Managing Contracting Risk Guide

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					Risk Management Guide
  Managing Contracting Risk

                  Patrick Ow
                     May 2010
          Contents

1   Introduction.................................................................................................................. 4
    1.1         Contract management....................................................................................4
    1.2         Relationship of contracting process components............................................5
    1.3         Contract manager responsibilities ..................................................................5
    1.4         Risk management ..........................................................................................6
    1.5         Definitions ......................................................................................................7
2   Contract planning ........................................................................................................ 8
    2.1         Deciding to contract .......................................................................................8
    2.2         Identifying the contract objectives ..................................................................8
    2.3         Total contract value and business rules .........................................................8
    2.4         Raise purchase requisition .............................................................................9
    2.5         Establish business case .................................................................................9
    2.6         Determine contractual risk..............................................................................9
3   Contract formation .................................................................................................... 17
    3.1         Communication ............................................................................................17
    3.2         Develop request for proposal (RFP)/ tenders ...............................................17
    3.3         Signing of non-disclosure contract ...............................................................17
    3.4         Pre-tender or tender briefings ......................................................................18
    3.5         Understanding the contract ..........................................................................18
    3.6         Intellectual property rights ............................................................................18
    3.7         Contract payments .......................................................................................19
    3.8         Evaluate offers .............................................................................................19
    3.9         Negotiations and due diligence ....................................................................20
    3.10        Service level management ...........................................................................22
    3.11        Resolve any arising problems or issues .......................................................23
    3.12        Finalise and award contract .........................................................................23
    3.13        Documents that will constitute the contract...................................................23
    3.14        Process for awarding the contract ................................................................24
    3.15        Notify unsuccessful supplier .........................................................................25
4   Contract management ............................................................................................... 26
    4.1         Overview......................................................................................................26
    4.2         Benefits of effective contract management...................................................26
    4.3         Who performs the monitoring? .....................................................................27
    4.4         Measuring contract performance..................................................................27
    4.5         Continuous Improvement .............................................................................28
    4.6         Handling unacceptable performance ............................................................29
    4.7         Acceptance ..................................................................................................29
    4.8         Complete, extend or renew the contract.......................................................29
    4.9         Occupational health and safety ....................................................................31
    4.10        Contract reporting ........................................................................................31


          Risk Management Guide for Managing Contracting Risks – May, 2010                                                Page 2 of 41
    4.11        Progress/ review meetings ...........................................................................32
    4.12        Managing problems/ issues..........................................................................32
    4.13        Audit trail......................................................................................................32
    4.14        Contract variations .......................................................................................33
    4.15        Change management...................................................................................33
    4.16        Consent to sub-suppliers..............................................................................34
    4.17        Receipt and acceptance of deliverables .......................................................34
    4.18        Criteria for effective disputes management ..................................................35
    4.19        Invoices and payments ................................................................................35
    4.20        Securities, performance guarantees and retention moneys..........................36
    4.21        General guidance concerning waivers..........................................................36
    4.22        Assignment and novation of contracts..........................................................36
    4.23        Discharge of a contract ................................................................................37
    4.24        Contract termination and cancellation ..........................................................37
5   Contract administration ............................................................................................ 38
    5.1         Establishing a contract administration file.....................................................38
    5.2         Debriefing with suppliers ..............................................................................39
    5.3         Conduct kick-off meeting with business units ...............................................39
    5.4         Record maintenance ....................................................................................39
    5.5         Payment on scheduled/ pre-determined list..................................................40
6   Contract close-Out .................................................................................................... 41
    6.1         Evaluating and documenting the results.......................................................41
    6.2         Techniques for conducting the evaluation ....................................................41




          Risk Management Guide for Managing Contracting Risks – May, 2010                                                Page 3 of 41
1     Introduction

1.1   Contract management
       Contract management is the process of administering a contract and includes:
             defining the business, and user needs and requirements
             developing the means and methods to meet the needs and requirements
             complying with all legal and procedural requirements
             assessing risks and allocating resources
             monitoring the performance of the contract
             comparing measured performance and agreed service levels to established
             standards
             communicating concerns and taking timely corrective action, as necessary, to
             ensure the successful completion of the contract.


       Contract administration is generally referred to as the last stage of the contracting
       cycle, and includes all administrative duties associated with a contract after it is
       executed, including contract review.
       The specific nature of contract administration or management varies from contract to
       contract. At the simplest level it can involve the receipt of goods, a check of the
       goods against the order and payment of the supplier. On complex and long-term
       service delivery contracts, contract management may involve:
             active monitoring of day-to-day activities
             certification of payment
             negotiation of variations
             management of disputes
             maintenance of records to provide an audit trail.


