Wednesday, April 6, 2011

Continuity of Supply

To ensure continuity of Supply many companies standard contract templates may have:
·       Requirements for disaster recovery plans,
·       Periods of guaranteed availability for products, spare parts, repairs or services, 
·       End of life notice requirements and last time buy rights.

There are other ways to manage continuity of supply.
·       Dual source items and make sure both Suppliers get volumes as it may be difficult to get a Supplier to respond to a problem with another Supplier if they were not getting business.
·       Have inventory held either by the Supplier or third party to minimize the impact of force majeure events.
·       Require Software Escrow & Licensing requirements and Hardware Escrow and licensing requirements, with rights to make or have the material made in the event of a material breach.
·       Require suppliers to set up a dual source (either requiring they produce the product at multiple locations of theirs) or the license a third party to build it.

The biggest challenge in managing continuity of supply is cost.
·       It costs money to develop and qualify a second source and it would cost to have the Supplier set up a dual source.
·       Having dual sources may affect the average price you pay as the volumes are split, potentially reducing volume based savings.
·       Having dual sources may affect the average price you pay, as the supplier prices may not be the same because their products or cost structure are not the same.
·       Inventory whether the Buyer holds it, Supplier or a third party adds to cost.
·       Escrow and licensing requirements cost money and there will always be cost to establish a new source even with getting the escrow materials and rights.

Most supply chains focus on pushing as much inventory as possible back into the supply chain to reduce inventory levels the Buyers carry and reduce their cost associated with excess or obsolete material.  When you do that your ordering and forecasting need to be well managed. If you forecast and order too little, you have the cost of expediting and any premiums required. If you forecast too much, but pull too little, the Supplier then has excess inventory that they are paying for. If they don’t get recovery for their costs of that excess inventory, they won’t trust forecasts and will only order consistent with actual demand, which can cause supply shortages and interruption to the continuity of supply.

To ensure continuity of supply there has to be a balance struck between what’s needed for continuity of supply versus what’s desired for cost reduction. If cost always wins out, you will have continuity of supply problems on an on-going basis. 

Contract Construction

In drafting and negotiating contracts its very important to understand how they will be interpreted if the contract were to be interpreted by Courts as part of a law suit. There are some basics rules / standards that apply:
  1. If the parties attach the same meaning to a term, the interpretation will be based on that even if a third party may not interpret it the same way. If the parties have a different understanding of the meaning, a contract may not be enforceable as there was no meeting of the minds.  If you had reason to know what the other party understood the term to mean, it may be interpreted according to their meaning.
  2. If the language is clear and explicit, the court will look no further in interpretation. The exception to that is if the language would lead to an absurd result.
  3. Contracts are construed against the drafter if there are any ambiguities.
  4. Words are given their ordinary meaning unless a special meaning is given to them in a technical sense or by usage such as creating defined terms.
  5. Technical words are interpreted by persons in profession or business they are used in.
  6. If a term is omitted, courts will supply a term that is reasonable.
  7. If there is a written agreement, evidence of a prior or other agreement is inadmissible to vary or contradict the terms of the written agreement.
  8. If the meaning is plain and unambiguous, the meaning will be determined within the document without extrinsic evidence.
  9. Enforcement will be according to the terms or the agreement provided that the agreement is clear and complete.
  10. Terms will be interpreted to be complimentary.

To put this into the perspective of a contract:

To make sure that the parties attach the same meaning to an item, contracts usually have a definitions section and create defined terms and each time the term is used that has that special meaning, it is capitalized to show that it is a defined term

To prevent extrinsic evidence from being introduced, contracts will have what is called a “merger clause” such as “This Agreement replaces any prior oral or written agreements or other communication between the parties with respect to the subject matter of this Agreement” to show the clear intent of the parties that what is within the “four corners” of the agreement is all the parties intend to constitute the Agreement.

To deal with issues where a term may be found by the courts to be unenforceable, most contracts will also contain a severability provision that says that the if the unenforceable term doesn’t materially affect the parties rights under the Agreement, the agreement without that term will remain in effect.

Another key term in interpreting an agreement is making sure that there is a clear understanding between the parties on exactly which terms will survive the termination or expiration of the agreement. That is done in a survival provision.

Another issue in interpretation of an agreement can be the specific actions of the party. For example if you have a specific term within your agreement that you continually do not enforce, in interpreting the agreement a court could determine that by your actions you have “waived” your rights to enforce it. To prevent that, most agreement will normally include a “waiver” provision which both requires that any waivers must be in writing and that a waiver of one instance will not be deemed to be a waiver of future instances. 

