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Business and Finance>Anyone Can Reduce
His Contracting Risks |
Anyone Can Reduce
His 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.
To ensure changes are binding make them in writing
and have the amendments signed by duly authorized
representatives of both parties. This documents the
change, provides clarity and binds both parties
should problems arise later.
Three clauses complement and support the risk
management process. They are hold harmless,
indemnification and insurance. I recommend that
these clauses be written separately.
In most vendor-provided contract documents, the
Indemnification/Hold Harmless provision is far
broader than what your organization would want to
accept. Many vendor-provided indemnification and
hold harmless clauses are limitless. If you accept
these clauses you may be accepting responsibilities
that your organization never wanted nor intended to
assume and may not be able to insure. Usually you
want to only sign contracts where the language
limits your liability to acts over which the
municipality has control and to the extent that it
exercises that control. Assuming liability for
independent contractors and consultants who are not
under the municipality’s control is unwise.
The intention of the hold harmless clause is to
describe exactly what type of circumstances the
supplier accepts responsibility for. In particular,
they specify who will pay for loss or damage arising
out of the performance of the work contemplated by
the contract. Most corporations will only enter into
contracts in which the indemnification language
limits their liability to acts over which they have
control and to the extent that they exercise
control. The hold harmless clause however, is only
one clause of the trio needed to adequately protect
the parties.
The second clause used is an ‘indemnity clause’. It
will state that if something does occur leading to a
loss, of a type that I/we have held you harmless for
– then we will pay on your behalf (or reimburse you)
any costs arising from our negligence. In other
words, ‘the buck stops here’.
The final clause of the trio is the insurance
clause. The insurance clause promises that the party
performing the work (e.g. builder, supplier, etc.)
will obtain and maintain the type and amount of
insurance that you have stipulated to pay for any
claims, losses and related expenses that may arise
out of their negligence in performing the work
planned in the contract. The intention is to ensure
that the contractor has sufficient financial
resources to support the indemnification provision
in the contract.
With these three clauses, you have obtained a
promise from your supplier or contractor to:
1. accept responsibility for their own errors or
negligence,
2. pay any costs arising from those errors or
negligence, and
3. carry insurance evidencing sufficient resources
to keep their promises.
Often, I find that contract document presented by
contractors have been written by lawyers or other
‘non-insurance’ professionals. In these cases, the
language used may be out-of-date or simply not
reflective of terminology used by insurance
professionals. When this occurs, it is prudent to
revise or replace those clauses with descriptions
and phrases commonly used in the insurance industry
today. This reduces the chance of ambiguity and
difficulty in obtaining evidence of the type of
insurance you want the contractor to carry. The most
common example I see is the phrase “Additional
Insured’ VS ‘Additional Named Insured’.
It is important that this phrase be limited to
‘Additional Insured’. Additional Named Insureds have
at least two disadvantages: only Named Insureds are
responsible for paying premiums and some policy
exclusions apply only to Named Insureds. Benefits to
your municipality of being an additional insured
are:
Coverage remains in force for Additional Insureds if
a Named Insured breaches a policy condition,
Reinforces risk transfer agreements in the contract,
The Additional Insured has a right to claim defense
from the insurer, and
It usually prevents the insurer from subrogating
from the Additional Insured.
Certificates of Insurance:
There is much debate amongst the risk management and
insurance community about the value of obtaining and
maintaining evidence of insurance on contracts.
Certificates of Insurance verify the type of
insurance that the Named Insured on the policy has
purchased and specifies the coverage levels under
that policy at the point in time that the
certificate is issued. I firmly believe that
certificates are of limited value – but they are the
best and only evidence available at this time
providing some level of comfort that contractors
have a source of funds for defined claims
situations.
There are two broad categories of certificates,
those that you receive coming in and those that your
send out to other parties. Municipalities usually
receive certificates and infrequently send them to
others.
Incoming certificates of Insurance are commonly
issued by the contractor’s insurer or insurance
broker. To be valid, I want to see the ‘live’
signature of a person authorized by the insurer to
issue the certificate. Before issuing a certificate,
the insurer wants some information describing reason
for the certificate, the length of the subject of
the certificate (e.g. a multi-year contract) and
specific details of the name of the contact
person/mailing address of their and at your
organization.
Upon receipt of a certificate in your office, you
will want to see at least the following information:
name and address of the organization to whom the
Certificate is being issued,
brief description of planned activities/work,
name and address of the Named Insured, (who must
match the name on the contract)
amount and type of insurance in force,
effective dates of coverage, and
a statement that your municipality is included as an
‘additional insured’.
When you are asked to issue certificates of
insurance you should review the contract to be sure
that you provide evidence of the proper type and
amount of coverage required. Under no circumstances
should you issue a certificate on behalf of any
party or other organizations independent of your
municipality, no matter how close a working
relationship you may have with it.
When reviewing tender or RFP documents and the
contracts that arise from them you can effectively
use the risk management process to review the
proposal and draft appropriate language. Manage
exposure in any contract situation by ensuring
conformity with generally accepted ‘due diligence’
practices from the very beginning. Be sure that
appropriate risk transfer provisions are included at
the tender or RFP stage. Finally, once the contract
draft is agreed upon, ensure that evidence of
insurance (and bonding, if required) is obtained and
maintained throughout the life of the contract. As a
risk management professional, remember that your
training and experience makes YOU an expert who can
protect your municipality. |
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