This article is written by Shivani Varade pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from Lawsikho.
When any business or industry undertakes a certain project, it aims to complete it with the minimum cost on resources and maximum profit. For this purpose, first, it is necessary to determine whether the projects or the tasks can be completed using the internal resources available with the company or whether outside vendors need to be hired. Services that are required to be outsourced by the company are obtained through the process of ‘procurement’. For instance, a telecommunication company may outsource invoice creation to a printing company, which would then print the invoices and mail them to subscribers. Therefore, in simple words, procurement means the acquisition of acceptable goods or services that meet the timing, location, quality, and quantity requirements of your project at the lowest possible cost.
This article aims to provide an overview of the meaning of procurement management, types of procurement contracts, and essential clauses in the procurement contracts.
When do you need procurement?
If any of the following apply to your company, procurement may be required:
- You lack the necessary skills to complete a task.
- You are unable to accomplish a task or a project due to a lack of resources.
- You lack the necessary capability to provide the goods or services in question.
- Obtaining the goods or services in question through outsourcing is substantially less expensive than obtaining them in-house.
The procurement process can entail purchasing hardware, equipment, or other commodities required for a project, or it can entail engaging the services of a consultant or service provider. Effective procurement management refers to finding the right contractors and suppliers for the goods and services you need for your project. It is a cost-effective way to avoid the time, money, and stress of training workers to perform work they have never done before, and allows your company to focus on its core business while outsourcing tasks that aren’t related to it.
Private procurement and public procurement
Private procurement takes place in the context of for-profit businesses (FPs). It takes place within the privately-owned companies, also known as the private sector. The funds belonging to the private sector are more centralized, which helps to speed up the purchase procedure. Because they have more time and money, privately owned businesses can seek out different suppliers to obtain the best bargain. They are more concerned about saving money and getting things done swiftly.
Public procurement or government procurement refers to the purchase of goods or services by governments and state-owned or state-controlled institutions. Governments are expected to carry out public procurement efficiently and with high standards of conduct to ensure high-quality service delivery and protect the public interest, as it accounts for a significant portion of taxpayers’ money.
The Indian agencies that can go for public procurement are:
- Central and state government ministries and departments.
- Undertakings/organizations in the public sector.
- Governments or public bodies own or control a large portion of these entities.
- Entities that receive significant financial help from the government or are under the control of the government.
Relevant legislation on public procurement
The following elements make up India’s legislative and regulatory public procurement framework:
The Indian Constitution empowers the central and state governments to contract for goods and services in the name of the President of India or the Governor of the State (as the case may be) and directs autonomy in spending public funds. It does not, however, include any procurement policies or procedures.
Even though there is no comprehensive central legislation that governs public procurement exclusively, central legislations such as the Indian Contract Act 1872, the Sale of Goods Act 1930, the Prevention of Corruption Act 1988, the Arbitration and Conciliation Act 1996, and others guide various procurement rules and policies. In addition, states such as Tamil Nadu, Karnataka, Andhra Pradesh, Assam, and Rajasthan have enacted state-specific legislation governing procurement procedures, such as the Tamil Nadu Transparency in Tenders Act, 1998, Karnataka Transparency in Public Procurement Act, 1999, and Rajasthan Transparency in Public Procurement Act, 2012.
The General Financial Regulations (“GFR”), which were first established in 1947 and last changed in 2017, provide comprehensive administrative rules and directions on financial management and procedures for government procurement. All government purchases must conform to the GFR’s principles, which include particular standards for goods and service procurement and contract administration.
What are procurement contracts?
A procurement contract refers to a written agreement between a buyer and a seller in which the buyer commits to buy products or services from the seller in exchange for compensation. A procurement contract lays out each party’s responsibilities and often contains full pricing lists, payment information, delivery terms, and other legal terms and conditions. A procurement contract, like other contracts, binds two or more parties, usually a buyer and a seller, and spell out the terms and conditions of a project.
Procurement contracts are used in practically every industry and business. Private companies have flexibility when it comes to procurement, whereas government agencies must adhere to certain norms and regulations as they are spending public funds.
Types of procurement contracts
Procurement contracts are categorized into the following types
Fixed price contracts
When someone knows exactly what the scope of work is, this is the best contract kind. This contract, also known as a lump sum contract, is the best strategy to keep expenses down when the scope is predictable. For example, if a company requires services from a vendor and the scope is specified, the contract ensures that the company only pays a fixed cost for the task.