As agreements frequently consist of a number of documents that are either attached to or are incorporated by reference into the Agreement, ever good contract will have an “order of precedence” provision that establishes the priorities in the event of a conflict between the documents.  In situations where the parties have agreed to an order of precedence, that will be used to interpret the parties obligations. If there is no order of precedence, or if multiple documents that make up the agreement have the same precedence, they will be interpreted to be complimentary. So if one document called for A to M and another called for N to Z, it would be interpreted to require A to Z. Even when there is an order of precedence, the order of precedence only establishes the priority between conflicting provisions. So if you have A to M required in a document that has priority and you have N to Z required by a document of lesser priority, you could still have A to Z required. However, if something in Section C has priority over anything in sections N to Z and there is a conflict with something in Section P, the contract would be interpreted such that the conflicting language in P would not apply. The more important things are, the more important it is to establish the right order of precedence and that can apply not just between contract documents like an agreement and a statement of work, but also between things like the specifications that are made part of the agreement. For example, you may want a Statement of Work to have precedence over the terms of the agreement, but do you also want all the documents that are incorporated into that statement of work to also have priority over the Agreement? Where this is extremely important is if you will be incorporating any of the other party’s documents into your agreement where if you don’t correctly establish the order of precedence the supplier’s document could have priority over the terms of the agreement negating the term.

In dealing with documents that are executed at different times, unless there is an order of precedence established between those documents, the latest writing in time will always have priority. For example an amendment could potentially change both the agreement it is amending and it could change a prior amendment if it is written at a later date. In writing amendments it’s important that they be drafted in a way where the scope of the change is clear and it identifies whether it applies to only a limited scope or the entire agreement. Remember, as the drafter of the document any ambiguity will be held against you.

As a Buyer, if you are using your own contract form, all this means is that if there are errors, inconsistencies, or if a particular point is vague or ambiguous, that may be construed against you so its better to clearly define exactly what the obligations of the parties are and what they mean. 

The last point I is the combined impact of both #7 and 8.  If the agreement is clear an unambiguous a court will only look at what's contained within the Four Corners of the Agreement. With this an prior 
representations, promises, agreements will not be considered.  If a promise or representation was an important consideration in making the purchase, make sure that its included in the agreement!

Contract Drafting with Precision

Some languages are very precise. For example the German language is very precise and when you see a word that may be 20 plus characters or more long, it’s because the word is describing something exactly.  Other languages like English are far less precise. Individual words can easily have a number of different meanings.  The impact of this is when you deal with contracts in English or another less precise language, as the drafter of the document you need to be precise. A second reason for being precise is that in the event of ambiguity, Courts will normally interpret the ambiguity against the party who drafted it.

Precision needs to start with the Bid or Request Phase where you need to tell the Supplier exactly what you need or want. Two things can happen if you don’t.  One is they can make an assumption about what you need, and they may be assuming something that is costlier than what you really need.  They may also interpret it in a manner that is most favorable to them. I did construction contracting for a number of years and probably half the changes I saw throughout the course of a project resulted from either the drawings or specifications not being precise. Contractors would use that lack of precision to interpret the requirement in the way that was most favorable to them. Then, if you wanted something different than they were planning to provide, it required a change (and additional cost). Precision needs to apply not just to the contract but also to any documents that make up the contract.  Trying to slide something through by being ambiguous can only lead to a dispute that you will lose one way or another. You may win the battle, but lose the war.  

There are a number of ways to be precise:

Use Defined Terms
A “defined term” is either:
·   A term defined in the Definitions section of the Agreement or Agreements.
·   A term defined within the text of the Agreement after its initial use (an “in-line” definition)
·   Make sure you always capitalize each use of a defined term.
o   For example: “Product” – when capitalized, the parties signify that the definition applies. If “product” were not capitalized, the definition of “Product” would not apply, causing confusion on what the parties intended “products” to mean.  
             Make sure that the same terminology is used in all documents.
             If your contracting approach uses multiple documents to create an agreement, do not assume that the current template is compatible with the definitions of existing agreements. Make sure the definitions and defined terms are consistent.
Use the right “standard of commitment”
The words you use to describe the obligations of the parties create different standards of commitment. For example you can:
1. Intend to do something
2. Agree to agree in the future
3. The party can make a commitment that they may do something
4. Agree to agree in the future with both parties acting in good faith
5. Agree to act in "good faith"
6. Agree to do what is "commercially reasonable"
7. Agree to do what is "reasonable"
8. Agree to do it with "best efforts"
9. Make a conditional commitment (If X happens then we will do Y)
10. Make an absolute commitment ("shall, will")
11. Make a material representation.
12. Make a warranty.

