Developing Contracts in Procurement and Supply: Terms and Conditions

Executive Summary

Developing contracts in procurement and supply is a very critical task to any firm that heavily relies on raw materials or services of other firms to run normally. The terms and conditions stated in the contract define the nature of business relationship that a firm will have with its suppliers. Terms and conditions are meant to protect the parties involved from risks of poor quality, unnecessary time extensions, increased costs, or any other unethical business practices. These conditions not only protect the buyer but also the sellers who may try to default payments after the delivery of products are made. In past experiences, it became apparent that when contracts are supported by clear terms and conditions, then one party may take advantage of the other. Such cases can only be eliminated if there are clear terms and conditions in the contract. When drawing the contract, care should be taken to avoid battles of forms by being precise and categorical when making offers and counteroffers. The paper also focuses on battle of forms as an issue that a firm should give a serious consideration. A business transaction should not take place when there is no clear acceptance of the offer or counteroffer made by the parties involved. The terms and conditions should help ensure that the relevant performance measures are monitored and managed for the benefit of all the parties.

Introduction

Securing raw materials and other inputs needed for smooth running of an organization is one of the biggest challenges that firms face in the current business environment. According to Turner, competition in the market is increasingly getting stiff and firms are under pressure to deliver high quality products which surpass what their rivals offer (67). This nature of the environment has forced many companies to outsource some services and products in order to concentrate in what they have the best skills to deliver. These market forces have made procurement and supply very important in any business setting. Companies now need reliable sources of raw materials and other products they need to operate normally. The suppliers must be capable of delivering high quality products, in the right amounts, at the right time, and at the right cost.

Sometimes what is expected from a supplier is never delivered because of excuses, some of which may not be valid. It is, therefore, necessary to find ways that can protect the company from unscrupulous suppliers who may engage in unethical business practices which may hurt the prosperity of the organization. Developing a binding contract in procurement and supply is hence of great importance. The contract clearly defines the obligation of each of the parties and how they are supposed to relate. It also defines the possible consequences that each of the parties may be subjected to in case they fail to deliver on their promises (Baily 56). In this paper, the focus will be to determine how terms and conditions set when developing contracts in procurement and supply may help in protecting the interests of the parties involved in the contract.

Terms and Conditions of Procurement and Supply

How the Terms and Conditions Help in Managing Risks

In procurement and supply, there are a number of risks which should be properly managed in order to protect the interests of the parties involved. Risks of poor quality, time extension, increased costs, and unethical practices must be put to check to ensure that they do not affect the outsourcing firm in an unfair way. According to Mishra, when two or more firms enter into a business relationship, it is critical to have clear terms and conditions that must be followed by all the parties to guide the business process (110). There must be binding laws and regulations that define the roles and responsibilities of the individual parties in order to ensure that they keep their promise at all times. Before looking at how terms and conditions of a procurement and supply contract may help a firm to manage risks of poor quality, extension of time, increased costs, and unethical practices, it is necessary to understand that a contract must be done in a legally binding manner (Snider and Rendon 90). Both parties must be fully aware that the relationship is legally binding, and any of them who fail to follow the set regulations may face punitive measures set by the law. The following are some of the terms and conditions and how they can help in the management of risks.