       Broadly there are three levels of contract administration.
             first operational level is for standard contracts for goods and services. Day-to-
             day contract administration should become no more than a monitoring, record
             keeping and payment authorisation role. A standard contract, which requires
             excessive administration, is almost certainly the product of a failure in the
             contract preparation stages. An example of an operational contract would be a
             stationery supply contract.
             second or intermediate level is for more complex contracts for services, where
             for example user(s) may have outsourced part of an organisation. These


       Risk Management Guide for Managing Contracting Risks – May, 2010                Page 4 of 41
             involve a more active role of the contract manager in developing the
             relationship between the user(s) and supplier.
             third or strategic level is for strategic contracts involving complex partnerships
             and outsourcing arrangements. These need more active management of the
             business relationships between the supplier and the user(s), that is, manage
             outputs and not the process. Sufficient resources need to be dedicated by all
             parties to managing these supplier relationships to ensure a successful
             outcome and where feasible, to achieve long-term partnerships. A partnership
             is the result of mutual commitment to a continuing cooperative relationship,
             rather than parties working on a competitive and adversarial basis.


       In this Guide, the term used is contract management, which will encompass a
       broader aspect of managing and administering contracts and contractual
       relationships.

1.2   Relationship of contracting process components
       Although the contracting process is divided into five (5) discreet stages, it is
       essential to treat each stage as part of an interdependent process, as each part
       impacts upon all other parts of the contracting process. For example, the effects of
       procurement planning directly influence and determine the contract result, while
       conversely the outcome of contract management (or more importantly contract
       review) impacts upon the development of a new Specification or contract. The
       results flowing from the operation of all individual stages contribute to the quality of
       the contracting or purchasing outcome.

1.3   Contract manager responsibilities
       The generic responsibilities of a contract manager (or similar) are:
             participating, as necessary, in developing the solicitation and writing of the
             contract
             monitoring supplier progress and performance
             ensure that goods and services provided conform to the contract requirements
             making payments consistent with contract requirements
             exercising remedies, as appropriate, where a supplier’s performance is
             deficient
             resolving disputes in a timely manner
             contributing to the development and approval of the contract management
             plan for the project
             regular meetings with key stakeholders
             ensuring insurance terms and conditions provide adequate protection for the
             organisation and are maintained throughout the contract period




       Risk Management Guide for Managing Contracting Risks – May, 2010                  Page 5 of 41
             ensuring all products and services provided are certified as meeting the
             contract specifications and regulations before the supplier is paid
             maintaining adequate records (paper and/or electronic) in sufficient detail to
             provide an audit trail
             managing contract change/ variation procedures
             conducting post contract reviews (lessons learned)
             seeking remedies in the event of contract breach or non-performance.

1.4   Risk management
       All activities embody a degree of risk that can never be completely eliminated.
       However, risks can be identified and controlled. The management of risks requires
       cost-effective strategies to manage risk and continuity planning to respond to risks
       that may emerge.
       Risk management should be part of an overall and integral part of contracting and
       contract management.
       High value purchases and projects of lesser value but of a complex nature require
       the preparation of a risk management plan. The risk management plan must
       consider risks at all stages of the procurement, contracting and project management
       cycles.
       The risk management plan is to address the following factors:
             risk identification - identifying risks associated with the project (what incident
             could occur and what or why the incident could occur)
             risk assessment – consequence and likelihood of the risks (develop a
             consequence and likelihood matrix)
             risk treatment - strategies for managing the occurrence of a risk (identify
             options for reducing the likelihood of the risk occurring and treatment
             strategies if a risk eventuates)
             risk allocation - detailing responsibility for managing a risk (specifying the
             degree of responsibility for avoiding the occurrence of the risk and the
             treatment of the risk should the risk eventuate).
             monitoring and control - identifying new risks as they emerge.


       Insurance provisions (professional indemnity, third party legal liability, all risks and
       public and product liability insurance) are to reflect the assessment of risk arising
       from the planning process.
       Contracts should clearly define what constitutes a default and detail those
       processes for managing a breach of contract and contract variation.




