Managing against changes and claims - a buyer's perspective for construction

In many parts of the world when you select the low bidder you will have one of two things occur. One is
You are dealing with the supplier or contractor that made the biggest mistake in their numbers. The other is they deliberately bid low. In either case one they have the award their goal will be to either make back the amount of their mistake or add to their profitability through changes and claims. As a result the contract manager of the buyer needs to manage the potential for both changes and claims.

The first place to start as a buyer is with the design. When I managed construction of buildings for an owner we would interview potential architects and engineers in advance and would review their work and samples of drawings and specifications. We would also get references and would check with those references about the frequency and nature of claims and would want to understand whether those were the result of problems with the architect or engineers design. Our list of potential designers would then be limited to experienced firms that showed that they had good internal quality control processes in place to avoid both problems with their designs or specifications. A problem to me is one where either the design in its current state cannot be build and requires modification or a design or specification that can have multiple interpretations, where the contractor assume the least cost option and you don’t want that.

While the design is in process you also want to pre-qualify your potential contractors or suppliers. I view pre-qualification to have multiple goals. First, does the supplier or contractor have the capability and capacity to perform the work? Second, each company has their own character and if you check customer references of the supplier you can understand what their character is like when it comes to both changes and claims. I normally seek to avoid companies that generate a high incidence of claims. Third, as part of the pre-qualification activity I also what see what the company does, how they do it, how they manage their work and their people. If I identify problems with what I see, I keep track of them so I can address them in the proposed contract. The last thing I use prequalification for is to uncover information that I can use in the negotiation or negotiation or claims. Many times a company may want to claim an extra charge for something you want them to do. If you have seen them routinely do that for all their work you viewed, I wouldn’t want to pay for what is really their standard.

In the contracting phase one of the most important things to include in a contract is a changes or variations clause where you limit the potential cost of any changes to cost plus a fixed percentage and required that the supplier or contractor provide you with documentation of the cost. The commitment to pay cost plus an agreed percentage should require the cost to be both actual and reasonable. You want actual cost so the provide invoices proving the cost. You want the requirement of reasonable cost as extra protection. You want protection against the supplier or contractor getting an inflated invoice from a sub-contractor or supplier that they frequently deal with and can dispute an invoice if its not competitive with costs others might charge. With respect to claims, one of the most important things to include is a requirement that the supplier or contractor notify you in writing of a claim and allow them a reasonable period in which to substantiate the claim and its cost. The last thing you want to do is come to the end of a long term contract and be flooded with a sea of claims and many of the project personnel who may have been familiar with it may no longer be working for the company or in that general. It much easier to understand the facts and take a position when you are able to quickly get all people involved in identifying the circumstances, cause, and impact of the claimed item.

In construction the next phase is the start-up phase. It is during the start-up phase when a supplier or contractor will propose the use of alternative materials or equipment. Some of the time those requests are based upon schedule needs where the item specified has a lead-time that would cause schedule problems. Many times the contractor or supplier may be proposing an alternative because it’s cheaper for them to purchase. This occurs frequently when a specification calls for a specific company’s product and allows “or equal”. The individual the manages any of these substitutions needs to do two things. First, they need to make sure that the change isn’t going to impact performance. Second, they need to understand any cost difference so they have that as a financial claim against the supplier or contractor.
Third, they need to look at the substitution from a total cost / total life cycle cost perspective. If the substitution is going to increase your total cost you want a further reduction to approve. For example
If the specified item had a three year warranty and the substitution had a two year warranty, the adjustment should include what your cost would be to purchase a service and maintenance contract for that year. For example if the specified item had lower energy consumption than the substitute, I would want the difference in cost over the equipment’s useful life to be deducted to make it equal.

In terms of the actual management of the work, there are a number of things that need to be in place. My contract management blog on my website has a number of tips on managing the work to avoid problems and claims,
Assuming contract management responsibility
Contract management as part of a team
Cradle to grave procurement contract management tasks
Dispute resolution
Establishing the contract file
Managing and documenting performance
Managing changes and the cost of changes
Managing claims
Managing amendments and change orders
Managing confidentiality or non-disclosure agreements
Managing payment
Managing bailed, loaned or consigned items
Managing terminations
Manage meeting minutes and correspondence.

