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21st Century Contracts and Contract Administration

Author(s):

Preston J. Leavitt, Ph.D., J.D., C.P.M.
Preston J. Leavitt, Ph.D., J.D., C.P.M., 9609 West Gould Avenue, Littleton, CO 80123-2344, 303/973-2625

84th Annual International Conference Proceedings - 1999 
Abstract

A contract is a legally enforceable agreement between two or more parties involving mutual promises to do or not to do something. The contract lies at the heart of all commercial transactions. A good contract can protect your company from liability, guarantee the quality of purchased goods and services, and provide remedies if terms and conditions are not met. 21st century contracts will be automated, just as binding as traditional contracts, easier to form, and will help the purchasing professional be more efficient. They will also require skillful contract management to guarantee performance in the world of electronic commerce.

21st Century Contracts

The rules of contract law are followed in all business agreements except with regard to the sale of goods. These are governed by the Uniform Commercial Code (UCC). The UCC is a compilation and formalization of the accepted practices of the market place. It offers guidelines concerning transactions involving personal property only; it does not apply to contracts for land, personal services, or employment.

The UCC provides that formation of a contract does not require the same formality as previously required under general contract law. Under the UCC a contract can be found to exist where there was nothing more than an exchange of written correspondence between parties. Only the quantity needs to be clearly stated to establish a contract.

Whether formal or informal, the contract needs to include all terms and conditions that are important to both parties. These Ts and Cs should cover such areas as risk and how much is acceptable to both buyer and seller; cost and the type of contract that will control it; changes and what's acceptable when; statement of work in specifics that are acceptable to both seller and internal customer; simplicity in a self-contained, understandable, all-inclusive document. In addition, the purchaser should maintain impeccable documentation as the contract is being performed.

Make use of online contracting wherever appropriate. It not only saves time but money. While not the answer for all buying situations, online contracting is generally ideal for small dollar, repetitive type transactions. Remember that e-commerce does not afford the opportunity to modify the supplier's "click-on" terms and conditions. Regardless of this, in 21st century contracts electronic commerce will be the rule. Buyers and sellers should therefore formulate a Trading Partner Agreement (TPA) that spells out the requirements for electronic contracts. Define these issues specifically because the rules on e-commerce are still evolving. The TPA is for when things go wrong. This TPA should be a good basis for organizations who do regular online contracting together.

But what about the one-time or infrequent business between buyers and sellers? The time and money to draft a TPA isn't going to be worth it. Suggested precautions include taking note of the supplier's terms and conditions on their Web site. These Ts and Cs are referred to as "click wrap" — that is, by clicking you agree to the terms and conditions stated. Indeed, clicking may very well equate to a digital signature.

If you do a lot of business with particular suppliers, it may make sense for both of you to use the same type of encryption software to lessen the digital signature concerns. The law has always moved slowly when it comes to changes and revisions. Someday the digital signature will be officially recognized as "the real thing," just as the faxed signature has been accepted in addition to the original signature today.

If buyer and seller act as if electronic signatures have sealed a contract then they indeed have a valid contract. Ongoing revisions to Article 2-B of the UCC address online contracting. When these will be finalized and then adopted by the individual states is still unclear. According to Barry D. Weiss, an attorney with Gordon and Glickson in Chicago, the digital signature in electronic contracting should perform, three specific functions. These are authenticity, integrity, and confidentiality.

Authenticity confirms the identity of the sender. It provides that "meeting of the minds" necessary in contract formation. Also "time-stamping" of digital signatures enhances authenticity confirming when an outstanding offer was accepted. Integrity maintains the terms and conditions of the electronic agreement. Both buyer and seller need the assurity that they are agreeing to identical terms. And confidentiality ensures that these Ts and Cs are not disclosed to competitors or to the public.

The contract of the future will be based on electronic business with standard computer programs. Encryption will be the rule for all e-commerce. In fact, eventually online contracting will be just like putting a purchase order in an envelope and mailing it. With that in mind, purchasing needs to be the function that determines who has the knowledge and authority to electronically bind the company. Like a signature, a "click" can create a valid contract. Access to digital contracting should be only for those with appropriate product knowledge and processing expertise.

21st Century Contract Management

Contract management is the process of ensuring that each party's performance meets contractual requirements. Effective contract administration is critical because an organization's failure to fulfill its contractual obligations could have legal consequences. The contract document is the primary guide for administering the contract. Work results must be measured and reported. Change requests, as a common element in most contracts, must be handled smoothly. An efficient process for monitoring invoices and payments must be maintained throughout the life of the contract. And effective disposition of disputes and claims is essential to successful contract management.

Also present will be a detailed description of the goods or services covered by the contract. Price is a critical inclusion or a method of determining price at the appropriate time. Manner, time, and place of delivery are also important.

With these contract basics attended to, specific contract administration techniques are in order. Contract management refers to all activities by buyer and seller from contract award to contract closeout. The purpose is to ensure that both buyer and seller complete all commitments and obligations.

