Contract preparation is the most important part of a contract lifecycle. A meticulously prepared contract, having all the relevant provisions and clauses in it with considerations of future potential issues not only helps executing and closing the contract smoothly but also saves the contracting parties from disputes and litigations. There are some standard clauses and provisions to be considered while drafting contracts. Some of them are discussed below in detail:
Statement of Work
For procurement of any work or service the statement of work (SOW) is required. The SOW provides a clear definition or description of what work is to be done or which service is to be provided, limitations, timelines, expected end results and criteria for evaluation of performance/ quality or work or service. This statement of work (SOW) must be included in the contract because it helps to control and manage the contract throughout its execution.
During the procurement process of works or services, the bidder is expected to submit the methodology of work. The methodology provides the systematic methods and procedures to accomplish the end results. It also incorporates the methods for complying various environmental, social norms, safety procedures and other government regulations. The work methodology is also evaluated along with other criteria, during the selection process of bidders. This work methodology should be a part of the contract because then the supplier/ contractor will be bound to follow the set procedures as agreed.
Specifications/ Codes & Conducts/ Guidelines of Work
The desired end results of every work or service are achieved by following some specifications and guidelines. These may be various codes & conducts, guidelines or other documents issued by authorizes agencies/ organizations. The details of these specifications, codes and guidelines should be incorporated in the contracts so that the contractor or supplier will be bound to follow these.
In large service contracts or works with large volumes like infrastructure projects, work milestones are mentioned in the contracts. The milestones are fixed either on the basis of physical or financial targets. The timeline for achieving each milestone is mentioned in the contract and after completion of each milestone the progress and quality of work is reviewed. If the milestone is not achieved by the contractor or service provider within the stipulated timeline, then liquidity damage (LD) id levied on the contractor as per the relevant provisions of the contract. The milestones are put in place to control deviations that occur during the project execution.
Performance Evaluations Factors
The performance evaluation and quality measurement criteria are mentioned in the statement of work (SOW). These criteria should be communicated to all the stakeholders so that proper compliance may be done.
Intellectual Property Rights
These are various types of intangible personal property that have an inherent commercial value and these rights are legally protected. They include copyrights, trademarks and patents. These IP rights should be kept in mind while preparing contracts because these might potentially be involved in the transaction.
Provisions of subcontracting
Contracts normally permit the prime contractor to subcontract a part of the scope or some specialized work. The limit or nature of subcontract work should be clearly mentioned in the contract. The criteria for evaluation of subcontractors should be incorporated in the clause related to the subcontracting.
All contracts typically have payment terms. These are the most important clauses of the contract because unclear payment terms and conditions later lead to disputes. The payment clause should incorporate payments terms and the timeline of invoice submission, verification and payment of invoice. It should also include any discount the supplier offers as incentive for early payment. Sometimes the contracts mention some special terminology for payment. For instance, net 15 days means payment of the entire invoiced amount should be made within 15 days of the invoice date. The term 2 percent 10/ net 25 generally means payments received within 10 days from the date of invoice receive a two percent discount; otherwise, the full amount is due in 25 days.
Domestic and International Laws
Every country has their laws for trades and transactions. The parties under the contract has to follow the law of the country where they are doing business. Particularly in international sourcing, the governments of both the buyer’s and supplier’s countries laws will affect the transactions. Therefore, both the buyer and the supplier should be aware of each other’s laws and the provisions of the contract should be framed in such a way that no issues arise w.r.t. the compliance of these laws. There are various types of restrictions on imports, including import licenses, customs duties and quotas. The government authorities also require various documents like export licenses, import declarations, certificates of origin, commercial invoices, insurance policies and bills of lading.
Insurance and Indemnification
Insurance clauses are important part of any contract. Insurance in a risk transfer measure and therefore it must be insured that appropriate insurance policies like project insurance, labor insurance, machinery & equipment insurance, etc. has been taken by the contractor or supplier to cover various risks. Proper insurance clauses mentioning the type and amount of insurance should be incorporated in the contract. The insurance should be in joint names of both purchaser and supplier. The clause pertaining to insurance should also mention that in case the contractor does not purchase insurance then the client shall purchase insurance and deduct the premium amount from the bills of the contractor. The clause might include statements about property damage, public liability, professional liability, builder’s risk, errors and omissions, workers’ compensations, etc.
In construction contracts generally the insurance is taken by the contractor to cover the following:
- loss of or damage to the Works, Plant, and Materials [which are Incorporated In works];
- loss of or damage to Construction Equipment;
- loss of or damage to property (except the Works, Plant, Materials, and Equipment) in connection with the Contract; and
- personal injury or death.
Termination of Contract
Termination means the action of one party pursuant to specific contract language to end the contract either for breach of contract or termination by convenience. The reasons for which the contract may be terminated, actions of either party making breach of contract, procedure of termination and handing over after termination, penalty to the party making breach of contract, etc. should be included in the termination clause of contract.