From a claims management perspective these additional items need to be done:
1. The contract manager should review the contract and identify any deliverables that they or their separate contractors have to provide. With this list you create an internal action item list where you identify who owns the deliverable, when they have to provide it, the date they were notified of the deliverable, and the current status. This allows you to manage deliverables to avoid potential claims.
2. It should be clear to the supplier or contractor and their subcontractors on who has authority to order any changes to the work, as that can be a source of claims.
3. There should be periodic project meetings to review status, problems and deliverables.
4. As part of those meetings, the contract manager should establish and maintain an action item list where each issue gets documented, responsibility for correcting it assigned, date is was first raised is note and the current status get updated. The action item list should be used to expedite delivery of any owner or owner contracted companies deliverables to avoid potential claims because of delays in delivering approvals or materials.
5. Site supervision also plays a key role in managing potential claims. On major projects you will normally have a full site management office. One of their major responsibilities is to document all activities that occur on the site, deliveries made to the site and all items removed from the site. Those should all be consolidated into a site engineer’s log. That log should provide an excellent overview of what occurred on site on a particular date and is needed to manage and negotiate claims.
6. As work is being performed the engineer, architect or site project manager should also be maintaining a set of as constructed drawings and specifications that document what was changed, what change order or variation number that authorized the change, and when it was changed. As claims may apply to a specific date or time, if you update the documents you can see exactly what was required at any specific point in time.
The key in managing claims is to know what was required, what occurred, who was involved, and the impact.

Here is one example of how I managed a claim. I had an earth works contractor claim additional costs for removal and replacement of soil. I go a copy of the architect/engineers log of the work and our site engineer’s daily log. What I found was early on in the work the contractor had removed a significant amount of soil from the site. What I also found was the architect/engineer had instructed the contractor to stop uncovering as much soil as they were because they were concerned that the soil would be come unusable if it rained. The contractor continued to uncover large amounts against the architect’s instructions. It rained and the soil became unusable which force the contractor to being soil in and remove the unusable soil. I had evidence from the engineer’s log that showed how much had been removed from the site and that was more than they need to buy. So I didn’t agree to pay for the cost of their buying soil and trucking it to the site. I also had as evidence the engineers instructions not to uncover so much earth. I consider uncovering the excessive amount of soil to be a risk that they assumed.
What I offered to pay them was 1/20th of their claim amount. That equated to an amount that should have been reasonably uncovered that was now unusable and what it would have cost them to move it
from where they should have stored and protected the excess soils until completion of the work.

Contract Signatures - Who signs the contract first?

That was a discussion in a linkedIN group with a lot of opinions. Legally there is no rule about what party should sign the contract first. However, from a business perspective, my advice is to always have the supplier sign the contract first. My rationale is simple, most of time you don't have a bid bond that forces the supplier to sign the contract within a specific period of time. If the buyer signs first they lose some of their leverage. When a buyer signs the contract first, that represents an offer to the supplier. Unlike “mission impossible” where things self-destruct, that offer it remains open. The supplier has the right to accept or reject the offer within a reasonable period. A disreputable supplier may withhold signing the agreement as leverage to negotiate better terms because the buyer wants or needs to get the work performed.

If the buyer takes the position that the supplier has to sign the agreement first, if the supplier delays in signing the contract, the buyer could hire another supplier to perform the work. If the buyer signs it first, the buyer would need to provide notice to the supplier to rescind their offer. That would need to be done before the supplier signs the agreement. Since there is no notice requirement in place that would require written notice if you felt that the supplier was playing games with the signing, you could always call them with a witness listening on and ask them the status. If they say it hasn’t been signed yet, you could give them a verbal notice that you are rescinding the offer and confirm that in writing.

I have a reader that had problems with subcontractors signing their contracts within a reasonable time frame and wanting to negotiate further. When I asked for details she said they would provide a letter of intent. Since a letter of intent can be binding its not a lot different than signing the contract first. You are obligating yourself without the supplier being obligated. My suggestion to her was to simply stop using letters of intent, required the subcontractor to sign within a short period of time. If they don’t hire the next one and let the original supplier know that they didn’t get the job because they didn’t sign the agreement on time. It may cost you a little more that time, but it send a strong message that they can’t hold you up and play games.

In locations where it is legally acceptable I use counterparts language to expedite contract signing. What counterparts language does is allow copies made by any reliable means be considered to be an original. When I have counterparts language in the agreement I e-mail a PDF copy for the supplier for them to sign and require them to fax it back to me where I can sign it. I then fax that signed copy back to the supplier. Where counterparts language really works well is when you have a number of entities that need to sign the agreement where you can do the signing in parallel with all of them rather that serially having to send copies to one and have them transmit it to all others for their signatures.

