If you are long enough in procurement, chances are you will get into some kind of trouble with your supplier. He will delay shipments. Or try to increase the price. Or your stakeholders will figure out that their forecast was a bit too bold. Like 200% higher. And then you will start looking into your contract.
Procurement contracts do not need to be 25 pages and cover every possible option. Besides the fact that you will be going forward and backwards with amendments, the supplier will increase the price. They need the extra profit to cover their risk. Also, you can’t create them on one page and in 15 minutes. You will skip something that may cost you dearly later. Possibly even your job.
There are several kinds of contracts. Let us try to classify them
They are limited by
- Duration: month, year, 5 years and even longer
- Quantity: for example, a contract for 1 million barrels of oil. No matter how long it will take to get the goods the price and terms are fixed for the quantity.
- Project: you have agreed with a construction company to build the new office building. While there is a given timeframe, the contract is closed and inactive once the building is handed over.
We have as well unlimited contracts, also known as framework contracts. They usually clarify the way two parties intend to work. The focus is on payment terms, price adjustment rules, general terms and conditions etc. The contract you have with your bank is a good example of it. It covers the obligations of both parties but has no time limit.
Elements of a contract
So, now we know what kind of contract we need. But what, at a minimum, should be in the contract?
- Full legal names of both parties, including full names of the legal representatives. Also, in the signature area make sure you have the full names of the signatories. I saw many contracts signed by persons who are not legally authorized to do so. The court may deem the contract as invalid due to this.
- The scope, product, service the contract covers.
- Price of course. Make sure there is no room for misinterpretation. I just had a couple of days back a contract where the hourly and monthly rates did not match. So, based on which one to pay?
- Payment terms. Besides the payment time frame, I would suggest entering the payment procedure in detail. Wire transfer is quite common in Europe, but a supplier in Africa could prefer Western Union. Also, in the case of international trade, do not forget the payment currency and bank charges agreement.
- · Delivery terms and time. Make sure they are precise and realistic. Use INCOTERMS, and include some buffer. Penalizing a supplier because the ship is late is not fair.
- Contract termination rules. They depend heavily on the nature of goods. If it is something custom made, make sure you promise to take all stock from the supplier before closing the contract. Also, give a possibility to the supplier to terminate the contract. You can provide a couple of rules, but still, there should be an option.
- Health and safety rules. Do not put yourself in legal trouble if a drunk delivery driver hits someone in your company.
- Don’t forget the penalties. While we generally do not like to discuss them, they must be a part of the contract. You never know when things could go wrong. Even if you are not planning to use them, they are a great leverage to push the supplier.
- The legal stuff. Which court is responsible in the case of a dispute? Force majeure, which became so important in the time of COVID-19. Intellectual property. Confidentiality.
Aim to have all long-term deliveries contracted. This will give you peace of mind, and protect you if anything goes wrong.