How contracts help define supplier performance
Contracts and agreements provide a framework to manage suppliers.
“Consider yourself served,” said the deputy, handing me an envelope with a court summons, plus a ten-dollar bill, a quarter and two dimes.
It was money for transportation to a date in superior court later that morning, where I would have to defend my actions in the context of a contract. After a panicked visit with my boss, we found the offending purchase order in the file and set off for a trip to the city, and a real fascinating day testifying in open court.
The fundamental issue was my fault. I placed a purchase order – a contract – with a manufacturer’s representative in the printed circuit board business. My intent was for him to bring the business to supplier A. He brought it to supplier B and supplier A sued the representative directly. I was the star witness.
Meanwhile, as the attorney’s battled it out, I began plotting my new commodity strategy. First, I would not do business with any of them again. Second, contracts matter, and I better get a bit more focused on their importance and construction.
As the sophistication of spend grows in the complex end-to end supply chain, creating and administering comprehensive contracts is a critical skillset for managing multi-level supplier relations. That responsibility falls squarely on the procurement organization. Buyers have a fiduciary responsibility, based on the trust and confidence of their employer, or principal, to spend the employer’s funds ethically, fairly, and knowledgeably. It’s the law.
Far too many buyers, and sellers, are scared off by contracts and agreements. Any financial agreement between a buyer and a seller is a contract, no matter if it is verbal or written. The written contract is just an acknowledgement of the oral agreement. Why not take the time to outline all of the issues necessary for successful completion of the order?
The foundation: the Uniform Commercial Code
It is important to understand that Article 2 of the Uniform Commercial Code (UCC), the legal codification of the rights and obligations of buyers and sellers, governs the procurement process in the United States. It provides the legal framework of the terms and conditions, or the “boilerplate,” found in most purchase orders and contracts.
The law of agency is also important. Agency identifies who is authorized to act for their company in business dealings with a third party. Those in procurement are considered general agents of the company and have been granted the legal authority to sign contracts and commit the company to its terms and conditions. Suppliers have representatives with agency as well, and those agents have the right to rely on the individual buyer’s written and verbal word in transactions.
Contracts and purchase agreements are a fundamental element of the procurement process.
Procurement Systems and Tools Lead, Shire
This concept is important in companies where the formal procurement process is fragmented, with many non-agents, such as engineers and office managers, entering enforceable contracts and agreements.
Those without permission who enter agreements leave their company on the hook if their actions resemble those with permission, or agency, no matter how poor the deal. In some cases they may be personally liable. That is why contracts and agreements must be the responsibility of the procurement organization. Essentially, it’s the law.
The deal: contracts and agreements
A contract is defined as “the total legal obligation that results from the parties’ agreement as affected by the applicable rules of law,” according to the UCC. Note that a contract is an agreement that the courts will enforce.
The purchase contract under the UCC is based on four concepts:
- agreement resulting from offer and acceptance;
- consideration of mutual obligation;
- competent parties; and
- lawful purpose.
“Contracts and purchase agreements are a fundamental element of the procurement process,” said Ray Mazzoleni, procurement systems and tools lead for the biopharmaceutical company Shire. “Contracts are more than just terms and conditions. They ensure what you are buying and also provide a framework for supplier performance by defining the customer relationship.”
Mazzoleni adds that contracts and agreements are not only becoming more commonplace, but also significantly more complex.
The stakes: When do I need a contract?
The most common type of contracts between buyers and sellers is the standard purchase order, but even those contain essential legal rights that impact both parties.
It is important to note that oral agreements between the buyer and seller are as binding as written agreements, but it may be more difficult to prove the essential facts in the agreement. In the contract, the buyer’s obligation includes payment, acceptance, and inspection of the goods.
But, as the stakes with a supplier increase, the level of contractual obligation may increase as well. An overriding agreement may be negotiated between the parties utilizing individual purchase orders as release mechanisms. In some other types of agreements, perhaps in capital equipment, the supplier’s contract may be the prevailing document. And in some cases, especially in small orders, a credit card receipt may be the only existence of a contract. Yet, they all contain fundamental obligations supported by commercial law.
The maintenance: Contract reviews and management
Too often contracts are negotiated, signed, celebrated and then filed away in a three-draw or digital filing cabinet, never to be seen or heard from again.
Contract reviews are critical cornerstones of managing supplier performance and relationships and their review should be on the agenda for any formal supplier meeting. Assume that your supplier is keeping an eye on the contract as well and judging you on your performance to the terms of the agreement.
Mazzoleni notes that with this complexity comes an increased need for contract management and administration. “Contracts and agreements are living documents and need to be actively managed with suppliers to maintain the integrity of the contract management process,” said Mazzoleni. “Contract reviews are a critical part of regular meetings with suppliers and form the basis for regular performance appraisals.”
Contracts and agreements must be the responsibility of the procurement organization.
Supply Chain Dive
Contract administration from the buyer’s side calls for the management of the various facets of a contract to ensure that that the supplier’s performance matches their obligations, typically around delivery, support, warranty and third-party relationships.
The seller will be also evaluating contracts on a regular basis to ensure that the buyer is meeting their obligations around forecasts, payment, inspection and even communication protocols.
Shire’s Mazzoleni recommends larger organizations adopt contract management software, either as a stand-alone product or part of a larger enterprise system. “It is important not to lose sight of contracts, especially in complex supply chains with multi-party agreements,” said Mazzoleni. “Yet contracts are critical in small and growing businesses as well, and spreadsheets or simple database tools would be a good first step.”
Leave it to the pros
My purchase order was held as evidence and a settlement between the manufacturing rep and the two companies was eventually reached. I never saw the suppliers again. I never saw that PO again, either. The courts kept what they called “Exhibit A.”
I’ve placed orders and wrote contracts for twenty-five years. That was my first and last time in court. Either my contracts were stronger or my suppliers more honest. Perhaps both.
Regardless, the old saying is that ignorance of the law is no excuse for breaking it.
The UCC provides the legal framework for commercial relationships. While they are quickly coming up to speed to incorporate digital communication and increasingly fluid business relationships, the fundamentals of buyer seller responsibilities and obligations remain the same.
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