Termination – What happens after you have terminated a contract?

What process or steps do you need to take after issuing a notice of termination? There are two types of terminations. A termination for cause is used when there has been a material breach of the agreement and a failure to cure the breach within the agreed time frame to cure (correct) the breach. A termination without cause is a right that you need to negotiate and include in your agreement. What you need to do will depend upon the type of termination you made (with cause or without cause) and what the agreement obligates you to do. For example if your contract was for the purchase of products you might have a termination without cause such as:

“Buyer may, upon ___ days written notice to Supplier, terminate this Agreement without Cause. In the event Buyer terminates without Cause, Buyer will compensate Supplier for the actual and reasonable expenses incurred by Supplier for work in process up to and including the date of termination. Supplier shall use reasonable efforts to mitigate Buyer’s liability by returning to its suppliers, selling to others the canceled Products (including raw materials or works in process). In accordance with Buyer’s written direction, Supplier will immediately cease work and prepare and submit to Buyer an itemization of all completed and partially completed Products. Supplier shall deliver to Buyer all Products satisfactorily completed up to the date of termination at the agreed upon Prices. Buyer and supplier shall agree upon the disposition of any work-in-process or raw materials. If Buyer wants work-in-process or raw materials, failure to provide them shall void Buyer’s obligation to pay for those materials. Buyer’s total payment obligations on a per unit basis shall not exceed the purchase price for the completed product.”

In this language, you have the right to terminate the agreement without cause but you are also obligated to make payment to the supplier. The supplier is obligated to help you mitigate the cost of such termination. So under a termination without cause, the supplier must first try to take those steps to mitigate the cost by attempting to return unused materials to their suppliers and to try and minimize any restocking charge. If the item could be used in products that the supplier sells to others, you want them to consume that inventory so there is no charge. If the volume is high and it will take some time for them to consume what they purchased for you, you might agree to pay them an inventory carrying cost while the proceed to consume them. If the supplier has no use for the materials and their supplier won’t take them back, you may want to sell the materials through the broker market where even if they need to sell for less than what they paid for it as it reduces what you need to pay. One the terminated party has taken that action the they need to prepare an itemization of all that is remaining and all the costs involved. That list needs to show their actual and reasonable cost of purchasing that item. It needs to show any costs they recovered as part on mitigating the cost. You then need to review and potentially negotiate what’s on the list. Is the cost actual and reasonable? Were the quantities consistent with what you had committed and your orders or forecasts? Once agreement is reach on the amount to be paid you then need to have them invoice you. I would also have legal provide you with a “waiver and release of claims” document where the waiver and release is conditioned upon being paid. I would do that to makes it a final settlement for the termination’s payment obligation as the waiver and release prevents them from making further claims for payments resulting from the termination.

In other types of contracts you can have a variety of different termination without cause provisions that place different financial obligations on the buyer in the event of a termination without cause. For example, in a professional services agreement a supplier might want to be compensated for labor costs for a period of time to account for the period of time it will take for their workers to be deployed to work for other customers. For companies that provide contract workers, they may only want to cover what their financial obligations are to that customer. In contracts for construction, you probably would need to commit to pay de-commissioning or winding down costs, any costs they may have in terminating all their subcontractors, and any contractor costs involved in work in process (WIP). The process you would follow to manage would be the same.

In terminating a contract for cause, I do not believe that the breaching party should be paid anything. They breached the agreement and shouldn’t be rewarded for that by having their costs paid. In almost all cases when there is a breach you need to hire someone else to complete the work and the cost to complete the work will be more than they amounts remain unpaid under the contract. If you paid the breaching party for their costs associated with the termination, that’s money you don’t have to complete the work. You may also have incurred damages and the easiest way to collect on those is to offset those damages against payments. The only time I would make a payment would be if the cost to complete and the damages you sustained are less than what remains under the contract and probability of that happening is zero. If you had a performance bond or financial guarantee the first thing you would do is provide notice to the guarantor or bond issuer that there has been a breach of the agreement, the contractor failed to cure the breach and the contract has been terminate and you are making a claim against their bond or guarantee. In many cases as part of issuing the bond, they may have the right to hire someone else to complete the work. If they determine that the cost of the remaining work would exceed the bond or guarantee, they may waive that right and make payment of the bond or guarantee amount. What you next need to do is identify all the damages you sustained as a result of their breach. You must read your limitation of liability section to determine if there are any limits on the types and amounts that may be claimed. For the remaining amount you may try to negotiate your claim with the breaching party. If that fails you need to litigate the claim to recover those damages.

