L4M3 – COMMERCIAL CONTRACTING

Chapter 1 – Legal Issues in Relation to Commercial Contracts

1.1 Documentation that can comprise a commercial agreement for supply of goods or
services.
1. Invitation to tender (ITT) & Request for Quote (RFQ)
 Invitation to tender (ITT) – A formal process of obtaining bids normally (not always) includes
quality variables as well as price aspects.
 Request for quotation (RFQ) – RFQ is normally used when the only variable is price whereby a
framework agreement have been locked down contract terms. Degree of formality is less than in
ITT.
Unlike an estimate, a tender and quotation which are essentially same thing are each firm offers to
do something for the quoted price although a tender can be more detailed and comprehensive. An
estimate has no legal standing and merely a supplier’s best guess at price.
2. Specification
Specification is central to all commercial contracts. It is a document that sets out the detailed
requirements for goods and services or works that is to be procured. There are two main types of
specification (performance & conformance specification) as detailed below.
Performance Specification Conformance Specification
 Focuses on outputs  Focus on inputs
 Sets out results to be achieved  Gives specific methods, processes and
 The “what” not “how” materials
 Gives supplier flexibility to present solutions  The “how” as well as “what”
that the buyer may not have considered  May identify specific make or model
 Ties supplier to pre-set details
Ten key things to consider while designing a specification
1. Purpose – Current/future need, make or buy decision
2. Perspective – The stakeholders, their influence and preference.
3. Scope – The boundary limits, what should be included and excluded
4. Type – Whether to use a conformance or performance specification
5. Performance – Acceptable quality standards using KPIs, warranties, etc.
6. Clarity – Making the specification clear and unambiguous.
7. Relevance – Defining minimum and maximum standards
8. Improvement & Innovation
9. Regulatory compliance
10. Service condition
3. Performance Management Frameworks (PMF) & Key Performance Indicators (KPIs)
A performance management framework is a series of standards and targets to be achieved by the
supplier, definitions of how those standards will be measured and actions to be taken on the basis of
the measurement results. The aim is to promote the best control possible of things that can be
influenced and to ensure best possible outcome against agreed measures.
Key components of PMFs are summarized below.
 KPIs – what is being measured which is very necessary and needs to be contractual
 Targets – performance level to be achieved
 Consequences – what happens if the measures are not achieved, this can also come as incentive
or disincentive (to discourage a particular deviation or action).
4. Contractual terms
Also referred to terms and conditions, makes up the main body of the contract document. It is what
might be thought of as the “core contract”.
A formal contract is any contract or agreement which is evidenced in writing and is intended to be
legally binding. Non-written contracts also exists and contracts can go by other names such as letter
of appointment, a commission or service level agreement (SLA).
SLA is an agreement between the provider and end user of a service that details what performance
and quality will be provided. It is legally enforceable if it is referred to in the contract.
Key sections of the contractual terms document
1. The Articles – clearly spells out the parties to the contract with reference to their legal names,
generic function (client/contractor/supplier/service provider, etc.)
2. The Recitals – spells out the context of the agreement. i.e., the facts that surrounds the situation
in which the contract happens. By convention they start with the word “whereas” and followed
by “it is hereby agreed”.
3. Contract Particulars – Sets out some specific variables such as required date of completion and
any specific insurance requirements.
4. Full Terms and Conditions – These cover the ifs, buts, maybes and what will happen in respect
to X if ABC happens to Y. They will be in standard wording with specific meaning set out in
definitions.
5. The Schedules – These set out specific detail either as designed by the purchaser (e.g., KPIs) or
as submitted by the supplier.
An informal contract is a type of agreement that will not require any sort of legal intervention to be
considered enforceable. They are different from formal contracts because they do not need to be
sealed, witnessed, or written. A verbal agreement or a sales contract are two examples of informal
contracts
5, Pricing and other Schedules
A schedule to a contract is simply an appendix to the body of the contract form, making it easier to
incorporate project-specific information without many changes to the main body. There is no limit to
number of schedules that can be included in a contract however, it has to be referred to within the
terms and conditions to be enforceable.
Contracts that do not involve a single fixed-fee payment on completion will have a pricing schedule.
6. Contract Variations
Many contracts have to allow for change which can occur as a result of unforeseen circumstances
such as change in regulations or foreseeable need for change such as price adjustment over time.
However, the change process should be set out in the contract to include who can request for
change, who can authorize, who can accept, mechanism for agreeing price adjustment including a
format for variation order. Copies of all change orders should be held with the original contract
documents.