       Risk Management Guide for Managing Contracting Risks – May, 2010                  Page 6 of 41
1.5   Definitions
       Unless the usage clearly shows otherwise, the following definitions apply in this
       Guide.
             contract - a contract is any contract between two or more persons or legal
             entities which creates a legally enforceable obligation to do or not to do a
             particular thing
             contract administration –management of all actions, after the award of
             contract, that must be taken to ensure compliance with contract
             contract management – all activity that occurs in the contracting process
             contract manager – includes contract administrator
             contracting process – includes contract planning, contract formation, contract
             management, contract administration and contract close-out
             letter of award - letter issued by the organisation awarding the contract to the
             supplier
             proposal – bid for the award of the contact
             purchasing - acquisition of the goods and services required by an organisation
             scope of work – guidelines, criteria and schedules for the completion of works
             set-out in the contract and as updated from time to time by user
             service level management – disciplined, proactive methodology and
             procedures that ensure adequate levels of service are delivered to user(s) in
             accordance with contract scope of work
             specifications – detailed description of work to be executed, the goods or
             materials to be supplied, or the service to be rendered

             sub-supplier – third party contracted by the supplier to carry out any part of the
             works specially made and/or adapted pursuant to the contract
             supplier - an organisation (whether in the private or public sector) which is
             awarded the contract for the provision of goods and services, which includes
             manufacturers, agents, merchants, distributors, consultants and service
             providers
             tender - bid or tender for the award of the contract
             tender document - means this invitation to tender and terms and conditions of
             tender, and includes all annexes attached hereto;
             tenderer - any person or organisation participating in this tender by submitting
             a proposal or bid document
             user – employees of organisation and its subsidiaries, organised in business
             units and divisions involved in the contracting process as recipients/
             beneficiaries of the supplier’s goods and services




       Risk Management Guide for Managing Contracting Risks – May, 2010                Page 7 of 41
2     Contract planning

2.1   Deciding to contract
       Sometimes, it is difficult to determine what kind of contract is required for the
       transaction. Some contracts may involve acquisitions of both goods and services, or
       others may involve both acquisition and revenue-generating activities. Most of the
       time, user(s) can determine which type of contract by answering the following
       questions:
             Is the primary purpose of the contract to acquire goods, material, equipment or
             other tangible things? If so, it’s a purchasing contract.
             Is the purpose of the contract to obtain services or performance from another?
             Is the contract one for acquiring mixed goods and services? If in doubt
             whether the contract is one for the acquisition of goods or services, or if it
             clearly involves both, it is best to treat the contract as one for services.
             Is this a lease of land or building space, with the organisation acting either as
             the lessor (landlord) or lessee (tenant)?
             Are user(s) creating or renewing a contract involving another government
             agency, educational institution or other organisation for a cooperative
             program? The likely form of contract will be a memorandum of understanding.
             Not sure, or none of the above? Contact the contract manager or legal
             advisor.

2.2   Identifying the contract objectives
       Contracting objectives should be carefully defined and clear so that contracting risk
       can be managed more effectively.
       In order to identify the contract requirement, considered the following:
             reason for the need/ requirement
             alignment of the need/ requirement with user(s)'s strategic objectives
             priority of the requirement compared with competing requirements of user(s)
             result if the requirement is satisfied e.g. whether an existing resource will be
             replaced or a totally new requirement is created
             range of options available to user(s) to satisfy the requirement
             achieving a value for money outcome.

2.3   Total contract value and business rules
       As far as practicable, the estimated total contract value for all contracting
       transactions should be identified. This is to ensure that the proper “business rules”
       are applied, especially to determine whether a tender is necessary or not.


       Risk Management Guide for Managing Contracting Risks – May, 2010                 Page 8 of 41
2.4   Raise purchase requisition
       All purchases should be officially initiated via a purchased requisition, and signed off
       by the respective user pursuant to the delegation limits schedule prevailing at that
       time.

2.5   Establish business case
       Perform an investment logic map of the proposed investment before developing the
       business case.
       The business case should address the following:
             investment logic
             user, technical and operational requirements briefly identified
             estimated total contract cost (and budget charge codes)
             availability and source of funds
             cost benefit and/or sensitivity analysis
             any risks associated with the project
             compliance with applicable government policies and regulations
             market capabilities
             economic impact on the project and effect on the community
             impact on quality of service/ service expectations
             possible contractual performance indicators for performance and service level
             monitoring
             timelines, days to complete/ milestones.

2.6   Determine contractual risk
       The resources devoted to managing a contract should bear some relationship to the
       degree of risk associated with that contract. The size, complexity and sensitivity of a
       contract should dictate the amount of resources devoted to its successful
       completion.
             size of the contract is measured in terms of its dollar value
             complexity of the contract is measured in terms of its scope
             sensitivity of the contract is measured in terms of its exposure.


