Wednesday, August 24, 2011

Novating a Contract or Purchase Order

In the April 11, 2011 post I talk about the general concepts of assignment and novation. Novation is an activity that excuses an original party to the agreement from future performance obligations.

To actually do a novation you would normally write what is called an assignment, assumption and novation agreement letter that is signed by the three parties involved.For example, if you made an early purchase and did a contract or PO with a Supplier and then wanted to assign and novate that agreement to contractor there would be three parties, you, the supplier and the contractor.

An assignment, assumption and novation agreement would normally include a recitals section that describes what you are assigning and why to show the intent of the parties. It then needs to do three additional things.

You include language that exercises your right to assign agreement or PO to the contractor.Under an assignment you would still remain secondarily liable under that assigned agreement if it isn't novated.To avoid that liability you then include the novation portion where the supplier acknowledges the assignment and agrees that the contract is being assigned and novated to the contractor and that only the contractor will be responsible for performance under that contract in the future, Then to close it, you include language where the party to which the agreement is being assigned (in our example the Contractor) where the Contractor agrees to accept the assignment and assume the responsibility for the full performance of the agreement

If you expect of plan on having to do assignments and novations, in both agreements (using my example the Supplier and Contractor) you need to include those rights otherwise it would be subject to their agreeing to them. In the Supplier's agreement you should include the right to assign the agreement and have it novated (usually subject to some reasonable creditworthiness standard) to a third party. In the contractors agreement you should provide them with advance notice of the contracts that you may assign and novate to them and have them agree that they will accept those assigned and novated contracts or P.O.'s and manage them as their own.

The agreement is then signed by the three parties.

In jurisdictions like New York for there to be a novation it must specifically state that it is a novation.

Assignments and novations are frequently used in construction contracting or any other area where fast tracking programs requires a lot of advance contracts and orders and then requires assigning them.

I also used them frequently in divestitures where I needed to assign contracts and didn't want to have any liability going forward. If you are on the receiving end of an assignment and novation agreement (as happens when companies spin off businesses or sell business to third parties) always make sure that the new party has the assets and resources to meet all the obligations. I've had suppliers want to assign and novate agreement to companies that I had concern about and would refuse to accept the novation aspect. So that it didn't affect my supply
I would go to the new supplier and suggest that we create a duplicate of the current agreement and sign that. In doing that the original company would still be responsible for all liability for purchases we made from them and we only needed to look to the new company for protection for what we purchased from them going forward.

Most company law departments have standard templates that should be used.

Frustration of a contract

Frustration is one of the events that excuses performance under a contract.Other events include things such as subsequently illegality, impossibility of performance, impracticability of performance, rescission, novation and lapse of the contract.

The event of frustration is unforeseen and uncontrollable and makes it impossible for one of the parties to fulfill their commitment.The party that is frustrated in their performance of the contract may rescind the the contract and not perform without any liability.

Examples of frustration could be a number of things: destruction of the goods prior to purchase; damage to premises before work was scheduled to perform; intervention by public authorities that would prevent the work to be done; rulings by government authorities that would prevent the work being performed.The key is the event must be unforeseen and uncontrollable.

If a party failed to allow access to the work or failed to provide items they were required to provide during the agreement making the suppliers work be unable to be performed, the supplier would argue that their performance was deliberately prevented by the Buyer. Those types of acts would not allow the Supplier to rescind the contract and be excused of performance. Since the owner or buyer failed to meet their obligations and in effect breached the contract, the supplier could sue the supplier for breach to recover any damages they sustained.

Checking the Group's Productivity

To add value you need to also focus on making sure that the function is as productive as it can be given the number of cost drivers you must deal with. The first step in the analysis is to look inward in conjunction with your customers/.

Is the group’s focus correct (Are we doing the right things ?)
What is the department’s purpose?
Who are the customers and suppliers?
What are the customer’s requirements?
How are we doing in meeting their requirements?
Do we have any fiduciary requirements to the company?
How are we doing in meeting those requirements?
Are we doing things not required by the customers or our fiduciary responsibility?

The next part of self evaluation is to look at the work:

Are we doing the work right?
What are our priorities?
What are the problems and the root causes?
What is the best available solution for the problem? (Short term, Intermediate Term, Long Term)
If we do the fix, will it eliminate the customer’s problem?
Have we prevented the problem from recurring?
What are our other priorities which need to be attacked?
If you have problems a six-sigma appRoach should be used to understand and correct them.

Next you focus on what you could be doing better

Continuous improvement
How can we operate more efficiently ?
What are the priorities for improvements ?