Use words to define whether it is a right or an obligation. Obligations must be performed, rights may be exercised.
Write “active voice” sentences
             Active voice sentences are shorter, and easier to read and understand than sentences that we write in the passive voice. In active voice sentences, the subject performs the action expressed in the verb; the subject acts
             In sentences written in the passive voice, the subject receives the action expressed in the verb; the subject is acted upon
            Supplier shall deliver the Product to the Buyer on June 1, 2009 (active voice example)
            The Product shall be delivered to the Buyer on June 1, 2009 (passive voice example with agent performing the action omitted)
Active voice sentences are more clear and concise, they clearly define who does what.  Passive voice sentences are longer and can create confusion.  They can also de-emphasize the responsibility of the acting party. For example: “The Product shall be delivered to the Buyer on June 1, 2009” (the party responsible for the action is not identified)
Manage any “incorporation by reference”.  Include the information that makes no mistake about what document you intend to include by referring to the title, the date, or revision, and the number of pages.
Always check to make sure you language answers five basic questions:
·   Who is responsible to perform the action?
·   What are they responsible to do?
·   Where will it be done?
·   When will it be done?
·   How will it be done?
Example:  Supplier shall deliver the Product to Buyer, ex-works Supplier’s dock in Taipei, Taiwan, on August 1, 2009. Who” is the subject of the sentence. In this case it’s the Supplier. “What” is the delivery of the Product. “Where” is the Supplier’s dock in Taipei, Taiwan. “When” is July 1, 2012.”How” is Ex-Works

Other ways to drafting with precision:
·   Make your sentences short.
·   Use common words
·   Be precise. For words with multiple meanings establish a defined term or don’t use them
·   Avoid repetition as it creates the potential for conflicts.
·   If you use an example make sure it’s accurate and can only be interpreted one way. 
·   When including a list, identify whether it’s inclusive or not. . “This includes, but is not limited to”.
·   Follow each issue to completion to make sure the term is established.
·   If documents should not be of the same standing, make sure you establish the priority.
·   Ensure that the section and sub-section numbers are in the correct sequence
·   Ensure accuracy of all cross-references.
·   Ensure accuracy of dollar amounts by stating amount in both alphabetical and numeric descriptions.
·   Ensure accuracy of percentage references by stating percentages both alphabetical and numeric descriptions.
·   Ensure accuracy of date and time period references by searching for: Day, Date, Week, Month, Year, and Annual
·   Ensure references are clear by defining them e.g. Does  “Day” mean business day or calendar day. If you use Business day, whose Business day applies?
·   Ensure that uses of “include” (and variations) are consistent (e.g., including but not limited to vs. including)
·   Ensure that each defined term is actually used in all appropriate places (including the defined terms for both the “Supplier” and the “Buyer”)
·   When needed to show the intent add clarifying statements or examples.
·   Perform a spell check. Read the document, as the functionality of word processing spell checks will not highlight when the incorrect word is used if it is spelled correctly.
             If you are using an agreement that you used for another Supplier, make sure you remove all references to them.
             If you are using a template that contains instructions or alternatives, delete the instructions and select the alternative you want.
             Be extremely careful in incorporating any Supplier document as part of your agreement. Even if you give it the lowest priority, as long as the language included in it doesn’t conflict with the other terms it could place additional restrictions or obligations on the Buyer or relieve the Supplier from any obligations where your agreement may be silent. For example, if your agreement was silent about the implied warranties of merchantability or fitness for a particular purpose and the Supplier’s document disclaimed them, you would not have those warranties.  

Contract Management / Contract Administration

The concept of contract management or contract administration is to ensure that the other party to the agreement meets all the obligations of the terms and conditions agreed upon and that you meet your obligations. Even with the simplest form of contract (a purchase order) may require some administration such as expediting to get delivery, return of non-conforming or defective products or service, and management of what may be required to make payment.  In many contracts the Buyer’s sole obligation may be to make payment. 
The more the Buyer has to provide deliverables, or provide reviews or approvals the more you must manage those commitments as failing to provide them or failure to provide them in a timely manner can create claims for additional performance time and additional cost resulting from not meeting your obligations.