Some benefits of fixed price contracts are:
- The seller must complete the service within the specified term after both parties have signed the contract. This goes a long way toward ensuring that the job is done on time.
- Since pricing is no longer based on guesswork, it is easier to maintain price control.
- Because of the legal obligation to project requirements, the seller bears the majority of the risk.
Fixed price contracts are further classified as follows:
Fixed Firm Price (FFP): This category features both a fixed price and time frame. The contract specifies the project’s price and deadline, such as Rs. 50,000 at the end of the month. If the vendor makes a mistake or causes the costs to rise in any other way, the price remains Rs. 50,000, and the seller is accountable for the difference. When the scope of work is clearly defined with a lot of detail, this is the ideal option.
Fixed Price Incentive Fee (FPIF): This contract is similar to the FFP contract, but it includes a monetary incentive for the seller to do a better job or finish the project ahead of schedule. The fee can be specified by the contact, as well as the conditions under which it will be paid, such as when the project is completed below estimated cost, ahead of schedule, or with excellent performance.
Fixed Price with Economic Price Adjustment (FP-EPA): When a project is projected to take a long time, this contract type is frequently used to safeguard the seller from inflation during the course of the project. For example, this contract allows a clause that gives the contractor a percentage rise after a predetermined amount of time.
Cost reimbursable contracts
When the project scope is unknown or expected to change, cost reimbursable contracts, also known as cost dispersible contracts or cost-reimbursement contracts, are perfect. Its purpose is to keep people and budget, both on track. The concept is that the vendor will be compensated for the project’s cost after it is completed, as well as earn a fee for profit. For example, it could be based on how effectively the seller meets (or exceeds) the project objectives if the project was completed on time, and how well the contractor kept the project on budget.
Cost reimbursable contracts are further classified as follows:
Cost Plus Fixed Fee (CPFF): This is used when a project is deemed high-risk and the procurement team is concerned that it will not be able to attract bidders. Since the procuring company bears all of the risks, CPFF protects vendors. A clause in the contract states that the seller will be compensated for all extra costs, as well as a fee that is not based on cost performance.
Cost Plus Incentive Fee (CPIF): The buyer bears the risk in this sort of contract, but it is reduced because an incentive offer is included in the terms. The contractor is repaid for his expenses but receives a performance-based fee. This charge is usually fixed and is a percentage of the money saved by the buyer as a result of the seller’s performance.
Cost Plus Award Fee (CPAF): In this, the compensation is calculated depending on how effectively the buyer believes that the seller achieved the performance goals. Since this is a subjective matter, it cannot be changed, and hence the language used must be clear. One must wordings that specify that the contractor will be awarded up to a particular amount if the job requirements mentioned in the terms are met or exceeded.
Cost Plus Percentage of Cost (CPPC): This covers all of the seller’s expenses as well as a profit percentage. There is an incentive for sellers to increase their actual expenses to raise their profit margins.
Time and material contracts
It is mostly used when the seller supplies labour. Both parties share a similar level of risk. This contract specifies the experience and qualifications required when hiring outside vendors. For their bid, sellers submit an hourly rate. It’s important to set a budget limit, or else the project could go beyond the budget.
Selecting the type of procurement contract
The purchasing department is in charge of deciding on the type of procurement contract to employ when forming partnerships with vendors and suppliers.
The following procedure is generally followed in selecting the type of procurement contract:
- In consultation with the project manager, the purchasing department considers all the items to be bought for the project and defines the product kinds, quantities, services, and desired delivery dates.
- The project team assists the purchasing department by providing technical specifications and requirements for the products.
- The procurement management department will next engage with numerous vendors and collect bids to choose the best ones.
- Once a vendor has been chosen, the department signs a deal with that vendor and begins purchasing things that meet the department’s standards and quantities, promptly, and at a reasonable price.
- The procurement management department reports to the project manager on deadlines and delivery terms after the agreement is signed.
Why are procurement contracts important?
Maximization of profits
The procurement contracting process is important because a company needs to buy quality supplies and services at the best possible price in the required numbers to maximize profits. Those things must be delivered to the correct destination within a reasonable time. A good procurement management strategy helps the company to find the best supplier or contractor for the work and negotiate the best deal possible.
