THOROGOOD PROFESSIONAL INSIGHTS
A SPECIALLY COMMISSIONED REPORT
PROJECT RISK MANAGEMENT THE COMMERCIAL DIMENSION
Tim Boyce
THOROGOOD PROFESSIONAL INSIGHTS
A SPECIALLY COMMISSIONED REPORT
PROJECT RISK MANAGEMENT THE COMMERCIAL DIMENSION
Tim Boyce
Published by Thorogood
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The author Tim Boyce began his career in the Ministry of Defence holding executive positions in contracts, contracts policy and finance. His industrial career began at Plessey in 1980 after which he enjoyed appointments with Siemens, British Aerospace and more recently as commercial director at BAE SYSTEMS. His functional responsibilities have included contracts, commercial, procurement, estimating, legal, project accounting and the implementation of the European Business Excellence Model. His committee work includes the Chartered Institute of Purchasing and Supply National Contracts Management Committee, the CBI Contracts Panel, the CBI Defence Procurement Panel and the CBI/MoD working groups on partnering and incentive contracting. He was the CBI observer at the HM Treasury Central Unit on Purchasing working group on incentivising industry. In 1997 he was invited by the Director General of the CBI to join the CBI Public Private Partnership Forum. He has lectured widely in the UK and in the US on business, contract and commercial management.
Contents
1
TOTAL RISK MANAGEMENT
1
2
GETTING TO CONTRACT
8
1. The risk – risk scenario ...........................................................................9 2. The bid/no bid decision ..........................................................................9 3. Bidding ...................................................................................................16 4. Pricing for risk ......................................................................................19 5. Risk review board .................................................................................23 6. Making an offer .....................................................................................25 7. The priced list of risks ..........................................................................29 8. The caveats register ..............................................................................30 9. An effective contract ............................................................................31 10. Negotiation ..........................................................................................34 11. Contract launch ...................................................................................35 12. Pointers for project risk management ..............................................36 Checklist .....................................................................................................36
3
FINANCIAL RISK
38
1. Prime contract financial risk ................................................................39 2. The nature of price and the sharing of cost risk ...............................39 3. The client will not pay ..........................................................................43 4. The client cannot pay ...........................................................................46 5. Inflationary cost increases ...................................................................46 6. Foreign currency fluctuations .............................................................48 7. Contract termination ............................................................................51 8. Financial claims against the prime contractor ..................................53 9. Pointers for project risk management ................................................54 Checklist ....................................................................................................55
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TECHNICAL RISK
58
1. Do we want to take this risk? ..............................................................59 2. Analysing the requirement ..................................................................60 3. Options ...................................................................................................60 4. Sharing the risk .....................................................................................61 5. The commercial engineer ....................................................................62 6. Setting the baseline ..............................................................................63 7. Requirement creep ...............................................................................64 8. The changing requirement ..................................................................65 9. The work takes longer than expected ................................................66 10. The never-ending contract ................................................................68 11. Failure of performance ......................................................................69 12. Buyer initiated problems ....................................................................70 13. Pointers for project risk management ..............................................71 Checklist .....................................................................................................72
5
TIMEFRAME RISK
74
1. Bidding compliant delivery .................................................................75 2. The timeframe obligation .....................................................................78 3. Time is of the essence ...........................................................................79 4. Consequences of delay .........................................................................79 5. Liquidated damages .............................................................................81 6. Force majeure .......................................................................................81 7. Delivery incentives ................................................................................83 8. Client delay ............................................................................................84 9. Subcontractor delay .............................................................................86 10. Prime contractor delay .......................................................................86 11. The threat of termination ...................................................................88 12. The threat of damages ........................................................................89 13. Pointers for project risk management ..............................................91 Checklist .....................................................................................................92
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SUBCONTRACTOR RISK
95
1. For the want of a nail ...........................................................................96 2. Subcontracting: Benefit, risk and strategy ........................................97 3. Subcontractor lateness .......................................................................104 4. Subcontractor failure .........................................................................105 5. Subcontractor work unfit ..................................................................106 6. Monitoring subcontractors ...............................................................106 7. Pointers for project risk management ..............................................107 Checklist ...................................................................................................108
7
PROJECT COMPLETION AND BEYOND
113
1. Life after completion ..........................................................................114 2. Key contractual milestones ................................................................114 3. Residual obligations and risks ...........................................................117 5. Acceptance ..........................................................................................118 6. Products rejected ................................................................................120 7. Title does not pass ..............................................................................121 8. Products lost or damaged in transit .................................................122 9. Failure after delivery/acceptance ......................................................122 10. Warranty ............................................................................................123 11. The hand over of technical data to the client ................................125 12. Third party intellectual property rights .........................................127 13. Account management ......................................................................129 14. Pointers for project risk management ............................................130 Checklist ...................................................................................................131
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Section 1 Total risk management
Section 1 Total risk management The basis of all business is buying and selling goods or services or a combination of the two. The word product is these days used for both goods and services. A television is a product and a particular type of insurance scheme may be described by the provider as a product. For the purposes of this Report the word product will be used in the former sense. Products are designed and produced and sold to customers as end items in themselves. The characteristics of a product might include: it is available off-the-shelf; it is produced (hardware) or replicated (software) in quantity with each unit being identical to every other; the design is driven by the supplier (albeit aimed at specific markets) rather than by an individual customer; the performance characteristics are well known prior to the product being made available to customers; its constituent parts are readily available as materials or components. On the other hand there is a particular type of service which is called a project. It commonly comprises the bringing together of many disparate products into an overall solution. The characteristics might include that it is bespoke; it is unique; the design is driven by one customer; performance characteristics can be designed and modelled but not known until the project is complete; its constituent parts may comprise products which themselves must be specially designed. Projects tend to be of large financial size and long timescale. Whilst no business enterprise is without risk, it can be seen quite readily that projects are by their very nature of considerably greater risk than products. Management of risk in a projects environment is therefore of considerable importance. Project Risk Management is a well established doctrine supported by many tools and techniques. Risk analysis, risk registers, risk models and active risk management are all important in seeking that ultimate goal of project management – completion on time, to specification and within budget. There is, however, another key distinction between products and projects, the significance of which is perhaps sometimes overlooked. Products tend to be bought or sold subject to standard terms of contract. The buyer or seller, usually whichever is in the stronger position, subjects the transaction to his standard terms. In a percentage of cases there may be some negotiation of these terms, but frequently not. Conversely the prime contract terms for a project are invariably negotiated, specially drafted and often of significant contention before the parties come to agreement. Each side may come to the negotiation armed with a preferred set
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of terms, some or all of which may be based upon standard terms. Each will try to exploit the strength of its bargaining position to secure its terms but ultimately the agreed terms will always be of a bespoke nature, reflecting not only the outcome of commercial negotiations but in many instances reflecting the fact that individual standard terms may simply not exist or may be inadequate for the unique situation of the particular project. Interestingly the choice between buyer and seller standard terms in a routine product transaction is fraught with danger for the side that concedes, for the simple reason that standard terms are never generated with fairness or balance in mind. The reason that every transacting organisation has different standard terms for sale and for purchase is that each organisation expects to purchase from its suppliers on terms which it would ideally never confer on its customers and vice versa. The central reason is that each organisation likes to both buy and sell at zero or minimum risk to itself. Standard terms are a means of pushing risk ‘down’ to suppliers and ‘up’ to customers. Everyone in the supply chain has the same motive. Of course in simple product transactions little attention is given because nobody expects anything to go wrong. The product is identified by part number or catalogue number, specifications exist, and price and payment are straightforward. The client gets what he is expecting and the supplier gets his money. The allocation of risk under the contract terms is of no practical interest other than in the very small percentage of cases where things do go wrong. Projects are different. It is not so much that the parties expect things to go wrong (if they did, they have no business in proceeding) but that they are aware that the risk of difficulty is inherently much higher. Not only are there usually more risks but several of the risks may have a significant probability of arising and the impact of a risk that materialises may be catastrophic. This results in two things. Firstly, each side (preferably jointly) will consider how best to manage the project so that risks do not materialise at all or, if they do, that the impact is minimised. Secondly great attention is given to the negotiation of bespoke contract terms. The contract is ultimately the single vehicle by which risks are allocated (or shared) between the parties. It is essential that each party knows where it stands both before a final decision is made to enter into the contract and afterwards, if risks materialise. A project management plan may ascribe responsibilities between the parties. A risk management plan may purport to allocate individual risks to one party or the other but the contract must be clear on what these allocations mean from a legal perspective. This is not just a point of technicality. For example, if the client agrees to carry responsibility for a particular risk (which affects the probability of timely completion of the project) and to undertake risk mitigation activities,
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where does that leave the prime contractor? Supposing the client neglects to undertake the mitigation (perhaps to save money) and the project runs late, can the prime contractor charge for his own increased costs? If the project runs late because of this failure to mitigate, where does that leave the client? Can he still terminate the prime contract for default (failure to complete on time) on the part of the prime contractor? Common sense or a sense of fair play may incline the reader towards one answer or another, but common sense and fair play are unfaithful guides. The answer of course is that what happens in the real world of project management and active risk management cannot be divorced from the hard questions of liability and the consequences of doing or not doing something. So, the prime contract is the ultimate risk vehicle. Pre-contract negotiations will have established an allocation of risks enshrined in the prime contract. The form of contract may represent a simple allocation of risks – i.e. it is a record of which party owns each risk and the consequences of that ownership. Alternatively, the form of contract may in itself be constructed so as to deal with risk in a way that encourages client and prime contractor to cooperate in the management of risk. Project risk management is the hands on tool for helping the project towards a successful conclusion. Putting these things together we are inevitably drawn to the fact that risk identification must inform the prime contract negotiations and the prime contract must inform the management of risk during project execution. Understanding between project or risk managers (doing the job) and business or commercial managers (doing the prime contract) is therefore essential. In fact the combination of project risk management and commercial risk management might be called Total Risk Management:
TECHNICAL RISK MANAGEMENT
COMMERCIAL RISK MANAGEMENT
TOTAL RISK MANAGEMENT
It worked
We got paid
Happy company
We finished it
We didn’t get sued
Happy customer
Cost within budget
We made a profit
Happy shareholders
Figure 1: Total Risk Management
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If this idea of TRM is to succeed it is first necessary to consider when the relationship between project risk management and commercial risk management of a project really begins. The two facets certainly come together at the prime contract negotiation stage, but in many ways that is already too late. There are four key points when the coming together must occur: TRM STAGES
THE KEY QUESTION
Bid/no bid decision
What is the probability of submitting the winning bid?
Tender preparation
What is the probability that the emerging risks can be contained?
Prime contract negotiation
What is the probability of securing a ‘safe’ deal?
Prime contract performance
What is the probability of completing the prime contract on time, to specification and within budget?
The view of total risk can be considered as maturing as these stages come and go:
Bid/no bid
An initial view
Tender preparation
A considered view
Can we win at an acceptable risk?
Contract A merging view Negotiation
Can we complete the project to time, budget and performance?
Contract performance
An ongoing view
Figure 2: Maturing View of Risk
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Although there is an overlap between them, the two questions – can we win and can we perform? – are in essence quite different in character. A mistake that is sometimes made is to undertake risk analysis during the bid stage only in respect of the second question. This is to deny to the fundamentally important first question the benefits of risk analysis and risk management. Consider these issues presented somewhat differently:
Can we win? Bid risk management
CONTRACT NEGOTIATION
Can we perform? Pre-contract project risk management
Request for bids received
Bid submitted
Project risk management
Contract awarded
Project completed
Figure 3: Risk Management Transition
In the pre-contract stage two risk management activities should be underway. One looks at the problems associated with preparing an attractive bid on time and defeating the opposition. The other is concerned with predicting whether or not the project can be completed successfully. Naturally if the early work on the latter question produces a very high probability of failure, then that result could have a devastating effect on the desire to bid and bid risk management would become superfluous. In this diagram it has been convenient to introduce the expression bid risk management but preparing a bid for a project is in fact another project. So it would be more accurate to say that the prime contract negotiation is the transition from one (bidding) project to another (doing) project and that project risk management in tandem with commercial risk management are needed in both stages.
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There are many other considerations in business risk management from personnel recruitment strategy to investment strategy to market orientation strategy. These are outside the scope of this Report which addresses itself to the commercial aspects of total risk management in a projects environment. The text describes matters from the perspective of a prime contractor undertaking a project for a client. In this context the prime contractor places work with subcontractors. Where a very general point is to be made the text adopts the more neutral buyer and seller. In places the text refers to penalties. The usage is that of the layman and not the lawyer. To a layman a penalty is an unfortunate consequence of some event. Lawyers have a more particular definition that leads to a general principle that penalties are not enforceable in English law contracts. The text refers in places to products. This is intended to mean the physical manifestation of the project as delivered, for example a system or any part thereof which is handed over to the client. At the end of each Section is a paragraph called Pointers for Project Risk Management. The purpose of this is to capture the essence of the commercial aspects that most need to be absorbed into a project risk management perspective. Each Section also has an appendix that provides a more detailed checklist of do’s and don’ts to better illuminate how key commercial risks may be dealt with in a contractual manner. For a much fuller exploration of the commercial aspects of business the reader may refer to The Commercial Engineer’s Desktop Guide (Hawksmere).
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THOROGOOD PROFESSIONAL INSIGHTS
Section 2 Getting to contract 1. The risk – risk scenario 2. The bid/no bid decision 3. Bidding 4. Pricing for risk 5. Risk review board 6. Making an offer 7. The priced list of risks 8. The caveats register 9. An effective contract 10. Negotiation 11. Contract launch 12. Pointers for project risk management Checklist
Section 2 Getting to contract
1. The risk – risk scenario Bidding for a contract involves a twin risk. Firstly there is the risk of losing the competition and secondly there is the risk of winning it! As has been said before now, ‘the good news is that we’ve won the competition, the bad news is that now we have got to perform the contract’. In any competition for business there is the risk that the prize turns out to be a lemon. A lemon contract is one that is more difficult to complete than expected or one that becomes impossible to complete at all. This is bad news for all the stakeholders. The prime contractor’s finances and reputation will suffer, with potentially disastrous consequences. The client will not get what he wants when he wants it. His reputation (as a competent procurer) may also suffer, with knock on consequences. The client may suffer additional cost which may not be recoverable from the prime contractor or anyone else. The prime contractor’s shareholders will suffer and any end users of the project (for example in public services) may also lose out. So the decision to bid is not to be undertaken lightly. In this Section the process of moving through evolving bid risk management into a ‘no turning back’ decision and then on into an effective ‘risk understood’ contract will be explored.
2. The bid/no bid decision Making a decision to bid for a significant prime contract is a major step. Once the decision has been made the bid gains a momentum and almost a personality of its own. Once it is thundering along it can be almost impossible to stop. The risk that is taken at this early stage is gambling the cost of bidding against the chances of winning. The cost of bidding is more than just the money spent. The diversion of resources, the inability to bid for other contracts and the reputation of the prime contractor are all considerations. Money spent on one bid means that money not being available for bidding for other contracts. Bidding soaks up valuable resources as the prime contractor not un-naturally wishes to put its best people onto bidding for an important new project. Many companies do
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not have the luxury of maintaining top teams whose task is exclusively bidding. Indeed such dedication may in itself be a risk insofar as bid preparation by people not involved in prime contract execution lacks that vital element of experience, the absence of which either makes the bid of academic interest only to the client or some key activity or risk is missed in the costing/pricing exercise. Thus the best source and possibly the only source of expertise for the bid team may be those people engaged on current contact work, where the diversion of key people may introduce additional risk, cost and possibly delay to that work. Once the bid is underway it becomes a personal challenge, and rightly so, for the bid manager to submit the bid no matter what and, of course, to win the prime contract. Similarly the prime contractor in its dealings with the client and with potential subcontractors is keen to show that it can submit an attractive bid. Again, this is rightly so but the point is that once bid preparation is in hand noone wants to stop it for fear of loss of face, writing off nugatory expenditure and losing the chance of winning. This means that the decision to bid in the first place must be a good decision. Risk analysis of the prospects of winning and risk analysis of the potential prime contract must begin very early on and be maintained throughout. Certainly the prospects of winning can alter as the bid phase proceeds, as more information or intelligence becomes available. News that an arch competitor has a new and unique approach to the particular project, news that an overseas bidder has support from his own government in making a subsidised bid, news that the prime contractor has become unpopular with the client all might indicate that the prospects of winning have slumped. These things do happen and so bid strategy should be based upon:
Pre-bid: Predict and prevent
In-bid: React and mitigate
Post-bid: Pro-act and manage
Figure 4: Phases of Risk Management
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In the examples given it might be possible to predict the possibility of an overseas subsidised bid and prevent it by political lobbying. If the prime contractor is rumoured to be unpopular (e.g. because of problems on a current contract) then it should react and take extraordinary steps to mitigate whatever the problem might be before the client develops a mind-set in which the perception of the prime contractor’s alleged poor performance becomes absolutely fixed. If after the bids are submitted, a competitor is discovered to have unexpectedly offered a novel approach the prime contractor may try spoiling tactics by attempting to rubbish that new product in the client’s eyes by drawing its attention to the unproven and hence high risk nature of that approach. In the extreme, a continuing risk analysis (of the probability of winning) as bid preparation proceeds might lead to a conclusion that, where at the outset the chances of winning were estimated at a certain level, the unfolding of events and the gaining of intelligence during the bid alters that initial perception:
100%
Confidence in winning
IFB received
Bid decision
Bid confirmation
Bid submitted
Winner announced
WORTH BIDDING AXIS
BID ZONE
NO BID ZONE 0 Time
Figure 5: Progress of confidence in winning
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Figure 5 gives a not untypical view of the progress of the confidence level in submitting the winning bid: Pre-IFB:
Early confidence may be very high because the initial intelligence is that the prime contractor is the market leader, has the best record of delivering projects on time and is competitive on price. Confidence may wane as, perhaps, discussions with the client show he is keen to encourage new, innovative solutions to his requirements that point to the selection of a different prime contractor.
IFB Received:
Confidence recovers as it is realised, perhaps, that the IFB highly matches the prime contractor’s intended solution. So a decision to bid is made.
Post decision to bid:
Again confidence wanes as the enormity of the requirement, lack of adequate bid preparation time, scarcity of top people all strike home.
Bid submitted:
Confidence level is high as the bid team congratulates itself on completing the bid and getting it submitted on time.
However, the prime contractor should be clear at what level of confidence it is worth bidding. If ongoing risk analysis shows the confidence level (the dotted line on figure 5) falling through the Worth Bidding Axis then there should be a serious re-appraisal of the prospects and if action taken does no stop the rot, a decision to withdraw should seriously be considered. Bid re-appraisal/confirmation points should be built into the bid plan at least as far as two thirds the way through the bidding period. After two thirds most of the bidding cost may have been incurred and it may be as well to finish the bid even if confidence is low. Before the two thirds point the options are greater. Indeed it is possible to postulate a Rule of Thirds (figure 6).
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BID SUBMITTED
BID DECISION • Too difficult to re-assess risk
• Re-assess risk
• Bid cost mostly spent
• Press on
• Not too late to cut losses
• See it through
1/3
1/3
1/3
Figure 6: Risk re-assessment – the rule of thirds
In the first period, unless some fundamental, catastrophic event occurs any risk re-assessment would be too uncertain to allow a positive decision to stop the bid. It is only really in the middle period when a more objective re-assessment is possible and while sufficient time and un-spent bid cost remains to make a reversal of the bid decision a possibly wise choice. In deciding to bid, the following risks need to be considered and re-assessed as events unfold. Competitors: •
How do their products compare with ours?
•
How do their prices compare with ours?
•
What is their delivery performance like?
•
Do they offer long term product support?
•
What standing/influence do they have with the client?
•
What pricing strategy will they follow (e.g. ‘loss leading’)?
•
Is there a ‘sitting contractor’?
The Requirement: •
How complex?
•
Are we familiar with it?
•
Can we offer compliancy on technical features?
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Bidding Resources: •
Do we have top team people available to produce the bid?
•
Have we got the money to bid?
Partners: •
Do we want to bid in a team?
•
If so do we lead?
•
Is there enough time to put a teaming agreement in place?
•
Can/will team members defect to the opposition?
Subcontractors: •
Do we need any?
•
Are they single source?
•
Do we have time to get and negotiate formal proposals?
Prime contract Award: •
What validity must we offer?
•
How does this fit in with our long term resource plan?
Prime contract: •
Can we or dare we reject or comment on the terms and conditions?
•
What risks do they contain?
It can be seen that there are very many things to consider and in terms of those risks, which are not associated so much with the process of bidding but more to do with the potential prime contract, it is essential to have a strategy for dealing with all such risks. The options may be:
Option
Principle
1
Ignore the risk and hope it does not materialise
2
Comment on it at the bid stage (i.e. draw it to the client’s attention)
3
Remain silent at the bid stage but aim to deal with it at the prime contract negotiations
4
Remain silent at bid and prime contract negotiation stages but have a plan to eliminate or transfer the risk once in contract
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Ignoring the risk is not an option! Of the other choices the best approach is not always obvious. Commenting on a risk at the bid stage is theoretically the right thing to do because it exposes the issue early on and shows the client how thoroughly the prime contractor has understood the potential prime contract and the lengths to which it has gone to respond realistically. On the other hand it may count against the prime contractor when the client adjudicates all the bids. To eliminate the risk of a caveat against the potential prime contract prejudicing the adjudication, companies sometimes choose not to mention the issue until the process is sufficiently well advanced for prime contract negotiations to have started. The danger here is that a good opportunity may not present itself or that the client may not entertain new things being introduced at that stage. In this latter situation the risk is that introducing new things may at best irritate a friendly client or at worst cause him to re-open the competition. This leaves the final choice which is to say nothing until the prime contract is awarded and underway when raising the issue, with the intent perhaps of re-negotiating the prime contract, may meet a stonewall or a penalty of some sort. For example, if a prime contractor considers bidding for a prime contract knowing or believing it could not complete the project on time it has a number of choices:
Option
Principle
1
No bid
2
Offer an alternative schedule
3
Bid to meet the completion date but aim to shift the date in prime contract negotiations, perhaps by offering something in return
4
Bid to meet the completion date but plan to ‘manage’ the problem away as opportunities arise during prime contract performance
Option 1 may very well be the right answer if it is known that the client will not under any circumstances consider alternative dates and if the prime contractor is convinced that it could not in any circumstances meet the required dates and if there was no probability at all of things changing during prime contract performance. These are big ifs and the circumstances quite unique. If any of these propositions does not hold true then another option should be preferred. Bidding an alternative date is ostensibly the right thing to do, but it runs the risk that the bid will be ruled out at an early stage of the adjudication. However the client will no doubt do his own risk assessment on offered completion dates and it may be that the prime contractor’s preferred but ‘late’ date is of lower risk than
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any offered by competitors. So this option could turn out to be the best. To avoid the risk of premature elimination it may be that Option 3 is preferred. It is driven by the ‘let’s get to the table’ philosophy but of course runs the risk that the client’s risk analysis will reveal the strategy. The final option depends on a hard nosed, some would say pragmatic, approach that major projects almost always entail a change of scope or direction at some stage and that such events are the best time to reset the prime contract schedule.
3. Bidding Once the decision to bid is made, it having been decided to risk the cost of bidding, diversion of resources etc against the potential benefits of securing the prime contract, the real risk is that the bid will not be produced in a way that generates an attractive result. Putting a bid together is a project in its own right. There is a requirement to meet and a deadline to achieve. The result must be a quality bid, produced within budget and delivered on time. Like any other project it needs a management team (figure 7) and the disciplines that go with it.