       User(s) should identify the risks associated with the contracting process and project
       itself ensure that:
             risks are identified in terms of consequence and likelihood
             consequence if the supplier fails to perform the contract


       Risk Management Guide for Managing Contracting Risks – May, 2010                Page 9 of 41
          strategies are developed to manage identified risks and any potential
          consequences.


Possible types of risk encountered during the administration of the contract include:
          changed circumstances
          breakdown in communication
          breach of confidentiality
          breach of intellectual property – including pre-existing copyright, patents
          breaches of security and privacy arrangements
          inappropriate management of occupational health and safety
          insurance policies do not adequately indemnify the organisation, depending on
          the nature of the contract - insurances required can include worker’s
          compensation; personal injury; public liability; product liability; professional
          indemnity; comprehensive insurance of motor vehicles and plant
          breaches of contract such as: (a) performance securities/ guarantees not
          received; (2) deliverables not in accordance with the contract
          fraud
          variations
          disagreement or disputes.


There are a significant number of risks associated with the contracting processes
which will need to be identified and managed as the project or activity progresses.
Examples of risks are as follows1:




1
    Source: Good Practice Guidelines, Developing a State Purchase Contract Business Case, January 2009.


Risk Management Guide for Managing Contracting Risks – May, 2010                                     Page 10 of 41
Risk Description                       Potential                           Strategy
                                       Consequence

Supplier is generally            Supplier barely meets key            Establish contract key
capable but provides             performance indicators               performance indicators
only average services                                                 which recognise supplier
                                 Variations introduced to
                                                                      ability as well as user
                                 reduce expected service
                                                                      needs
                                 levels
                                                                      Provide governance
                                 Service credits reduce
                                                                      arrangements which
                                 supplier profitability and
                                                                      promote communications
                                 further impact performance
                                                                      Ensure service level
                                 Contract management
                                                                      management is based
                                 relationship becomes
                                                                      upon reasonable and
                                 adversarial
                                                                      agreed expectations

Lack of experience or            Inadequate level of                  Ensure skilled project staff
availability of the Project      compliance with relevant             appointed for duration of
Manager and/or Project           procurement and                      tendering/ evaluation/
Team                             acquisition guidelines               negotiation/
                                                                      implementation cycle
                                 Key elements of the
                                 requirement are                      Team includes Project
                                 overlooked and the                   Delegate, Steering
                                 procurement outcome                  Committee, Project
                                 does not meet the                    Manager, Project Team,
                                 underlying need/                     and Specialist advisers as
                                 specifications                       required
                                 Inadequate attention to              Ensure adequate
                                 probity requirements                 resourcing and
                                                                      contingency plans to cover
                                                                      absence or unexpected
                                                                      unavailability of staff
                                                                      Engage probity practitioner
                                                                      to advise on/ monitor/ audit
                                                                      process

Contract manager may             Contract manager unable              Ensure contract manager
not be adequately skilled        to accurately assess                 adequately trained and/or
in the specialisation            performance                          engage expert contract
                                                                      management resource
                                 Contract manager unable
                                 to negotiate from strength




       Risk Management Guide for Managing Contracting Risks – May, 2010                  Page 11 of 41
Risk Description                      Potential                           Strategy
                                      Consequence

Contract manager need           Service delivery priorities          Governance arrangements
to coordinate service           not well managed                     need to coordinate service
provision across                                                     delivery management
                                ‘Finger pointing’ between
specialist boundaries                                                within the organisation
                                suppliers when service
                                delivery standards not met           Engage with suppliers
                                                                     through joint coordination
                                                                     committee structure (user/
                                                                     supplier)

Scoping data contained          Tenders will not be                  Conduct a comprehensive
in the proposal                 soundly based                        data collection program
document is deficient,                                               during the specification
                                Inappropriate supplier is
misleading or invalid                                                development stage
                                selected
                                                                     Provide for the preferred
                                Prices will not reflect true
                                                                     tenderer(s) to conduct a
                                cost
                                                                     due diligence process prior
                                Contractual disputes occur           to finalising tender pricing
                                over the scope of the
                                contractual requirement
                                vis-a-vis the total
                                contracted price
                                Poor contractual
                                relationship reflects on
                                performance overall and
                                the level of user
                                satisfaction

Requirements are not            Tendered offers do not               Ensure requirement is
adequately described in         address the requirement              consistent with stakeholder
proposal documentation                                               needs analysis
                               
				
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Description: Risk management guide to manage contracting risk. Organisations enter into contracts all the time and the ability to manage contracting risks is vital for organisational success.
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PARTNER Patrick Ow