1. Managing risks of poor quality
   According to Mosoti, one of the biggest risks in procurement and supply is the delivery of poor quality products (630). It is common for a firm to deliver a substandard product instead of what it promised. In most of the cases, a firm will always give the best sample when making an application for the contract. However, when the contract has been awarded, the product that is finally delivered may not be as good as what was promised. Setting clear terms and conditions may help in eliminating these risks. In the contract, terms and conditions should clearly specify the quality of the product and the firm contracted for the job must promise to deliver such quality in writing. For example, there should be a term stating that the products delivered must be of the same quality as the sample that was provided when requesting for the tender (Turner 78). The supplier will, therefore, be bound by this policy and will be required to deliver products as per the set rules. Any little deviation must have financial implication on the supplier. In my organization, there have been cases in the past where suppliers deliver sub-standard products basically because the contract was silent or unclear about the needed quality. As such, they take advantage of the inadequacy of the contract to deliver products which fail to meet expectations. Such issues can be eliminated by having terms and conditions about the expected quality clearly stated. For instance, there should be a clause stating that if the supplier delivers substandard products, then the firm shall not accept them, and the supplier will bear all the financial consequences that may arise from the failure to meet the agreed terms (Baily 93). This will be a warning to unscrupulous suppliers who may want to follow short-cuts by delivering sub-standard products.
   Quality should be defined in very specific terms, including issues such as the material, color, shape, durability, or any other relevant characteristics that may define quality. Both parties must agree that the quality desired is reasonable at the agreed price and that nothing will be offered which falls below the set prescriptions. This condition must be accompanied by a clause which would help the parties in defining what happens in case the set quality is not met (Snider and Rendon 34). The contracting firm may choose to reject the sub-standard product, pay less for it, or demand for a fine for time wastage. When such conditions are clearly spelt out, my company will be protected from unscrupulous traders who may be interested in making quick gains without delivering quality. Both parties must agree in writing that the conditions are binding. Such conditions will be a constant reminder to the firm awarded the contract that the set quality must be met. Such a company will be aware that failure to meet the set qualities may lead to punitive measures that may affect its normal operations. This will act as a motivation to ensure that it delivers high quality products. Such agreements will help the contracting firm to manage risks related to quality of the products. I believe that if the law is clearly defined, my company will be assured of high quality products, and in case the right quality is not delivered then there will be compensatory measures in place to protect it. Losses arising directly or indirectly from the suppliers who fail to offer the expected quality for one reason or the other shall be eliminated. As such, I believe this firm will be more profitable than it is currently.
2. Managing risks of extension of time
   In procurement, and the entire supply chain management, one of the biggest issues that firms face is delivery of products within the agreed timeline. It is common for the contracted firm to come up with many excuses to justify why they need extension of time in delivering products or services. However, Shi says that delays in delivery of products may have serious negative consequences on a firm (1960). For instance, manufacturing firms may source for their raw materials from different companies. When one company fails to deliver a product at the agreed time, the entire production process may be halted. Such eventualities may have varying consequences on the contracting firm. First, there is the risk of the other raw materials going stale while waiting for the delayed product, especially for companies dealing with perishable products. I have witnessed cases where some raw materials have to be disposed because of delay in delivering other materials needed for the processing to begin. In such cases, the company may run at a loss for a mistake committed by the supplier. There is also the risk of delaying the delivery of products in the market which may lead to customer dissatisfaction. I have experienced cases where the company is forced to delay in delivering products in the market because of a delay caused by the supplier. There should be a clause in the terms and conditions stating that any late delivery of products will be subject to a given amount of fine to help compensate for any consequences of the delay (Turner 121). As such, the suppliers will be warned that they have to be responsible enough and to deliver products in time in order to avoid the set penalties. As Turner says, people often tend to be efficient when they know that there are consequences in their delays (56). It should be stated that the set fine is not meant to punish the supplier, but to compensate the firm for any resulting losses from the delay. If such clauses exist in a contract, I know that the current and future suppliers will do their best to avoid delays.
   The overall cost of the production will also increase when time is wasted waiting for the delivery of a given product. It is, therefore, very critical to avoid delays in delivering of products. When drawing the contract, there must be a time clause, which specifies the time when the ordered products are expected to be delivered to the company. There may be window period of one week or so that can be acceptable by both parties, taking into account some of the complexities that may exist in delivering the products (Baily 43). The acceptable extension time must be stated in the contact. If the delivery is made at a later date than what was agreed upon, then measures to compensate the contracting firm may be taken. The contract may state that any direct or indirect loss caused by the delay will have to be compensated for by the supplier.
3. Managing risks of increased costs
   The fluctuating market prices of various products in the local and international market are other issues that many firms face in procurement and supply. It is normal for the prices to fluctuate, but sometimes the fluctuation may be so big that it may negatively affect the operations of a firm, especially if a company had not factored in the impact of such fluctuations (Turner 88). When making a contract with a supplier to deliver a given set of products, it is often prudent to consider the effect of such fluctuations. For a supplier to make profit, it may be forced to pass the additional costs to the buyer. However, it is important to note that the price of a product may either fall or increase. In the past, there have been instances where suppliers adjust the price of their products very suddenly, which affect the profitability of the firm. Such sudden change in the price of the suppliers may have devastating impact on the firm, especially if it is a basic material needed for the production. The firm may not suddenly transfer the cost directly to the customers. In such instances, the firm is forced to bear the cost, and that may harm its profitability.
   In most of the cases, the suppliers are always silent when the prices have fallen and will deliver the products without mentioning anything about the abnormal profits they make due to the reduced product prices. However, when there is an increase, they would rush to demand for additional compensation to cover for the additional costs. Having clear terms and conditions may help a firm to manage the risks involved in price fluctuation. In the contract, there must be a clause defining what happens when prices of the products fluctuate (Turner 63). The parties may have two possible options. The first option is for the supplier to deliver the products at the originally agreed costs irrespective of the increase or decrease of the market price. The second option may be for the contracting firm to increase payment or receive compensation in case of price reduction proportional to increase or decrease in market prices. Whichever option that is acceptable to all parties must be put in writing within the contract. According to Turner, the suppliers are often keen to ensure that they do not incur any losses when the prices of their products go up (55). However, they should not be allowed to make abnormal profits in cases of drop in the prices of products in the market.
4. Managing risks of unethical practice
   In procurement and supply chain, there are a number of other unethical practices that may unfairly benefit some of the parties involved in the contract at the expense of others. Some of the suppliers may use unscrupulous means to win a tender, promising to supply products or services that they lack the capacity to deliver. Providing false information is common when firms are trying to win a tender. Some suppliers overstate their capacity to help them look more qualified than they really are in practice. When given a tender based on the qualification stated in their application, the firm often expects them to deliver what they promised. However, the reality is that they are often unable to deliver on their promise. Managing such a risk can be done in a number of stages. The first stage is conducting a thorough background check of every applicant (Snider and Rendon 38). During the pre-qualification assessment, there must be a requirement that each of the applicants must provide the background information about their existence, financial status, operational capacities, past records of business engagements with other firms, and any other relevant information that may help in determining their capacity to deliver the products needed by the contracting company. Once this is made available, the contracting company must use all the available means to verify the information provided by the individual applicants. Any inconsistencies would automatically lead to disqualification, and this must be stated in the prequalification forms given to them (Chimia 79). When the most qualified applicant has been selected, then when signing the contract, there must be a clause which should state that if inconsistencies are identified at a future date, then corrective measures shall be taken as appropriate. The contract must also state that any unethical practices that shall be detected in the course of the contract meant to harm the contracting company shall be subject to corrective measures as per the existing laws. I have witnessed cases where some suppliers deliberately use terms that are meant to confuse their customers when signing contracts just to ensure that they are protected in case their customers run at a loss because of their mistakes. The terms stated in the contract must be strict in protecting both parties against unethical practices.