BID MANAGER Task setting Bid structure Bid approvals Co-ordination Risk analysis
Proposal structure
Marketing manager
Finance manager
Commercial manager
Project manager
• Story boarding
• Competitor analysis
• Bid cost control
• Partners
• Technical
• Word processing
• Lobbying
• Costing
• Subcontractors
• Programme
• Printing
• Intellegence
• Pricing
• Legal
• Project management
• Briefings
• Negotiation • Quality
Figure 7: Bid Management
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This is a fairly stylised structure but indicates the sort of organisation, functions and responsibilities that can be involved. Its size and constitution will depend on the scale of the bid but to be successful it will depend upon: •
Having top team experts
•
Operating as a tight, effective team
•
Being dedicated to the bid
•
Having the necessary assets and facilities
•
Having the necessary finances available
A half hearted, non-expert, part time, unfunded team will not produce the winning bid! As an absolute minimum the project manager must be retained from the bid phase into the prime contract phase. Ideally the commercial and finance managers should also be common to both phases. A successful bid put together by these key players will be translated into a major risk to project implementation if there is little or no continuity of personnel between the bid and the contract. This can then become a resource management problem for the prime contractor. As has already been said, bid teams need the experience of staff working on contracts and yet, if successful in a new bid, some of those key staff need to move onto the new contract to provide that essential continuity. An important task for the bid team is to establish a win strategy so that cost and effort can be optimally deployed. The win strategy will always be highly project-specific but must be based on the best intelligence with regard to: •
Mandatory requirements of the IFB;
•
Adjudication procedures;
•
Adjudication criteria.
Identifying adjudication criteria is not always easy. Adjudication criteria tend to be: formal and published to the bidders; formal but not published; informal (i.e. invented once bids are received) or absent. If there are no criteria at all then lobbying could well be the principal if not the single element to the win strategy. If there are formal, published criteria which include relative weightings between criteria then a more objective, scientific win strategy can be developed so as to ensure that valuable bid time, money and effort are devoted to those aspects which will win most points in the adjudication. Another technique for reducing the risk of the bid being unsuccessful is to put in place a bid review team. The review team’s task is not to contribute in any way to the preparation of the bid but to regularly review the bid during its prepa-
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ration from the client’s perspective. Its role is not an editorial check of the bid. Its task is to shake the bid and ask the fundamental question, is it any good? The characteristics of the review team are: •
Members must be senior to the bid team members so as to command respect and exercise authority;
•
Disciplines must mirror the disciplines of the client’s adjudication team;
•
Members must know the client and have the experience to put themselves in the client’s shoes;
•
Members must have the time and commitment to read and absorb all the bid invitation material and not just ‘float around’ being clever but disruptive;
•
Members must be hard nosed and willing to sack members of the bid team or to tell the bid team to tear it up and start again.
The review team has two principal questions to answer. Firstly it must ensure that the bid is attractive in terms of presentation, content, substance and intelligibility. It is often the case that bids, certainly the major ones, are comprised of contributions from a wide range and number of sources possibly including subcontractors or teaming partners. The result can be incoherent and look as though it has been thrown together, even down to relatively minor points such as paper size (EU and US use different standard sizes for example) and character style/font size of typescript. The red team must aim to ensure that the end result is pleasing to the eye and is reader friendly. Again, this is more than a proof read. The essential question is: does this bid have the look and feel of a serious and professional offer from a prime contractor competent to undertake the project? The second purpose is to ensure that the bid responds to the questions set by the IFB. Bid invitations frequently specify the required structure of bids (e.g. number of volumes, content of each, number of copies with and without price information), documents to be provided (e.g. plans and specifications), responses to be given (e.g. compliancy matrices) and options to be offered. Bid teams can get carried away doing their own thing. It is the task of the review team to drag the bid team back onto the right path. The aim is not simply to verify that the bid is technically competent and well presented. The aim is to confirm that the bid is answering the right question.
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4. Pricing for risk Assuming then that a final, irrevocable decision to bid has been made and assuming that the pre-contract project risk analysis is well established then a most pressing question arises as to what allowances should be made in the price to cover perceived project risks. Theoretically if the price is high enough the prime contractor will take any and all risks. However, clients do not have unlimited funds, competition does not permit generous covering of risk within the price and in any event a primary obligation of the prime contractor is to protect the shareholders’ interests and that militates against ‘unintelligent’ acceptance of untenable or high impact/high probability risks. If the level of risk is significant and the nature of the principal risks is such that they lend themselves to mitigation and elimination through joint action between prime contractor and client, then a form of contract that is based upon costrisk sharing may be preferred (see Section 3). In such a contract all risks are effectively shared because the immediate risks of performing the contract (e.g. technical and timeframe risks) have, it could be said, no more than a cost impact if they arise. Thus if costs are shared, risk is shared and there is a mutual incentive to cooperative active project risk management. The remote or consequential risk of performing the contract (e.g. a third party claim against prime contractor or client) is not so easily shared, but must still be considered. If cost-risk sharing is in operation the degree of provision to build into the scheme still needs to be assessed and discussed, but by both sides. However, for the purposes of this Section it is assumed that cost-risk sharing does not apply and it is for the prime contractor alone to determine how to cover risk with regard to prices to be offered. This is called pricing for risk. Some provisions may be included in the cost base or added as percentages or amounts to cost or added as percentages or amounts to price. For these purposes all will be referred to as pricing for risk. The primary aim is to keep risk provisions out of the price as any unnecessary allowances merely make the price uncompetitive. To reiterate, it is better to get to the negotiating table with a low price and a game plan to improve the position than to take the safe route of fully pricing for all risk and being immediately eliminated from the competition on the basis of high prices.
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Thus, using the project risk register, it should be possible to eliminate certain categories of risk insofar as pricing is concerned:
Category
Risk description
1
Risks that can be passed to the client under the prime contract
2
Risks that can be passed to subcontractors under the terms of purchase orders and subcontracts
3
Risks that can be covered by insurance
4
Risks that, ostensibly, the prime contractor will carry but for which feasible plans exist to shed the risks if and when they should materialise
These categories cause very many risks to be excluded from pricing. Category 1 risks include such things as inflation risk which can be passed to the client by including a variation-of-price clause (see Section 3). Category 2 risks may, for example, include eliminating exchange rate risk by paying overseas suppliers in Sterling. In Category 3 insurance may cover costs of delay caused by fire. Liability for lateness in Category 4 might be later transferred to the client by showing that delay was caused by his acts or omissions. Finally attention should be turned to those risks that remain. It is sometimes helpful to split these into two main headings: Risk Allowances:
Events certain to occur but to an uncertain extent.
Risk Contingency: Events which are uncertain to occur. Provisions for both may be included in pricing. Whatever the type of risk, analysis of impact and probability should be carried out and thought given to the relationship of risk to price (figure 8). Pricing for risk is an essential part of bid preparation.
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High
IGNORE IT
IGNORE IT
PRICE IT
Impact
IGNORE IT
IGNORE IT
Low Low
Probability
High Figure 8: Impact and Probability
Figure 8 shows that many risks are best ignored in so far as pricing is concerned. No risk should be completely ignored but, other than in a cost-risk sharing scheme (see Section 3), there is no point covering all the risks by provision in the price. Not only would this produce an uncompetitive price but some risks are not appropriate for treatment by pricing provision. The risk of the prime contract being cancelled for the convenience of the client is a serious financial risk but there is little point in putting something in the price for it as, if the prime contract is cancelled, the price will never be paid as such. High impact, high probability risks can be ignored because if the impact is high, having a notional value of, say, five times the prime contract price, then there is absolutely no purpose in including 5% or 10% in the price. Such risks can only be treated in one of two ways. Firstly by having a plan to avoid or shed the risk if it arises. Secondly by deciding not to bid in the first place! High impact, low probability risks can more safely be ignored. Again there is little purpose in putting a nominal risk provision in the price against a high impact risk which is actually not expected to arise. The strategy should be to ignore it in pricing but keep it under constant review in risk management to ensure it does not materialise. High probability, low impact risks on the other hand demand a provision
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in the price, but if the impact is very low it is unlikely to be noticeable in the swings and roundabouts of prime contract performance. Almost by definition, low probability, low impact risks need not have a pricing provision made for them. The foregoing material on pricing for risk has made one implicit assumption. This is that the cost of the job is the subject of sound cost estimates to which provisions are then added, or not added as the case may be, in relation to identified risks which may later arise, the impact and probability of which have been analysed. However, it is possible that this stable basis may be unstable if the basic cost estimates are wrong, either because of poor estimating or because the job was not understood at the time it was priced. There is little comfort in having done a brilliant analysis of future risks as a result of which 12.75% risk provision was included in the price if the basic costs were underestimated by 500%! Needless to say a comprehensive understanding of the prospective job backed up by quality estimating is an essential pre-requisite to pricing.
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5. Risk review board In many companies when a bid is approved for submission many people are involved in ‘signing it off’ but sometimes the approval procedure is excessively concentrated on the price. Such procedures should make it clear that each function within the prime contractor is signing for something slightly different. These functions and their responsibilities can be many and varied:
Function
Primary approves the bid in respect of
Project Manager
The entire requirement is understood. Plans and resources exist to discharge the prime contract
Technical Manager
The technical aspects are understood
Production Manager
The manufacturing requirements are within the prime contractor’s capability and capacity
Estimating Manager
The requirement has been fully analysed and estimated ‘bottom up’ using appropriate estimating methods
Programme Manager
Detail plans exist to show the prime contract can be completed on time
Finance Manager
That cost estimates and prices have been formulated in accordance with approved rates and factors
Contracts Manager
That the terms and conditions have been reviewed and commented upon in line with prime contractor policy
Quality Manager
That the quality requirements are consistent with prime contractor approvals
In addition, those functions which will provide resources in the performance of the prime contract should: •
Confirm that resources and their facilities exist or will be brought online as the prime contract demands.
•
Contribute to the cost estimating process and confirm that their responsibilities can be discharged within the costs allowed.
•
Identify any capital expenditure or other investment necessary for the performance of the prime contract.
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The whole bid should be reviewed and authorised with perhaps the final sign off occurring at a ‘bid approval’ or ‘tender vet’ meeting. However, such procedures make the implicit assumption that each function has identified and dealt, in some way or another, with any risks which are associated with their area of responsibility. This type of approach is inadequate as it fails to give risk the necessary exposure in the review-and-approve part of the process. The procedure should require the establishment of a Risk Review Board whose tasks are: •
To review, modify if necessary and approve the Pre-Contract Risk Analysis;
•
To interrogate the bid team or the prime contractor functions listed above on the identification of risks in their respective areas and the mitigation plans;
•
To ensure that all risks are owned by an individual.
•
To make the final decision that the risks having been identified analysed and mitigation planned result in a net total risk that is acceptable to the prime contractor.
These heady responsibilities demand that the Risk Review Board is comprised of senior managers representing the broad perspectives of the prime contractor’s interests. In particular the fourth responsibility listed above is most onerous. Companies are in business to make a profit in return for taking a risk, but that does not mean that a prime contractor is in business to take any risk no matter how great, no matter how dire the potential consequences. Therefore the final decision to proceed or not with the bid must rest with the Risk Review Board un-swayed by the bidding costs incurred, the momentum and wishes of the bid team or the possible reaction of the client if a bid fails to appear. Of course the risk-risk scenario demands that initial bid/no bid decisions are made only in relation to those projects where there is an acceptable probability of winning, combined with anticipation that the resultant potential prime contract will be good business. Thus the risk-reassessment undertaken during the bid should not only continue to question the probability of winning but, as the precontract risk analysis develops, it should also continue to question the attractiveness of that potential prime contract. No-one will thank the bid team for developing a position where there is a 99% probability of winning the greatest lemon in business history. Thus in the normal course of events, bids coming to the Risk Review Board for sanction will be approved but nevertheless in performing its duties as Grand High Risk Inquisitor the Risk Review Board will have made an invaluable contribution to the bidding process.
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6. Making an offer Having seen preparation of the bid through to its completion and approval surely there can be no risks associated just with putting the offer on the table? Well, there are eight areas of possible risk: •
Accidental offers;
•
Validity considerations;
•
Differences between client and prime contractor terms;
•
Misrepresentations;
•
Representations;
•
Entirety of the offer;
•
Language;
•
Law.
When the prime contractor is ready to make its offer then it should do so by sending its letter, quotation, proposal, bid, or tender and in all cases marking the bid as a quotation and signed by the prime contractor representative having the authority to make formal offers. On the latter point, to the outside world it matters relatively little if the person signing the offer does not actually have the authority of the prime contractor provided that he appears to have. Indeed it could be said that there is no greater implication of such authority than the act of signing the offer. However, in regular dealings with particular clients it is good practice for the prime contractor to ensure that the client does know which of its representatives is entitle to sign offers. Furthermore, in the extreme, there is no requirement for offers to be signed by a person provided it is clear that the prime contractor is making an offer albeit that some clients will demand signed offers. The corollary of making it clear that an offer is indeed an offer (i.e. capable of acceptance in the legal sense) is to make sure that communications with the client which are not offers should be clearly so identified. Letters or other documentation conveying information, outline proposals, indications of cost, budgetary estimates etc should be phrased so that it is clear that no offer is being made. Oral communications should be similarly safeguarded. When an offer is made it is wise to express a validity period. This is the period within which the offer can be accepted so as to create a prime contract. Unless there is a tender bond, or some valuable consideration for holding the offer open for the stated validity then the offer can be withdrawn or amended by the offering party at any time, although to do this during the adjudication of competitive tenders can be risky unless the client has called for revised proposals
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or otherwise allowed adjustments to be made. In any event an offer is effectively cancelled if a counter offer is made, such as the client making an offer of prime contract which is different in some way to the prime contractor’s offer. The risks in offering a validity period of any significant length are principally two fold. Firstly that new information will emerge which would cause the prime contractor to wish seriously to re-consider its willingness to bid either in absolute terms or on the basis of the prices or other terms presently on the table. Secondly there is the problem that the validity required is longer than that offered by the prime contractor’s subcontractors. This risk should have been identified, assessed and allowed for as appropriate in the pricing exercise but it is nevertheless a good example of the need for careful consideration in offering particular validity periods. By the time that the offer is submitted to the client all negotiations with major subcontractors should ideally have been completed both as to price and terms but with the proviso that further negotiations may be necessary as negotiations evolve with the client. Ideally those completed negotiations will have produced terms and conditions agreed with subcontractors which are no less onerous than those required by the client or those upon which the prime contractor expects to settle with the client. The phrase ‘no less onerous’ is important because it represents the minimum position in terms of holding subcontractors on ‘back-to-back’ terms with the client’s potential prime contract. For example if the client wants twelve months warranty then subcontractors should be required to give twelve months warranty. However, whilst this is strictly back-to-back and no more onerous it leaves the prime contractor with the risk of failure of a subcontractor item which is just outside the subcontractor’s warranty but still within the client’s warranty, because of the dwell time between prime contractor receipt and onward handing over to the client. Hence the prime contractor should seek, say, fifteen months warranty from the subcontractors so as to eliminate its risk in this area. Thus the prime contractor can legitimately seek ostensibly more onerous terms from its subcontractors. However, the real risk at the point of making the offer to the client is that those ideals (subcontractor negotiations complete, no less onerous terms) may not have been achieved. At that stage, actual or anticipated mismatches should have been taken into account either in pricing or in responding to the clients intended terms. Nevertheless the risks should be recognised and negotiations with subcontractors continued after the offer has been made in order to eliminate or reduce those risks. A danger here is that having failed to achieve the ideals, subcontractors’ bargaining positions are strengthened if they know that the prime contractor’s bid has been submitted.
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Misrepresentations are those inducements to the client to enter into a prime contract which are deliberate or innocent misrepresentations of factual information. In the extreme the remedy is recession of the prime contract and liability for damages plus the possibility of criminal proceedings if the misrepresentation was fraudulent. Thus great care must be exercised when saying and doing things which are intended to persuade the client to place the prime contract with the prime contractor. On the other hand, representations are those inducements which are factually correct and which the client is entitled to believe that he can rely upon even though the prime contractor may not have intended those inducements to form part of his offer or of the consequent prime contract. If the client took into account such inducements in making his decision to award the prime contract then he can expect them to be implied into the prime contract even though express terms are absent. Representations can be made quite unintentionally and the risk can be high of undertaking a greater obligation than was intended. Although clients are expected reasonably to distinguish between material which is merely advertising puffery and that which is intended to create a binding obligation, the division between puffery and real intent can be unclear particularly in matters of technical detail. In the bidding and adjudication process it is common for clients to seek clarifications from bidders as to the detail or ambiguities in their individual offers. Answers given can be the simple clarification sought or they can possibly create additional obligations either because a simple, brief answer establishes a broader obligation than that conveyed by the detail of the original technical proposal or because the prime contractor chooses to take advantage of the request for clarification by ‘improving’ its bid (indeed it may be that was exactly what the client was seeking). Similarly so when the client allows bidders to summarise their offers by giving a presentation of their bids followed by a question and answer session. This is usually a golden opportunity for the prime contractor to really sell its offer and yet in enthusiastic, ‘don’t worry, we can do it’ presentation-speak representations really can accidentally be made. The risk of accidental representations can be avoided by including in the prime contract an ‘entire agreement’ or ‘complete agreement’ clause which details all of the documents which together constitute the whole agreement between the parties. The parties can therefore decide whether the prime contract is made up only of those prime contract documents prepared by the client as a formal offer of contract or whether the agreement can incorporate by reference earlier material such as the prime contractor’s bid, written clarifications, third party specifications and standards. Thus by expressly stating what is in the agreement, anything else is automatically excluded including representations (such as those
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conveyed by presentation visual material, hand-outs etc) which could otherwise be implied into the prime contract. The use of entire agreement clauses to exclude what otherwise would have been implied terms is subject to a reasonable test. Preceding the entire agreement clause, the prime contract should have the prime contractor providing an ‘entire offer’ statement within its bid. For example the bid may be submitted under a covering letter highlighting the key benefits of the offer written in marketing terms rather than those of the lawyer. The offer may be bound in several volumes of which one is an executive summary the purpose of which again is to focus on the main advantages of awarding the prime contract to the prime contractor. In either case it should be decided whether such summaries are part of the formal offer in the strictest sense. They certainly are part of the proposal but are they intended to be part of the resultant prime contract? Sometimes the client may ask for information (e.g. an analysis of prices, predicted life cycle costs) which is helpful in bid adjudication but which is definitely not intended (by the prime contractor at least) to be part of the prime contract. The discipline of providing an entire offer statement helps the prime contractor to be clear what exactly it is offering and what it is not. Finally there are the issues of the language and applicable law of the prime contract. In any international contract the contract should state the official language of the contract. All contracts should state the applicable law under which the prime contract is created and to which it will be performed (these can be different, one law for formation and one for performance and possibly a third for arbitration). If the language is other than English there is a risk of ambiguity arising in the translation. The converse is true for the non-English speaking client of course but since English has become the standard language of commerce, business and industry English is preferable. If the law is other than English Law or Scots Law there is introduced much uncertainty as foreign laws can be markedly different from the UK varieties in terms of implied obligations and duties. Thus the English language and a UK law should be stated as a premise for the bid.
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7. The priced list of risks The foregoing shows that the simple act of making an offer can be fraught with risks. Nevertheless as the bid goes onto the table it represents, amongst other things, a particular set of proposed risk allocations between prime contractor and client. However there is nothing to prevent, and much to commend, the prime contractor offering options in terms of allocation of risk. Most risks have a value to a buyer (how much would he pay not to carry a risk) and a value to a seller (how much would he reduce his price to avoid a risk). These values are variable in themselves and may not naturally coincide between prime contractor and client. For example the prime contractor may be prepared to reduce its price by 5% in exchange for the client carrying the risk of inflation-driven cost increases. The client may be prepared to pay 10% more not to carry that risk. Clearly there is room to negotiate! Such variation in the valuation of particular risks may reflect no more than a differing perception of the probability and impact of the risks. It may reflect the fact that one side may be better able, or is logically the more appropriate, to carry the risk. Emerging from these considerations is the idea that the prime contractor could put forward a priced list of risks as options for the client to consider. All companies are used to offering options that would have the effect of altering the cost, scale, performance and timescale of the project but the concept of offering risk options is one that should be given some thought. The risk options can be offered with the bid or during prime contract negotiations whichever appears the optimum strategy in the given circumstances. Not only does this approach do full justice to the principle of using the prime contract as a risk allocation vehicle but it would also assist in post contract dispute resolution. For example, if postdelivery liabilities (express warranty, implied warranty, Sale of Goods Act implied undertaking) can be shown to have been discussed in detail pre-contract with the client, who took some financial or other valuable advantage in return for eliminating such liabilities, the prime contractor has a strong and clear case for defending any later action by the client in the event of a post-delivery problem.
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8. The caveats register From the point at which the invitation for bids is received through to the moment at which the prime contract is signed, the very many people involved in bid preparation and in the planning of prime contract execution regularly identify issues associated with the potential prime contract. Some of these issues may be so important that they must be identified at the time of bidding. Some may be less critical and can be left until prime contract negotiations. Some may be minor issues to do with the terms and conditions. Others may be fundamental premises upon which the price has been formulated. All these assumptions, exclusions, premises, understandings, dependencies etc can collectively be referred to as caveats and should be put into a register (figure 9).
Serial
Caveat
Source
Resolution
Price Impact
Action
Figure 9: Caveats Register
The register should be brought into being on the first day of the bid preparation and it should be the receptacle for all thoughts, ideas, concerns that are at all to do with the potential prime contract. In many instances the pre-contract risk analysis and caveats register can be merged into a single document which should be kept up to date throughout the period of bid preparation and prime contract negotiation. Once prime contract negotiations have commenced it may be decided to produce a version of the register to table with the client as a basis for structured discussions on risk allocation.
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As well as providing the essential function of recording all the identified caveats the greatest purpose of the register is to keep each caveat ‘open’ until something positive has been done to resolve it. In principle there are only seven possible resolutions: 1
OBE – Overtaken by Events because…
2
Risk carried by client – expressly by prime contract clause…
3
Risk carried by client – impliedly because…
4
Risk carried by prime contractor – expressly by prime contract clause…
5
Risk carried by prime contractor – impliedly because…
6
Prime contractor risk but covered by insurance – see policy clause …
7
Prime contractor risk but conveyed to third party – see subcontract clause…
In particular categories 4 and 5 force the prime contractor to keep in mind pricing for risk. Categories 6 and 7 force the person negotiating the prime contract to be mindful of and interactive with other business functions such as insurance management and purchasing.
9. An effective contract Having concluded negotiations the aim is to sign the prime contract as soon as possible. This aim conveys two concepts. Firstly that the prime contract must be signed by people (one from each party) and secondly that if signature is required then the prime contract must be in writing. Apart from so-called speciality contracts (which cover a very small range of types of contract) there is no requirement either for signatures or for the prime contract to be in writing. However, written, signed contracts serve to eliminate the risk of uncertainty both as to the intent of the parties to make their prime contract and as to the detail if later a question of understanding or interpretation were to arise. Both parties will want their prime contract to be effective and there are four main risks to achieving this: •
Improper Formation
•
Uncertainty
•
Mistake
•
Frustration
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To be properly formed a contract must satisfy the legal requirements of valuable consideration; offer and acceptance; mutual intent to create legal relations; capacity of the parties to make contracts; legality and possibility. In business contracts the only one of these that usually gives a problem is offer and acceptance. Although Lord Denning made attempts to soften the rule, the law still demands a clear offer met with an unequivocal acceptance for a contract to have been formed. The Battle of the Forms 1 is one example where a complete offer and acceptance can be difficult to determine. Another area of difficulty is where one side ‘accepts’ the other’s offer ‘subject to the following’. This strictly speaking is a counter offer and no contract is created (unless the counter offer is met with an unequivocal acceptance) and yet the parties proceed as though there were a contract. Indeed if the ‘contract’ is eventually performed (seller delivers and buyer pays) then a contract will indeed have existed and if there is then a dispute it would, in the ultimate, be for the courts to deduce the applicable terms. This is not a satisfactory situation. If the uncertainty is to be avoided the parties must strive at the outset to ensure that there is an entire agreement reflecting a genuine offer and acceptance. Another facet of offer and acceptance is the method of acceptance. The general rule is that acceptance must be communicated, but with the exception of acceptance under the postal rule, which allows acceptance to have occurred when a communication of acceptance is put into the post, whether or not the other side ever actually receives the communication. Even today cases come before the courts on the question of the postal rule. To avoid this problem the offering party should include in his offer an explicit, written statement that a contract has only come into being upon his receiving a written, unequivocal acceptance from the other side. The word uncertainty has already been used here in the sense of an entire understanding as to terms not being achieved. As has been mentioned this would not necessarily affect the existence of the contract. A court would have to imply ‘missing’ terms or to arbitrate between conflicting terms, but only in so far as the original intent of the parties can be deduced by the court. However, if the uncertainty is so great that a court cannot find any evidence of a common understanding then the entire ‘contract’ can be made void for uncertainty. To avoid this risk the parties should go to great lengths to ensure that the agreement is not only complete but also clear and unambiguous.
