L4M3 Chapter 3 Notes

3.1: Terms and contracts (contract terms, standard T&Cs and model form)

3.2: Examples of contractual terms (key contract terms e.g. indemnities, liabilities) 

3.3: Pricing arrangements (fixed price, cost-plus, incentives etc)

 

3.1: Terms and contracts

Recap on T&Cs:

●       As mentioned before, terms can be implied through statute. Another common way is custom and practice, where it’s commonly assumed that things are done in a certain way.

○       There are other everyday ways this can happen, for example the context within which the contract was placed could imply certain terms

●       Conditions versus Warranties: conditions are deal-breakers for a contract, warranties entitle a party to claim damages without ending the contract

○       ‘Innominate’ terms are terms that sit in the middle and may need to be determined in court

 

An example of express terms: ‘Time of Essence’ clause. This states that something must be delivered within a timescale, and missing this ends the contract.

 

Liquidated damages and penalty clauses

• Basically means the wronged party gets paid

• They need to be seen as fair, to be legally binding

• Liquidated damages are compensation, not a penalty

• Liquidated damages clauses are legally binding, whereas penalty clauses aren’t

• Under penalty clauses, you don’t get extra compensation: you only get compensated for losses

 

Standard terms

All organisations will have their own standard terms. I.e. their own way of doing things.

• It’ll cover all transactions apart from those that are covered by a contract

• They might be attached to order forms and can be overarching (generic and not specialised to a transaction)

• The ‘small print’ basically

 

Advantages

• Allows you to embed a culture in the organisation

• Saves time in negotiations

• Can reduce administrative confusion and delays

 

Disadvantages

• Likely to be quite vague

• Could be outdated

• Might create ‘battle of the forms’: back and forth between parties attaching their own terms in a negotiation

 

Model form

These are contracts published by third parties, considered experts. NEC is one example for engineering.

Advantages

• May be reflecting industry best practice and therefore ensuring quality

• Less likely to be a back and forth

• It won’t induce bias in the terms

Disadvantages

• Might be inflexible to a given situation for the buyer

• A negotiation could allow for a new way of doing things

 

Model forms will allow for project-specific documentation that procurement staff will need to fill in.

 

3.2: Contractual terms

Liability and indemnity

Liability: legally responsible for something

• Could be addressing potential negligence

• ‘Strict liability’: these are things that a party is responsible for no matter what

• ‘Vicarious liability’: organisations are held responsible for employees’ actions

• There may be a reference to when liability is transferred between the parties

Indemnity: protecting against loss, and the party will have to offer compensation

• There may be a financial limit applied to this

 

There can be an exclusion / limitation of liability clause to omit a party from having to accept liability in certain circumstances.

• Suppliers would be keen to do this

• Statutes try to limit this to prevent ‘cheating’ with small print

 

There will also be an insurance clause, making sure that the party can pay the costs of claims if they arise. Insurance is essentially transferring the risk.

 

Ethical Sourcing

This is ensuring that the supply chain is responsible and sustainable, with CSR and ESG considerations.

Some ways they can do this:

• Commit to legal and regulatory compliance

• There may be codes of conduct or voluntary schemes that can be signed up to

• A requirement for a supplier to ensure ethical sourcing of their suppliers

3.3: Pricing arrangements

For more complex contracts, you might need to use pricing schedules. This is so that you can offer further detail on price, for example by milestones, labour required etc.

• A guaranteed maximum price creates a price ceiling to prevent spiralling costs over time

• Price schedules are different to a schedule of rates, which is a breakdown of the headline price into constituent parts

 

You could instead use fixed-pricing

• Fixed-pricing: sets a fixed price for a period of time at least, but can be adjusted after some time. This could be combined with a schedule for certain things and be hybrid

• Firm price: this is more fixed. There is no flexibility at all in moving the price

The benefits of fixed pricing are quite intuitive from experience

• Who it benefits depends on how the project turns out: if costs exceed the estimation, the supplier loses out and vice versa

• It helps both sides budget easier, since there’s no need for uncertain forecasts.

Disadvantages also intuitive:

• Inflexibility in price could lead to a more inflexible approach to delivery

• There is a risk in the estimation upfront being wrong, leaving one party worse off

 

Cost-plus and cost-reimbursable

Cost-plus: the price is basically the supplier’s costs + a defined profit margin

• Requires suppliers to be transparent about their costings

• Perverse incentive for suppliers: they don’t need to care about keeping costs down

• But it might be seen as fairer if done right, because there won’t be excessive profiteering

 

Indexation and price adjustment formulae

You could link prices to an index to allow for variation as the contract progresses.

• A common one is inflation: this could be a general inflation measure (i.e. CPI), or a more targeted one (like a services inflation measure for service contracts etc)

• Both parties would try to use an index that gives them more of an advantage; e.g. RPI includes housing costs, so tends to be a higher inflation measure than CPI

 

The benefits and risks of these are intuitive: things like the risk of choosing the wrong index, a sense of inflexibility to contract-specific circumstances versus the benefit of having a neutral way of defining price increases and an evidence-based view of it.

 

Incentivised contracts

Providing incentives tied to good performance. Some examples are:

• Target fee: a payment made if suppliers keep costs low (setting a target cost)

• This is a bolt-on to cost plus contracts

• You could provide incentives for other things (think about some of the Five Rights)

 

Payment terms

Keeping this high-level: these terms will outline when payments are made, when they can be withheld and the payment processes.