Entering into a contract with a vendor is often more cost-effective and efficient than making a component or performing a task yourself as it saves the cost of training the employees in specialized tasks, or introducing new machinery to complete a task. Business owners should always consider if it is cheaper to create the product or perform the activity themselves, or whether they can negotiate better pricing from a vendor. It is a better route to purchase goods or services from the vendor at a deep discount.
Essential clauses in a procurement contract
The basic clauses which are to be included in any type of procurement contract are as follows:
Goods and services
The main reason for companies and suppliers to enter into a procurement contract is the trade of capital and goods. Therefore, detailed terms must be provided that specifies the product or service being offered by the supplier, as well as specified quantities. This eliminates any misunderstandings about the vendor’s responsibilities.
The product to be supplied under this agreement must meet the descriptions, quantity, shape, performance, and functions set forth in Appendix 1, or such additional specifications as the parties may agree to in writing. Modifications to the product or specifications must be made with the parties’ mutual written approval and in line with Appendix 2 of this agreement. The product must be properly packaged and labelled in compliance with industry standards and requirements under applicable laws and government regulations, including but not limited to those relating to safety, health, and the environment.
Cost and payment
After the selection of products or services, both parties must agree on a price and payment schedule. It’s also crucial to spell out the payment method and the consequences if the company doesn’t pay the compensation to the vendor on time.
Payment for the first system acquired by the buyer will be made according to the following schedule:
- 30% of the price will be paid when the purchase order is issued to the seller, and 20% of the price will be billed when the product is delivered to the carrier for shipment at the FOB point, and
- 50% of the price shall be invoiced on acceptance of the products.
The seller may adjust its prices to compensate the seller’s direct and indirect expenses resulting from any change in the specifications, production, or delivery processes, as a result of governmental requirements, given thirty (30) days prior notice to the buyer.
Confidentiality and ownership
When it comes to trading goods, it’s easy to get confused about where the ownership lies. While some partnerships agree that the assets are technically owned by the distributor after the supplier begins production, others prefer to trade ownership at the time of the transaction. To ensure confidentiality when it comes to sharing intellectual property, the company must clarify that the vendor is not allowed to disclose any production information with any third party.
No title or right of ownership to the product shall pass to the buyer under this agreement. Further, the receiving party shall keep the information, including but not limited to any intellectual property confidential, use it only for the purposes stated in Appendix 3 of the agreement, replicate it only to the extent necessary for the aforementioned purposes, and not disclose it to any third party without the other party’s prior written agreement.
It is usual for vendors to limit their obligation for any production-related costs, risks, or losses. As a precaution, businesses should include disclaimers that negate these clauses in the event of misconduct, fraud, or negligence. If the supplier fails to fulfil the entire contract, the company will be protected from legal liability.
The seller agrees to indemnify, defend, and hold the buyer harmless from and against any and all losses, expenses, damages, claims, fines, penalties, and expenses (including reasonable lawyer’s fees) arising out of or resulting from any and all third-party claims that the product infringes any patent, copyright, trademark, or trade secret right. The following liability does not apply to claims that are based on or arise out of the use of the Product: I outside the scope of the permission granted; (ii) in any manner not described in the applicable documentation or the specifications.
In the event of dire circumstances, both parties must decide the consequences if one of them breaches the contract. Long-term agreements usually provide the right for either party to terminate the agreement at any time without notice or explanation. These conditions, on the other hand, can be changed to suit the needs of either party.
If the other party is in significant breach of any of the terms, conditions, or covenants of this agreement, any party may terminate this agreement 60 days prior to written notice unless the defaulting party remedies the breach during the notice period. The failure of either party to enforce any right or remedy provided to it under this agreement or otherwise with respect to any breach or failure by the other party at any time shall not be construed as a waiver of such right or remedy with respect to any subsequent breach or failure by the other party.
To conclude, procurement is simply an umbrella term for purchasing. While private companies have flexibility while procuring goods or services, government companies have to adhere to certain guidelines as seen above. An efficient procurement system and the use of appropriate procurement contracts have a direct impact on a company’s profits. Therefore, one must understand which contract type best suits the company’s objectives, which may help them stay on budget while maintaining high-quality standards. To avoid paying extra costs or any further disputes, parties entering into a procurement contract must ensure that all the essential clauses are in place and do not contradict their interests.
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