1.2. Legal issues that relate to creation of commercial agreements with customers or suppliers
Five conditions for a legal and enforceable contract.
1. Offer – A full statement of what the offeror is willing to provide and the terms by which they are
willing to provide it. If something is not an offer then it cannot be accepted even if it appears to
be, no contract is created. Things that not valid offers include:
 Invitation to treat/tender (ITT)
 Declaration of intention
 Mere puff (or boast)
 Provision of information
 An offer is however not available infinitely and there are six(6) ways it would cease to be capable
of being accepted.
 Withdrawal (or revocation)
 Lapse (exceeded time limit for acceptance)
 Death of either of the parties before acceptance
 Rejection by one party (maybe via a counteroffer) invalidates the previous offer.
 Failure of conditionality ( conditions can be express or implied)
 Acceptance of offer (for public offers, it becomes unavailable once one person accepts)
2. Acceptance – This is subject to three conditions; can only occur while offer is still open, must be
absolute and unconditional and cannot be made by someone with diminished capacity (like a
minor, mentally unstable person or under substance influence or threat).
Acceptance does not need to be explicit; it can be implied by terms – known as acceptance by
performance. Another exception to explicit acceptance is the mailbox rule which holds that if a
letter accepting an offer has been properly posted then it will be effective from the date of
posting – this however applies to only acceptance of offers.
3. Consideration – In commercial contracts, this can be thought of as the payment for the goods or
services being provided. It is normally financial payment but legally, it does not have to be as
there can be payment in kind. For contract to exist, there must be consideration and it must
have value.
There are also certain things that looks like value but are not valid consideration. E.g.,
 Past consideration
 A promise to perform an existing obligation
 A promise given to a third party – this is based on concept of privity of contracts
However, Implied consideration and A promise to perform over and above an existing obligation
can be regarded as valid consideration.
The exception when consideration is not required is where a promise is made by the way of a
deed. An example is collateral warranties but only effective if executed as deeds otherwise there
would be a need to introduce some minimum consideration for it to be valid. A document is a
deed only if it explicitly says that it is and signed by the parties.
4. Intention to create legal relations – This means intentions by the parties that an agreement
should be capable of being enforced via the courts if necessary.
Commercial arrangements are generally assumed to be intended to be enforceable, while purely
domestic agreements are thought not to be. However, for a contract to be valid, there must be
intention from both parties for the agreement to be enforceable by the courts.
5. Capacity to contract – A person has the legal capacity to enter a contract if there are no legal
reason why they cannot. Some of the reasons include:
 Infants/minors (usually under the age of 18 in most countries)
 People suffering from mental health issues
 People under the influence of drugs.
If a person without capacity enters into a contract, it will not be legally binding on the.
There is also a similar provision that applies to the public sector known as the “ Ultra Vires rule”
meaning beyond powers which limits the areas the organisation can and cannot contract such
that any contract beyond the limits will not be capable of being enforced against it. This rule has
been eradicated slowly in UK and other countries because it leads to complications.
An equivalent in commercial companies is that they are not permitted to do anything beyond
what is set out in their articles of incorporation.
The battle of forms and precedence of contract terms - This involves series of forms such as orders,
notes, etc. issued in sequence by purchaser and supplier, each containing terms that appear to
override those on the previous document.
Precedence of contract terms - This explains the fact that anything explicitly set out in a contract will
override anything implicit or previously agreed. The one exception to this is where terms are implied
into a contract by statute or legal regulation.
Standard forms & attached schedules – The general rule is that specific clauses override general
ones
Risks presented by contracting on suppliers’ terms
Accepting supplier’s terms means accepting a contract drafted entirely in the supplier’s favor. This is
could include the following.
 No warranty of quality or fitness
 A spec that reflects what supplier wants to sell rather than what purchaser wants to buy
 All risk of damage in transit resting with purchaser
 Payment terms which may not be favorable to the purchaser
 Exclusion of liability (to the extent permitted by law)
 Lack of protection of any of the purchaser’s intellectual rights
 Inability to control shared data
Risks presented by relying on oral contracts
In principle, oral contracts are enforceable however, procurement and supply personnel should be
careful to avoid them because of the inherent risks. The purchaser may believe it is contracting on its
normal terms as well the supplier which will lead to battle of forms upon any creep of formal
documentation like delivery note. Conflict comes in areas such as:
 Warranty
 Specification
 Timeline
 Cost
 Liabilities, etc.