1
Where the parties proceed with the ‘contract’ without achieving a clear instant of unequivocal acceptance but ‘exchange blows’ in passing paperwork – quotation, purchase order, delivery note etc – in which seller and buyer each in turn refers to its own standard conditions
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The final possible risks to the effectiveness of the contract are mistake and frustration. In both cases a court could set the contract aside. A mistake in this sense is something fundamental (such as the existence of the goods) in which the parties were in error at the time the contract was made. A frustrating event is an occurrence (such as the destruction of unique goods) which happens after the contract was made which so fundamentally alters the position as to have been entirely outside the imagination of the parties when the contract was made. Fulsome discussion, checking, examination prior to contract should remove the risk of mistake. Frustration is theoretically a risk which is impossible to prevent since the intervention of something completely unforeseeable can not be dealt with in advance. However, in business contracts virtually all risks can be foreseen and dealt with in the contract and a contract voided on the grounds of frustration is a rare event. Incidentally the law does not recognise that a contract can be set aside for mistake or frustration because one side made a bad bargain. If the buyer mistakenly orders the wrong thing that is just hard luck for him. If the seller finds that he cannot complete the contract within his budget that is just hard luck for him. These things are all important in avoiding these risks to properly form a contract which is complete and certain. And yet in the dynamics of the real business world a buyer may issue a Letter of Intent (LOI) or an Instruction to Proceed (ITP). Although an LOI may increase the confidence of the seller that the buyer is going to proceed, the seller nevertheless goes ahead at his own risk if he starts work solely on the basis of an LOI. An ITP can be more useful if it is so drafted to be an offer of contract albeit that it conveys only the key terms such as a summary of the work, timeframe for performance, price (or method by which price will be agreed) and payment. If the ITP is capable of acceptance then acceptance will constitute a contract although there is then a risk that the parties will never conclude complete terms. Certainly the risk to the buyer is that once the seller is working against an accepted ITP there is little incentive for the seller to agree unfavourable terms which the buyer later seeks to introduce, especially since ITPs tend to be used in cases of urgency leaving the balance of bargaining advantage with the seller. The last point to note is that a contract need not be effective upon signature. It is permissible to include a condition precedent, the non-satisfaction of which would cause the contract to fail to come into existence. The most common example is a condition which requires that the seller shall have received the buyer’s advance payment before the contract shall come into effect. To start work prior to the satisfaction of a condition precedent is to proceed at the risk of loss of the cost incurred and the effort deployed being wasted if the condition is not then satisfied.
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10. Negotiation Somewhere between making an offer and making an effective contract is the risk of throwing away all the good work of the bid team and securing a lemon contract. Between bid and contract there will be a period of negotiation between bidder and client. The negotiation is a crucial phase that can make the difference between the contract proving to be a commercial success or disaster. The golden rule of negotiation is to follow the seven Ps: – Prior Planning and Preparation Prevents Pretty Poor Performance. The importance of planning, preparation, objectives analysis, rehearsal, game planning, tactics and timing in contract negotiation cannot be over-stressed. The risk of being out-smarted by the client’s ace negotiator is a real one. The prime contractor should field its strongest negotiator or negotiation team comprised of those who have the best balance of negotiation skills, job knowledge and ‘acceptability’ to the client (figure 10).
Difficult to get to agreement
NEGOTIATION SKILLS
JOB KNOWLEDGE
Negotiates in the dark
CUSTOMER RELATIONSHIP
Cannot get the best deal
Figure 10: Components of the Ideal Negotiator
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For a full analysis of the skills and risks in contract negotiation readers are invited to refer to Successful Contract Negotiation (Hawksmere).
11. Contract launch The final risk of the pre-contract stage is that those people to whom responsibility falls for the performance of the prime contract may not fully understand the nature of the prime contract, its risks and the evolution of terms through the process of prime contract negotiation. The best way to mitigate this risk is to hold a prime contract launch meeting immediately following prime contract award and prior to commencing the work. Indeed ISO9000 proposes such a review and provides a basic agenda for that purpose. All of the relevant business functions must be required to attend including those not closely involved in the work. For example it is important for functions such as Finance (who provide project, cost and management accounting) and Personnel (who may have to recruit staff for the prime contract) to be as involved as those actually undertaking the project. The principle aims of the prime contract launch meeting are to: •
Describe the nature, scope and timeframe of the prime contract;
•
Identify the key terms and their meaning;
•
Review the entire pre-contract risk analysis/ caveats register and explain how all the risks were dealt with;
•
Summarise the progress of the negotiations with the client highlighting any sensitive areas to be avoided in future contracts with him;
•
Identify key subcontractors, suppliers and partners and describe how dealings with them should be conducted;
•
Launch the prime contract risk register based on mitigating all risks residing with the prime contractor;
•
Identify the budget and cost allocations available to spending departments within the prime contract price.
The meeting should be properly minuted with key actions identified. In fact IS09000 requires a written record to be kept but the individuals responsible for conducting the meeting must ensure that the record produced is a useful basis for undertaking the work and not a blank record produced solely for the purpose of satisfying the ISO.
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12. Pointers for project risk management •
The linking of project risk management and commercial risk management must commence at the earliest possible stage in the life of a project. The best opportunity is in the time leading up to the decision to bid for the project.
•
Bids for major projects should be treated as projects in their own right. This leads to active risk management not only for the bid but also for the prospective prime contract. The decision to bid must be kept under review with a preparedness to withdraw if ongoing project and commercial risk analysis points either to a low win probability or to the probability of winning a lemon.
•
The actual process of converting a bid through negotiation into a binding, effective and lemon free contract is itself subject to many risks. Risk management through this key phase is crucial.
Checklist Risk: The potential prime contract is a lemon DO
•
Keep the decision to bid under review
•
Link project risk management and commercial risk management together at the bid decision stage
DON’T
•
Keep going with a bid just because you have started or because of the sunk costs
Risk: The bid is not taken seriously DO
•
Treat all bids as ‘must win’
•
Allocate top quality resources
•
Plan to retain key bidding staff into the prime contract phase
•
Establish a bid review team
•
Give the bid review team teeth and staff it with senior managers
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DON’T
•
Do bids on a simple percentage basis
•
Leave the bid team to its own devices
Risk: Pricing for risk is unintelligent DO
•
Price for high probability low impact risk
•
Differentiate between risk allowances and risk contingencies
•
Remember risks can be contractually allocated to client or suppliers
•
Remember it is possible to insure against some risks
DON’T
•
Price for low probability low impact risks
•
Price for high impact risks
•
Just add an arbitrary percentage or amount for risk
Risk: Offer is unintended or defective DO
•
Remember an offer can be met with an acceptance creating a contract
•
Be clear when an offer is being made
•
Be clear what constitutes the offer
•
Specifically exclude what is not in the offer (e.g. representations)
•
Give a validity period
DON’T
•
Allow unauthorised offers
Risk: Prime contract is defective DO
•
Take care to ensure prime contract is properly formed
•
Hold a prime contract launch meeting in line with ISO9000
DON’T
•
Forget a defective contract at best will not provide for what was expected and at worst may be no contract at all
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Section 3 Financial risk 1. Prime contract financial risk 2. The nature of price and the sharing of cost risk 3. The client will not pay 4. The client cannot pay 5. Inflationary cost increases 6. Foreign currency fluctuations 7. Contract termination 8. Financial claims against the prime contractor 9. Pointers for project risk management Checklist
Section 3 Financial risk
1. Prime contract financial risk There are two financial parameters that are at the heart of any project. Profitability and cash flow. Profitability relates to the final relationship between cost and price. The outturn profit compared with the expected profit (being a main reason for the prime contract having been bid in the first place) is a function of the outturn costs compared with the costs estimated at the bid stage. Costs are both internal (primarily labour and overheads) and external (primarily subcontract). Internal costs may be under the direct control (for example the hours booked to the project) of the project manager or outside his direct control (for example overhead rates that are dependent on business volume). External costs likewise may be inside his control (multiple sources of supply) or outside his control (dominant subcontractors). Cash flow similarly may be inside his control (for example achievement of payment milestones) or outside (for example pay day for the labour force).
2. The nature of price and the sharing of cost risk There are four basic types of contract price that are used for most projects: Governing principle Firm Price
A price which is not variable for any reason other than change in specification, quantity or time for performance.
Fixed Price
A price the final value of which is fixed by reference to some variable parameter such as an inflation index or currency exchange rate
Cost Incentive
A price based on the prime contractor’s actual costs but with client and prime contractor sharing overspends or under spends against a pre-agreed target cost.
Cost Re-imbursement
A price based on the prime contractor’s actual costs plus a predetermined amount or percentage by way of profit.
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Combinations of these may be used and there may be what appear to be variations, such as where the price for the project does not become due in effect as a lump sum2 upon completion of the project, but in installments as and when the completed project delivers the service for which it was intended. But these four basic patterns reveal the essential relationship between cost and price. In effect they represent a spectrum of cost-risk allocation between client and prime contractor as shown in figure 11.
FIRM PRICE
COST RE-IMBURSEMENT
Seller has cost risk
Buyer has cost risk
Figure 11: Cost Risk Spectrum
In a conventional arms-length relationship the prime contractor will prefer a firm price where he perceives the risk to be small and the opportunity for profit great. Where the risk is high he will prefer cost re-imbursement and hope that the client will have plenty of money to cover the inevitable expenditure that will be incurred purely as a result of the uncertainty in the contract. The client’s perspective is the exact opposite. The greater the risk the more he will want a firm price arrangement so as to contain the risk, allocate it to the other party and avoid any financial liability beyond paying the contract price. The fixed price approach deals with one or two risks only such as inflation and foreign currencies, of which more later. The primary choice is between firm price and cost-reimbursement which sit at opposite ends of the cost risk spectrum. The cost incentive contract provides the compromise solution for high risk work where neither side is willing or able to carry the entire cost risk. The relationship between cost and profit is illustrated in figure 12.
2
Notwithstanding that the amount is paid out in stages during, on or after performance of the contract.
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Fee Unlimited fee
A Maximum fee Max % fee
60/40 Min % fee
B Target fee
70/30
C Minimum fee
D Cost Most optimistic cost
Target cost
Most pessimistic cost
Max price
E
COST INCENTIVE RANGE Figure 12: Cost Incentive Scheme The essential principles of the cost incentive scheme are: •
The price is agreed after the prime contract is completed on the basis of costs incurred but according to a cost incentive scheme agreed at the outset.
•
The parties agree a target cost and a cost incentive range within which the actual costs are expected to fall.
•
The parties agree a target fee which is the profit to be paid if the actual costs exactly equal the target cost.
•
The parties agree ratios in which they will share under spend or overspend against the target cost.
Thus the final price for the prime contract is the actual costs incurred plus the target fee plus the agreed share of savings against the target or less the agreed
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share of overspends against the target. A key difference therefore between a firm price and a cost incentive scheme is the tolerance within which the costs are reasonably expected to fall. For a firm price where the technical content of the contract is well understood the cost estimating accuracy may be +5%. In a cost incentive scheme where the technical risk is much higher the tolerance around the target cost may be +15%. In the example shown in figure 12 the following are assumed:
Parameter
Normal Assumption
Target Cost
Reasonable estimate assuming normal efficiency and typical problems
Most Optimistic Cost
Improved efficiency and no problems
Most Pessimistic Cost
Degraded efficiency resulting from and together with major problems
Target Fee
A percentage of the target cost
Under-run share ratio
Negotiable (shown as 60/40 in figure 12)
Over-run share ratio
Negotiable (shown as 70/30 in figure 12)
If life were as simple as assuming that the actual costs will definitely fall within the cost incentive range then the scheme and the graph would only run from point A to Point C. However, the parties must legislate for the possibility of costs emerging outside the two extremes where they have a number of choices: Point A:
The scheme might permit the prime contractor to continue to improve its fee at the same under-run share ratio if costs are lower than the most optimistic cost. This results in an unlimited fee opportunity. Alternatively the parties may agree to limit fee either in absolute or percentage terms.
Point C:
The scheme might allow that for costs exceeding the most pessimistic cost the prime contractor should suffer no further erosion of its fee and a minimum fee in absolute or percentage terms should apply. On the other hand the client may demand an absolute limit on its liability and include a maximum price (point D).
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Point E:
If a maximum price is operative point E does not exist as the prime contractor’s fee erodes at the rate of 100% from point C until it reached point D after which losses would accumulate at the rate of 100%. However, in such event the client may agree to limit the prime contractor’s liability for loss and introduce a point E at which the curve changes shape to fix the loss in absolute or percentage terms.
This one graph shows the scope for variation that can be negotiated not only beyond the normal boundary conditions at A and C but also between them in terms of the share ratios, target fee and cost incentive range. The first main advantage of such schemes is that they are flexible and can be tailor-made to individual circumstances. The second advantage of cost incentive schemes is that they promote co-operation, openness and sensible decision-making between client and prime contractor. If both sides are set to benefit by technical decision-making and problem solving which minimises cost then so much the better than in a firm price arrangement where the client is motivated to squeeze the last ounce of performance from the prime contractor (regardless of cost to the prime contractor) and the prime contractor is motivated to deliver the bare minimum performance (regardless of client’s situation).
3. The client will not pay In essence when the prime contract is fully performed the client is obliged to make payment of the prime contract price. From the prime contractor’s perspective reliance on this simple premise has three main drawbacks: •
Negative cash flow while the prime contract is in hand
•
No time limit on when the client should pay
•
Inadequate remedies if payment is late
Taking these in turn it is clearly the case that carrying the burden of funding work in progress under the prime contract is a risk. If no payment is to be made at all until the work is finished there is at best the cost of funding the work in progress and at worst there is the risk of the prime contractor becoming insolvent as no cash comes in to offset the outpouring of cash into salaries, wages, overheads, materials and suppliers. Set against the client’s wish to pay nothing until the prime contract is fully performed is the prime contractor’s wish to have
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100% of the prime contract price paid as an irrevocable down payment placed with order. Somewhere there is an acceptable medium between the two. The basic options are as follows:
Arrangement
Operative principle
Advance payment
A proportion of the prime contract price placed with order
Stage payments
Discrete sums of money paid as and when proportions of the work are completed
Milestone payments
Discrete sums of money paid as and when specific, key tasks are completed
Progress payment
Regular re-imbursements of costs incurred by the prime contractor
The details of these arrangements should all be worked out pre-contract. Inevitably these approaches will feature in the price negotiation as the effect of them is to move the cash flow risk between client and prime contractor. Having agreed to make payments while the work is in hand the protection or security that the client seeks is to make payments only at his discretion (i.e. if he is happy that good progress is being made), to achieve early passage of title in parts and materials under vesting, to make the payments recoverable in the event of delay or default and to retain a sizeable element of the price until the prime contract is fully performed and all of the liabilities (e.g. including those under warranty) of the prime contractor have been discharged. All of these are undesirable to the prime contractor as they mean that the timing of such payments and their absoluteness are at risk. Unless the prime contract specifies the time within which valid invoices shall be paid the prime contractor has to fall back on the Sale of Goods Act which merely requires the client to pay within a reasonable time. This is too vague and open to interpretation and argument. The prime contract must be crystal clear that once the relevant event (e.g. completion of a milestone, the making of a delivery) has occurred the prime contractor is entitled to raise an invoice which must be settled within a fixed and specified number of days. Client discretion or the client’s right not to pay until he has received monies from his customer (the ‘pay-when paid’ regime) introduce uncertainty and therefore risk to the prime contractor both of which were supposed to have been avoided by the inclusion of firm payments arrangement. Payment against a letter of credit whereby a third party (normally a national bank in the country of the prime
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contractor) will automatically pay against the proper presentation of documents defined in the prime contract removes this uncertainty and risk although such arrangements are usually reserved for trading with overseas clients who may be considered of low credit-worthiness, not motivated to pay and remote from effective legal action. Traditionally the prime contractor’s remedy for late payment is generally not strong. The law makes no immediate commercial linkage between performance and payment. It takes a clinical view that once the parties have exchanged their promises and made their contract the client is entitled to expect performance and the prime contractor is entitled to receive payment, in that order. That is to say if 100% performance is met by non-payment the prime contractor is entitled to sue for payment and that is all. It leaves the prime contractor with no bargaining power and no recourse other than the pursuit of his money through litigation. However, governments have for some years been seized of the damage that is done, especially to small firms, if payments are delayed. There is an expectation that payment should be made within 30 days of a legitimate invoice and, in some circumstances, there can be an entitlement to interest on payments outstanding. Nevertheless, contractual rights and remedies are almost always of greater utility than general law or regulation and the prudent prime contractor will seek both to have these standard rights enshrined in contract and to have stronger remedies, which might include a right to terminate or suspend the prime contract if payment is late. In many cases termination might injure the prime contractor more than the client and as such it would be a measure of last resort. The right to retain title in the product until full payment can also be a powerful position in which to be since it allows the prime contractor to recover the goods and sell them elsewhere. Again this can be a two edged sword since recovering the goods can be difficult, costly and unrewarding. The right to interest on late payments can be more persuasive as it is more immediate and hits the client where it hurts – in the pocket. In the absence of a contractual provision, recovery of lost interest is not a financial loss which the courts normally recognise. Finally, it can be as well to include a contractual right to set off in the circumstances where the client both buys from and sells to the prime contractor. Thus if the client owes the prime contractor money the prime contractor can set the debt off against amounts which he owes to the client under a different transaction.
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4. The client cannot pay From the prime contractor’s perspective the difference between the client being unable to pay and his not paying for some other reason may be largely academic. If money is owed it must be pursued although the cost of pursuit should be weighed against the value of the debt. Small debts may be better written off. Of course if the client has no money then pursuit of the debt is unlikely to be rewarded any more than if the client simply is not paying for his own cash flow motives or as a result of a technicality. Either way the aim is to reduce or eliminate the risk of non-payment by a combination of contractual terms which motivate the client to pay (e.g. the right to interest on late payments), a watertight mechanism (e.g. the letter of credit) and the passing or sharing of the risk with an insurer (e.g. ECGD).
5. Inflationary cost increases It is important to be precise about the term inflation, which is generally taken to mean the effect on costs brought about by changes in economic conditions, where economic conditions means those generally prevailing as opposed to those specific to the prime contractor. Passing some of this inflation risk to the client can be worthwhile using prime contract clauses variously described as ‘Variation of Price’ (VOP) or ‘Contract Price Adjustment’ (CPA). These generally work on the basis of a formula: Pa = Po x (A + B Lf + C Mf) Lo Mo
Where Pa = Prime contract Price as adjusted Po = Original Prime contract Price A
= Non-variable element of price
B
= Labour proportion of variable element
C
= Material proportion of variable element
Lf = Labour index final Lo = Labour index original Mf = Material index final Mo = Material index original
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The original prime contract price is the prime contract price at a particular economics base. It may be the economics prevailing at the date of contract, the date of quotation, the date of invitation to tender or any other convenient point. The prime contract price as adjusted is the final value of the original price after the application of the formula albeit that interim adjustments can be made rather than wait entirely to the end. A, B and C add up to one. For example if their values are respectively 0.1, 0.7 and 0.2 it means 10 per cent of the prime contract price is not variable, 70% is attributable to labour which is variable and 20% to material which is also variable (the labour/material proportions of the prime contract being 7:2). It is important to express it in this way so that it is the entire prime contract price (excluding the non-variable element) which is adjusted including overheads and profit rather than just in respect of wages/salary/material cost changes. L and M refer to inflation indices published by Industry or the Government and selected for the relevant sector of industry. Lo and Mo are the indices as at the economics base date of Po. Lf and Mf are the value of the same indices prevailing at appropriate later dates. For example Mf may be at the mid point of material deliveries or invoices. Lf may be at, say, three months prior to due delivery reflecting the mid point of the manufacturing cycle. In a fixed price contract the prime contractor would prefer A to be zero conveying all the inflation risk (to the extant that movement in the chosen indices is likely to reflect actual potential changes in the particular prime contractor) to the client. VOP/CPA clauses, therefore, tend to cover some or all of what may be referred to as ‘background’ inflation over which the prime contractor can exercise little control. Material costs can be controlled by seeking long term prices and salary/wage costs can be controlled by everything from fear of redundancy to profit sharing schemes. However, buyers are generally wary of inflation clauses which link to the prime contractor’s actual variation in wages/salaries and materials as there is little incentive on the prime contractor to exercise any control.
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6. Foreign currency fluctuations The choice (for a UK based prime contractor) of currency in which to trade depends on the circumstances:
UK Client paying in £
US Client paying in £
US Client paying in $
UK Suppliers £
√
√
X
US Suppliers £
√
√
X
US Suppliers $
X
X
√
The example is between Sterling and US dollars. This is only an example and the framework shown suits any Sterling v overseas currency situation. However, many projects involve circumstances much more complex than that shown especially if suppliers are chosen from a wide range of overseas territories. Considerations to bear in mind are: a)
The currency in which the end client will pay.
b)
The stability of various currencies – the greater the instability the greater the risk.
c)
The availability of currency.
d)
The commercial advantage in paying overseas suppliers in currencies other than their own.
e)
The cost of dealings in foreign currencies.
Primarily the aim is to quantify the risk so that it can be adequately provided for in the price at the time of agreeing the prime contract. For example if a UK prime contract paid in Sterling has a large overseas supplier content then the suppliers should be paid in Sterling (which transfers the exchange rate risk to them) or the value of the suppliers orders should be bought forward in the relevant currencies so that the exchange rate(s) in question have been effectively fixed at the date of contract. Alternatively, if a UK prime contractor is selling abroad to a client who will pay in his own currency, the currency should be sold forward or the prime contract should include a formula for adjusting the price for variations in exchange rate: Pa = Po x (A ER0 + B) ER1
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Where Pa
= Price as adjusted for exchange rate variation
Po
= Price at date of prime contract
A
= Variable element
B
= Fixed element
ER0 = Exchange rate at base date ER1 = Exchange rate at date of variation Rather like the VOP or CPA formula covered earlier in this Section, ERV formulae tend to have a fixed element and a variable element. The greater the fixed element the greater the currency risk which is left with the prime contractor. The exchange rate base date might be the date of tender or date of contract. The date of variation might be the date of delivery or invoice to the client. An ERV formula can protect the prime contractor against all or part of the currency risk when a client pays in other than the prime contractor’s own national currency. It works by adjusting the prime contract price as the prime contract price currency fluctuates – However an ERV formula can also be used where the client pays in the prime contractor’s national currency but where the prime contractor has significant expenditure in a different currency. So in this case the formula works by adjusting the prime contract price for changes in the prime contractor’s costs caused by currency fluctuations in its overseas expenditure. In the formula given above the variable element (A) would be less than (fig) 1, reflecting the proportion of the prime contract price which is attributable to the overseas expenditure. ER1 would be the exchange rate at, say, the mid point of disbursement of the foreign currency.
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Customer
Sell forward if customer pays in foreign currency
ERV formula if customer pays in foreign currency
Use ERV to protect against overseas expenditure
Company
Buy forward for overseas expenditure
Pay in own currencies
Pass currency down from customer
Suppliers
Figure 13: Currency Risk Management
The final approach which is illustrated in Figure 13 together with the other currency risk management options is having foreign currency ‘flow through’ the prime contractor transparently. For example a UK client could be invited to pay partly in sterling and partly in the currency of the prime contractor’s overseas suppliers. This completely insulates the prime contractor from the exchange rate variation risk and requires no involvement in currency dealing. As with VOP and CPA clauses it should be remembered that ERV formula can produce reductions in the prime contract price as well as increases depending on the actual direction of movement of exchange rates.