This term translates as “a superior or irresistible force” and refers to a contract provision under which major and usually uncontrollable events (e.g. severe weather, fire, war, etc.) may prevent any party to fulfill its obligation under the contract. The force majeure clause excuses a party, in whole or in part, from the performance of its contractual obligations. This provision is commonly referred to as an “act of God” and normally is included in contracts to protect both the buyer and the supplier.
Limitation of Liability
Suppliers in general attempt to include contract language that will limit their liability for damage and loss due to warranty claims or other breathes of contract. Such statements will restrict the purchaser’s ability to recover the damages in a lawsuit. One of the most common limitations addresses the warranty claims that the supplier permitted to repair or replace defective goods. In this case the supply management organization is not permitted to cancel the contract and seek damage for loss.
Waiver of Consequential Damages
To limit the potential disputes, contracting parties may agree to a waiver of consequential damages. Consequential damages refer to damage, loss or injury that arises not directly form a party’s act (e.g., breach of contract) but form some consequence or result of that act (e.g., lost profit, lost revenue, personal inquiry or property damage).
Fraud and Corruption
Every contract should include ‘fraud and corruption’ clauses to prevent any potential fraud and corruption cases. These clauses also include the action to be taken if any such case comes to the knowledge of the purchaser, which includes debarring/ blacklisting of the supplier or contractor up to a definite period as per the policy of the client/ purchasing organization.
In further pursuance of this policy, in case of public procurement, bidders shall permit and shall cause their agents (whether declared or not), subcontractors, sub-consultants, service providers, suppliers, and their personnel, to permit the purchaser/ client to inspect all accounts, records and other documents relating to any initial selection process, prequalification process, bid submission, proposal submission, and contract performance (in the case of award), and to have them audited by auditors appointed by the purchaser/ client.
For the World Bank funded projects, these practices are divided into following groups:
- “corrupt practice” is the offering, giving, receiving, or soliciting, directly or indirectly, of anything of value to influence improperly the actions of another party;
- “fraudulent practice” is any act or omission, including misrepresentation, that knowingly or recklessly misleads, or attempts to mislead, a party to obtain financial or other benefit or to avoid an obligation;
- “collusive practice” is an arrangement between two or more parties designed to achieve an improper purpose, including to influence improperly the actions of another party;
- “coercive practice” is impairing or harming, or threatening to impair or harm, directly or indirectly, any party or the property of the party to influence improperly the actions of a party;
- “obstructive practice” is
- deliberately destroying, falsifying, altering, or concealing of evidence material to the investigation or making false statements to investigators in order to materially impede a Bank investigation into allegations of a corrupt, fraudulent, coercive, or collusive practice; and/or threatening, harassing, or intimidating any party to prevent it from disclosing its knowledge of matters relevant to the investigation or from pursuing the investigation; or
- acts intended to materially impede the exercise of the Bank’s inspection and audit rights provided for under paragraph 2.2 e. below.
Suspension of Contract/ Payment Terms
The client or purchaser may suspend activities on a contract due to any reason. There may also be clauses regarding suspension of payments of the contractor or supplier if they do not fulfil their obligations timely. If the suspension occurs for the reason other than the fault of contractor or supplier, the supplier or contractor must be given written notice and will need to be reasonably compensated as per the provisions of the contract, otherwise the payments of the contractor/ supplier are withheld till the time the contractor rectifies the defects or faults. If the suspension lasts for an extended period of time (e.g. more than 30 days), the supplier may be entitled to additional compensation for costs incurred because of the suspension.
Reservation of Rights
The purchaser or client when developing a contract should reserve all rights to contract performance in accordance with the stated terms and conditions. A ‘modifications’ clause prohibits supplier from making any changes in the contract without the consent of purchaser. A “waiver” clause may be used to protect the purchasing organization against possible loss of contractual rights in the event the organization inadvertently fails to enforce certain rights.
In an attempt to avoid the problems of calculating and proving damages in a lawsuit, contracting parties often will state a predetermined amount of damages, known as “liquidity damages”, in their agreements. Because punitive damages are not allowed in contract law cases, it is important to ensure that the liquidity damages amount is reasonable in light of the actual damage suffered. Generally, in the construction contracts, the liquidity damage is kept as some percentage of initial contract price per day for e.g. ‘0.05% of initial contract price per day or 1/200 of initial contract price per day’.
A warranty is a legally enforceable promise for quality or performance of goods or services made by the service provider or supplier. It is a legally enforceable promise as long as it is included in the contract. The warranty clause should be incorporated in the contract for ensuring quality goods or services.
Remedies relieve or correct a legal wrong. In contract terms, available remedies are money damages or an order of the court for specific performance. In legal terms, cure refers to making the situation right and could include restoring everything back to its original state or fulfilling the contract as originally agreed. Cover is a remedy available to a buyer in the event of a breach of contract by the supplier. After displaying due diligence, the buyer is entitled to obtain goods in the open market and recover damages from the supplier.