The Vienna Convention on Contracts for the International Sale of Goods (CISG)
The Vienna Convention on CISG is a voluntary treaty under the auspices of the UN Commission on
International Trade Law (UNCITRAL) seeking to harmonize contract terms for sale of goods between
different countries. As at December 2017, 89 countries have signed the treaty with India, South
Africa, Taiwan & UK yet to sign for varied reasons.
The Vienna Convention only applies in specific situation.
 Only applies to goods (not services or works) including custom made goods.
 Only applies to private commercial transactions and not to private sector contracts
 Only applies where the parties have their place of business in different contracting states.
At state level, countries signing up the treaty can exclude parts of it or exclude the whole of the
treaty from some part of their territory.
At contract level, parties to the contract can exclude or alter the provisions as they see fit on a case-
by-case basis.
Exceptions from the CISG
 Distribution agreements (since they are for transport of goods not transfer of ownership
 Goods bartered for other goods or services – anything where payment is not money
 Framework agreements – which are generally accepted not to be actual contracts
 Franchise agreements
 Sale of ships or aircraft
 Sale of electricity
 Anything sold at auction

Misinterpretations made pre-contract award

Misinterpretation is a false statement of fact made by one of the contracting parties before or at the
point of entering the contract which lead the other party to contract. For a misinterpretation, there
must be a statement made, statement must be false, & must have induced the contract.
Types of misinterpretation
 Fraudulent misinterpretation – where a person making the statement does so knowing it to be
false or is reckless in using information without taking any step to see if it is true or not.
 Negligent misinterpretation – where the person making the statement has a duty of care and
fails to take such reasonable care to the accuracy of the statements.
 Innocent misinterpretation – where the misleading statement is neither fraudulent not
negligent because it is genuinely and reasonably held to be true by the person making it.
Remedies for misinterpretation
 Rescission of contract – an equitable remedy that seeks to place both parties in their pre-
contractual position as though the contract never existed.
 Damages
In case of fraudulent or negligent misinterpretation, the court may award both rescission and
damages but in case of innocent misinterpretation, it can only award one or the other.

1.3. Types of contractual agreements made between customers and suppliers

1. One-off purchases – there is simple (e.g., marketing leaflets) and complex one-off purchase
which can be as much as purchasing and aircraft carries. Use of one-off purchases have
significant benefits and risks to both purchaser and supplier.
2. Framework arrangements and agreements – Framework arrangements are informal and has no
legal standing. It is essentially an approved list of suppliers and service providers. Approved
suppliers are not guaranteed any work nor any terms and conditions if such work is offered to
them. Framework agreements on the other hand are formal with legal standing. It is not a
contract, primarily because there is no consideration involved but it is an overarching (or
umbrella) agreement under which contracts can be created.
Framework agreements sets out how call-offs can be made – whether a mini-competition is
required or a direct call-off. It also states how price would be calculated, how to determine
specification, duration of the agreement and who can be further enlisted (true framework
agreement usually gives no room for new entrants.
3. Call offs or term contracts – this is a form of contract which exists for a fixed period of time
rather than for a specific purchase. They are used where a purchaser has a regular requirement
for goods or services of similar nature from a single supplier. Call-offs or term contracts can
further be split down into contract for goods, services (such as maintenance of fire alarms,
cleaning, etc.) or works (such as civil construction, heavy maintenance, etc.)
4. Contracts for hiring and leasing of assets – The term hire and lease are often used
interchangeably, however hire is more commonly used for short-term arrangements while lease
if for longer-term contracts. Hire or lease contracts does not mean transfer of ownership as
there is no “sale” therefore agreements such as UK sale of goods Act or Vienna Convention
which relates specifically to sale of goods does not apply. A unique scenario is the hire purchase
agreement whereby the end goal is transfer of ownership subject to certain commercial terms
and conditions. Regardless of the nature of hire or lease contracts, the five elements of valid
 contract still apply. The parties must carefully consider which risks are to be transferred to the
hirer and which would remain with the owner.