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7. Contract termination Essentially a prime contract can come to a premature end in one of only three3 ways:
Arrangement
Key premise
Enabled by
Mutual agreement
Termination suits both parties. No matter their respective reasons neither has any wish to continue.
Agreement
Termination for default
One side (usually the prime contractor) fails in some fundamental obligation under the prime contract.
Contract Law and/or a contractual provision
Cancellation for convenience
One side (usually the client) may opt to end the prime contract.
Contractual provision
If termination suits both sides then that event is hardly a risk in the sense that it is here being used. Insofar as the financial consequences are concerned the effect might be small. For example a low value contract terminated early in its life on the basis of anticipatory breach might leave the defaulting party with little unrecoverable costs, although lost anticipated profits or lost business opportunity may be a bigger concern. On the other hand the impact may be very great where a large value contract is terminated for actual lateness leaving the defaulter with huge costs, an idle workforce, unsellable part-used materials etc. However, one thing which is clear is that termination for default on a major contract is probably assessed as high impact low probability at the bid stage; thus if the risk materialises the defaulter has little control (obviously if he had control the prime contract would not have been late in the first place). In a termination for default clause it is most unlikely that the innocent party will agree to compensate the defaulter in any way other than to pay for goods received and accepted. However, it is possible that a period of notice may be provided. If this obligation on the client to give notice can be further refined to require him to allow extra time for the prime contractor to catch up, or propose an alternative programme, so much the better.
3
For practical purposes we ignore contract frustration mentioned in section 2
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Cancellation for convenience is usually understood to mean cancellation for the convenience of the client. Rarely do contracts allow the provision to be operated vice versa. Because it is for the convenience of the client, the client must accept liability for the consequences of his breaking the original deal. The frequent dilemma is over the extent of the consequences. Clients will agree to reimburse costs properly incurred to the date of cancellation and perhaps profit on those costs but usually not anticipated profits. For these reasons it is as well for prime contractors to avoid cancellation for convenience clauses. A decision to take a prime contract may in part have been based upon anticipation of the benefits beyond making a profit on that prime contract. The order may take the prime contractor into a new business field or onto a grander scale of operation. For these opportunities decisions may have been made to invest in capital, acquire new premises or take on new staff. The particular order may have been taken at the expense of other more routine work. To have these opportunities and decisions potentially frustrated for no greater reason than the convenience of the client is wholly unattractive. Finally it is a major risk to assume that a termination or cancellation will be revoked. Clients may threaten one or the other in order to get the prime contractor’s attention or as a negotiation tactic and it is important to analyse the risk of such threats being carried out. Having made such a major decision actually to cancel or terminate it is unlikely that the client would revoke that decision since he too will have done his analysis and presumably have determined cancellation or termination to be his best possible course of action.
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8. Financial claims against the prime contractor Claims against the prime contractor must always be taken seriously. The sources of claims can be as follows:
Examples Contractual
Liquidated damages Price reduction for under-performance Damages following termination Express warranties
Statutory
Implied undertakings under Sale of Goods Act Product safety under Consumer Protection Legislation
Legal
Failure in duty of care Failure against implied terms
These categories and examples should not be taken as exhaustive. They merely suffice to show that there is more to this contract business than meets the eye. It is important never merely to admit a claim. Once admitted, liability is not in question, just the number of pound notes to make the claimant go away. Even recognising that a claim has been received could prejudice the position. It is better to rebut statements that purport to be claims. Often, if a claim is made, it causes the claimee to examine all the background facts, information and evidence in order to establish all possible defences, but in addition it causes him to think about the performance and behaviour of the other side. This can lead him to make a counter claim (usually bigger!) against the claimant. If nothing else it can be a useful bargaining card. Whilst the vast majority of commercial claims are settled by the parties, legal advice should be sought wherever there is the possibility of the matter becoming formal whether under conciliation, mediation, arbitration or litigation. Not only does this help to identify defences against the claim and lines of argument in commercial negotiations but it also helps to stop the claimee from saying or doing something which might later count against him in a formal forum. If there is any chance of money changing hands in order to resolve the claim then a financial provision should be made in the prime contractor’s books of account so that the risk of having to part with cash is planned into the business model. If this heart-rending act of the prime contractor parting with its money appears inevitable then the longer it takes the better. After all, if the delay is long enough,
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the claimant may give up. The possibility of blaming (i.e. transferring the liability for the risk that has materialised) someone else should always be considered. This has two avenues. Firstly as a bluff which, if it works, is fine. Secondly, and going back to first principles, the contract may allocate the particular risk to the other party despite what common sense may indicate to the contrary. If a deal has to be done it should always be without admission of liability and without prejudice and, if possible, without hard cash. Parties who trade with each other beyond a single transaction may well have things to offer other than cash. A discount on the next contract and dropping of another separate claim are examples of cash-free settlements.
9. Pointers for project risk management •
The most immediate financial risk in performing a prime contract is the risk that actual costs will exceed the estimated costs. This is blindingly obvious. Part of the solution may be to consider a form of contract in which cost-risk is shared with the client. For higher risk projects this may be the best approach and brings other benefits through the inherent encouragement of cooperative working. Remember the prime contract is the vehicle for allocating risks. Consider allocating some to the client. This may be better value for him too.
•
Give great attention to the principles and mechanisms by which the prime contractor will get paid. Use combinations of advance, progress, stage and milestone payments. Ensure milestone definitions are clear, meaningful, demonstrable and achievable. Make sure the prime contract is an active enabler of payment, not a barrier.
•
Take seriously the always-present risk of a claim against the prime contractor. No matter when a claim arrives, the seeds will have been sown much earlier. Combine project risk management with a constant alertness for downstream contractual danger. Today’s fudge or fix may be tomorrow’s claim.
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Checklist Risk: The Client will not pay DO
•
Make payment ‘the essence of the prime contract’.
•
Retain title to the product until payment is made.
•
Break prime contract performance into several separable parts.
•
Seek advance payments.
•
Seek milestone or stage payments.
•
Include a right to claim interest charges on overdue payments.
•
Require payments to be made under a confirmed irrevocable letter of credit.
•
Include the right to suspend work if payments are delayed.
•
Specify precisely procedure and paperwork required for invoicing.
•
Specify a maximum credit period.
•
Include a set-off right.
DON’T
•
Use unconfirmed or revocable letters of credit.
•
Accept payment retentions.
•
Accept rolling retentions.
•
Agree to pay-when-paid clauses.
•
Agree to client ‘discretion’ in the making of payments.
•
Agree to vesting clauses.
Risk: The Client cannot pay DO
•
Investigate the financial standing of the client pre-contract.
•
Seek bonds or guarantees from the client’s parent prime contractor (if appropriate) or from a third party such as a bank.
•
Seek credit insurance from ECGD or NCM depending on territory and status of client.
•
Seek payment in Sterling.
DON’T
•
Accept open credit terms from shaky clients.
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Risk: Inflation increases cost DO
•
Pass the risk to the client.
•
Seek firm (non-variable) prices from suppliers.
•
Seek long quotation validation facilities from suppliers.
DON’T
•
Assume that any government inflation figures and forecasts are representative.
•
Assume that inflation rates are stable.
Risk: Foreign currency fluctuates adversely DO
•
Buy or sell forward as appropriate.
•
Look for currency equivalence.
•
Pass the risk to subcontractors.
•
Mitigate the risk by exchange rate variation clauses.
•
Look for payment in multiple currencies.
DON’T
•
Forget to assess the currency issue at bid preparation time.
Risk: The Prime contract is terminated DO
•
Avoid termination clauses.
•
Include the obligations on the client to give notice of termination.
•
Include the right to recovery of costs and profits.
•
Include ‘back-to-back’ provisions with suppliers.
DON’T
•
Assume a termination will be revoked.
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Risk: Financial Claims against the prime contractor DO
•
Rebut any claim received
•
Consider making a counterclaim
•
Muster all the defences
•
Take legal advice
•
Consider a financial provision
•
Delay
•
Blame someone else
•
Include an overall limit of liability
DON’T
•
Admit a claim
•
Make a financial settlement other than as a last resort
•
Admit liability in any settlement
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Section 4 Technical risk 1. Do we want to take this risk? 2. Analysing the requirement 3. Options 4. Sharing the risk 5. The commercial engineer 6. Setting the baseline 7. Requirement creep 8. The changing requirement 9. The work takes longer than expected 10. The never-ending contract 11. Failure of performance 12. Buyer initiated problems 13. Pointers for project risk management Checklist
Section 4 Technical risk
1. Do we want to take this risk? Business is about taking risks. Take a contract and you take a risk. The risk is that you may not be able to complete the work on time and within budget. Cost and time are the key issues and it is the scale and complexity of the technical requirements of a project that are the main driving forces on cost and time. If the technical scale and complexity are not understood then cost will increase and the work will take longer. The cost will increase not only because there is more work to do than had been realised but also because more work usually takes longer. More time almost always means more money. Bidding for contracts of high complexity and long duration inevitably invites the question as to whether taking the risk on at all is a wise move. In a difficult economic environment any business is good business. The prime contractor that consistently chooses not to bid because the risks are too high has no work and no future. Its fate is sealed and it may as well issue the redundancy notices straight away. However, the prime contractor that bids and wins high risk work which it does not fully understand is only delaying its fate. Contracts which over-run on time or underachieve on performance lead to client dissatisfaction. Contracts which over-run on budget tend to disillusion shareholders. The combination of dissatisfied clients and disillusioned shareholders is not the best recipe for long term business survival! And yet not bidding for work which is obviously in the prime contractor’s market sector and ostensibly within its capability and capacity is not a serious option. The answer to the question ‘do we want to take this risk?’ is ‘No, but we will’. Unless the prime contractor is able to diversify into lower risk markets where there is a market share to be won against the sitting suppliers then, inevitably, the conclusion must be drawn that bidding is the only choice. The objectives then become the proper understanding of the scale and complexity of the requirement and finding ways of reducing, eliminating or sharing the risk inherent in the potential prime contract.
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2. Analysing the requirement The twin problems of bidding high-complexity contracts are not enough time and not enough money. And yet in the bid phase there are assumptions and decisions made which will forever affect the performance of the prime contract. It is far better to bid for fewer projects than to bid as many as possible hoping it will be alright on the night. For a complex requirement spread over a number of years the risk that can have an impact include: •
Rate and direction of technology evolution.
•
Rate and direction of manufacturing process evolution.
•
Availability of IT support.
•
Evolution of new software languages, tools and other development environments.
•
Obsolescence of designs, materials and components.
•
Scale and complexity under-estimated.
•
Changing technology in the client environment.
•
New or revised statutory requirements on standards, procedures, inspection and health and safety matters.
It is important that the formulation of the project risk register takes into account the commercial aspects of all such risks. For example, some of these may affect subcontractors, one result of which may be the late completion of project subcontracts, with all the consequences that might then be brought.
3. Options One approach in handling these sorts of matters is to offer the client options that allow a low risk path to meeting his entire requirement. If the technical requirement contains for example 10,000 features which have to be met and the pre-contract programme risk analysis shows only a 5% probability of delivering all 10,000 features on time, then it can be much better to offer initial delivery with limited functionality followed by phased upgrades over time which represent a growing capability culminating in total performance. This approach is lower risk to both sides. The prime contractor carries a lesser risk of encountering contractual and cost penalties and running into trouble. The client enjoys a greater probability of receiving something that works on time with a reliable path towards full specification.
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4. Sharing the risk The ultimate logic for the client to consider is that leaving all risk in the performance of the prime contract with the prime contractor does not equate to eliminating the risk of the prime contract not being performed on time and to specification. Hence if there is significant risk in the work it can be more prudent to accept that managing the risk is best done as a joint activity. After all, even if contractually all risk lies with the prime contractor this can in practice be of little consolation to the client if the prime contract is delivered late or at underperformance. The best means of sharing the technical risk is to share the cost risk. Technical uncertainty means uncertainty over cost. Hence if technical decisions are made jointly in an environment where both sides together stand to gain or lose financially depending upon the quality of those decisions, then there is the greater incentive for sound decision making. The principles of costrisk were discussed in Section 3. Furthermore the cost risk sharing scheme can be modified to actually allow variation in the achievement against the technical requirement (figure 14).
Profit
Performance incentive region
Target fee
Target cost
Cost
Figure 14: Performance Incentive
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In a scheme such as this, additional profit can be earned from bettering specified minimum standards of technical achievement providing both the opportunity for improved profits through pure cost management and additionally through a specific performance related formula.
5. The commercial engineer Many large contracts and projects absolutely rely upon engineers to undertake or participate in crucial activities such as: •
Estimating costs;
•
Estimating time;
•
Producing outline designs, prototypes at the tender stage;
•
Producing complex designs, products and systems in prime contract;
•
Producing technical proposals as part of the bid;
•
Producing implementation specifications in response to requirement specifications;
•
Producing specifications and statements of work for subcontractor/ supplier request for quotation;
•
Project manage the prime contract;
•
Generate change proposals;
•
Handle the day-to-day interface with clients and suppliers.
The importance of ensuring that the engineers who bear the responsibility for those activities are commercially aware as well professionally competent cannot be over-stated. The legal, contractual and financial implications of their actions should be an essential part of their understanding of their responsibilities. It is as easy to lose £100,000 on a £250,000 prime contract as it is to lose it on a £25,000,000 prime contract. The development of commercial engineers should be seen as a strong plank in the overall process of project risk management.
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6. Setting the baseline In any project prime contract it is necessary for the technical baseline to be established. This may be done through the following example documents:
Document type
Purpose
Performance
A definition of what the end result does
Technical
A definition of what the end result is
Acceptance
A definition of the method of proof of compliance
Statement of Work
A mostly qualitative description of the activities involved
The more such documents are included the better the definition of the requirement. However, if there is more than one document then the potential problem is introduced of mutual exclusiveness, inconsistency or ambiguity between the documents. This must be overcome by including a statement saying which document has precedence in the event of conflict. The choice of specification type can have the effect of allocating risk between one side and the other. For example if the client contracts against a performance specification then the risk of failure in the utility of the project output must lie with the prime contractor. The inclusion of a statement of work can both help and hinder the situation. A statement of work can confuse the position if full compliance with the technical specification requires additional work to that stated in the statement of work. Who then carries the liability for the cost of the extra work? On the other hand the statement of work may indeed help in the understanding of what is to be done and so may have a place in the scheme of things. If an acceptance specification is used to define the method of proof of compliance then the status of individual requirements of the technical specification which are not explicitly to be proven (for cost or practicality reasons) under the acceptance specification must be made clear. Clarity, therefore, can be improved by incorporating appropriate specifications in the prime contract and by stating an order of precedence in the event of conflict between them. Further clarity can be gained by including a compliancy statement which, for example, lists every paragraph of each specification against which is put a statement of compliance. This can be a simple ‘yes’ or ‘no’, or a quantitative statement can be given for partial compliancy.
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7. Requirement creep In any project there is a risk that the client’s generalised expectations are different from those of the prime contractor. In non-contractual and non-technical terms the client wants the greatest value from his expenditure and the prime contractor wants to complete at minimum cost. There can be a mismatch between maximising value and minimising cost with respect to the same understanding of a project. On either side a degree of mismatch may be realised. The client can perhaps see a requirement the full implications of which have not been realised by the prime contractor. The prime contractor may have certain understandings about the limitations of certain features that have not dawned on the client. Neither side wants to expose the realised mismatches for fear of consequences. The prime contractor may want more time or money. The client might go elsewhere. Although logic demands that any such realised mismatches should be cleared up before the prime contract is let, not infrequently both sides may hold back. Of course some mismatches may not appear to either side until work is underway. Whether mismatches are realised or not they represent a requirement gap between client and prime contractor. As work under prime contract proceeds the client is motivated to close the gap by pulling the prime contractor’s performance up to his preferred interpretation. This is called requirement creep. Requirement creep tends to be upwards in the direction of the client’s interpretation, not downward towards the prime contractor’s interpretation. This is for two reasons. Firstly, the client has control over payments to the prime contractor and this can cause a certain influence to come to bear. Secondly, the prime contractor’s personnel, especially at the working level interface, are naturally inclined to want to please the client by adopting his preferences. Sometime the reverse may apply. The client’s desire for progress may incline him towards the prime contractor’s more minimal interpretation, but generally, requirement creep is towards the client. To resist requirement creep, personnel so involved must always put the minimum interpretation on the requirement, understand the commercial implications of going beyond what was anticipated and keep written records of meetings and other avenues through which the client attempts to make the requirement creep. Once engineering staff understand that innocently concurring with the client’s view can lead to the prime contract running into a loss or being terminated (i.e. because the extra work cannot be completed in the prime contract timeframe) then they soon take a more commercial view of life. This may sound an obvious statement (and injurious to commercially aware engineers!) but it must be remembered that 99% of most engineers’ primary professional training is to do with ‘volts, amps and ohms’ and not with the commercial realities of business.
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8. The changing requirement Having established a sound technical baseline in the prime contract the client’s ability to alter the specification can arise either because the prime contract gives him the right to vary the requirement or he seeks the agreement of the prime contractor to modify the prime contract. The latter gives the prime contractor a much stronger bargaining position since it is not obliged to accept any variation. For this reason the client may seek a contractual right to issue variation notices. It is important to be clear as to which parts of the prime contract requirement are subject to this unilateral right of variation. The right may be limited to matters of pure technical specification or may extend to quantity and timeframe. In any event the prime contract should define strict procedures for controlling changes to the technical baseline. The procedures should require that proposals for prime contract change examine: •
The effect on price (the particular prime contract and other related contracts).
•
The effect on performance.
•
The effect on time.
•
The date of implementation.
•
Before and after implications (e.g. backwards compatibility).
•
Effect on operation, maintenance, spares holdings.
The prime contractor should be clear about whether it would recommend particular changes and take responsibility for their success or not recommend particular proposed changes and leave the risk of their success with the client. Both sides may wish to have the right to propose changes with, in most cases, only the client having the right to decide. The prime contract should also provide for liability for proposal preparation costs. Most importantly the prime contract must prescribe that the requirement changes do entitle the prime contractor to revisions to price, time for performance and adjustment of other affected features of the prime contract. Prime contract changes although potentially disruptive are nevertheless an opportunity in several senses. More work means more order book and turnover. More work means price increases with a chance to improve profits. More work usually means more time which may be helpful. Similarly the urgency with which changes must be introduced can be a powerful bargaining tool in the process of re-negotiating the price and other aspects of the prime contract.
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The right of the client to change the prime contract should be echoed in the terms of subcontracts so that changes dictated by the client that affect subcontract work do not leave the prime contractor powerless to obey and thus in breach of contract. There is a delicate balancing act to perform here that as subcontract price revisions should not be agreed prior to equivalent revisions being negotiated to the prime contract price. The main thrust of the bargaining advantage to the prime contractor is in avoiding the obligation to introduce changes prior to agreeing a price revision. To do otherwise runs the risk of negotiation being left until the prime contract is finished. This situation hands the bargaining advantage back to the client who has the goods and the money. Thus the prime contractor should hold out for agreeing changes prior to going ahead. This is also important from a cash flow point of view. To proceed without prior adjustment to price and payment arrangements runs the risk of real extra cost being incurred beyond the limits of the prime contract payment scheme exposing the risk of negative cash flow and financing difficulties. Whilst changes are an opportunity for the prime contractor since, in the words of the client, ‘the price only ever goes up’ the prime contractor should be wary of changes which reduce the scope or the scale of the prime contract to the point where the prime contract is no longer commercially attractive, or of changes which are unrealistic or impossible to implement. Changes which are uneconomic of achievement or which may be unrealistic (e.g. halving the timeframe) are wholly undesirable and it can be as well to put lower boundary conditions on the client’s right to vary the prime contract.
9. The work takes longer than expected Technical difficulty and delay are obviously inter-linked. Technical difficulty is only one reason that can cause delay. The pure technical issue is the one where, notwithstanding prudent and professional estimating and adequate resourcing, there emerges a problem beyond the expectation of the reasonable man and therefore beyond whatever allowances were made in cost and time for contingent events. This situation must be tackled judiciously with the client. The emergence of an unpredicted technical issue may generate loss of confidence by the client triggering a chain reaction that could culminate in termination.
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The resolution of technical problems is inherently a part of any prime contract involving complex work but the emergence of that special category of problem, if it should be of a significant scale, could well be the event that brings down rack and ruin. The usual reaction of the prime contractor is to concentrate on the time factor with a view to persuading the client that all will be well, if only a little more (and a little more, and a little more) time could be allowed. This makes good sense in many cases but there is a risk that soldiering on can become an indefinite process with an indeterminate end. The prime contractor should very carefully examine the situation to see if this is likely to be the case and, if so, consider an early attempt to re-negotiate the prime contract not just to extend the time but to reduce the requirement in such a way that the issue is effectively removed. It can be better to reduce the scope and the price by 10% than to overrun the price by 20% in order to achieve 100% of the scope. The consequences and difficulties of re-negotiating the prime contract should not be under-estimated. The client is not obliged to go down this path. The requirement giving rise to the technical problem may be an absolutely mandatory feature in the client’s eyes and if, to get it removed, the client wants a 30% reduction in price for a 5% reduction in performance then the decision for the prime contractor is certainly not an easy one. However, the point is that re-negotiation should be given early consideration, even if it is not raised with the client until later, rather than flog on regardless. Part of the equation will be the respective bargaining positions of the two sides and their relative negotiating strengths and weaknesses. Certainly if the approach is attempted it must be properly planned and executed with the prime contractor being sure of its ground at each step. For example it is nothing short of foolish to confess that ‘we cannot meet 100 db but we can achieve 98 db’ only later to find, after the client has accepted that 98 db will do, that only 95 db can be attained.
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10. The never-ending contract The difference between the risk ‘the work never finishes’ and ‘the work takes longer than expected’ is perhaps a little obscure. The latter covers the situation where a substantial problem occurs which may be utterly insoluble or not soluble within a cost or timeframe which is remotely comparable with the prime contract as agreed. The risk of the work never finishing is more to do with the attitude of the people in both the client and prime contractor organisations. Sometimes the work drags on because the prime contractor’s engineers ‘won’t stop engineering it’ or the client’s people are excessively pedantic and refuse to confirm that the work or stages are complete. Thus, if this distinction is accepted, the issue becomes one of ensuring that the engineering team is disciplined to meet the requirement. The other issue here is the application of Pareto’s law. The final 5% of the work or the last ounce of performance may soak up a degree of time and money which is hugely disproportionate to the ostensible intrinsic value or to the true worth to the client. Notwithstanding that the last drop of performance may be entirely incidental to the real needs of the client he is nevertheless perfectly entitled to insist upon 100% performance. Therefore it can be extremely useful for the prime contract to include a provision allowing concessions to be granted against the prime contract requirement. Provisions might be drafted so that the client is bound to approve concessions, perhaps limited in some qualitative or quantitative way to marginal or non-serious deficiencies only. The disadvantage is that the client may wish an entitlement to some price reduction but concurring with such unreasonable demands may well represent the best compromise! The other risk to achieving a tidy and timely close to the prime contract is the situation in which completion or acceptance requires positive action by the client. From the prime contractor’s viewpoint the prime contract should be so constructed that discharge of the prime contractor’s obligations can be a matter of objective determination. Thus clauses which, for example, specify that the prime contractor ‘must work to the satisfaction of the client’ or that require the ‘client to issue an acceptance certificate’ introduce an unacceptable degree of subjectivity which is both unnecessary and wholly undesirable given that the client is not necessarily under any incentive to confirm that the prime contractor has discharged its obligations.