The process includes control of work process, adherence to contract Ts and Cs, control of finances, and systems and process monitoring. The buyer must have in place mechanisms for identifying problems and determining their significance to contract objectives. These compliance measures should include scheduled performance, cost estimate adherence, resource commitment, consistent quality, and follow through on all contract provisions.

Few contracts are completed without some type of modification. For substantive changes, agreement must be obtained from all who will be affected by the change. The purchaser's authority is defined by the contract's clauses, and therefore these provisions should give the buyer authority to make changes.

One key to contract management is to become involved in the seller's performance. Let the contract itself specify the buyer's right to become involved — from actual participation in the process to having appropriate penalties for non-performance. The best performance insurance is to know your supplier — either through previous business dealings or respected references.

The basic contract administration process ensures compliance with all the Ts and Cs. These practices include thorough reading of the contract, assuring that each of the buyer's internal business functions knows their responsibilities in relation to the contract, establishing systems to verify conformance to contract requirements, checking actual performance against requirements, identifying significant variances, taking appropriate corrective action, managing the contract change process, and maintaining contract documentation.

Four contract administration policies are key to every contract. The first is the policy of compliance with contract terms and conditions. The contracting parties should know and understand the Ts and Cs and keep their promises to comply in good faith.

The second is effective communication and control. One of the greatest problems in management is communicating contract obligations to all affected people and maintaining control over their contract performance. Good intentions about contract performance will not be enough to avoid legal consequences in the absence of effective communication. Contracts must specify who is the designated point of contact and who has the authority to modify the contract. Each contract party must keep the other informed of its progress, problems, and proposed solutions.

The third administration policy is effective control of contract changes. Since contracts are dynamic, as performance proceeds original expectations and plans must be modified to adjust to real events. The contract agreement should reflect "real status" with regard to performance. Effectively controlling changes includes establishing formal procedures for changing the contract and limiting the number of people entitled to make changes. It also entails establishing recognition and notification procedures in response to unauthorized changes. And it requires establishing procedures for identifying, estimating, and measuring the potential and actual effect of changes on all aspects of contract performance.

The fourth is the effective resolution of claims and disputes. In contracting, disputes are inevitable. They are a normal and expected part of contract management. Disputes need to be resolved effectively and fairly. Experienced buyers and sellers recognize that claims and disputes do not indicate incompetence or ill will. Instead, they demonstrate that foresight, planning, and performance are imperfect. While each party to a contract has the power to litigate if that party believes it has been wronged, such litigation is costly and time consuming, and its results are uncertain.

A contract can end in one of three ways: successful performance, mutual agreement, or breach. Most end by successful performance. In a breach of contract, one or both of the parties fail to keep their promises. Contract closeout means the seller has delivered the required supplies or performed the required services, and the buyer has inspected and accepted the supplies or services. In contract termination the contract ends before the closure of the anticipated term of the contract. Contracts may be terminated or cause, that is, performance default by one of the contracting parties. Also, contracts may be terminated by mutual agreement or convenience.

A basic knowledge of relevant, legal principles is essential for successful purchasing and supply management. Proper attention to the legality of the contracting process and the use of the appropriate contract provisions will help ensure effective transactions. Modern commercial law allows for easier contract formation. Effective contract management allows for more successful contract completion. The buyer must not only know what to purchase, but must have in place the procedures for effective contract management.

References
  • Cain, David, Diane Savage, and John McMahon. "Commonly Asked Contract Questions." Purchasing Today, June 1998, 45-47.
  • Cohen, Gary, Effective Contract Administration. New York: Amacom, 1997.
  • Dobler, Donald W., and David N. Burt. Purchasing and Supply Management, 6th Edition, New York: McGraw-Hill, 1996, Chapter 30.
  • Fearon, Harold E., Donald W. Dobler, and Kenneth H. Killen, eds. The Purchasing Handbook. 5th Edition, New York: McGraw-Hill, 1993, Section 17.
  • Gabbard, Ernest G., "What Constitutes a Contract." Purchasing Today, June 1998, 16.
  • Garrett, Gregory A., World-Class Contracting. Arlington, VA: ESI International, 1997.
  • Hopper, Gary, "Contracting Do's and Don'ts: A Checklist." Purchasing Today, June 1998, 6.
  • King, Donald B., and James J. Ritterskamp, Jr. Purchasing Manager's Desk Book of Purchasing Law. 3rd Edition, Paramus, NJ: Prentice Hall, 1998.
  • Leenders, Michiel R., and Anna E. Flynn. Value-Driven Purchasing. New York: Irwin, 1995, chapter 7.
  • Pye, Carolyn, "The Look of the Contract in the 21st Century," Purchasing Today, June 1998, 18-24.
  • Ricketts, Dan J., "All's Well That's Contracted Well." Purchasing Today, June 1998, 33-35.
  • Weiss, Barry D., "Click and Contract." Purchasing Today, June 1998, 4.

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