2.0. Specifications and Key Performance Indicators (KPIs)

2.1. Content of procurement specifications
Specification is the most important section within a procurement contract. Any ambiguity,
misunderstanding or lack of clarity about the spec will result in a failure against one or more of the
“five rights” of purchasing – Quality, Quantity, Time, Place & Price.
Modern professional procurement in addition to the transactional approach of “five rights” further
considers operational risks, stakeholder engagement, supplier relationship management and
regulatory compliance.
A good procurement exercise needs to be project managed. The first key stage is scoping which asks
questions relating to specification about “who would produce the first draft, whether there is an
existing basis for a draft, if not, what are the fundamental objective needs to be achieved. It is also
important to understand who the stakeholders are - who needs to be consulted about spec.
Shortcuts to specification include Use of brand names, Use of recognized standards and Use of
samples.

Typical sections of a specification

 Title
 Version control/Issue reference
 List of contents
 Foreword (or background)
 Scope – limits of requirement, should be as detailed and as clear as possible
 Definitions – terminology, abbreviation, units of measurements, etc.
 Consultation requirements – legal, regulatory compliance etc.
 Reference to other documents, standards or CoPs
 Substantive requirements – The bulk of the spec. and sets out what the requirements are.
o Characteristics – design, dimensions, interfaces, labelling, etc.
o Timescales – delivery dates
o Response times – maintenance, defects repair, etc.
o Performance/reliability – KPIs, operating conditions, testing methods, etc.
o Lifespan/durability
o Packaging
o Social and environmental criteria
o Information requirements – user manuals, operating/maintenance procedures, etc.
o Implementation – training? Integration requirements?
o Guarantees and warranties

Standardization of requirements vs Increasing the range of products

Standardization started with the industrial revolution in late 1700s and has continued ever since.
There are a number of advantages associated with it but also a disadvantage that it reduces range of
products available.
Advantages of standardization
 Clarity of specification
 Economies of scale leading to more efficiency and cost reduction
 Product reliability
 Service enhancement
 Time saving in procurement process
 Accuracy of quotations
 Inventory savings
 Wider supply market and less reliance on few specialists
 Reduced risk

Advantages of increasing range of products

 More breath of market coverage leading to more revenue
 Innovation
 Product differentiation
 Appeal to cultural differences
 Meeting different economic preferences
 Flexibility

Including social and environmental criteria in specifications

Social, environmental and ethical criteria are becoming increasingly important. Driving forces include
regulation, consumer and stakeholder pressure, more informed stakeholders and cost savings from
waste reduction.

Role of information assurance (IA) in developing specifications

IA is the name given to the processes and methods used to protect information systems, databased,
computer systems and networks, etc. Below are the five key elements or pillars of IA.
1. Integrity – Ensuring that data is not falsified or tampered with via use of right policies, anti-virus.
2. Availability – Ensuring that data can be accessed by authorized persons when required.
3. Authentication – Ensuring that users are genuine & who they say they are through access
control.
4. Confidentiality – Ensuring that the data can be accessed only by those with relevant authority.
5. Non-repudiation – Ensuring that people cannot deny having taken actions which they did.
IA sits within the wider context of information governance (IG) which includes the protection of
information that is managed outside of such systems and goes beyond the five pillars or IA. IA only
protects the data and information held within its system while the wider IG approach include
training and policies relating to general data management such as;
 “Clear desk” policy
 Requirements for filling cabinets to be locked
 Control of visitors to certain areas
 Control/destruction of paper copies
Two key roles of IA and IG in developing specifications are as follows.
1. Ensuring that specification is based on valid and accurate data
2. Ensuring that specifications itself includes requirements for meeting the necessary standard of
IA in delivery of goods or services especially when they are related to ICT hardware, systems or
software.