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11. Failure of performance The phrase performance failure may usually be taken to mean that some requirement of the specification has not been met. However, from a commercial perspective, the meaning is wider. Any failure, including some technical deficiency, is a failure to perform the prime contract for which there may be contractual remedies (or ‘penalties’ as seen by the seller) and other legal rights available to the buyer. Thus a failure of performance would in strict terms only be absolutely apparent at the due date for performance (i.e. completion) of the prime contract or at some stage after delivery. However, it is covered here on the basis that the essential technical obligation is fixed at the outset of the prime contract and the extent to which that obligation represents a risk to the seller is determined by the terms of prime contract. Thus we return to the nature of the prime contract. Different stages of a project might be subject to different terms:
Project Stage
Type of prime contract (expressed very loosely)
Risk to seller
Study/research
Do the best you can
Nil
Development
Produce a design that should work
Medium
Manufacture
Make what’s been designed
Medium
Support
Keep it working
Medium
Many projects are, however, subject to turnkey type arrangements, where the whole design, build, implement and support responsibility is handed to the prime contractor as a package. Here the risk is much higher.
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12. Buyer initiated problems Where performance of the prime contract depends on information, material or facilities to be provided by the client, it’s obligation to do so by certain dates and for certain periods should be stated. Failure against these obligations may give rise to delay. Delay may also be caused by the dates being achieved but the information, material or facilities proving inadequate. The client’s liability for the risk of the time and cost effects of delay are covered in Section 5. However, it is not inconceivable that lateness or inadequacy of these things does not delay the performance of the prime contract but does increase its costs through nugatory and diverted effort expended prior to the realisation that, for example, the client-provided information is inadequate and the consequent expense incurred in having to work around the problem. For these reasons it is important to state that client-provided information will be in a specified format and that the client warrants that it is ‘complete, up to date and fit for purpose’. Similarly client-provided material and facilities should be subject to equal rigour in definition and warranty. The prime contract must expressly provide the prime contractor with the entitlement to revise the price and other affected features of the prime contract in the event that any client obligation is not properly discharged. If the prime contract has been concluded on the basis of the client providing information, material or facilities then that obligation should not be disturbed by a clause that transfers the risk in that provision to the prime contractor. For example, clauses which require the prime contractor to satisfy itself that clientprovided information is fit for purpose should be avoided.
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13. Pointers for project risk management •
The prime contract is the vehicle by which specifications move from the realm of engineering interest into a new role as legal documents. Specifications should not only be expressed in clear unambiguous terms for reasons of engineering rigour (actually some engineers like to leave specifications on the ambiguous side) but also because they will form the basis for measuring contractual performance. Engineers should encourage commercial colleagues to review and comment upon specifications with this second, but fundamental, purpose in mind.
•
Requirement creep is a great danger where projects are concerned. The slide towards increased cost and lateness must be avoided. Requirement creep makes the contractual performance hurdle higher. If the hurdle can not be surmounted the contractual and other penalties will follow. It is too late to turn to the buyer and say ‘we were only doing what you wanted’
•
In many projects the onus on the buyer can be of the same order of magnitude as that on the seller. It is always important to make sure that both sides’ obligations are fully delineated in the prime contract. In such balance situations both parties will be trying to avoid requirement creep on their own obligations. The total mismatch can get wider. This situation must be managed very carefully and the prime contract re-negotiated from time to time as necessary.
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Checklist Risk: The requirement is ill defined DO
•
Ensure that specifications are included in the prime contract.
•
Include a statement of precedence.
•
Include a compliancy statement.
•
Adopt the minimum interpretation of the requirement.
•
Consider the commercial implications when ambiguities are resolved.
•
Keep a proper record of decisions made or directions given by the client.
DON’T
•
Agree that the client is always right!
Risk: The requirement keeps changing. DO
•
Operate strict prime contract change control procedures.
•
Include a contractual entitlement to price revisions etc.
•
See fluidity as an opportunity.
•
Use urgency as a bargaining tool.
•
Include ‘back to back’ provisions with subcontractors.
DON’T
•
Implement changes prior to price agreement.
•
Ignore cash flow implications.
•
Accept unrealistic changes.
Risk: The work takes longer than expected DO
•
Handle the client relationship carefully.
•
Consider re-negotiating the prime contract.
DON’T
•
Give ill-considered promises.
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Risk: The work never finishes DO
•
Define completion and acceptance.
•
Seek entitlement to concessions.
DON’T
•
Wait for client approval per se.
Risk: Performance Failure DO
•
Avoid ‘turnkey’ obligations.
•
Avoid certifying ‘fitness for purpose’.
DON’T
•
Hold the prime contractor out as an expert.
Risk: Client-provided information, material or facilities are inadequate DO
•
Include an obligation on the client to provide the information, material or facilities by a certain date and for certain periods.
•
Include a definition or specification of client-provided information, material and facilities.
•
Include a client warranty that information, material and facilities are fit for their intended purpose.
•
Include an entitlement to revise the prime contract if the client’s obligations are not met in full.
DON’T
•
Assume responsibility and risk for the client’s obligations.
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Section 5 Timeframe risk 1. Bidding compliant delivery 2. The timeframe obligation 3. Time is of the essence 4. Consequences of delay 5. Liquidated damages 6. Force majeure 7. Delivery incentives 8. Client delay 9. Subcontractor delay 10. Prime contractor delay 11. The threat of termination 12. The threat of damages 13. Pointers for project risk management Checklist
Section 5 Timeframe risk
1. Bidding compliant delivery The risk of not completing the prime contract on time arises either before prime contract award and/or during prime contract performance:
Sources of timeframe risk Pre-contract award
Requirement not fully understood Resources underestimated Elapsed time for performance underestimated Resources planned to be free do not become available
Post-contract award
Loss of key resources Work proves more difficult than expected Client delays the work Subcontractors delay the work Extraneous factors delay the work
The key question of resources ought to be the one area in which the prime contractor can exercise the greatest control because the recruitment and deployment of resources is virtually entirely within the prime contractor’s control. However, the build up of resources for a project remains a typical problem (figure 15).
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Planned Actual
Resources
Trailing tail
Time Contract award
Contract completion
Actual completion
Figure 15: Project Resources
This shows the typical position whereby an early, steep build up of resources is planned, with a relatively short peak and a steady run-down as the prime contract is completed on time. In practice the build up starts late and does not grow as steeply as required leading perhaps to a higher peak and possibly a trailing tail as completing the entire prime contract proves more complicated and demanding than expected. In theory these problems can be avoided. Perfect management of resources will prevent this resource allocation problem. Perfect estimating will ensure the requirements are fully understood. Perfect planning, project management and programme risk management will ensure that the prime contract is completed on time and within budget. However, life is not perfect and unexpected things do arise to interfere with prime contract performance.
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Nevertheless the prime contractor ought to be as clear as possible at the bid stage as to the likely turn of events:
Probability of meeting desired project time scale
Bidding posture
Expected outcome
Risk of lateness
High
Compliant
On time
Low
Low
Offer later timescale
On time to offered timescale
Low
Low
Compliant
Late
High
So bidding compliant delivery with a high expectation of completing on time should not be a problem either in terms of bid adjudication or prime contract performance. Bidding non-compliant on delivery to eliminate risk of delay in prime contract performance is sound so that client and prime contractor are both clear as to the position and the risk of prime contract penalties are avoided. However, this runs the risk that the prime contractor may be ruled out at the bid stage for non-compliance and this leads to the decision to adopt the final option which is to bid compliant having a high expectation of lateness. This approach can be said to be unethical but in the hard commercial world it can be a key tactic in securing business. The client’s own risk analysis at the bid stage may draw him to his own conclusions about the viability of individual bids on timeframe matters but, at the end of the day, the prime contractor is entitled to take the view that winning the prime contract and then working to eliminate delay or to persuade the client that some delay is tenable is a legitimate approach. The unavoidable and unfortunate point is that sometimes circumstances force companies to bid on whatever basis it will take to win the prime contract. The real risk to all concerned is in sorting the mess out later.
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2. The timeframe obligation The prime contractor’s obligation to complete the prime contract by a specified date is a fundamental one. If the contract does not specify a completion date then the Sale of Goods Act comes into operation and obliges the prime contractor to complete within a reasonable period. However, the rule implied by the Sale of Goods Act does not usually apply to commercial contracts as it is rare for a commercial contract not to indicate the required completion date in some way. The complication is that many large contracts specify many dates on or by which things are supposed to be done and so the question must arise as to whether all such dates are equally important insofar as the fundamental obligation is concerned. Both client and prime contractor have a dichotomy to answer on this point. On the face of it the client wants to have it absolutely clear that he has not accepted any part of the work until the whole is complete and that the whole must be complete by no later than one specified date. On the other hand key events or milestones along the way for which the prime contract mentions date can be critical to him in assessing progress of the work and perhaps in deciding to release interim payments. Thus he does not want these dates to be of secondary importance. The prime contractor would not wish to have any dates carry great significance in case he runs into trouble and yet he would like to have the contract constructed so as to permit partial performance which provides that the work can be completed and accepted in stages so that early stages, once accepted by the client, are forever accepted even if the entire contract is never completed. This construction implies that individual stages could well have specified dates the meeting of which individually carry the weight of fundamental obligation. To bring this sharply into focus it must be said that failure to complete on time normally allows the client the remedy of termination. Thus it must be made clear in the contract whether only the final date or milestone dates as well allow the termination remedy if it, or they, are missed. The prime contractor must try to avoid milestone dates carrying this penalty and careful drafting of the contract can still permit partial performance and staged irrevocable acceptance by the client. Regardless of the status of milestone dates, if progress is patently slow or other evidence (such as progress reports by the prime contractor) exists as to indicate the contract to be most unlikely to be performed on time, the client can anticipate the breach of contract and terminate immediately.
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3. Time is of the essence ‘Time is of the essence of the contract’ is a statement which clients are traditionally recommended to include in the prime contract and prime contractors are urged to avoid. The truth of the matter is that in business contracts time is usually considered to be of the essence, provided dates are specified, whether or not this expression is included. The effect of it is therefore only to emphasise the implied condition. To be sure of avoiding the duty to meet particular dates the contract should state that time is not of the essence. This defeats the general assumption about the nature of business contracts. It is not as peculiar as it sounds. Despite the general assumption, timeliness is not invariably important in an absolute sense. By including the negation of the general principle the prime contractor thus avoids the risk of the client later deciding that absolute timeliness is of the essence. As with most things it is important for the contract to be clear one way or the other.
4. Consequences of delay Whilst unplanned delay is bad news for the prime contractor in terms of additional costs, delayed payments, negative cash flow and other such effects that impact its operation, potentially the biggest risk is the client taking action beyond exercising those provisions of the contract which are aimed at focussing the prime contractor’s attention e.g. suspending payments. The two ultimate remedies available to the client are termination of the prime contract and damages. The law expects the contracting parties to keep to their bargain. If the prime contractor fails to complete on time then the client is not expected to wait even a reasonable time. If the delay is one day or one hour or minute beyond the due time the client can terminate summarily for default. The client may want to reenforce this right by having a contract clause to the same effect. This gives the prime contractor some opportunity to open out a debate at the time of contract regarding periods of notice or core principle, but essentially the client will be looking for a simple contractual statement of what is his legal right. In the event of default the client is entitled to recover damages from the prime contractor to the extent necessary to compensate him for any financial loss suffered. In this context compensate means recovery of loss suffered and the loss suffered is strictly financial loss. In damages of this kind there is no sense of payment to compensate for upset or injured feelings and the loss must be real and not notional.
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Damages that can be recovered are those which flow directly from the default and are not those consequent upon it. There is no good definition of direct and consequential damages since the distinction is not absolute, it depends upon the particular circumstances. This is because the core principle is one of foreseeability. That is, the defaulting prime contractor is liable for those damages suffered by the client which were reasonably foreseeable by the prime contractor at the time the contract was made. Thus in the absence of the client having explicitly told the prime contractor of the potential consequences of delay the degree of foreseeability would be circumstances dependant. The most obvious example of client direct damages flowing from a prime contractor’s default is the possible additional cost of purchasing elsewhere. This is in principle true whether the object in question is a television or a billion pound power station. Again, the preference of many clients is to include the ‘purchase in default’ remedy as an express contract condition. It can be as well for the parties to decide how far the liability for damages should go and determine a list of potential categories of potential damages for inclusion in the contract. However, neither side is usually disposed towards this clinically correct approach beyond trying either to include or exclude everything generically consequential. The client’s right to recover damages arises whether or not he elects to terminate the contract. He may choose to continue with the contract if it remains the best opportunity to acquire the goods in an acceptable timeframe. In continuing with the contract he does not lose his right to damages. However if he does continue he can lose his right to terminate. After all it can be said to be unfair to the prime contractor for the client to let him continue, thus increasing his expenditure against the possibility of termination, and so a termination should be executed promptly following default. The client might think otherwise. He may consider it both fair and prudent to give the prime contractor another chance but not indefinitely so. In this situation the prime contractor hopes that by continuing, the client has impliedly waived his right to terminate. The client may notify the prime contractor of his intention to continue and in so doing seek to reserve his rights including those of termination. It is certainly unsatisfactory and risky for the prime contractor to carry on spending money with the threat of termination hanging over his head.
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5. Liquidated damages Generally the prime contractor’s liability for damages is unlimited and, in the ultimate, a court would fix the amount of damages following presentation of arguments regarding foreseeability and having seen evidence of real financial damage suffered by the client. However, it is open to the parties to fix this sum themselves when they make the prime contract. This ‘liquidated damages’ is thus a reasonable pre-estimate of the likely level of damage potentially to be suffered by the client in the event of delay. Having agreed the sum and fixed it within the contract the damages are then payable in the event of delay whether or not the client actually suffers any damage nor does he have to offer any proof of damage being incurred. Thus each party takes a risk. The client takes the risk that the amount so fixed would indeed cover his actual loss but gains in return a much more ready means of securing payment for damages. The prime contractor takes the risk that if he is late he will almost certainly have to pay whether or not the client is harmed, but in return his liability is limited to the amount pre-determined. Since delay in most cases will cause a client to suffer increasing damage as time goes by, liquidated damages clauses generally provide for a certain amount (or percentage of the price of the goods in delay) to be paid per week (or other period) to a maximum period and/or maximum amount or maximum percentage. To be effective liquidated damages clauses must be properly constructed and must satisfy the rule of reasonable pre-estimation. Liquidated damages which are set so high or that cut in so rapidly that their effect is obviously penal rather than compensatory will not be enforceable (at least not by the courts) nor will penalty clauses which masquerade as liquidated damages.
6. Force majeure If the prime contractor is late he is liable for damages and his contract is open to termination by the client. Lateness is not performing the contract by the due date. Thus one way to avoid these risks is for the due date to be extended. It can be extended by agreement or by some automatic mechanism. If the contract is late the prudent client is unlikely to simply agree to an extension as in doing so he waives his rights to damages and to terminate. He may do so in return for some valuable consideration but in the normal course of events there is nothing in it for him to extend. Thus agreement by the client should not be seen as having much chance of success if the contract runs into delay. Much better is to have an automatic mechanism. This is the concept of force majeure or excusable delays clauses which automatically entitle the prime contractor to more time if delay
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is caused by events which the parties could not have intended to be within his risk when the contract was made. This concept indeed is a form of risk sharing. One side or the other will carry the risk of delay caused by particular events. Ostensibly the entire risk lies with the prime contractor. A force majeure clause moves part of the risk to the client. Therefore the parties must agree which force majeure events lie with the client. There are two approaches. The first is to say that the prime contractor is entitled to more time if delayed by any event beyond his reasonable control. The second is to list the particular events. The advantage of the former to the prime contractor is that it appears wide embracing, the disadvantage is that because it is vague it is inevitably open to dispute which compromises the principle of risk sharing. If a list is given, at least there should be no question as to the application or not of the clause to the particular event. The list typically includes fire, flood, war, riot, insurrection and industrial action (i.e. inaction!). It should be remembered that the effect of a force majeure clause is usually to allow only more time, not more money. This is legalistically sound, as to allow more money would be inappropriate since many of those risks are insurable in terms of financial consequence and the opportunity of more money would not motivate the prime contractor to avoid these risks or to mitigate their effect in practice. Two special categories of force majeure are delays caused by subcontractors and the client himself. The prime contractor may well feel that the acts or omissions of suppliers which delay the work are outside his control but it would be risky to assume that force majeure includes supplier problems unless the clause specifically says so. As far as delays caused by the client are concerned it is as well not to treat this as force majeure as such. This is because force majeure offers only more time. If the client is in default he should be obliged to grant the prime contractor more time and more money. Whether or not force majeure relief can be implied into the prime contract, it is always far better to have an express provision which gives the widest possible definition so as to allow the maximum degree of contractual protection. It is important to observe any terms that relate to the availability of that protection, such as a duty to report events within a specified time of their occurrence and to estimate their likely effect. It is also important to ensure that people working on the project understand that this relief is available, that prompt reporting is essential and that the definition of force majeure will be limited in some way so as to exclude many things which might otherwise be thought covered. Force majeure relief does not give carte blanche to sit back while delay mounts. It is a fundamental duty to ensure that steps are taken to eliminate the cause of delay and mitigate its effect.
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7. Delivery incentives This Section has so far concentrated on exploring ways of avoiding, or limiting the effect of, the risk of delay, it being taken as read that, from the commercial perspective, the prime contractor is bound to see a firm contractual commitment to meet a specified timeframe as inherently bad news, albeit that consistently delivering on time is very good for client satisfaction and prime contractor reputation. However, every cloud has a silver lining and the requirement to hit a particular deadline can be an opportunity as well as a threat (figure 16).
THREAT
OPPORTUNITY
• Termination
• Bonuses
• Damages
• Customer satisfaction
• Reputation
• Reputation Figure 16: Delivery Commitment
Convincing the client that meeting urgent delivery requirements implies special measures, greater cost and more management attention can be converted into higher prices or a bonus arrangement of some sort. A bonus might be fixed or variable amounts or percentages of the price which are linked either to hitting an exact deadline or to achieving performance within a specified timeframe band. A delivery incentive scheme can also be combined with the cost incentive scheme described in Section 3 as shown in figure 17.
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Fee
Target fee
MOC
Target cost
MCP
Cost
Figure 17: Delivery Incentive Scheme Thus, in addition to the cost risk sharing principle, the prime contractor would be entitled to earn delivery bonuses perhaps (as in the scheme shown) as a percentage of the cost fee earned. This is very similar to the technical performance bonuses described in Section 4 and again allows the prime contractor to carry out cost benefit trade-offs between efficiency and timeframe of performance.
8. Client delay It is important to ensure that the prime contract specifies clearly all of the obligations of both sides to the bargain. It is easy to fall into the trap of thinking that the prime contract records a long list of duties on the prime contractor whilst the client’s obligation is limited to paying. As remarked earlier, the client frequently has obligations over and above this. Typically these might include obligations to provide materials, facilities, information and data. It is essential that the prime contract specifies such things in detail including the date(s) required, the periods over which they are to be provided, their state and location, responsibility for transport or transmission, a general warranty from the client that the items are fit for purpose, and any financial details including
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insurance. Patently any failure in a contractual duty on the part of the client in complying with these detailed obligations can give a right to the prime contractor for an extension in time for prime contract performance and possibly an increase to the price. This right is best expressed as a definite prime contract clause as it is generally easier to rely upon an express remedy than an implied one. Beyond the obligation to provide things, the client may well be required to do things such as commenting upon or approving/rejecting designs, data, documents, stage completion certificates, plans, specifications, deliveries and invoices. Again, every such obligation must be precisely stated including the timeframe within which the obligation must be discharge. Similarly if the client seeks the right to vary the work or otherwise direct the prime contractor as to the method of performance then that right should be stated including any limitations (e.g. that the client cannot vary the work so as to cause a reduction in prime contract value of more than 10%) and the circumstances within which the right can be exercised (e.g. in the event of ambiguity between different specifications or other documents incorporated in the prime contract). The consequences of exercising that right must be stated which, surprise surprise are more money, more time for the prime contractor. As with all claims, the events giving rise to the claim and any resultant claim must be brought promptly to the attention of the client. Apart from the prime contractor’s general duty to mitigate the effect of delay, the prime contract clauses which provide these remedies for the prime contractor may place obligations to report such problems and there may be time limitations within which claims may be brought. Clearly it would be unwise to accept prime contract clauses which absolve the client from liability for his own acts or omissions and yet such clauses are used. The justification for which is that the prime contractor is on notice that it carries the entire responsibility for and risk in performing the prime contract. Taken to the extreme this would be absurd. If the client issues a stop work order (a common provision in US contracts) then the supplier can hardly be expected to complete the work according to the original timeframe. On the other hand the prime contractor should not be entitled to more money and more time every time the client expresses some view about the scope or progress of work. Hence the need for a balanced approach as to the extent to which the prime contractor can claim for more time/money as against the client being reasonably liable for its acts and omissions.
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Notwithstanding any contractual provisions, the prime contractor must avoid absolving the client from liability for its acts and omissions as they arise in the everyday course of dealings between them. For example, the prime contractor’s project manager on hearing that the client is going to be late in discharging one of its obligations should not say ‘don’t worry, we were going to be late anyway’!
9. Subcontractor delay Delivery performance by subcontractors is a major risk in many projects. Some are suited to Just in Time procurement strategy where the business operation is relatively repetitive and the immediate benefits (low/zero stock, reducing inventory costs in the balance sheet, no storage space required for materials/ components) outweigh the obvious risk. Just in Time procurement is usually run hand in hand with partnership sourcing resulting in a small number of (hopefully) reliable suppliers. The risk to the prime contractor may be assessed as high impact, low probability and therefore the risk is taken provided effort is devoted to the sound management of the chosen suppliers. In this context management does not mean controlling and directing but liaising, problem solving, mutual quality assurance etc. Whether Just in Time, Partnership sourcing or otherwise, subcontractors are at risk which demands that the contractual terms and management of subcontractors must be appropriately addressed. This is examined in Section 6.
10. Prime contractor delay If the prime contractor delays the work it is only for one of two reasons. Either it wants to delay or it cannot help delaying. It might want to delay for a variety of reasons: •
In order to divert materials, goods or personnel to more urgent or more profitable orders.
•
In order to take advantage of forthcoming falling material prices.
•
In order to absorb personnel coming free from other projects who might otherwise leave.
•
In order to keep the project team together pending receipt of a followon prime contract.
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•
In order to release deliveries, sales or profits in line with business requirements.
•
To conceal problems allowing more time for their resolution.
The very best way to have this flexibility without exposing the normal risks consequent upon delay or default is to build into the prime contract the right to deliver or perform at the prime contractor’s discretion. This will be totally unacceptable to the client in many, but not all, cases. It is always worth trying. In the absence of a clause which allows the prime contractor to vary the performance then all delay, in the client’s eyes, is down to the prime contractor regardless of it being desire or event that produces the delay. Thus a force majeure clause offers some protection. More pragmatically, or deviously depending upon point of view, blame may be attributable directly to the client through his default or indirectly to him by his having given direction to the prime contractor or been involved in decision making or otherwise embroiled in events which, it can be said, show the client approving or concurring with delay or of condoning failures or omissions of the prime contractor. Of course delay and phrases such as ‘of the essence’ are only meaningful expressions if the prime contract specifies dates at or by which performance is to have occurred. If the prime contract is silent, ambiguous or vague then it is hard for the client to demonstrate delay. Provided there is no other relevant material, such as a price quotation giving delivery information, which would indicate the intent of the parties, then the client must rely on the ‘reasonable period’ of the Sale of Goods Act. If this line is to be followed then care must be taken as, for example, the ambiguity must be clearly ambiguous! A delivery date expressed only as a ‘target’ may perhaps be ambiguous. The prime contractor might feel that a target is only something at which to aim, there being no great penalty for missing by an inch or a mile. The client or a court might think otherwise, that hitting the target is indeed the fundamental purpose and a miss means trouble. Thus a difference of interpretation is not as good as a clear ambiguity such as the prime contract referring to different delivery dates for the same thing. The giving of delivery promises that cannot be met has already been discussed as being sometimes the only way to be considered for a prime contract. Whilst in the tough commercial world the legitimacy of this can be justified it must be seen as a measure of last resort as it takes the prime contractor into a prime contract with 100% probability of being late. However the ‘double whammy’ with such a prime contract, or indeed any prime contract which runs into time difficulties, is the risk of termination for anticipatory breach. Thus care must be taken in providing progress reports and similar material which forecasts delay.