The Concept of the “Battle of the Forms”

The concept of the ‘battle of the forms’ refers to a situation where two parties (supplier and buyer) issue two contracts to each other which have marked differences. According to Snider and Rendon, a contract can only exist between parties if an offer made by one party is accepted by another party (340). It is common to find a situation where an offer made by one party does not fully meet the expectations of the other party. In such a case, instead of accepting the offer, the other party may decide to make little changes on the offer in line with their expectations in what is referred to as counteroffer. When this happens, the party that sent the first offer is expected to review the new conditions put in place by the other party and determine if they are acceptable. In case they are acceptable, then the party will send an acceptance, at which stage the two parties will be considered to have entered into a binding contract. If the party is not satisfied with the conditions, then it may be at liberty to make some concessions but write another offer to the other party taking into account the proposed conditions. The two parties are legally expected to reach a consensus before starting their commercial engagement.

There are some cases where the two parties may get engaged in business before clearly having express terms in the contract made for the supply of goods or services. One party may assume that the offer or counter offer they made was accepted by the other party and proceed to deliver goods or accept the delivered goods. In such cases, each of the parties will be assuming that their offer or counteroffer was accepted by the other parties. Disagreement is bound to arise when it comes to payment when the issue was primarily about the cost. When such disagreements arise, then the ‘principle of last shot wins’ is often used. This principle holds that when there are two differing documents used to create commercial agreements (offer), then the last offer made will prevail over other offers if the other party did not expressly reject it.