2.2.Examples of Key Performance Indicators (KPIs) in contractual agreements.

KPI measurement is about improvement. The measures must be about things which are Important,
which relate to Potential Problems or Potential Improvements and which can be Influenced (IPI
rule).
Types of KPIs – there are three main types.
 Binary measures – where only one of two options is possible; like yes/no answers, pass/fail
measures.
 Numerical measures – most commonly used measure and where a range of possible solutions is
possible. Example could be max. no. of incorrect orders or a % of total orders.
 Qualitative or subjective assessments – this is in form of pure opinions about how well or
otherwise goods are performing or service is being delivered. e.g., users may be asked to provide
ratings of unacceptable, poor, adequate, good or excellent which can be further converted into
0-4 score. Such surveys also include free fields for respondents to explain why they feel the way
they do.
KPI data - generally, KPI data must be easily accessible and capable of being trusted by both parties.

Setting targets – to drive improvement through KPIs, targets must be set against the criteria to
compare such improvement. Any target used must be Specific, Measurable, Achievable, Relevant &
Timebound (SMART). Other consideration is to determine what value an improvement on the KPI
would deliver to the business, what would it cost to deliver the improvement & who will bear the
cost? Are there likely to be unintended consequences in the process?

Five steps to defining KPIs

Step1 – Decide what matters, i.e. what would be measured by asking questions like what are the
risks? what are the opportunities? What can be improved?
Step2 – Determine how it will be measured, i.e., what data will be used? Does it already exist? What
type of measure is most appropriate? Pass/fail or numerical?
Step3 – Determine who will conduct the measurement? i.e., who would collect the shared data and
provide the initial analysis?
Step4 – Determine the frequency or time-period for measurement. e.g., daily, monthly, quarterly?
Step5 – Determine quantitative rating/score. i.e., how does the measure convert into a score? What
does the spec. require? Is their room for tolerance? Can there be a reward or penalty?

Use of Service Level Agreements (SLA)

SLA is an agreement between the provider and the user of a service that details what performance
and quality standards will be provided; this agreement is legally enforceable if it is referred to in a
contract.
Supplier-defined SLA – SLAs have been known and defined to be largely specified & drafted by the
purchasers. However, there are also circumstances where suppliers have standard SLAs in respect of
their product which purchasers may have to accept as standard part of the package. This is common
in the IT sector.
Designing SLA
SLA Core Element Key Considerations
Service definition Defines what exactly and precisely needs to be provided by the
supplier. Care should be taken not to duplicate the information to avoid
conflicts.
Quality definition This should cover the following.
 Minimum standards, failure which will result to breach of contract
 Unacceptable standard which is considered as breach of contract
 Poor standard, which may not be seen as contract breach but
enough to result to penalty payment or service credit.
 Acceptable/required standards as per specification and goods
standard which exceed specification if applicable. Care should be
 taken not to duplicate the information both in SLA & Specification.
KPI details What is measured? How is it measured? Who measures it? How often it
is measured, How measures convert to scores and the targets. Normally
set out separately from specification either in an SLA or performance
management framework schedule to main contract.
KPI management Covers actions and consequences if targets are not reached and
response consequences if targets are exceeded. This can be in the SLA or rights
and remedies section of the core contract document but not both
Operational performance Covers day-to-day operational issues and how they will be managed.
Should consider foreseeable operational failures and their significance.
Operational performance Sets out the actions and consequences for each performance failure
management response including a first response action with resolution timeline, escalation
procedure and threshold of tolerance. This can be in the SLA or rights
and remedies section of the core contract document but not both
Constraints or mitigating Sets out circumstances whereby normal service cannot be maintained
factors and requirements can be waived. Can be equivalent to force majeure.