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There is a fine balance to be struck between silence which avoids this risk and the need to apprise the client for the purposes of good relationships and to allow the client the opportunity to mitigate the effect of the delay on himself. As part of the process of managing delay it is sometimes assumed that clients will agree to concessions or relations against the prime contract requirement on the basis of a preference to have 90% on time rather than 100% six months late. This can be a dangerous assumption unless the prime contract can be made so as to oblige the client to approve relaxations. This is an acceptable approach particularly if the extent of such ‘mandatory’ relaxations is bounded in some way. Thus the risks consequent upon time delay might be reduced although there is then the risk that the client will want some financial consideration for approving the relaxations. Another question of balance is the desirability or otherwise of contractual penalties such as liquidated damages. If the client can be managed into accepting delay then it is better not to have liquidated damages in the prime contract. The presence of such a clause (regardless of its original purpose – penalty or compensation for real anticipated damage) creates a psychological hurdle in persuading the client to accept late performance. On the other hand a combination of certainty of lateness and hostile client can argue for the inclusion of liquidated damages as a means of limiting liability for lateness.
11. The threat of termination The first measure of protection against termination is to have the prime contract require the client to give notice and permit a period of cure in which the problem can be fixed or proposals made. This should ensure that a termination cannot come completely out of the blue. However, if the prime contract is in delay either by due dates for performance having passed or by it being obvious through lack of progress, then unless some relief is available (i.e. force majeure if the delaying events are covered by such a clause or some act/omission of the client provided such risk is not within the prime contractor’s liability) it is the case that the client is entitled to terminate either by law or under an express prime contract condition. The risk of termination may be high impact but low probability if the client’s requirement continues to exist and cannot be met more quickly elsewhere. However, that is no reason not to react immediately by approaching the client to discover his real intentions, his reasons and what might be done to placate him if he is serious and
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the threat cannot be nipped in the bud. Indeed seizing the initiative may be enough in itself to dissuade the client since immediate, positive pro-active action demonstrates the kind of client care the apparent lack of which possibly being a motivator for the client having contemplated termination in the first place. Nevertheless the threat of termination is most serious and it is prudent to take early legal advice so as to be sure of the formal situation should the client determine to proceed with such drastic action. Since litigation may ensue it is important to ensure that all communication with the client whether oral or written is handled extremely carefully in case friendly negotiations do deteriorate into legal action. Whilst bluff plays its part the conduct of commercial negotiations, calling a threatened termination as a bluff can only be considered if there is 110% certainty that it is indeed a bluff. Do not take the risk.
12. The threat of damages If the prime contractor is late in performance and cannot pass the responsibility to someone else then it does face the prospect of a claim for damages from the client. Thus it should treat all hints of a prospective claim seriously and aim to nip them in the bud. This can be attempted by: •
Pointing out to the client that he was wholly or partly to blame (sometimes the thinnest of information can be enough to frighten the client off).
•
Hinting at the possible consequences, e.g. further delay and disruption as key resources are pulled off the work to assist in defending the claim.
•
Highlighting the possibility of a major counter-claim.
The objective is to prevent a formal claim being made. Once someone has put a claim on the table it must be assumed that he is serious, believes he can support the claim and intends to see it through. None of these may be true but on the other hand once a claim is made the claimant is unlikely to simply withdraw it if, for no other reason than loss of face. If a claim is made then simple rebuttal and the making of a formal counter-claim can be enough to kill the claim off. A tough, firm but well considered rebuttal may make the client realise the mountain he must climb in order to succeed and the sheer scale of it with its implication of bad feelings; diversion of resources to pursue the claim and the cost may be enough to cause the client to back off particularly if it can be made obvious that
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notwithstanding his degree of resolve, the facts themselves show less than 100% probability of winning. Thus, if the rebuttal can draw out facts or opinions not realised by the client when he formulated his claim, this can be a big disincentive for him to press on. Similarly, a seriously made, well presented counter-claim may have the same effect. However, whether rebuttal or counter-claim, care must be taken not to reveal all of the prime contractor’s defences and arguments against the possibility that the client cannot be dissuaded resulting in the claim possibly becoming a dispute leading to litigation. The prime contractor must keep some of its powder dry. The immediate harm to the prime contractor in prime contract termination may include: •
Return of monies paid
•
Write-off of costs incurred
•
Unsellable stock
•
Loss of profits
•
Loss of overhead recovery
•
Redundancies
•
Loss of related business
•
Loss of confidence and reputation
This list is bad enough but after this initial shock wave a second hit may arrive in the form of a damages claim from the client. As been seen such a claim can be on the basis of damages flowing directly or consequentially from the prime contractor’s default. The primary example of the former is any additional cost suffered by the client in having to purchase elsewhere. Frequently clients will seek to include purchase in default clauses which prima facie are unattractive (to say the least!) but since they only provide a contractual prescription for what the law allows anyway the introduction of such a clause can be an opportunity to limit these purchase in default rights, for example by specifying a time limit within which the rights must be exercised and by requiring the client to demonstrate the reasonableness of his actions in purchasing elsewhere and in containing his own costs in pursuit of that end. Since consequential costs such as the client’s own loss of business are only claimable from the prime contractor if an express prime contract condition conveys that liability, or if such loss was reasonably foreseeable by the prime contractor, then the prime contractor must avoid those clauses and also avoid allowing itself to be put into a position where the client could argue that its damages were foreseeable by the prime contractor.
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When a claim is made, the first question in the claimant’s mind is how easily he can get the money from the other side. Thus the prime contractor should have it in mind when negotiating the prime contract in the first place to avoid the client having a simple means to take its money. There are three main clauses to watch out for. Firstly, if the issue is one of liquidated damages, avoid clauses which allow payment of liquidated damages to the client to be made automatically following lateness by deduction against outstanding or future invoices. Ideally the method of settlement should be left to the prime contractor allowing it to choose how and when to pay if it were ever in the position of conceding a liquidated damages claim. Secondly, prime contract clauses which allow the client to set off one alleged debt against another liability (i.e. by reducing payment on another prime contract in the sum of the claim to which it feels entitled) should be avoided. Finally there is danger in those payments clauses which allow the client, at his discretion, to reduce or suspend payments in the event of his not being satisfied with the progress or performance of the prime contract.
13. Pointers for project risk management •
On the face of it the array of project management tools available today should prevent projects from overrunning a stipulated time. But they still do. The classic problems of underestimation of complexity, undue optimism in the build up of project resources, client delay and supplier delay remain problematic. Mechanisms for limiting or eliminating the damage can be built into contractual arrangements.
•
Contractual arrangements by definition are set at the outset of the project. To ensure that arrangements are in place and effective requires a high degree of understanding between project risk managers and commercial risk managers. It is too easy for each to assume that the other has a potential situation under control. Such assumptions are themselves a major risk in project risk management.
•
If delay bubbles up during the life of the project, two linked principles are essential. Firstly there must be the earliest possible discussions between project and commercial risk managers to decide the right course of action. Secondly, once delay is likely then the project has drifted into the arena of contractual rights and remedies. It is very easy at this stage for these rights and remedies to be seriously prejudiced by well-meaning, but misplaced actions, statements and promises. At this stage it is essential for project managers dealing with client and supplier interfaces to tread extremely warily.
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Checklist Risk: The Client delays the work DO
•
Use the prime contract to identify all the obligations on the client.
•
Include a provision to modify the prime contract in the event of client default.
•
Specify the periods within which the client must give relevant approvals.
•
Ensure that any right of the client to direct or alter the work is provided for in the prime contract.
•
Promptly report any client-caused delay to him.
•
Pursue claims against the client if he causes delay.
DON’T
•
Accept clauses which absolve the client from liability for his own acts and omissions.
•
Agree that acts or omissions of the client are without consequence.
Risk: Suppliers delay the work DO
•
Select subcontractors on the basis of proven reliability and performance as well as cost.
•
Give purchasing/subcontract management high visibility and status within the prime contractor.
•
Ensure that subcontract management is involved in bidding/winning/ performing the prime contract.
•
Identify key suppliers at the outset and accord them special attention.
•
Make suppliers aware of the full consequences of lateness.
•
Make subcontractors contractually liable for consequential damages.
•
Include subcontractor default expressly or impliedly in any force majeure clause with the client.
•
Include the right to terminate for default or delay for convenience.
DON’T
•
Accept limitations of liability from suppliers.
•
Direct subcontractors.
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Risk: The Prime contractor delays the work DO
•
Include the right to vary the time for performance.
•
Include force majeure.
•
Involve the client in the work.
•
Avoid clear commitments to delivery dates.
•
Avoid ‘of the essence’ commitments.
DON’T
•
Give promises that can’t be met.
•
Give advance notice of delay.
•
Assume concessions will be granted.
•
Necessarily accept liquidated damages or other ‘penalty’ clauses.
Risk: Force majeure delays the work DO
•
Ensure that an adequate force majeure clause is included.
•
Ensure that force majeure delays are reported promptly.
•
Ensure that the definition of a force majeure event is understood.
DON’T
•
Forget the duty to mitigate
Risk: The threat of termination DO
•
Include a period of notice for termination rights
•
Take all threats seriously
•
React immediately
•
Seize the initiative
•
Take legal advice
•
Exercise care in all communications
DON’T
•
Assume its just a bluff
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Risk: The threat of damages DO
•
Treat all potential claims seriously
•
Consider a counter claim
•
Rebut the claim
•
Limit purchase in default rights
•
Avoid consequential damages
•
Create a financial provision
DON’T
•
Agree to liquidated damages payments by deduction
•
Agree to set-off clauses
•
Agree to ‘discretionary’ payments clauses
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Section 6 Subcontractor risk 1. For the want of a nail 2. Subcontracting: Benefit, risk and strategy 3. Subcontractor lateness 4. Subcontractor failure 5. Subcontractor work unfit 6. Monitoring subcontractors 7. Pointers for project risk management Checklist
Section 6 Subcontractor risk
1. For the want of a nail Many projects rely on the performance of subcontractors. To rely on somebody else in any endeavour is to take a risk. On the other hand it is said that placing part of the work, and thereby implicitly delegating responsibility for that work, with subcontractors is to spread the risk around. So is risk taken, or spread or both and if the latter where then does the balance lie? If the battle was lost for want of a nail then was it lost because the subcontractor of nails failed to supply, was late in supplying or supplied on time but his product failed? If the product failed did it fail against its specification, did it fail against the user’s reasonable expectation or did it fail because it was subjected to abnormal and unforeseeable stress in its use? In any event the king said the battle was lost for want of a nail. Did the subcontractor accept this allegation? Did it go to court? If fault lay with the subcontractor, how far was he liable, as opposed to being merely responsible? Did he just replace the nail, or was he sued for the loss of kingdom and crown? Perhaps it did not matter because everybody was dead anyway or, to drag the analogy back to the real world, perhaps the subcontractor and/or his client went out of business as a result. It is not difficult to see how analogous questions arise in a projects environment where a subcontractor failure of some sort has led to conflict between the prime contractor and its client. These questions could only be answered by reference to the contract between the prime contractor and subcontractor. There is no doubt, however, that subcontracting has both risk and potential benefit to the prime contractor.
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2. Subcontracting: Benefit, risk and strategy In subcontracting, a number of questions of principle are usually considered in determining strategy. Provided it seems like a good idea and the market can probably provide the required quantity, quality and specification then the three questions are selection method, pricing regime and contract strategy. It is not the task of this Report to explore all the aspects of subcontracting strategy but an outline appraisal of the balance of risk in each of the three points of principle (figure 18) is appropriate. So if the decision path towards subcontracting is perhaps as shown at figure 19 then the risk appraisal can be seen at Steps 3 and 6 (figure 19).
Out-sourcing strategy
Pricing regime
Procurement type – Non-competitive (sole source)
Contact strategy
– Cost re-imbursement
– Service only
– Cost incentive
– Design only
– Non-competitive (non-monolopy)
– Fixed price
– Make only
– Partnership sourcing
– Firm price
– Turnkey
– Competitive arms-length
Figure 18: Three Strands of Subcontracting Strategy
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Step 1 Initial cost/ benefit analysis
Step 2
Are quality, quantity, specification available?
Market survey Is it likely to be worthwhile?
Step 3
Decide the ‘shape’
Outline out-sourcing strategy
Step 4 Market testing
Cost/benefit review
Is the market responsive, willing?
Step 7
Step 5 Take the plunge in principle Cost/benefit decision
Implement Step 6
Take the plunge
Final strategy Decide details
Figure 19: Deciding to Subcontract
Taking these three principles in turn it is possible to visualise where the balance of advantage lies. In each of figures 20, 21 and 22 the relationship is shown between prime contractor control of the subcontractor and the level of risk which the prime contractor delegates to the subcontractor.
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BUYER CONTROL
Partnership sourcing
Non-competitive (non-monopoly)
Non-competitive (sole source)
Competitive Arms-length BUYER RISK Figure 20: Procurement Type
Figure 20 illustrates the wisdom of partnered subcontracting against competitive arms-length buying. In partnered subcontracting the prime contractor has greater control through communication, openness and cooperation which are the principles of that philosophy. In competitive arms-length procurement, control is much more limited as the nature of the transaction militates against it. In partnered subcontracting there is time to talk to and influence the subcontractor, in competitive arms length there is not. However, partnered subcontracting does not mean that the prime contractor has reduced his subcontractor risk to zero. Apart from the fact that things can and do go wrong no matter the nature of the transaction, partnered subcontracting in itself is not a perfect answer. Partnerships in subcontracting, just as in all other partnerships, can suffer from complacency and over familiarity. The aim must to be to ensure that the commercial objectives of the two sides to the bargain are as much in harmony as possible and partnered subcontracting is certainly an improvement over the tough but simple alternative of arms-length contracting where the respective objectives can easily come into conflict. Sound partnered subcontracting however retains a competitive element either as a ‘threat’ that the work could go elsewhere when the subcontract is due to be renewed or by maintaining two or more sources for the same work area.
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The generally much less desirable alternative to both partnered subcontracting and arms length competitive sourcing is the selection of a non-competitive subcontractor. The term non-competitive in this sense is used to mean selected without competition rather than un-competitive, as in unattractive on price or other grounds. Non-competitive sourcing is used where there is only a single source of supply, where urgency precludes the time taken by competitive selection or where constructing the basis for a competition is too difficult or impracticable. Whatever the reason the end result for the prime contractor is the same. Less control and more risk as the subcontractor, who essentially enjoys a captive client, is not motivated to heed the wishes of the prime contractor or to perform in such a way as to minimise risk to the prime contractor. After all if things do not work out quite right, the prime contractor has little alternative but to stick with the subcontractor until things come good. This is perhaps too black-and-white a picture. The advantage of a non-competitive subcontractor is that he may feel much more motivated to provide a long term commitment to support the prime contractor’s needs and it is in his interest to grow his business with this particular captive prime contractor which, in the final analysis, is still best achieved by delivering quality product on time at good prices and responding to the prime contractor’s needs. Nevertheless, before deciding on a procurement strategy it is as well to consider the general shape of the illustration at Figure 20 and determine where within that general envelope the optimum strategy lies taking heed of the particular situation.
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BUYER CONTROL
Cost re-imbursement
Cost incentive
Fixed price Firm price BUYER RISK Figure 21: Pricing Regime
Similarly figure 21 shows that the choice of pricing regime also has no perfect solution. The prime contractor must make the choice as to which pricing regime best suits the particular circumstances. These alternatives are the same as defined in Section 3:
Governing principle Firm Price
A price which is not variable for any reason (other than change in specification, quantity or time for performance).
Fixed Price
A price the final value of which is fixed by reference to some variable parameter such as an inflation index or currency exchange rate
Cost Incentive
A price based on the subcontractor’s actual costs but with prime contractor and subcontractor sharing overspends or underspends against a pre-agreed target cost.
Cost Re-imbursement
A price based on the subcontractor’s actual costs plus a pre-determined amount or percentage by way of profit.
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A firm price often most suits the prime contractor as it offers him maximum protection against cost increases no matter what the cause, whether the cause is simply the effect of inflation or merely poor estimating by the subcontractor in the first place. On the other hand if the work is so incapable of proper estimation it could be as well for the prime contractor to swallow the bitter pill of a cost re-imbursement arrangement (subject perhaps to a maximum price) with his subcontractor than to face an endless stream of claims for price increases resulting from inevitable changes in the requirement.
BUYER CONTROL
Service only
Make Design
Turnkey BUYER RISK Figure 22: Contract Strategy
Similarly with contract strategy the prime contractor must make his choice as to the degree of control he seeks to exercise over the subcontractor and the risk he is prepared to take. Figure 22 provides in some ways the best example of the principle which is being made here. It may very well be that the prime contractor considers that, overall, risk to his project is minimised by retaining maximum control of subcontractors by purchasing only a service or by allocating segments of the work at a time (e.g. feasibility, project definition, design, make etc). However, in doing so he has in the contractual sense retained also a degree of risk of failure. It is his decision to use or not use the advice of a consultant (acquired under a service subcontract). It is his decision that the design is mature enough to proceed to the make or do phase. The turnkey approach in which
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the subcontractor is responsible for everything has the effect, in that contractual sense, of passing risk to the subcontractor. So in the context of delegating risk to the subcontractor the choice must be made between maximum control, which equals retaining the contractual risk, and minimum control which equals delegating the risk. On a case by case basis the former may mean the lower overall risk or it may not. The same point can be seen in figures 20 and 21. In the first of these the prime contractor’s risk (of poor subcontractor performance) increases more as he moves away from the partnership approach although it must be said that the distinction is less clear since it all depends on the terms and conditions agreed between the prime contractor and subcontractor. The distinction is once again quite clear with regard to the pricing regime. The more the prime contractor wishes to control the subcontractor the more he must move towards a cost re-imbursement basis which leaves him with both the risk of cost over-runs and of the utility of the subcontractor’s output. Returning to the question, does the prime contractor want to take the risk at all? Figure 23 puts the question into perspective. The advantages of subcontracting not only provide the opportunity to share or delegate risk but also there is the chance to gain additional skills and experience in working with outsiders in areas for which the prime contractor has little knowledge. Additionally the prime contractor and subcontractor in partnership may well be qualified in terms of resources, capacity and skills base to bid for work for which neither by itself would be qualified or otherwise likely to be in a strong position. On the down-side subcontracting means working with an organisation which may be geographically remote, which may have different priorities from those of the prime contractor and which is not susceptible to local management action by the prime contractor (in the same way that the prime contractor’s internal activities are subject to control) in the event of problems. All of these things do cause the prime contractor a burden of management over subcontractors which can be costly and on any serious scale at all requires a dedicated, expert resource. Putting work out can mean providing jobs for subcontractors at the expense of the prime contractor’s own personnel. Finally, no matter how good the contract terms, a subcontractor can suffer a catastrophic failure causing serious problems for the prime contractor. Great thought must be given whenever the prime contractor arrives at its ‘make/buy’ decision to ensure that all the risks, advantages and disadvantages are taken into account.
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BENEFIT/ADVANTAGES
RISK/DISADVANTAGES
Gain knowledge Exploit synergy Risk sharing
No local control Differing priorities Employment for others Catastrophic failure Management overhead Geographically remote
Figure 23: Subcontracting: Benefit v Risk
3. Subcontractor lateness If a subcontractor runs late, or shows signs of running late, good project risk management will have detected this, opened discussions with the subcontractor (and possibly with the client), triggered mitigation actions , and all parties will work to solve the issue and move forward. The commercial perspective is entirely different. Commercial analysis will include the following considerations: •
What is the root cause of the subcontractor difficulty and who has the liability (subcontractor, prime contractor, client, no-one!)?
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•
What are the knock-on effects: additional/nugatory costs, loss of profits, loss of opportunity suffered by the prime contractor, other subcontractors, and the client?
•
Who carries the liability for these knock-on effects?
•
What penalties (e.g. suspension of payments, contract termination, liquidated damages) might be levied against the subcontractor or might be suffered at the hands of the client?
The answers to these questions will not be standard. They will depend upon the terms of the prime and subcontracts. But whatever the terms are, they amount to rights and remedies available to one party against another. These rights and remedies can be reinforced, prejudiced or eliminated by innocent or misguided word or deed. So a first reaction of commercial risk managers is to ascertain the relevant and respective rights and remedies and move to ensure that the prime contractor’s position is not compromised in any way. This has to be done in real time, whilst others try to solve the problem, in the doing of which matters may be made worse – at least from the commercial angle.
4. Subcontractor failure A subcontractor may get into such difficulty that he is rendered unable to perform at all. That is, he will never deliver or complete the work or the delay is so extensive as to amount to the same thing. In this situation the prime contractor may have no alternative but to terminate the subcontract. Provided that the problem is attributable to the subcontractor under the terms of the subcontract and that there is a clearly defined time obligation upon him and that nothing has been done by the prime contractor to disturb the clarity of the time obligation, then the prime contractor will have the right to terminate. The right to terminate and any relevant arrangements should be specified in the subcontract. There will be knock-on effects and as described above these must be examined and the consequences of different courses of action analysed. If the subcontracted work is of technical or time criticality to the prime contract then there is, theoretically at least, also the risk of a prime contract termination by the client. Again, all the commercial stuff must be exercised in parallel with the doers trying to sort things out.
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5. Subcontractor work unfit Setting aside the question of timeliness, and assuming that the subcontractor delivers something, the next question is whether the subcontract work as delivered (or more accurately, as offered for delivery) conforms to the requirements of the subcontract. Acceptance testing of the subcontract product by the prime contractor should reveal any patent non-conformances. These amount to a failure to perform the subcontract and then the same set of questions as mentioned above arise again. It is of course no argument at all for the subcontractor to say that he delivered on time if the product does not (even in part) work properly. The time obligation relates to the obligation to deliver on time something that conforms to the requirements of the subcontract. Latent defects that emerge only later, perhaps after integration with the prime contractor’s work or the work of another subcontractor, or even later after onward delivery to the client may lead to claims against the subcontractor (and also from client to prime contractor) under breaches of contract, express warranty, implied warranty or for breach of terms implied by the Sale of Goods Act.
6. Monitoring subcontractors Good relationships with subcontractors should bring about openness and visibility of progress and problems. Rights of access to reports, meetings and facilities are often secured under the terms of subcontracts. Such monitoring is of the essence of good project risk management, but again the commercial perspective is somewhat different. From the subcontractor’s point of view, such openness can reveal actual and potential breaches of the subcontract that may bring about penalties from the prime contractor, the most serious of which could be subcontract termination. In this situation the interests of the two parties are both common and opposing. In the first instance both will want to find a solution to the problem and move on. However, if the problem is serious and not easily remedied, then the subcontractor’s aim will remain the same, but the prime contractor must start to think of risk mitigation actions, such as switching to an alternative source. This would or might be in his interests and in the interests of the client, but not, or not necessarily, in the interests of the subcontractor. From the prime contractor’s perspective, active monitoring of subcontractors has enormous benefit but also risk. If the prime contractor can maintain a role of monitoring only, then all is well, but if the prime contractor is drawn into
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exercising influence or control or gives decisions or approvals (other than those required of him under the subcontract) then he risks transferring risk and liability to himself, as well as causing prejudice to rights and remedies that he may enjoy with regard to subcontractor failure of performance. One important feature of prime contractor monitoring is that it enables the prime contractor to keep track of where the subcontractor work is being done. Project subcontracts usually include provisions to prevent a subcontractor assigning the subcontract to another prime contractor or further subcontracting without the prime contractor’s approval. Again these provisions create tension between prime contractors and subcontractors. The prime contractor sees a need to limit the subcontractor’s freedom of movement whilst the subcontractor sees any such restriction as potentially hazardous to his ability not only to get the work done but also to his ability to manage his business in the best interests of his shareholders.
7. Pointers for project risk management •
Subcontracting is both an opportunity and a risk. Project risk management must address the issues of potential subcontractor failure – lateness, complete non-performance or defective performance.
•
Project risk management must recognise that, in the event of subcontractor difficulty, the immediate considerations of project progress may be in conflict with the needs of commercial risk management. The tradeoff between fixing a problem and possibly interfering with carefully constructed and balanced contractual arrangements is not easy.