Terminating a contract for cause is not an action to be taken lightly. You need to be absolutely sure that they have breached the agreement, it is a material breach, you have correctly notified them of the breach and the need to cure the breach and they have failed to cure the breach. If you are wrong you can be sued for a wrongful termination of the agreement. Termination a contract without cause is not something that a supplier or contractor likes, but it’s a tool that buyer’s need as needs change, business changes, your company’s financial position may change and the last thing you want to do is pour more money into work that you don’t need, don’t want or can no longer afford.

Authority and Authorized Representatives

Every company doesn’t want everyone within the company to be able to make changes to either the scope of the work or the terms of an agreement. Authority to sign agreement or act on behalf of the company related to agreement is delegated to individuals. For example, a purchasing organization on their own has no authority to sign contracts that bind the corporation. What usually occurs is the board of directors passes a resolution providing specific titles (such as the VP of purchasing or VP of sales) with the rights to sign agreements that are applicable to them. The resolution usually also allows them the right to further delegate authority to individuals in within their organizations to sign agreements. Those groups will usually have a policies or procedure on further delegation of authority. The normal approach is to have financial limits on the value of an individual contract that they can sign, with the amount based upon their position and experience. They may also have limits on the value of the amendments or changes they can sign so higher level review and approval is required once the value exceeds a cumulative amount.

An important fact about authority for companies with a number of subsidiaries, is that your authority is only limited to the specific company that granted the authority. For example, an employee of a subsidiary does not have authority to change another subsidiary or parent company’s contracts and vice-versa. To have authority the company that owns the contract needs to grant authority for others to act on their behalf.

Some people learn about authority the hard way. When I was in the Air Force many, many, years ago I was a contracting officer. We had a paving contract and when I received the request for payment there was an extra $500 on the bill. When I dug into the fact I found that a small paved walkway was added at the direction of a Colonel (who of course had no authority to make the change). I pointed out to the contractor the specific section of the agreement that identified who had authority to make changes. They agreed that the Colonel wasn’t authorized and I told them they should have known better than to do the work at his instruction. If they wanted to be paid, needed to collect it from the Colonel, which they did. The Colonel wasn’t too happy but he paid the bill and he learned about his authority.

To avoid this type of problem, when you write contracts you want to limit individuals from other groups from being able to either make changes to the terms and conditions or changes to the scope. Contracts will usually require that any changes or amendments to the agreement need to be signed by an authorized representative. That puts the contractor or supplier on notice that they can’t take direction from anyone in the buyer’s company, the individual needs to have authority. Many times the individual that signs the agreement can’t be in all places at all times and may need to have other parties act on their behalf. To do that you need to designate those as an authorized representative. That can be done in the contract or by a separate authorization letter from a party that has authority. The designation will usually include the scope of their authority and any financial limits to their authority.

For example in construction you may need to make a small change to the design. It needs to be done immediately or work will stop and it would subject the owner to claims for delay. As such we would designate both the project manager and site engineer with limited authority as owner representatives. The site engineer would have the authority to accept or reject work as it was being performed if there was a quality or non-compliance the drawings or specifications problem. The project manager would have the authority to agree to limited changes in the scope of the work up to a specific dollar amount.

The use of authorized representatives isn’t limited to construction. For example, with remote suppliers you may need to have your local subsidiary personnel or a third party perform actions on your behalf such as performing inspections of the progress of the work, checking quality, checking compliance with the terms of the agreement. Those local personnel do not have authority to do anything on your contract as they are employees of a subsidiary that is a separate legal entity. There needs to be a delegation of authority authorizing them to act on behalf of your company. If you hire a third party to perform such services, they too do not have authority to do those on your behalf. You need to designate them as an agent of your company so they have the authority to take those specific actions you authorized them to perform.

Establishing a Contract Management Group where none existed (Where to start).

Bea, from Paris asked that I write a post about taking over in an existing contract management team. “Where to start and how to optimize the organization where no negotiation team is build and no document system is created for retrieving past contracts? While this is a very broad request I thought I would share my thoughts on where to start.

