Is the Purchasing Contract Your Best Friend or Your Worst Enemy?

 

A friend of mine recently was going to sign up to a lease for a business location for her family counseling business. Business was booming for her. She had a non-profit organization that was funneling lots of money her way. Life was good.

I asked her “why don’t you let me take a look at the contract for that leased space before you sign it?”. She gave me a copy. It looked good, really good. All except for one thing: there was no termination clause. She didn’t have a way to escape the lease if business went sour.

I told her this, and she insisted it wasn’t necessary. After all, times were good for her.

I quite literally forced her to have a clause put in. We made it as termination for cause clause, sometimes also called termination for default. This is different than termination for convenience, which no building owner would ever sign up to in a lease agreement.

The termination for cause trigger was related to her losing business contracts or otherwise becoming unprofitable. In her mind, this could not and would not happen, and it was a totally unnecessary exercise that was only meant to appease me.

However, it did happen.

About six months into this three year lease, her big non-profit funding agency pulled the plug, and she was left holding the bag, with no path to recovery. She was able to get out of the lease just like that.

Had we not inserted that clause, she would have been financially devastated, because it was a big space. And it happens.

Another person I know shut down a pizza shop they owned, and they did not have a termination for cause clause in the contract. As a consequence, they made lease payments for 18 months on an empty shell of a building. How painful is that?

The point is, contracts can be your best friend or your worst enemy. The fact that this was a building lease example is irrelevant. The interesting thing is that it was not what was in the contract that was the problem, but rather what wasn’t in the contract. You have to know what you are doing to look for both.

Want another example? A government contract was put in place with a road and bridges building contractor in California. The government agency wanted to make sure the supplier would not finish the project late, so they put a delivery/delay incentive clause in the contract.

A delivery/delay incentive both gives a penalty for finishing late and a bonus payment for finishing early. If you call it a “penalty”, then the courts will look for there to be an incentive clause as well. However, if you call it a “price reduction”, then you don’t need the incentive clause. I’ve yet to meet a purchasing professional who knows that.

The project was to take 137 days. The supplier worked around the clock and shocked the government purchasing department by getting it done in 66 days (!!). As a result, the contractor got a whopping $14.8 MILLION incentive payment (not a typo), over and above payments due for the actual work performed. Oops.

I define “purchasing hell” as when the supplier is doing exactly what the contract states, and you are mad as hell about it. And guess who the only person to blame is? Yes, we need to be accountable.

There are a wide assortment of contract clauses that can create really bad situations for you, and for the vast majority of them, the legal department is not going to catch them for you. The reason is that they are looking for legal risk, not all risks. A contract with legal approval can still be a terrible deal for the business.

Some clauses that can give you a one-way ticket to “purchasing hell” if you are not careful include warranty, acceptance, insurance, termination for cause, termination for convenience, indemnification, limitation of liability, definitions, identified breaches and remedies for breach of warranty, and many others.

The point is not to scare you actually. My biggest regret on behalf of our industry is that, in general, purchasing professionals have a huge gap in contract law knowledge, with insufficient recognition of how big of a problem this is.

Are you allowing lack of contract knowledge to hold you down? Are you relying on the legal department to catch issues for you? Are you just attaching a SOW or specs to the contract and calling it done? Are you looking at both what terms are in the contract and also what terms are not?

Remember, the contract is just a generic template until you bring it to life. It has NO idea what you are buying, and only you can customize it to meet your specific requirements. If you are buying office supplies, your needs will be very different than if you are buying manufacturing capital equipment. Buyer beware.

Don’t let lack of contract knowledge be a crutch for you. Make contract knowledge your biggest asset. If you do it right, you will save tons, and I do mean tons, of time on the back end. Almost all customer and supplier excursions are due to poorly written contracts that don’t specify performance and remedies for breach of performance.

Develop knowledge in contracts, invest the energy up front, and enjoy the benefits on the back-end. Educate yourself and take these steps to find your purchasing advantage!