3.0. Key clauses that are included in formal contracts

3.1. Contractual terms for contracts created with external organisations
A contract term is any provision of a contract. Each term gives rise to a legal obligation either to do
something, to refrain from doing something or to do something in a specific way; breach of which
would lead to specific consequences including litigation.
Express and Implied terms
 Express terms are specifically and clearly “expressed” in words either orally or in writing and
sets out definite agreement between the parties.
 Implied terms on the other hand are provisions or conditions that are assumed to form part of a
contract even though they are not clearly stated by either party. e.g., custom & practice.
An implied term will not hold if the contract includes a term that goes against the custom and
practice. The exception to this is when the term is implied by statute.
The contract “clause” is just the express wording in a section of a contract while the “contract term”
is the combination of that wording and everything within the schedule to which it refers.
Standard terms and conditions (T&C)
These are basic terms and conditions of business governing transactions that do not have a definitive
contract, usually designed to be included in form documents such as orders.
Key areas that must be covered by standard terms & conditions
1. Definitions – explains repeated phrases in respective sections especially if used in a different
sense from dictionary meaning
2. Express terms to override other standard terms – included to avoid battle of forms
3. Express terms to state that in specific framework or term contracts signed by the parties, the
express terms take precedence over standard terms
4. Formation of the contract – sets out which document will be considered contract documents
under standard terms.
5. Order or precedence – express terms that set out what happens for terms or documents conflict
6. Price – exclusions or inclusions to price such taxes, delivery charges, insurance, discounts, etc.
7. Invoicing and payment – express terms on invoice cycle time, currency of payment, etc.
8. Specification – reference to where any spec. is to be found if not stated in the order.
9. Obligation to comply with the law
10. Delivery and risk – set out place and time of delivery including how defects will be managed.
11. Warranties & liability – this will normally include quantity, quality, description & specification
matching those of the order; freedom from defects, fitness for purpose or service to be
performed by appropriately qualified & experienced staff.
12. Intellectual property & similar rights – ensures that applicable rights are transferred or withheld
as the case may be.
13. Termination – Circumstances in which contract can be terminated.
14. Confidentiality and use of data – rules regarding data protection & data management.
15. Ethics and CSR – set out requirements on ethical considerations and compliance.
16. Law and jurisdiction – set out which country’s legal framework that would apply to the contract.
A standard T&C must cover all these areas no matter how short the document is.
It is important to remember that standard terms are useful for low value, low risk, repetitive
purchases. They are not appropriate for any purchase which warrants a full bespoke specification
and tender.