In my blog on contract management (http://knowledgetomanagecontracts.blogspot.com) or the “Contract Mgt.” page on my website I had already written several posts about Contract Management Systems, Assuming Contract Management Responsibility, and Establishing the Contract File. Faced with this situation, the first thing I would do is collect a copy of all existing contracts. While that may be a challenge, the first place I would start would be to meet with the accounts payable and accounts receivable function. The accounts receivable function tracks receivables from customers who have purchased your products or services so that may help identify any sales contracts and applicable sales person to get information from. Similarly, the accounts payable function makes payments on purchase orders or contracts that you owe suppliers and will have information about who the supplier is, who authorized the purchase, and what internal account or cost center it is being charged to. In both cases finding the owner can help uncover any open orders. If there is an in house lawyer they will normally keep copies of any contracts they were involved with so they can be a good source for contracts that do not have a financial payment associated with them. If there is no in-house lawyer, companies will usually use an external lawyer who would also keep copies. A general message from management to the employees requesting that they provide copies of any contract they have to the new contract manager would also help uncover existing contracts. In that message they should further require that all future contracts be provided to the contract manager.

Once you have all known contracts collected, I would do an inventory of them and determine which are active, which may have expired, and those that have been terminated or closed because they are completed. My first priority would be on the active contracts where I would establish a unique contract file and contract number. If you had purchased a contract management system I would load all the information about them into the system. If you don’t have a contract management systems I would capture key data needed to manage the contracts for each active contract possibly on an Microsoft Excel spreadsheet that can give you an overview of key information and can allow you to do some minimal reporting and planning. As a minimum I would want to collect the following information:
1.Unique contract number assigned to that contract.
2.Supplier or customer name, address, key contacts, email address and phone numbers.
3.Contract commencement date, completion or expiration date.
4.Key milestones and deliverables required for both parties.
5.Listing of all signed amendments, dates and subjects.
6.Contract Value (fixed/subject to change or estimated value).
7.Payment terms or schedules.
8.Key money terms such as damages or penalties that may be applied.
9.Other key requirements such as insurances required.

For contracts that have expired or been terminated I would establish a separate list and would:
1. Assign a unique contract number for filing purposes.
2. The supplier or customer name, address and a brief description of the subject of the contract.
While a contract may be completed, expired or terminated, the parties may still have rights under those contracts or claims, including third party claims could be made so those contracts should be filed.
You need to have a record’s retention plan based upon your company’s needs and the stature of limitations for any possible contract related claims. You need identify what you have, where it is located and when it is acceptable to have those documents destroyed.

Once you have this in place you can begin to perform contract management. In my post http://knowledgetomanagecontracts.blogspot.com/2012/03/cradle-to-grave-procurement-contract.html I listed what I call cradle to grave tasks in procurement contract management. The specific contract management tasks would be:
Contract filing and creation of contract management file.
Manage negotiations during mobilization of the work, requests for changes.
Manage and document performance.
Manage deliverables.
Negotiate changes.
Negotiate claims or disputes.
Negotiate amendments and file amendments
Manage payment or receivables
Manage bailed, loaned, or consigned items and their accounting or return.
Manage confidential information provided or received.
Manage any early terminations with or without cause.
Manage meeting minutes and correspondence.
Manage notices as required.
Manage acceptance and test activities required by the contract
Provide information or reporting on compliance.
Manage final acceptance and turnover of all required documents.
Manage collection and return of any items that must be returned upon completion.
Close or renew the contract.
Produce documents and provide support for any litigation.
Include documents for retention in accordance with your retention plan.

In contract management, at any point in time you may be asked to identify:
What agreements are active or closed?
What is the spend status against a contract and how much remains on the contract?
Is the contract amount a firm obligation?
What are the current terms?
What were the terms on a specific date or period?
Who the parties are?
What type of business are they such as small business, woman owned, etc,?
Where are they the located?
How much do you spend with them?
Who the internal customer(s) are for the contract?
This information can be used for a variety of purposes such as compliance reporting, financial management, claims management, etc.

Having key information readily available can simplify responding to data inquiries and provides you with more time to train your people and manage your contracts. For example, I have significant experience in both outsourcing and divesting business groups as part of a sale of the business. In those situations you would use a combination of purchasing systems, contract management systems and payment systems to determine several basic things.
a) What contracts are applicable to the specific business involved?
b) Can those contracts be assigned to either the outsource partner or buyer of the business or can the outsource partner use those contracts?
c) If the contracts supported more than just the business involved, and you need to do an assignment of the contract to the new business owner, how can you meet that obligation and your other group’s needs?
Without having those systems countless hours would be required to find the information. With the systems you can determine what groups made purchases under the contracts by their cost center information, how much the spent, when the last purchases under that contract were made by them etc.