Depending upon what you are buying, the Supplier you are dealing with, and the relationship you have with the Supplier, the scope of contract management that is required will vary. On one end of the scale contract management may be simply filing the contract away and only going back to it when there is a problem or dispute. That type of relationship may exist when you have a long-term relationship with the Supplier, and they consistently meet all the requirements, especially quality requirements. At the other end of the scale would be dealing with a potential problem supplier in which this is the only relationship you have with them and what you are buying has a critical schedule, a number of deliverables, the activity frequently changes and the purchase involves significant potential risks. A good example of the former would be a contract to purchase standard goods or services from a high quality supplier who consistently meets their obligations. A good example of the latter could be the purchase of construction of a new building needed to manufacture a new product or provide new service.

Contract Management is the process of managing all of the events that occur between the parties to the contract from the execution of the Agreement through the final completion of all obligations of the parties under that Agreement.
Contract Management activity should start as early as the bid/proposal process in which performance issues and risks are identified and a plan is established that defines how those performance issues and risks will be managed. The tasks involved in Contract Management can be performed by many people on the team, but there needs to be strong coordination and communication between the team members to ensure that actions and communications with the Supplier / Customer are consistent and reflect the team’s position. In major purchases there can be a multitude of activities that occur, and daily administration of the contract and timely updating of other team members is required for successful management of the program!
Negotiation is not a point in time task to be completed. Negotiation is an on-going process that starts with the initial meeting or discussions with the customer or supplier and continues through the process until the last warranty obligation under the agreement is met and all other obligations of the parties are compete. We call much of the activity that occurs after the negotiation of the agreement to be supplier or customer management. The more appropriate title should be “managing performance and the on-going negotiation process”.
How well you manage the basic process and the changes that will occur throughout will determine how costly or profitable the relationship will be. How well you are able to document the activities that occurred will determine how successful you will be in either initiating or defending a claim. If you are on the Selling side everyone on the team should know that their goal is not to maintain the margin, it is to improve it. On the Buying side your goal is to insure that “you get what you have paid for”, which means to maintain the margin status quo.
A complete, accurate contract file is needed to manage changes in personnel, temporary absences, claims, negotiations and the potential lawsuits that may occur. The contract file will consist of the legal documents which comprise the agreement plus:
·      Any documentation needed to be maintained under the contract;
·      All supplier, customer correspondence including letters, minutes of meetings, records of conversations, phone calls etc.;
·      All change requests, correspondence, back up data, disposition and revised documents;
·      All technical information relating to the Agreement including the engineers notebooks, technical reports, files, copies of inspection and test reports, logs maintained, and any other pertinent data;
·      Other records which show performance such as payment requests and records of disbursements, copies of required insurance policies,
·      Delivery and acceptance reports.
The actual contract portion of the contract file will consist of the contract itself; all of the contract appendices, attachments, exhibits, schedules, all documents incorporated by reference in the contract, and all approved amendments or changes to the contract. It is important to maintain and document the various changes and keep all copies of all items from a historical perspective as the question of what were the applicable documents were at a specific point in time may be the difference between being successful or not in the event of a problem or claim.
In the contract file it is important that all data be properly maintained as reference to the actual contract portion will only provide half of the information needed in the event of a problem. To resolve a dispute you may need to refer to correspondence, logs, notebooks and any other documents which will allow you to properly reconstruct the events in question and determine which party took what actions and who is responsible for what items, activities, charges, or payments.
All of the contract file should be maintained either as a single contract file or in separate locations as long as it will be properly maintained and the information, if required, will be easily accessible. The contract file needs to be maintained as both a history of the Agreement and as a legal record of the events that occurred during the Agreement.
If a customer or supplier brought a claim against you two years after the completion of an agreement, (and in many locations they would have two years because of the statute of limitation on contracts) the parties who would have to manage and negotiate the claims would need access to those records and those records have to be sufficiently organized so as to allow for easy fact finding.
Frequently the parties who were involved in the Agreement may no longer be available to provide the information. Those who assume the responsibility for managing or closing any disputes must be able to rely upon those records to re-construct the events that occurred in deciding how to respond to the actions at hand. As with all other records they must be maintained as long as obligations exist plus normal retention periods for legal and tax documents (usually seven (7) years for tax reasons). 
Upon assuming the Contract Management function it is important that you familiarize yourself with the detail of the contract. This is important so that you will have a general understanding of the roles and responsibilities that are identified and the familiarity will aid in your being able to interpret the contract when questions arise.