3.2. Examples of contractual terms typically incorporated into contracts that are created with
external organisations
1. Liabilities & Indemnities – Liability is legal responsibility while indemnity is a promise to meet
the cost arising from the liability. Contract terms may seek to limit liability by placing a financial
limit on indemnity levels. Below are the key aspects of liability & indemnity clauses and things to
consider when agreeing to them.
 Liquidated damages & the rate at which it will be charged
 Exclusion of liability, i.e., force majeure
 Negligence of the other party
 Financial limit of indemnity
 Limiting scope of liability
 Transfer of liability (transfer of risk)
2. Insurance – An arrangement where a fee is paid to one party (the insurance company) so that it
will accept any cost that would normally fall to the party who has the legal liability for them.
Effectively the risk is transferred from the person with the legal liability to the insurer. Clauses
relating to insurance normally fall within same section of the contract with liability & indemnity.
Below are types of insurance cover referenced in contracts.
 Employer’s liability – legal requirement for any company that employs staff
 Public/products liability – sometimes referred as ‘third-party cover’; relates to damage or
loss caused by company’s product or on its premises as a result of actions of its personnel.
 Professional indemnity cover – relates to loss that occur as a result of poor/negligent advise
given in a professional capacity (e.g., by accountants or engineers).
 Goods in transit cover – for damage caused during goods delivery process
 Works/buildings – cover for partially completed building works.
Below are key considerations in respect of insurance clauses
 Level of cover required
 Aggregate or ‘each and every’ – Aggregate means the total claims under a policy in a given
period while ‘each and every’ cover means that the financial limit applies to each individual
claim.
 Scope of cover – it is rarely possible to provide finite detail of the scope so the expression
such as ‘in respect of all customary risk’ is used.
 Auditability of insurance – the purchaser should ensure that it has a right to access evidence
of the cover.
3. Subcontracting – A subcontract is a contract that sits below, is directly linked to and is partly
governed by a higher contract to deliver part of the requirements of the higher contract. There
can be several layers and sub-layers of subcontracts. Below are some of the reasons why the
purchaser would want to control the subcontracting:
 Supply chain – supplier would want to ensure the equally competent subcontractors are
selected.
 Contract terms – supplier would want to ensure that equivalent contract terms are reflected
in the sub-contract.
 Liability – supplier would want to ensure that contractor remains legally liable for fulfilling
the contract and not transfer liability to subcontractors.
Below are key considerations in respect to subcontracting
 Requirement to subcontract part or entire supply/service scope
 Level of control over subcontractor selection
 Level of influenced needed over subcontract terms
 Ensuring that contractor retains liability to the contract
 Awareness of price impact of any subcontracting.
Contract terms should be used to control subcontracting, including whether it is permitted at all
and any specific terms that may be necessary in the subcontracts, regarding payment terms,
insurance, etc.
4. Guarantees – A guarantee is a formal written assurance that certain quality conditions will be
fulfilled, and it provides a specific remedy if they are not. It usually outlives the contract.
Below are the considerations in respect of guarantees.
 Need for a guarantee – By assessment of likelihood for product failure and the cost impact
 Guarantee period – Depends on the nature of product, most suppliers offer standard
periods.
 Guarantee scope/inclusions – Repair/replacement options
5. Liquidated damages – Damages is the legal term for financial payments to compensate for a loss
of some kind. Liquidated damages sometimes called ‘liquidated and ascertained damages’ are
the damages whose amount is predetermined during formation of the contract as being payable
for a specific breach of contract. Commonly used in respect of late delivery. It is intended to be a
compensation and not a penalty. Below are key considerations in respect of liquidated damages.
 Specific breaches that would result to liquidated damages
 Estimation of liquidated damage cost.
 Indicating the degree of damage quantitatively – e.g., $300 per week of delay up to $10k.
 Process for claiming damages – e.g., use of variation order, approvals, etc.
6. Labour standards and ethical sourcing – ‘Labour standards’ refer to the terms and conditions of
employment of the workforce, particularly the non-professional workforce who are generally
the lowest paid and most vulnerable members of an organisation’s HR. Current standards derive
from the work of International Labour Organisation (ILO) – a UN agency and covers the
following:
 The right to workers to associate freely and bargain collectively
 The end of forced and compulsory labour – slavery in order words.
 The end of child labour
 The end of unfair discrimination
From the perspective of procurement professional, the obligation is two-fold:
 As a minimum, to apply the national laws of the state in which they operate and the laws of
any other state that affects the contract, subcontract and upstream supply chains.
  Wherever possible to seek & encourage higher standards through commercial negotiation.
‘Ethical sourcing’ is a broad term which involves ensuring that the products being sourced are
obtained in a sustainable way, that the workers involved in making them are safe and treated
fairly and that environmental and social impacts are taken into consideration. The impact on
workers has already been considered under labour standards. The following are considered:
 Things done directly by the supplier – ensuring standard labour and environmental policies
 Things that will be done via subcontracts – need to ensure compliance down the line
 Indirect inputs (from upstream supply chain) – how the supplier’s suppliers act

