understood by the teams handling the contract.
- There is a failure to check the assumptions considered by the supplier/contractor.
- Authorities or responsibilities relating to commercial decisions are not clear.
- There is a lack of performance measurement during the contract execution.
- There is a focus on current arrangements rather than what is possible or the potential for improvement.
- There is a failure to monitor and manage retained risks.