Friday, February 11, 2011

Negotiation - Thoughts on Negotiating Audit Rights

If you have contracts where you agree to reimburse the Supplier for certain activities on a cost plus or time and materials basis, or you negotiate a form of most favored pricing commitment, you need to two things.  The first is a requirement that the Supplier keep and maintain records of those costs for a specific period of time so they can be verified. Second you need to have some form of audit rights. If you have most favored price language in a contract without audit rights, the only way you could enforce it is if stumbled across information that could show that the Supplier was giving a better price to another customer. Odds are fairly high that they aren't going to volunteer to give the information on their own.

When audit rights language is negotiated, the typical things that are negotiated are:
1.     Who can perform the audit.
2.     When or how often it can be done.
3.     The extent of the audit.
4.     What records will or won’t be made available.
5.     Who pays for the cost of the audit.

Audit rights are something that Suppliers are extremely reluctant to provide, as they are concerned about the information that the Buyer could discover. You should expect that Suppliers will as a minimum want to:
1)    Limit it to an independent auditor, rather than Buyer personnel
2)    Have agreement or approval over the auditor that will be used.
3)    Have the scope of the audit be restricted to only that information required to verify the charges
4)    Limit the frequency as much as possible to reduce the disruption and
5)    Want the Buyer to pay for all costs.

As a Buyer, all of these restrictions will add to your cost. One way to help keep the Supplier honest is to negotiate the responsibility for the cost of the audit. If the audit discloses minimal discrepancies the Buyer will pay the full cost. If the Audit discloses discrepancies above a certain amount, the Supplier must pay for the cost of the Audit along with reasonable interest on the shortfall.  Having the Buyer pay the cost of the audit will be viewed by the Supplier as something that will avoid frivolous audits. Having the Supplier pay plus interest is just a way do drive their behavior to act correctly in managing their records and charging you.

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