The better you understand the businesses you support the more efficient you will be so take the time to understand the business and their needs and priorities..

Understanding the business
How is the business / Function organized?
Who are the key players in the Business / Function?
Who makes the decisions?
What is relationship been between purchasing and the business/function?
What is the standard procurement cycle for the business/function?
What are the unique risks with the business / function?
Where does the business / function see as opportunities?

Next look at the processes you have.
What is the existing Supplier Qualification Process?
What is the existing Product / Service Qualification Process?
Who makes up the Procurement / Acquisition “Team”?
What are the team members current respective roles and responsibilities?
What starts the qualification or purchasing process?
What completes the process?
What are the existing process “Flows”?
What Contracts are used to support the Business / Function?
What are the Sales documents used for the business / Function?.
a. What do we promise our customers?
b. What do we exclude or limit?
What contract administration is performed
What Scheduling or Program Management tools are used?
What are the channels for communication exist?
What are the sourcing guidelines?
Where is data shared and how is it provided?
How is Supplier Management conducted?
How is Commodity Management conducted?
How are key suppliers and strategic relationships managed ?
What cost reduction efforts have been accomplished ?
What revenue enhancement efforts have been accomplished ?
What portions of the business are centralized ?
What training exists and how is it delivered ?
What is the existing supply base and character ?
What Metrics measure goodness of the Procurement function ?
What are the Metrics the Business is measured against ?
What unique tools, forms, etc. exist
Are there any Unique Policies and Procedures ?
What is size of the Business / Function and their future trends ?
What are the current business plans ?
What are the known problem areas and most recent audit results
What authority has been delegated ?
What unique internal controls have been required ?
What responsibility is retained for delegated work ?
What systems exist ?
Are all the processes and flows documented?

For each point you look at what you are doing, why you are doing it and the extent of the activity, You look at the value added it provides to see if you can eliminate or reduce low value added activities..Keys to look for in this are:
1. Wasteful activities
2. Amount of time spent controlling and checking to value added
3. Large numbers of exceptions, special cases.
4. Substantial redundant data, re-keying of data type activities.
5. No responsible party for the process.
6. Lack of understanding on “why it’s done”
7. Lack of understanding who uses the information.

Once you understand the problems then its time to focus on how to improve the work

Approaches to work improvements.
There are a number of approaches that can be used to drive improvement:
* Time management. How much time does it take to perform the activity.
* Categorize purchases, suppliers and customers by A,B,C analysis. The start with AAA priorities and work downward.
* Identify Improvement Metrics (Suppliers reductions, savings, quality improvement goals)
* Implement quality improvement programs such as Six Sigma.
* Implement cost improvement programs
* Implement leadtime, flexibility, delivery, JIT programs
* Perform Activity Based Costing analysis of activities.
a. Understand what activities your people spend their time on
b. Understand how much time they spend on each
c. Understand the cost of each activity, the value added and the opportunity for change or savings.

Another approach to work improvement is re-engineering the activities performed
Identify existing process and activities
Identify if processes provide added value.
Identify items that could potentially be eliminated or reduced (duplicate activity)
Identify items that could be automated.
For value added items,identify whether they must be done by the group versus done by others.
Involve customers in decisions and priorities
Seek to eliminate no value added activities.
Reduce, re-design activities where purchasing adds unique value.
Transfer value added work not requiring purchasing expertise when they can be done with less cost and the same quality elsewhere.
Provide customers with on-going impact of the value added provided by Purchasing.

A final approaches to improvement is benchmarking and competitive analysis..
Perform Benchmarking (cost and process) / Competitive Analysis by activity.

Focus on best in class companies. Look at dimensions of the business to understand any differences.
Understand the practices they use that lead to their superior performance..
Understand your own processes and practices to see if your practices can be changed or improved to the best in class approach..
Set directions, goals and objectives for improvement..

Competitive analysis:
Focus on the competition. Seek broad range of information. Determine capabilities. Understand your own capabilities. Define strategies and tactics to compete. Understand your own processes. Define your own performance levels. Understand best supporting practices. Set directions, goals, strategies and tactics to compete. If you are concerned about the potential of the function being outsourced, look at the outsource suppliers to see what they do and how they do it to identify areas for improvement..

As you can't do everything immediately, you need to establish priorities for improvement.Understand what the most critical success factors are for the business you support and for your group. Then determine how well you are managing against them. For example how are you doing in terms of cost management, pipeline and inventory management, sourcing and managing key suppliers, risk management, organizational empowerment, skills development, internal controls and performance management.