The contract will, in many instances, be made up of multiple documents and when there are multiple documents there is always the potential that some may conflict with each other. The contract should set forth the order of priority or precedence in the event such conflicts arise between the documents. This is especially important where you may have a Request for Proposals which contains one set of requirements, a Proposal which may propose alternative requirements or conditions and take exceptions to the Request for Proposals, and additional documents which seek to clarify the negotiated positions. Depending upon the priority in which these documents are given you may have different interpretations as to what is required.
Normal priorities that should be addressed in the establishment of an order of precedence are:
1.         Documents are prioritized by importance.
2.         Where multiple documents deal with the same issue, the priority should be in order of time, with the last document agreed in time having the highest priority.
For example if you had a RFP, a Proposal, and Clarifying Addendum to the proposal and wanted to incorporate all, the precedence would be:
First, to the clarifying addendum, second, to the proposal, last, to the Request for Proposals
3.         Where multiple formats deal with the same subject matter, such as drawings and specifications, you would normally want the written word (Such as the specifications) to have priority as they would provide the more detailed description of what was intended.
4.         Documents that are made part of another document are considered to be complimentary in nature, so they have to be read and interpreted as a whole. For example: An RFP could call for items A, B, &C to be performed. A proposal could call for items D, E, &F to be performed. A clarification could call for items G, H & I to be performed. If all documents were incorporated by reference into the contract, as long as the items are not in conflict with each other and, as long as the language does not specifically exclude any of these, they would be read to be complementary thereby requiring all items A-I to be performed.        
Every contract, complex or simple, has items that need to be administered in order to minimize risk and liability and to try to ensure performance. Throughout the agreement are activities that require performance. If the agreements are properly drafted they will also identify the time period in which performance is required and what happens if these are not performed on time.
One of the first tasks of Contract Management is to review the Contract in detail, understand the tasks, performance, and deliverables required and the time frames for performance and ensure there is a plan to manage the requirements. To manage a contract you need to understand what each of the terms mean, why they are included, what happens if you fail to manage to them. For example you need to understand the impact of a potential of waiver of certain rights.
Throughout the process, changes will occur to the various documents by amendments or change orders to the Agreement. A good practice in Contract Management is to maintain two separate copies of each of the documents. The first document should be the untouched or record copy of the document for the files. The second copy should be your working document on which you annotate all of the changes that have occurred and reference the Change Order in which the change was authorized. (E.g. the language change or price change, C.O.#1). In manufacturing changes to the design would have to be noted along with the effectivity date for those changes to have taken place. In those situations it is important that you be able to identify what requirements were in place for each shipment.
If installation or construction is required and drawings exist, an example of this activity would be to mark up the drawings with the change and change order producing a record drawing. Record drawings properly annotated with the changes made can then be used to easily generate “as-built” or “as constructed” drawings that may be a requirement. The practice of maintaining the two separate copies is strongly recommended as the annotated version, if properly recorded, will serve as a quick reference document for finding issues for day-to-day management and eliminates the need to look through and cross reference all changes to determine if the issue at hand has been changed by any of them. The longer the period of the agreement and the more changes which occur, the more valuable this approach becomes as a time saver. The second un-annotated copy serves as the legal record. As it is unchanged you can then, if needed, take and construct the status at a particular point in time, as there may be questions as to what was in effect at a particular date or during a particular period of time.
The person who has the Contract Management function should manage the entire contract file. Receiving and filing copies of all correspondence, documents and records pertaining to the agreement can either accomplish this. An alternative to this can be where there is agreement reached in advance as to who on the team will be responsible for maintaining which specific records and, that upon completion of the project all pertinent records be transferred to a central record keeping location for controlled access by any one needing the records.
Document! Document! Document! Many suppliers suffer from “SML” - Selective Memory Loss. Log all calls and maintain a contract diary keeping track of who at the customer you talked with and reduce all requests, verbal agreements, decisions on schedule, cost, contract terms and conditions, approvals and waivers and work activity, cause & effect and cost of delays, work stoppages, quick turn around activities and premium charges, responsible party. Etc., etc. to writing as soon as possible. Confirm back to the customer and the Supplier our understanding of the discussion.
If periodic review meetings or special problem resolution meetings are held we should publish the minutes of those meetings.
We frequently consider establishing capabilities for the Supplier to talk with us electronically. While this can speed up communication it can also help get the documentation process further out of control. It is important that the discipline be instilled that if electronic messaging is used a copy of each message be provided to the administrator as a matter of course. The same need for discipline applies for written communications. The Contract Manager should have the record copy of all documents.