In my past experiences, I witnessed a case where a supplier made claims about the price of the products delivered when it came to the time of making the payment. The supplier had been delivering products in the past to the company with which I was working, but on this specific occasion, the quotation was higher than what had been usually the case. The supplier cited increased cost of delivering the products as the primary reason of adjusting the price. However, the supply chain manager in my company made a counteroffer, stating that the company will be willing to accept the products under the old price because the change in price was very sudden and the company was not prepared. Instead of sending a reply to the counteroffer, the supplier went ahead and delivered the product. My company assumed that this was an indication that the supplier had accepted the counteroffer. However, when the check was written, the supplier claimed that the original offer stands and that the counteroffer will not be upheld. This brought a serious disagreement between the two parties. However, because of the trust they had developed and the fact that they still needed each other, they opted to solve the issue out of court. However, such incidents should be avoided to ensure that the relationship between the two parties is protected.

To ensure that any agreements are carried out under the terms and conditions which are desirable, then a firm must be explicit in responding to offers and counter offers. When a supplier makes an offer, then the company must critically assess it to determine if the terms included in the document meet the company’s conditions. If the conditions are not met, then the company should make a counteroffer to the supplier stating the conditions that will be acceptable. The company should then wait for the response from the supplier after the receipt of the counteroffer. If products are delivered without objections to the counteroffer made, then the company will be safe from any future complaints. In case the supplier delivers the product with a new set of conditions, then the company should not accept the products if the new conditions are not favorable. The company should ensure that its offer or counteroffer is the last one which is made in the process. The principle of offer and acceptance will always be applied in case there is a need to make legal interpretations. For that reason, the company should not accept or act in a manner likely to show acceptance to conditions it considers favorable to it. The following case laws are examples of the precedents set in courts in the battle of forms.

• B.R.S. v Arthur V. Crutchley Ltd 1.
  In this case, the claimant (a driver) handed the defendant a delivery note with conditions for the carriage. The defendant stamped the note which introduced new conditions in the contract. The driver did not take time to go through the statements introduced and assumed that his original offer was accepted (Turner 79). When they went to court, it was held that in cases where there are two or more conflicting offers, then it is believed that the final offer made before the parties started engaging in the commercial transaction is the valid contract.
• Butler Machine Tool Co Ltd v. Ex-Cell-O Corporation (England) Ltd 2.
  According to Turner, this is one of the most controversial and widely quoted cases of battle of forms (74). In this case, the seller (Butler Machine Tool) made an offer to the buyer (Ex-Cell-O Corporation) supply machines at a given price subject to terms stated in the offer. The offer had a clause which stated that the price shall be adjusted based on the escalations in the market. The buyer went ahead and placed an order, but with it sent a counter-offer stating buyer’s own term. The form of the buyer had tear-off slip that the seller had to sign and send it back to the buyer as a sign of acceptance of the buyer’s condition before delivering the products (Chimia 33). The seller signed the slip, but attached another letter stating that the contract was in accordance with the initial (seller’s) terms. The court held that the seller failed to make a counter-offer and that by signing the slips, agreed to enter into contract as per the terms of the buyer.

Monitoring and Management of Relevant Performance Measures

According to Baily, using contractual Key Performance Indicators (KIPs) in linking technical and commercial requirements in a given contract has become a major concept in enhancing quality of products obtained from suppliers (83). When developing contracts, it is necessary to create targets which can be used in the assessment of suppliers’ performance based on SMART targets. Some of the main issues that always arise when suppliers deliver their products include time and mode of delivery, and quality of the products delivered. In some of the past incidences I have witnessed cases where the supplier demands to be paid for the cost of transporting the raw materials to the premises of our company. These cases are common when the contract is not clear on the mode of delivery. In one incident, my firm had to compensate the supplier the full cost of transporting the raw materials from the supplier’s premises to the stores of our company. The terms and conditions in the contract will specify the key performance indicators expected of the supplier. In terms of quality, the terms will state the nature of the products expected in a very clear language that is not shrouded in ambiguity. The supplier and the buyer must have an understanding of the quality that should be delivered in terms of material, taste, color, shape, or any other factor that characterizes the quality of a given product. The set target for the quality should be specific, measurable in acceptable terms, achievable under the prevailing conditions, and timely.