•
The day-to-day management of the working interface between prime contractor and subcontractor is strewn with commercial pitfalls. There is no easy answer to this, but awareness of the issues amongst those managing the interface is essential.
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Checklist Risk: Consequences of subcontractor failure DO
•
Make the subcontractor aware in writing pre-contract of the criticality of his work.
•
Re-enforce this by putting ‘preambles’ or ‘recitals’ in the subcontract identifying the purpose of the subcontract and the consequences of failure.
•
Remind the subcontractor in writing from time to time of the importance of his work once the subcontract is underway.
•
Create a relationship with the subcontractor at senior management level as well as at the working level.
•
Include express contract conditions covering the subcontractor’s liability for consequential damages.
DON’T
•
Agree to clauses excluding subcontractor’s liability for special or consequential damages.
•
Agree to a financial limit on the subcontractor’s liability.
Risk: Subcontractor is late DO
•
Specify delivery dates in the subcontract.
•
Emphasise the importance of timely delivery by including ‘time is of the essence in the contract’ in the subcontract.
•
Require progress reports/forecasts from the subcontractor.
•
Consider including liquidated damages.
•
Remind the subcontractor from time to time of the importance of timely delivery.
•
Include a termination for default clause.
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DON’T
•
Allow submission of progress reports etc to have the effect of gaining acquiescence to late delivery.
•
Allow liquidated damages to eliminate the right to terminate for default.
•
Delay in reserving rights or taking action against the subcontractor in the event of his lateness.
•
Allow ‘force majeure’ or excusable delays clauses.
•
Be the cause of the subcontractor’s delay.
Risk: Subcontractor’s products are ‘unfit’ after delivery. DO
•
Require conformance to a performance specification.
•
Specify examples of the purposes to which the product will be put.
•
Include an acceptance clause which delays acceptance until the products are proven in use.
•
Include an express warranty.
•
Say that the subcontractor’s skill and judgement is being relied upon.
•
Retain payment of part of the price until post-delivery obligations are discharged by the subcontractor.
DON’T
•
Agree to exclusions of implied undertakings such as fitness for purpose or satisfactory quality.
Risk: The Subcontractor goes out of business. DO
•
A financial health check on the subcontractor beforehand.
•
Require (if appropriate) a parent prime contractor guarantee underwriting the subcontractor’s obligations to perform the contract and underwriting the financial liabilities arising there under.
•
Require a bond or guarantee from a bank or other third party covering the financial liabilities of the subcontractor.
•
Include a clause to vest ownership of parts and materials in the buyer as they are allocated to the contract.
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•
Include a right of termination exercisable in the event of actual or prospective insolvency, winding-up or bankruptcy.
•
If appropriate, require the subcontractor to enter into an ESCROW agreement whereby details of his designs are held confidentially by a third party and made available to the buyer in the event that the subcontractor is unable complete the subcontract or to provide product support in the future.
DON’T
•
Be persuaded by a financially insubstantial or shaky subcontractor that everything ‘will be alright on the night’.
Risk: You don’t know what the subcontractor is doing DO
•
Require the subcontractor to provide plans, reports and appropriate documentation and data to provide reasonable visibility of progress.
•
Hold progress-review meetings.
•
Use Quality Assurance surveillance to check on progress.
•
Employ an expert in the field of the subcontractor’s work to monitor and advise on progress.
•
Include a ‘no waiver’ clause.
DON’T
•
Allow that receipt, approval or acceptance of any document abrogates the liability of the subcontractor to fully perform the contract.
•
Allow that progress meetings or the minutes thereof have the effect of altering or varying the subcontract or of condoning non-compliances or lateness by the subcontractor.
Risk: The subcontractor fails to accord the subcontract any priority DO
•
Motivate the subcontractor by paying on completion only or, if interim payments are to be made, by suggesting that his cash flow can be improved by adherence to a sound milestone payment scheme.
•
Motivate the subcontractor with expectations of future business, client awareness of his success etc.
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•
Ensure the senior management interface between buyer and subcontractor is exercised to retain the subcontractor’s attention.
•
Involve the subcontractor in the planning and progressing of the activity into which his products merge.
•
Remind the subcontractor of the contractual and legal remedies available in the event of his default and, as appropriate, invoke those remedies.
DON’T
•
Delay in taking steps to encourage a slow subcontractor to perform.
Risk: The subcontractor damages prime contractor property DO
•
Include a clause making the subcontractor liable for physical loss or damage to prime contractor property which he causes.
•
Require the subcontractor to carry adequate insurance cover.
DON’T
•
Be talked into carrying the risk because ‘your own insurance must cover it’.
Risk: Subcontractor puts the work elsewhere DO
•
Include a ‘no assignment’ clause.
•
Reserve the right to approve his subcontractors.
•
Reserve the right to visit or inspect his subcontractors.
•
Require the subcontractor to ‘flow down’ (i.e. include in his purchase subcontracts) those terms and conditions which protect prime contractor interests.
DON’T
•
Take any liability with regard to the selection or performance of his subcontractors.
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Risk: The subcontractor ‘causes’ breach of the prime contract DO
•
Include all the ‘mandatory flow down’ conditions.
•
Negotiate with subcontractors pre-contract.
•
Include all other relevant prime contract conditions.
DON’T
•
Forget to secure adequate intellectual property rights.
Risk: The subcontractor’s products are no longer wanted DO
•
Include a cancellation for convenience clause.
DON’T
•
Agree to pay anticipated profits.
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Section 7 Project completion and beyond 1. Life after completion 2. Key contractual milestones 3. Residual obligations and risks 5. Acceptance 6. Products rejected 7. Title does not pass 8. Products lost or damaged in transit 9. Failure after delivery/acceptance 10. Warranty 11. The hand over of technical data to the client 12. Third party intellectual property rights 13. Account management 14. Pointers for project risk management Checklist
Section 7 Project completion and beyond
1. Life after completion The prime contractor wants to deliver, take the money and run. The client wants the products, doesn’t want to pay and hopes to have a stranglehold on the prime contractor forever! Somewhere between these two extremes there is a reasonable position regarding post delivery obligations. In a clinical sense both sides should be seeking certainty as to the point at which the prime contract has been wholly performed in return for which the full prime contract price is payable. There may well be residual obligations on the prime contractor after this point in terms of supporting the delivered products but the real risk lies in the question as to whether all liability in the material work has or has not passed to the client.
2. Key contractual milestones There are several key contractual milestones on the way to confirmation that the prime contract is complete:
Milestone
Principle
Inspection
The opportunity for the client to verify that products offered in the performance of the prime contract comply with the requirements of the prime contract
Delivery
The point at which the prime contract is performed (regardless of the passage of title and risk) whether by physical movement of products or handover following installation or by paperwork transaction
Passing of Title
The transfer of legal title in the products from prime contractor to client
Passing of Risk
The transfer of liability from prime contractor to client for loss or damage to the products
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Milestone
Principle
Rejection
The right of the client to reject products which do not comply with the requirements of the prime contract
Acceptance
The point at which the client concurs that the prime contract has been performed, forever extinguishing his right to reject the products or terminate the prime contract
Warranty
A period after delivery during which the prime contractor has express or implied liability to the client for defects in the products
Payment
Settlement of the prime contract by the client in return for the prime contract having been performed
Not surprisingly client and prime contractor have, in principle, exactly opposing views with regard to the timing of these events (figure 24).
WARRANTY
REJECTION
INSPECTION
Contract award
Delivery
Property passes
Acceptance
Payment
Risk passes
Figure 24: Client’s Preference
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REJECTION
INSPECTION
PAYMENT
Contract award
Delivery
Risk passes
Property passes
Figure 25: Prime Contractor’s Preferences The client likes the ability to inspect the work throughout the period of the prime contract exposing a risk of rejection even before the prime contractor has offered performance. He wants early title to parts, materials and finished products and only wants to pay way after delivery, having delayed acceptance and adoption of loss/damage risk as long as possible. The prime contractor, on the other hand, sees performing the prime contract as his private business until he offers performance where transfer of title and risk should transfer simultaneously with acceptance happening immediately thereafter (if not concurrently with) and, having enjoyed payment over the life of the prime contract, achieving 100% of the price on or before delivery. These things must all be worked out in the detail of the prime contract negotiation. Probably the most important event from the prime contractor’s perspective is achieving contractual acceptance. This is because where products are legitimately rejected and unless compliant products can be offered within the period allowed, the prime contractor is in fundamental breach and risks the prime contract being terminated for default. Once acceptance has occurred and the right to reject has disappeared, the risk of termination has evaporated and the client can only pursue the prime contractor under express or implied warranties if there are any problems with the products.
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3. Residual obligations and risks Depending on the construction of the prime contract, primary, post delivery risks to the prime contractor may therefore include: •
Rejection of the products
•
Products lost or damaged
•
Deficiencies discovered under warranty
•
Payment not made
However, the question remains as to what other risks remain with the prime contractor even once the primary risks identified above have been eliminated. Such residual obligations typically cover: •
Supply of additional products under prime contract options.
•
Delivery of technical data and licences for the use thereof.
•
Settlement of outstanding purchase orders, prime contracts, rental agreements, lease agreements etc.
•
Disposal of residual material within the terms of the prime contract.
•
Resolution of outstanding claims and disputes.
•
Disposal of client-owned property made available for the purposes of the prime contract.
•
Cancellation/closure of outstanding bonds, guarantees, credit facilities.
•
Termination of teaming, collaboration, consortium agreements.
•
Final negotiation and conclusion of any special pricing arrangements (e.g. cost risk-sharing schemes, variation of price adjustments).
•
Establishment of contractual, management and procedural arrangements to provide support services and maintenance of technical skills and data.
•
Application for patents and other forms of intellectual property protection in respect of the work of the prime contract.
Secondary duties such as these, which are not at the heart of the prime contract but nevertheless form part of the entire set of prime contract obligations, are very important. Where they relate to obligations owed directly to the client or to other parties they can be easy to overlook. The arrival of a letter from the client two years after the prime contract is finished legitimately exercising a prime contract option for more products which the prime contractor had entirely
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forgotten about can be an alarming experience. This is particularly so if the products are no longer in production or no longer capable of economic production. Similarly a late but proper invoice from a subcontractor which arrives after the books have been closed on the prime contract and the profit released to the profit and loss account can be disappointing! Just as it is important to plan the start up and execution of a prime contract, so it is important to plan the closure. Good administrative procedures should ensure that these residual obligations are not forgotten and positive action should be taken to discharge or eliminate them. For example, the prime contract option which survives completion of the main work should be examined for viability and, if there is a risk that the option could not be performed at all or not at a profit, early action should be taken to persuade the client to agree that the option right is deleted or perhaps to reduce the length of the period during which the option can be exercised. In business as in life there are more people who are good at starting things than there are people who are good at finishing things. This is a characteristic which is also true of companies. Great attention must, therefore, be paid to ensuring that residual obligations are effectively dealt with one way or another.
5. Acceptance In all contracts it is as well to have an express clause on acceptance. It is such an important milestone that the prime contract must make it absolutely clear when, where and how acceptance occurs. The best approach is to hang acceptance onto a key event or series of events which are objective and susceptible to clear yes/no, pass/fail criteria. For example, a prime contract for a complex system could specify a set of acceptance tests the successful completion of which conveys contractual acceptance. The tests may be of a representative sample of the features demanded in the technical, performance or other specifications which establish the basic requirements of the prime contract or they may test every feature. Testing is expensive and, in some situations, 100% testing is not feasible. Hence, once again, the principle of risk sharing applies. In the situation just described the client takes the risk that in accepting the work of the prime contract in the absence of 100% testing, some shortfalls against the prime contract may exist which are not detected at the acceptance testing stage. Once the work has been accepted, his bargaining power and remedies against the prime contractor are
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much weaker, although in taking that risk he will have had the benefit of a lower price and perhaps quicker completion and hence the bargain is balanced. If acceptance testing or something similar is not appropriate, the best approach to acceptance is for it to be conveyed upon the elapse of a stated period of time from physical delivery or handover or commissioning or whatever seems the most appropriate signal of the ostensible end of project implementation. This simple approach is objective and the length of the period can be negotiated on a case-by-case basis. A balance will always be struck between the two extremes where the prime contractor would want acceptance to occur concomitantly with delivery whilst the client would want to suspend acceptance for several years! If the prime contract is so constructed as to allow for partial performance, then it is important that acceptance is conveyed in stages. It is important to spell out in the prime contract the acceptance arrangements for every item of the prime contract or every stage of the work. From the prime contractor’s perspective the lightest burden of acceptance is clearly preferable and he should look for the simplest approach, certainly as far as an opening position is concerned. For example he might suggest that acceptance occurs on delivery provided he has submitted a certificate of conformity with the products. To back up an objective approach to acceptance it is crucial that the events upon which acceptance depends are thoroughly documented so as to prevent disputes as to whether acceptance has or has not occurred. The goal of objectivity is completely frustrated if acceptance is effectively left to the client’s discretion and yet this is the effect of clauses which say ‘the prime contractor shall complete the work in accordance with the prime contract specifications and to the satisfaction of the client’. Acceptance should be capable of determination without any element of judgement on the part of the client or anybody else. Nor should a special piece of paper be needed such as an ‘acceptance certificate’ from the client. If an acceptance certificate is required to complete, confirm or formalise acceptance then the implication is that the certificate is an essential component of the process or act of acceptance without which acceptance cannot have occurred. Hence the client is hardly going to be motivated to issue a certificate since it is in his interests to delay acceptance for as long as possible. The uncertainty of the client ‘saying so’, is matched by the uncertainty of clauses which provide for acceptance when the products are taken into use or the elapse of a ‘reasonable’ period from delivery. Although in the former case, if it is certain that the products will go into use very quickly (probably so), it would then be beneficial and safe for the prime contractor to agree to acceptance on that basis.
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In any other circumstance the uncertainty represents a risk. Similarly, references to a reasonable period are inherently risk and only guarantee disputes between the two sides regarding what may be considered a reasonable period in the prevailing circumstances. The client’s wish to delay acceptance can sometimes be manifested as a clear policy as opposed to a natural instinct. He may specify that acceptance can only take place following extensive use of the products so that their true utility or performance can be assessed. Clearly this would represent a much greater risk to the prime contractor and one which should be avoided if at all possible. Finally it is preferable to avoid the prime contract linking acceptance to payment. If the arrangements for acceptance are well defined, resistant to dispute and the criteria represent no major hurdle then such a linkage is perfectly fine. However, if the burden is onerous it is better that clearing the hurdle does not have the additional complication of cash flow issues surrounding it. However, at the fundamental level, if acceptance is not attained due to some deficiency on the part of the prime contractor then the prime contract has not been performed and the client can hardly be expected to pay although the question of actual remedies (termination, damages) must depend on the circumstances and the terms of the prime contract.
6. Products rejected In the prime contractor’s ideal world the client is obliged to accept the work and has no opportunity to reject, hence the correct if somewhat fanciful suggestion that the client should have no right of rejection. Assuming, therefore, that rejection rights must apply the question is how to limit this risk. The concepts of acceptance and rejection go hand in hand and the prime contract should re-enforce the general principle that acceptance extinguishes any right of rejection. Any period within which rejection is allowed should be stated, limited and triggered by some event such as physical delivery. If rejections are allowed then, sensibly, there should be a right of appeal as, presumably if the prime contractor was confident that he delivered conforming products, there must be some chance that the client’s purported rejection is invalid. Incidentally it should be stated that the right of rejection relates only to a belief that the products genuinely do not conform to the requirements of the prime contract. There should be no ability to reject the products on some general grounds of dissatisfaction. A rejection is potentially a very serious situation for the prime contractor and good practice and protocol demand that it is notified formally and in writing within the period allowed.
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The consequences of rejection can range from termination of the prime contract to delay in payment and the additional cost of investigating the rejection. It is therefore reasonable that if rejections are found invalid the client should be required to compensate the prime contractor for the effect of these consequences some of which will have occurred by the time the invalidity is established. Whether a rejection is ultimately shown to be valid or not there is a danger that the products are in a contractual limbo in terms of where lies title and risk and so it is important to make provision for this so that, amongst other things, one side has the loss/damage risk insured. As a corollary the prime contract should also nominate the party which is to have responsibility for moving rejected products around. Sometimes rejection clauses specify a timeframe within which appeals have to be lodged. The prime contractor should ensure that he has in place the procedures to trigger the lodging of an appeal very swiftly after receiving notice of a rejection with which he disagrees. It is no good for rejected items to be returned by the client and left lying in goods inwards for several months before anybody notices! Procedures should also exist for handling rejected products so that they do not accidentally (or deliberately!) become re-mixed with other good products.
7. Title does not pass The key question in the passage of title is the point or time at which it is conveyed and where the balance of advantage lies. On the one hand, retaining title in the products until payment has been made in full gives the prime contractor security insofar as if payment is not made it still owns the products and thus its remedy for non-payment would include recovery of the products for sale elsewhere. On the other hand, if the products are consumable, are inaccessible or likely to have deteriorated since delivery such a remedy is not that helpful and, if title has passed to the client, then a clearer case exists for legal action in respect of payment of the prime contract price. So the choice inevitably depends on the nature of the products and the characteristics of the client. Part of this equation is the degree to which it is reasonable for title to pass to the client prior to delivery under vesting arrangements. These are usually sought by the client in return for granting the facility for advance or interim payments. There is sense in the argument that his security for advancing monies is title in the products or material parts thereof as they are purchased or allocated to the prime contract. However, it can be argued that if he has already enjoyed the
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advantage of a lower price in return for promising advance payments why should he have the additional benefit of early passage of title in such products or materials. Setting aside the principle there are two main difficulties with vesting clauses. Firstly there is the problem of identifying materials or products in respect of which title has passed to the client. This is because of the limitations of accounting systems to provide this sort of facility are complicated by the fact that the prime contractor may purchase the same items for many contracts and may have several contracts with many different clients all of which include vesting clauses. Perhaps the best advice is that, if a vesting clause has to be accepted, it should be made clear that it does not allow the client any rights to verify compliance! The second concern is that care should be taken to ensure that title only passes if advance payments are actually made rather than just promised.
8. Products lost or damaged in transit There is the simple risk of loss or damage to the products somewhere between acquisition of the component parts and materials by the prime contractor through to the point of physical delivery to or acceptance by the client. Each party normally wants the risk to be carried by the other side and so when the point has been negotiated the key issue is to ensure that insurance cover is arranged for the period and scope of the risk and that any other arrangements to safeguard the physical security of the material are in place. Although insurance policies may cover the risk of loss or damage caused other than by the prime contractor’s own acts or omissions it is always prudent to have the prime contract state that the acts or omissions of the client are within his own responsibility and liability.
9. Failure after delivery/acceptance The primary objective is to avoid any liability once the prime contract is complete. Prime contract completion can mean many different things but here it is used to convey the idea that performance of the prime contract has been achieved insofar as delivery is complete and acceptance has been attained. Whilst residual obligations may remain, the primary objective has been secured. Setting aside any residual obligations (e.g. to maintain the manufacturing drawings) the question is what liabilities arise regarding the delivered products? If the client can be persuaded by a lower price or other valuable consideration to accept all the risk once the prime contract is complete so much the better. To avoid any
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risk the prime contract must achieve three things. Firstly there should be a clear and comprehensive statement on acceptance. Secondly there should be an express exclusion of implied warranties and undertakings including those stipulated under the auspices of the Sale of Goods Act. Finally there must be no express warranty of any sort. Exclusions of liability must be carefully worded but failure to expressly exclude the SOGA implied undertakings as to satisfactory quality and fitness for purpose mean they do apply unless convincing argument (such as the client having specified in detail his requirement and how the prime contractor should achieve it) can be mounted to the contrary. These undertakings are ill-defined in scope and time frame and, if only for the sake of certainty, are best excluded in favour of an express warranty if the client is not willing to carry all the postdelivery risk himself.
10. Warranty The warranty clause in any contract, but particularly in a contract for a project, is like a contract within a contract. That is to say that it is a vehicle for identifying and allocating risk between the parties. As in any other contract each party may want to assign the maximum possible risk to the other. This creates tension. Warranty clauses can be amongst the most difficult clauses to negotiate. The client may think that by insisting upon (and paying for) an express warranty that he is acquiring some special benefit. In fact he may be doing no more than signing away or diluting rights he would otherwise have at law anyway – and paying for the privilege of doing so. The prime contractor may think that a warranty clause, by excluding certain categories of problem, may protect him against uncertainty. This may be true but at the same time he may caught for quite onerous liabilities, such as rolling obligations. The one main advantage common to both sides – provided the clause is worded properly – is that it brings certainty as to post-completion liabilities. In almost every circumstance certainty is to be preferred to uncertainty. The warranty period and the event (preferably physical delivery or contractual delivery if earlier (e.g. ex-works) and not acceptance) that starts the warranty clock ticking should be stated and the clause should list all the exclusions of which the following are possible examples: •
Products not covered by the warranty.
•
Problems for which no warranty claim is received within the warranty period.
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•
Products not returned within the warranty period.
•
Products exhibiting defects other than those which are a demonstrable failure against the prime contract specification.
•
Products where the alleged defect is not remediable by the prime contractor.
•
Products exhibiting defects likely to be attributable to wear and tear; improper use, maintenance or storage; defective components.
The warranty should also be clear as to whether design and manufacture are both covered. A warranty on manufacturing workmanship and materials means that one product exhibiting such a defect would be covered by the warranty, but a warranty covering the design may require the prime contractor to remedy a defect in an entire consignment even though only one unit may exhibit the defect. Thus the difference between a manufacturing warranty and a warranty covering design as well is the scope and the scale of the risk. If the prime contractor is to be liable under warranty then he must seek to have the choice of remedy within his control. The option to repair or replace or refund money should be his. The prudent prime contractor will carefully scrutinise all warranty claims and never assume that it (the product) must be wrong just because the client says it is wrong. The wary client will have his own views on warranty obligations and one way for him to impose his view is to demand a warranty retention or bond. The warranty retention means that some part of the prime contract price will not be paid until the client is satisfied that all post-delivery problems have been satisfactorily ironed out. The warranty bond allows the client to call upon a third party to impart money in his direction if the prime contractor fails to discharge warranty liabilities notwithstanding that the prime contract price may have been paid in full.
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11. The hand over of technical data to the client Intellectual Property Rights (IPR) are the greatest asset any prime contractor owns. The prime contractor’s unique ideas, skills and reputation are what gives it its products, profits, position in the market place and its competitive advantage. More so than any other asset it should be jealously guarded. Tangible assets such as plant and machinery which are stolen, damaged or destroyed by fire can be replaced albeit with possibly disruption to business operation. By contrast the full value of the intangible asset of intellectual property can never be restored once it is lost either to the client, who might otherwise have come back for more work which he feels able to do himself if he acquires the prime contractor’s IPR, or to a competitor, who may well be able to make use of the information without actually infringing the IPR. Any grant of rights by the prime contractor should be as limited as possible. The first step is to restrict the rights to data which is actually deliverable under the prime contract and then to limit the definition of what is deliverable. Then, when it is time to deliver the data, the detail put into the deliverable material should be as sparse as possible so as to be minimally compliant with the least onerous interpretation of the definition. In any event, every effort should be made to grant rights only in that IPR generated under the prime contract. Any preexisting IPR brought to the prime contract by the prime contractor should be excluded from the grant. If possible any grant of rights should be in principle only and an express statement should be included in the prime contract that detailed terms will be agreed later. Apart from the fact that agreements-to-agree are difficult to enforce both legally and in practice, this leaves the door open for future negotiations on the terms (both fees and further restrictions) at a time when the client has much less bargaining power than at the pre-prime contract stage when the full heat of competition is bearing down on the prime contractor. A further restriction is to limit the rights to the client only, denying him the right to sublicense or assign the benefits or otherwise so as to prevent him from passing the information outside of his organisation and potentially into the hands of competitors. Whatever the extent of the rights granted, the prime contractor should ensure that the recipient, whether just the client or third parties, is bound by obligations of confidentiality. Confidentiality agreements or non-disclosure agreements primarily bind the recipient not to disclose the information without written permission, to safeguard it and to use it only for a specified purpose. This last point
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provides another opportunity to restrict the rights being granted. To enhance the degree of protection the prime contractor might consider requiring individual recipients as well as the client to enter into such agreements. Whether the information is actually disclosed under the terms of the prime contract subject to conditions of confidentiality or whether it is disclosed under a full licence agreement the two over-riding aims are to restrict and protect. Restrict the rights. Protect the information. In some ways the greatest danger is that, despite the terms of the prime contract, many personnel working on the prime contract who may either be ignorant of or not understand the IPR provisions of the prime contract may just give the information away anyway in the naive belief that if the client is paying he must automatically own all the IPR. Allowing this risk to exist is unforgivable and it can be avoided by including a clear briefing on the IPR position at the prime contractor’s contract launch meeting. Finally it should be remembered that in addition to protecting the information by the terms of the prime contract and any supplementary confidentiality or licence agreements, consideration should be given to statutory forms of protection (e.g. patents and design registration) and to practical measures such as the use of bold copyright legends on documents and software, procedures to prevent unintentional release and an awareness campaign centred on the abiding first principle of IPR: It’s ours, they can’t have it.