3.3. Types of pricing arrangements in commercial agreements

Cost and Price
 Price is the amount expressed in units of currency (pounds, dollars, etc.) to be paid by the
purchaser to the supplier in order to obtain the goods or services.
 Cost on the hand is the total sun of amounts paid by the supplier in order to produce the goods
or provide the services.
1. Use of Pricing Schedules
 Price schedule, sometimes called ‘free schedule’ when it applies to professional or consultancy
services is an appendix to a contract setting out what the prices are and when it would be
charged.
 A schedule of rates on the other hand is an itemized list of component parts within a lump-sum
contract, or a list of individual products, giving a price for each unit.
Calculating and expressing price – the number of ways prices can be expressed are listed below:
 Unit price – this is the simplest pricing method and expressed in naira, dollars, etc. per unit. The
unit can be a single item, a box, crate or pack containing many items.
 Hourly or daily rates – although this may sound different from ‘unit price’ but it is just a specific
type of unit pricing where the unit is one hour/day. It is mostly used for services where most of
the cost is for the person/equipment providing the service.
 Combination rates – used to reflect pricing when a mixture of goods and services (or parts and
labor) is required. Very common in repairs and maintenance contracts.
2. Use of Standard Schedules
Standard schedules which are usually published by professional bodies can be used for certain
contracts. They give a reasonable estimate of the price per a given product/service and negotiations
and tenders can then be carried out by reference to the price level.
It is critical that once the final version is produced, it is properly incorporated into the contract as a
contract document. When a standard schedule is used, it can be simply cross-referred to the
contract rather than reproducing the entire schedule as an appendix.
3. Use of fixed price arrangements
Also known as fixed-fee pricing, the purchaser will simply request for a specific product price amount
(e.g., $1000 worth of raw materials) to be supplied and will be quoted exact fixed fee. It can also be
used for services or works of small to medium scope projects with short timelines where likelihood
of changes to the specification, scope and input cost is limited.
In fixed-fee pricing, it can be argued that the model places all the risk with the supplier since they
cannot claim extra payment for additional works of if original price changes. However, the reverse is
the case if the input factors change in the supplier’s favor.
Overall, the disadvantages of fixed price model outweigh the advantage due to its inflexibility. It is
only suitable for circumstances where requirements can be established quickly and firmly.
4. Cost-plus and cost-reimbursable pricing arrangements
This model addresses some of the issues resulting from fixed-fee pricing arrangements.
The price is set on a basis of cost plus an agreed profit mark-up. [Cost + (Cost x % mark-up) = Price].
In practice, arriving at the agreed cost figure requires a degree of open-book accounting between
the parties and the supplier has to clearly show what the cost inputs are, whether they are fixed or
variable, the movements and how much control supplier has on them.
5. Use of indexation and price adjustment formulae
Indexation means linking of payments to an index (price % change over a given period based on a
starting year known as the base) and the adjustment of the payment in line with the movement of
the index. Two most widely used indices in the UK are the retail price index (RPI) & consumer price
index (CPI). The difference is that RPI includes VAT, other taxes & mortgage interest payments which
are all excluded from CPI. Supplier will naturally prefer RPI while purchaser will prefer CPI.
Beyond the indices, procurement professional should pay attention to other factors (macro & micro
economic) which can lead to seasonal change in price.

Use of incentivized contracts

In context of contract, an incentive is an extra payment to encourage better performance. Any
aspect of performance for which a KPI can be set could be considered for incentivization. Most
common application is in cost control & delivery timeline. For cost control, it requires introducing
concepts of target cost, target fee and sharing ratios.
Target fee is the amount that will be paid if the actual cost matches the target cost.
Target fee + [(Target cost – Actual cost) x Supplier share] = Final/Actual fee
Final price = Actual cost + Final fee
Implementing this approach creates a ‘cost plus incentive’ contract, also known as ‘target cost’ or a
‘gain-share/pain-share’ arrangement.
Another means of incentivizing performance is accelerated payment terms. In reality, this is difficult
to achieve except purchaser has a sophisticated software for invoice & payment admin.
Incentives however should be used only where the improvement sought is of financial benefit (over
and above the cost of incentive) to the purchaser.
Contract extensions
A contract may include the possibility of being extended subject to certain performance measures
being achieved. Consideration must be given to what level of performance to be achieved, whether
it must be achieved across all KPIs or some of them, how consistently it should be achieved and the
metrics of measurement. Very often, contract extensions are conditional on performance.
Payment terms
In every contract, it is important to pay close attention what it says about payment terms. Payment
term clause must include the following:
 Required documentation
 VAT & other taxes
 Payment period and how it is calculated
 Disputed invoices and pay-less notices
 Treatment of retentions
 Remedies for late payment

Study all glossary terms during revision