The timeliness of the delivery of a given product may have serious impacts on the operations of a buyer. When the contract clearly defines the duration within which the supplier is expected to avail the products, there will be a serious commitment on the side of the supplier to keep time, knowing very well that any delays may bring corrective measures. For instance, there should be a term stating that supplies must be made available on time, failure of which the buyer will be compensated for any loss arising from the delays. The buyer will, therefore, be assured that there is a motivation on the side of the supplier to ensure that goods or services are made available within the agreed timeline. The buyer will also be assured that in case of delays, measures specified in the contract will help in protecting it from losses arising directly or indirectly from the delays of the supplier. This is a condition that has proven to be very useful in the firm I was working with in the recent past. The introduction of that clause made the suppliers to be very committed in terms of delivering the materials in time. They are aware that any delays that may affect the production at the company may attract a given penalty. They do everything within their powers to ensure that they avoid such penalties by delivering their products in time. I noted that when there is no clause that talks about time, it is common for suppliers to delay in delivering products basically because they know that their actions are not subject to any form of punishment (Mosoti 630). As such, it becomes necessary to develop measures that will ensure that the firm remains protected.

Management and monitoring of the performance measures of the suppliers is enhanced by the terms and conditions. As Chimia notes, these terms and conditions always specify the systematic progress of the contractual activities, especially if it involves progressive delivery of products or services (36). The buyer’s own terms must not unfairly affect the terms of the seller. It is important to note that buyer is able to monitor how the supplier has performed at every stage based on the set measures at given timelines. In case there are some failures, the buyer can detect them very early by simply comparing what has been delivered by what was promised. It makes the work of monitoring and management very easy. Both parties can clearly see when the expectations are met or not. If the expectations are not met, then they can agree on what can be done to bring about the needed improvement in the delivery of goods or services.

Conclusion and Recommendations

Conclusion

The study has revealed that lack of clearly stated terms and conditions may make it difficult for the parties involved to detect areas of weaknesses. It may result into disagreement between the parties involved. The two parties may try to justify their positions even if they know they are wrong. Such events may bring unnecessary disagreements which may affect the overall quality of the products delivered. This can easily be eliminated by having the terms clearly stated. In so doing, each of the parties involved will know its specific responsibilities as stated in the contract hence eliminating any confusion that may exist. Both parties should ensure that they are committed to having a win-win situation where no party unfairly benefits at the expense of the other parties. Fairness and utmost good faith are very important when having procurement contracts. Having clearly stated terms and conditions help in managing any future misunderstandings, but good faith is also critical in such processes.

Recommendations

The study reveals that terms and conditions set when developing contracts in procurement and supply may help in protecting the interests of the parties involved in the contract. Parties involved in developing supply chain contracts must understand what is needed to ensure that interest of all parties involved are taken care of in an effective manner. The following recommendations should be considered when entering into a contract.

• The firm must state its terms and conditions very clearly when drafting any contract.
• When the other party makes a counter-offer, the firm should respond very clearly by referring to the other party’s counter offer when making the second offer.
• The firm should only commit to a contract after all the terms and conditions of the final contract are conformed to be favorable.

References

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Mishra, Abhay. “Antecedents and Consequences of Internet Use in Procurement: An Empirical Investigation of U.S. Manufacturing Firms.” Information Systems Research, vol. 18, no. 1, 2007, pp. 103–120.

Mosoti, Victor. “Reforming the Laws on Public Procurement in the Developing World: The Example of Kenya.” The International and Comparative Law Quarterly, vol. 54, no. 3, 2005, pp. 621–649.

Shi, Yael. “A Portfolio Approach to Managing Procurement Risk Using Multi-stage Stochastic Programming.” The Journal of the Operational Research Society, vol. 62, no. 11, 2011, pp. 1958–1970.

Snider, Keith, and Rene Rendon. “Public Procurement: Public Administration and Public Service Perspectives.” Journal of Public Affairs Education, vol. 18, no. 2, 2012, 327–348.

Turner, Robert. Supply Management and Procurement: From the Basics to Best-in-Class. J. Ross Publishers, 2011.