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12. Third party intellectual property rights If protecting the prime contractor against the risk of its IPR being compromised is a big enough challenge then equally demanding is dealing with the risk of infringement of third party IPR. In many projects the IPR situation is a minefield of conflicting interests and requirements (figure 25).
End customer
Licensors
End user
Sub-contractors Data required Customer
Company Data delivered Own information
Other contractors
Information held
Other organisations
Figure 26: Data Flow
For these purposes the word data is used very generally to describe any information which may be protected or protectable by an intellectual property right. This might range from copyright material (e.g. drawings, specifications, computer software) through design information (e.g. the unique shape or appearance) to patent details (the essence of an invention) and even the use of trade marks/ names (e.g. product names and logos). Coming into the prime contractor will be data from licensors, other contractors and perhaps teaming partners each of whom may be providing data which they own, have licensed from someone else or have stolen (intentionally or in innocent ignorance of a proprietor). The prime contractor’s own data may be a combination of that which is genuinely the product of its own efforts, that which it happens to possess (i.e. where the original source is obscure) and that which it possesses as a result of other contracts. Data produced under other contracts may have intellectual property rights vested in the relevant client(s), the prime contractor, third parties or combinations thereof. Data delivered to
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the client may be destined for his own use or to third parties under licence or prime contract each of whom may have further needs beyond their own use. Each link in the chain may need rights to possess, use, copy, merge or modify the data which it handles. Each may need the right to sublicense, assign, sell or otherwise dispose of the data. Each may wish to secure intellectual property right protection for its part or parts of the whole work. Each may want exclusive rights in jointly created data. All data transmitted may be governed by confidentiality agreements. Data may have come into the possession of individual parties legitimately, by breach of some restrictive agreement by that party, by breach of some restrictive agreement by another party or because the public domain now includes that data. Thus if, for the purposes of this discussion, the first and second parties are the prime contractor and the client then all the other parties shown (i.e. which may have a contractual relationship) with client or prime contractor) plus any others remote from or not ostensibly linked to the chain are the third parties in whom lies the risk of allegation of breach of intellectual property right. Any such third party may allege a breach of intellectual property right. On the basis that prevention is better than cure, the lowest risk approach for the prime contractor is to ensure that the entire IPR picture is clear and that all necessary licences and permissions are in place in writing. The sooner this is done the better. It is hardly ideal to supply the client under prime contract with copies of prime contractor copyright work only then to find that the prime contractor had no right to make such copies. Lack of time and impracticability sometimes prevent full researches being done and the proper measures being put in place prior to bidding or prior to making a contractual commitment to the client. In these circumstances the prime contractor is exposed to the risk of alleged breach of intellectual property rights and, following the principles of good commercial risk management, if a risk is carried then opportunities should be sought to pass to someone else the consequences of the risk materialising. The best approach is to seek indemnities from both ‘providers’ of data (i.e. licensors, prime contractors etc) and ‘consumers’ of data (i.e. the client). The logic to use with the providers is that they are the experts in the genesis of their products and data and must easily be able to offer an indemnity unless there is something to hide! With the client the logic is surprisingly similar. Only the consumer can know to whom and for what reason data may be disclosed. Hence he too can surely provide an indemnity unless there is something to hide! Notice that the prime contractor appears to know nothing about anything! This position of innocence is a good one, but for the fact that in most cases of breach of intellectual property rights, innocence is no defence.
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Hence the importance of the prime contractor being protected by indemnities, from both data providers and data consumers, that pass to them the responsibility for defending claims and the liability for the cost of defence, the cost of settlement and, in the perfect case, the cost of any consequential effects such as the disruption to the prime contractor’s operation. If avoiding the risk is not feasible and if passing the consequences elsewhere is not an option, for example because the providers and consumers do not agree to offer indemnities, then the last option is to insure the risk. Indeed this is a common policy for companies to adopt but nevertheless it should not be seen as a soft option. ‘We needn’t worry because it’s covered by insurance’ is a wholly unacceptable and dangerous ethos. This essay should be sufficient to show that the greatest risk lies in simply ignoring the problem. Education of all concerned within the prime contractor as to the principles of intellectual property rights is in many ways the best form of practical protection. The subject is seen as a black art for obscure experts and whilst the legal, statutory, procedural and international dimensions of intellectual property matters should not be under-estimated for a nanosecond, the rules of simple self-protection should be understood by all. Returning momentarily to the issue of indemnities, there is a straightforward rule which says that if it is good to be the beneficiary of an indemnity it must be bad to be the benefactor. The only possible benefit to the prime contractor in giving an indemnity would be to limit the scope and monetary value of a liability which might otherwise be by implication an open ended liability.
13. Account management Every risk is an opportunity. The primary and residual risks that lie at the tail end of the prime contract are very real and need to be carefully managed. Eliminating the risks, for example, of late delivery and deficient products means not only a greater chance of completing the prime contract at the anticipated level of profit but it also means a satisfied client. Needless to say, satisfied clients are more likely to come back for more and the prime contractor’s reputation will have grown in the marketplace. Thus the prime contract should not only be seen as the mountain of obligations and risks but as the opportunity to make profit and secure further orders. This much is a blinding glimpse of the obvious but many companies fail to take the opportunity at the start of the prime contract, or even before hand, to work out how the particular prime contract can be used
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to generate more business. A product plan may look at the technical evolution of a product, how and when it will come to the market, the investment needed, the likely client base, target selling prices and margins, the volume, timeframe and phasing of orders and particular major potential orders may feature as key milestones but this is inevitably a little bit too general. What is needed is a specific plan for the exploitation of the particular prime contract which looks at the tactics and timing of introducing to the client ideas for improvements, enhancements, upgrades, maintenance and other support services. Indeed these opportunities may grow out of problems and risks encountered during the prime contract or anticipated to emerge post-delivery.
14. Pointers for project risk management •
It is all too easy for those working under contract on a project to assume that they know what project or contract completion means. This is particularly so when the project is of long duration. The contractual aspects of completion and the contractual milestones of transfer of risk and title and the gaining of acceptance are of equal importance to a physical description or understanding of completion.
•
Post-completion obligations should be described in an explicit warranty clause which is stated to stand in place of all other liabilities. In a project of long duration the warranty phase may seem too far away to attract much interest but every care must be taken in establishing the warranty obligations. Amongst other things, a problem fixed under warranty may cost much more than having got the thing right in the first place.
•
Just as with project or contract completion, project staff may jump to the wrong conclusions as to what is covered by warranty. This is hardly surprising. People assume that the sort of thing covered by warranty in consumer transactions would also apply to a business contract or they may make assumptions based on what seems reasonable. Both are very dangerous premises. Staff should be quite clear on the extent and limit of the prime contractor’s warranty obligations.
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Checklist Risk: The products are not accepted DO
•
Ensure the prime contract has an acceptance clause.
•
Ensure acceptance occurs on a specific event or the elapsing of a stated period of time from delivery.
•
Seek acceptance in stages.
•
Ensure that events are clearly documented to evidence acceptance.
DON’T
•
Agree to acceptance occurring when the client says so or when the products are taken into use or the elapsing of a ‘reasonable’ period.
•
Agree to ‘delayed’ acceptance.
•
Agree to acceptance being linked to payment.
Risk: The products are rejected DO
•
Avoid the prime contract giving rights of rejection.
•
Link rejection with acceptance.
•
Limit the period within which a rejection can be made.
•
Provide a right of appeal against rejection.
•
Require notice of rejection to be in writing.
•
Seek a right to compensation for invalid rejections.
•
Make sure that title and risk in rejected products is specified.
•
Prescribe responsibility for returning/redelivering rejected products.
DON’T
•
Forget to lodge appeals.
•
Fail to challenge rejections and interrogate the rejection closely.
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Risk: Title does not pass DO
•
Ensure the prime contract has a clause on passage of title.
•
Retain title until the last possible minute.
DON’T
•
Agree to vesting clauses.
Risk: The products are lost or damaged in transit DO
•
Ensure the prime contract has a clause on passage of risk.
•
Seek the earliest possible transfer of risk.
•
Arrange appropriate insurance.
DON’T
•
Carry risk in the acts or omissions of the client.
Risk: The products fail after delivery/acceptance DO
•
Avoid any post-delivery liability.
•
Exclude the provisions of the Sale of Products Act.
•
Limit the extent and scope of express warranties.
DON’T
•
Assume client dissatisfaction equates to a contractual liability.
•
Agree to warranty bonds or retentions.
Risk: Technical Data must be handed over DO
•
Avoid any clause granting rights in Intellectual Property.
•
If unavoidable, deal with the issue with an eye to the future.
•
Grant rights only in deliverable data.
•
Limit the amount of deliverable data.
•
Grant rights only in that work required under the prime contract.
•
Grant rights in principle only, leaving terms to be negotiated later.
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•
Grant rights in the following order: use; use and copy; use, copy and modify
•
Limit rights to the client only.
•
Include express provisions regarding confidentiality.
DON’T
•
Fall into the trap that because the client has paid he must own all the IPR.
•
Forget to maximise IPR protection by patents etc.
Risk: Breach of third party IPR DO
•
Identify all IPR issues at the bid stage.
•
Secure comprehensive licences from licensors/other contractors.
•
Grant specific licences to the client
•
Secure indemnities from data providers/data consumers.
•
Secure indemnities from the client.
•
Insure against the risk.
DON’T
•
Ignore IPR
•
Give indemnities
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Other specially commissioned reports BUSINESS AND COMMERCIAL LAW
The commercial exploitation of intellectual property rights by licensing
The Competition Act 1998: practical advice and guidance
CHARLES DESFORGES
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Expert advice and techniques for the identification and successful exploitation of key opportunities.
Failure to operate within UK and EU competition rules can lead to heavy fines of up to 10 per cent of a business’s total UK turnover.
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how to identify and secure profitable opportunities
•
strategies and techniques for negotiating the best agreement
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the techniques of successfully managing a license operation.
Insights into successfully managing the in-house legal function BARRY O’MEARA
£65.00
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Damages and other remedies for breach of commercial contracts ROBERT RIBEIRO
£125.00
Negotiating the fault line between private practice and in-house employment can be tricky, as the scope for conflicts of interest is greatly increased. Insights into successfully managing the In-house legal function discusses and suggests ways of dealing with these and other issues.
1 85418 226 X • 2002 This valuable new report sets out a systematic approach for assessing the remedies available for various types of breach of contract, what the remedies mean in terms of compensation and how the compensation is calculated.
Commercial contracts – drafting techniques and precedents ROBERT RIBEIRO
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1 85418 210 2 • 2002 The Report will: •
Improve your commercial awareness and planning skills
For full details of any title, and to view sample extracts please visit: www.thorogood.ws You can place an order in four ways:
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Enhance your legal foresight and vision
1 Email:
[email protected]
•
Help you appreciate the relevance of rules and guidelines set out by the courts
2 Telephone: +44 (0)20 7749 4748
Ensure you achieve your or your client’s commercial objectives
4 Post: Thorogood, 10-12 Rivington Street, London EC2A 3DU, UK
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3 Fax: +44 (0)20 7729 6110
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The legal protection of databases SIMON CHALTON
Email – legal issues £145.00
SUSAN SINGLETON
£95.00
1 85418 245 5 • 2001
1 85418 215 3 • 2001
Inventions can be patented, knowledge can be protected, but what of information itself?
What are the chances of either you or your employees breaking the law?
This valuable report examines the current EU [and so EEA] law on the legal protection of databases, including the sui generis right established when the European Union adopted its Directive 96/9/EC in 1996.
The report explains clearly:
Litigation costs MICHAEL BACON
•
How to establish a sensible policy and whether or not you are entitled to insist on it as binding
•
The degree to which you may lawfully monitor your employees’ e-mail and Internet use
•
The implications of the Regulation of Investigatory Powers Act 2000 and the Electronic Communications Act 2000
•
How the Data Protection Act 1998 affects the degree to which you can monitor your staff
•
What you need to watch for in the Human Rights Act 1998
•
TUC guidelines
•
Example of an e-mail and Internet policy document.
£95.00
1 85418 241 2 • 2001 The rules and regulations are complex – but can be turned to advantage. The astute practitioner will understand the importance and relevance of costs to the litigation process and will wish to learn how to turn the large number of rules to maximum advantage.
International commercial agreements REBECCA ATTREE
£175
1 85418 286 2 • 2002 A major new report on recent changes to the law and their commercial implications and possibilities. The report explains the principles and techniques of successful international negotiation and provides a valuable insight into the commercial points to be considered as a result of the laws relating to: pre-contract, private international law, resolving disputes (including alternative methods, such as mediation), competition law, drafting common clauses and contracting electronically. It also examines in more detail certain specific international commercial agreements, namely agency and distribution and licensing. For full details of any title, and to view sample extracts please visit: www.thorogood.ws You can place an order in four ways: 1 Email:
[email protected] 2 Telephone: +44 (0)20 7749 4748 3 Fax: +44 (0)20 7729 6110 4 Post: Thorogood, 10-12 Rivington Street, London EC2A 3DU, UK
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HR AND EMPLOYMENT LAW
Employee sickness and fitness for work – successfully dealing with the legal system GILLIAN HOWARD
£95.00
1 85418 281 1 • 2002 Many executives see Employment Law as an obstacle course or, even worse, an opponent – but it can contribute positively to keeping employees fit and productive. This specially commissioned report will show you how to get the best out of your employees, from recruitment to retirement, while protecting yourself and your firm to the full.
How to turn your HR strategy into reality TONY GRUNDY
£129.00
1 85418 183 1 • 1999 A practical guide to developing and implementing an effective HR strategy.
Internal communications JAMES FARRANT
£125
1 85418 149 1 • July 2003 How to improve your organisation’s internal communications – and performance as a result.
Data protection law for employers SUSAN SINGLETON
£125
There is growing evidence that the organisations that ‘get it right’ reap dividends in corporate energy and enhanced performance.
1 85418 283 8 • May 2003 The new four-part Code of Practice under the Data Protection Act 1998 on employment and data protection makes places a further burden of responsibility on employers and their advisers. The Data protection Act also applies to manual data, not just computer data, and a new tough enforcement policy was announced in October 2002.
MARK THOMAS
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1 85418 270 6 • 2001 Practical advice on how to attract and keep the best.
Successfully defending employment tribunal cases
1 85418 008 8 • 1997
This report will help you to understand the key practical and legal issues, achieve consensus and involvement at all levels, understand and implement TUPE regulations and identify the documentation that needs to be drafted or reviewed.
New ways of working STEPHEN JUPP
DENNIS HUNT
£95.00
Why do so many mergers and acquisitions end in tears and reduced shareholder value?
Successful graduate recruitment JEAN BRADING
Mergers and acquisitions – confronting the organisation and people issues
£99.00
£95 1 85418 169 6 • 2000
1 85418 267 6 • 2003 Fully up to date with all the Employment Act 2002 changes. 165,000 claims were made last year and the numbers are rising. What will you do when one comes your way?
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New ways of working examines the nature of the work done in an organisation and seeks to optimise the working practices and the whole context in which the work takes place.
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Knowledge management SUE BRELADE, CHRISTOPHER HARMAN
changes to internal disciplinary and grievance procedures
•
significant changes to unfair dismissal legislation
•
new rights for those employed on fixed-term contracts
•
the introduction of new rights for learning representatives from an employer’s trade union
£95.00
1 85418 230 7 • 2001 Managing knowledge in companies is nothing new. However, the development of a separate discipline called ‘knowledge management’ is new – the introduction of recognised techniques and approaches for effectively managing the knowledge resources of an organisation. This report will provide you with these techniques.
Reviewing and changing contracts of employment ANNELISE PHILLIPS, TOM PLAYER and PAULA ROME
This specially commissioned new report examines each of the key developments where the Act changes existing provisions or introduces new rights. Each chapter deals with a discreet area.
Email – legal issues £125
SUSAN SINGLETON
£95.00
1 85418 215 3 • 2001
1 85418 296 X • 2003 The Employment Act 2002 has raised the stakes. Imperfect understanding of the law and poor drafting will now be very costly.
360,000 email messages are sent in the UK every second (The Guardian). What are the chances of either you or your employees breaking the law? The report explains clearly:
This new report will: •
Ensure that you have a total grip on what should be in a contract and what should not
•
Explain step by step how to achieve changes in the contract of employment without causing problems
•
Enable you to protect clients’ sensitive business information
•
Enhance your understanding of potential conflict areas and your ability to manage disputes effectively.
Applying the Employment Act 2002 – crucial developments for employers and employees AUDREY WILLIAMS
•
•
How to establish a sensible policy and whether or not you are entitled to insist on it as binding
•
The degree to which you may lawfully monitor your employees’ e-mail and Internet use
•
The implications of the Regulation of Investigatory Powers Act 2000 and the Electronic Communications Act 2000
•
How the Data Protection Act 1998 affects the degree to which you can monitor your staff
•
What you need to watch for in the Human Rights Act 1998
•
TUC guidelines
•
Example of an e-mail and Internet policy document.
£125
1 85418 253 6 • May 2003 The Act represents a major shift in the commercial environment, with far-reaching changes for employers and employees. The majority of the new rights under the family friendly section take effect from April 2003 with most of the other provisions later in the year. The consequences of getting it wrong, for both employer and employee, will be considerable – financial and otherwise. The Act affects nearly every aspect of the work place, including: •
flexible working
•
family rights (adoption, paternity and improved maternity leave)
For full details of any title, and to view sample extracts please visit: www.thorogood.ws You can place an order in four ways: 1 Email:
[email protected] 2 Telephone: +44 (0)20 7749 4748 3 Fax: +44 (0)20 7729 6110 4 Post: Thorogood, 10-12 Rivington Street, London EC2A 3DU, UK
S e e f u l l d e t a i l s o f a l l T h o r o g o o d t i t l e s o n w w w. t h o r o g o o d . w s
SALES, MARKETING AND PR
Implementing an integrated marketing communications strategy
Tendering and negotiating for MoD contracts
NORMAN HART
TIM BOYCE
£99.00
£125.00
1 85418 120 3 • 1999
1 85418 276 5 • 2002
Just what is meant by marketing communications, or ‘marcom’? How does it fit in with other corporate functions, and in particular how does it relate to business and marketing objectives?
This specially commissioned report aims to draw out the main principles, processes and procedures involved in tendering and negotiating MoD contracts.
Defending your reputation Strategic customer planning ALAN MELKMAN AND PROFESSOR KEN SIMMONDS
SIMON TAYLOR £95.00
1 85418 255 2 • 2001 This is very much a ‘how to’ Report. After reading those parts that are relevant to your business, you will be able to compile a plan that will work within your particular organisation for you, a powerful customer plan that you can implement immediately. Charts, checklists and diagrams throughout.
1 85418 251 • 2001 ‘Buildings can be rebuilt, IT systems replaced. People can be recruited, but a reputation lost can never be regained…’ ‘The media will publish a story – you may as well ensure it is your story’ Simon Taylor ‘News is whatever someone, somewhere, does not want published’ William Randoplh Hearst When a major crisis does suddenly break, how ready will you be to defend your reputation?
Selling skills for professionals KIM TASSO
£65.00
1 85418 179 3 • 2000 Many professionals still feel awkward about really selling their professional services. They are not usually trained in selling. This is a much-needed report which addresses the unique concerns of professionals who wish to sell their services successfully and to feel comfortable doing so. ‘Comprehensive, well written and very readable… this is a super book, go and buy it as it is well worth the money’ Professional Marketing International
Insights into understanding the financial media – an insider’s view SIMON SCOTT
This practical briefing will help you understand the way the financial print and broadcast media works in the UK.
European lobbying guide £129.00
1 85418 144 0 • 2000
Corporate community investment £75.00
Understand how the EU works and how to get your message across effectively to the right people.
1 85418 192 0 • 1999 Supporting good causes is big business – and good business. Corporate community investment (CCI) is the general term for companies’ support of good causes, and is a very fast growing area of PR and marketing.
t +44 (0)20 7749 4748
£99.00
1 85418 083 5 • 1998
BRYAN CASSIDY
CHRIS GENASI
£95.00
e
[email protected]
w w w w. t h o r o g o o d . w s
Lobbying and the media: working with politicians and journalists
Managing corporate reputation – the new currency
MICHAEL BURRELL
SUSAN CROFT and JOHN DALTON
£95.00
1 85418 240 4 • 2001
1 85418 272 2 • June 2003
Lobbying is an art form rather than a science, so there is inevitably an element of judgement in what line to take. This expert report explains the knowledge and techniques required.
ENRON, WORLDCOM… who next?
Strategic planning in public relations KIERAN KNIGHTS
£69.00
At a time when trust in corporations has plumbed new depths, knowing how to manage corporate reputation professionally and effectively has never been more crucial.
Surviving a corporate crisis – 100 things you need to know
1 85418 225 0 • 2001
PAUL BATCHELOR
Tips and techniques to aid you in a new approach to campaign planning.
1 85418 208 0 • April 2003
Strategic planning is a fresh approach to PR. An approach that is fact-based and scientific, clearly presenting the arguments for a campaign proposal backed with evidence.
£125
£125
Seven out of ten organisations that experience a corporate crisis go out of business within 18 months. This very timely report not only covers remedial action after the event but offers expert advice on preparing every department and every key player of the organisation so that, should a crisis occur, damage of every kind is limited as far as possible.
FINANCE
Tax aspects of buying and selling companies MARTYN INGLES
Practical techniques for effective project investment appraisal £99.00
RALPH TIFFIN
£99.00
1 85418 189 0 • 2001
1 85418 099 1 • 1999
This report takes you through the buying and selling process from the tax angle. It uses straightforward case studies to highlight the issues and more important strategies that are likely to have a significant impact on the taxation position.
How to ensure you have a reliable system in place. Spending money on projects automatically necessitates an effective appraisal system – a way of deciding whether the correct decisions on investment have been made.
Tax planning opportunities for family businesses in the new regime CHRISTOPHER JONES
£49.00
1 85418 154 8 • 2000 Following recent legislative and case law changes, the whole area of tax planning for family businesses requires very careful and thorough attention in order to avoid the many pitfalls.
S e e f u l l d e t a i l s o f a l l T h o r o g o o d t i t l e s o n w w w. t h o r o g o o d . w s
MANAGEMENT AND PERSONAL DEVELOPMENT
Strategy implementation through project management TONY GRUNDY
£95.00
1 85418 250 1 • 2001 The gap Far too few managers know how to apply project management techniques to their strategic planning. The result is often strategy that is poorly thought out and executed. The answer Strategic project management is a new and powerful process designed to manage complex projects by combining traditional business analysis with project management techniques.
For full details of any title, and to view sample extracts please visit: www.thorogood.ws You can place an order in four ways: 1 Email:
[email protected] 2 Telephone: +44 (0)20 7749 4748 3 Fax: +44 (0)20 7729 6110 4 Post: Thorogood, 10-12 Rivington Street, London EC2A 3DU, UK
t +44 (0)20 7749 4748
e
[email protected]
w w w w. t h o r o g o o d . w s
