Managing Contract Risks - Assignment Example

Managing Contract Risks 1. Introduction Contract risks are inherent problems arising in contractual agreements between parties of interests of a specific development projects. Legal luminaries interpose that parties of the contract must have a clear understanding of the nature of the contract, its inherent risks and probable measures to be adopted to mitigate negative impacts by identifying necessary contingency. This document will explicate managing contract risks by identifying legal and alternative measures for a company to limit the risks in a project development out of contractual relations. 2. Contract & its Nature Contract is a legal agreement which bind parties with the intention of performing obligations in exchange for substantial consideration which are generally done formally in writing or by verbal agreements. It is either bilateral or unilateral. The mutual assent of parties however, gives rise to obligations between parties involved and breaches thereof are remedied by law either by payment of damages, otherwise known as monetary compensation (Katz, 1997). As an economic activity, contracts also consider the sociological, anthropological and environmental terms of the agreement (Katz, 1997). Contract moreover is described as an offer accepted by another party based on the meeting of minds and some evidences showing their mutual assents to discourage ambiguities of terms. The consideration inherent in this agreement is of value in exchange for goods and services that will be rendered or delivered. Such consideration must be sufficient on its own. A contract can be illustrated in purchase agreements where one party delivers a thing or good in exchange for payment. Other examples can be mirrored in specific performance of services in exchange for just compensation or payment. This is evident in a contract of employment or in case of constructing facilities as in the case of hiring engineers to perform the actual construction. Generally, contracts are made if parties have the legal capacity to make a contract; the purpose is legally warranted and forms are legal; parties have the intention to create legal relations; and mutual consent are adduced. Under the law, contract can be vitiated when one of the parties of the contract made an irreparable mistake; is legally incapacitated; if contact is exacted out of duress and undue influence; if contract is done in unconscionability and of misrepresentation; and, contract frustrate the purpose. 2.a. Standard form of contract. This contract arises from parties of interests where one party where one party set the terms and conditions and the other party has to comply with all of contract’s stipulations without right to renegotiate terms (Bakos, Marotta-Wurgler & Trossen, 2009). . In business parlance, it’s otherwise expressed as “take it or leave it”. Such is very common in commercial relations, insurance policies, or in contractual relations happening in government agencies, and in the access of credit cards (Bakos, Marotta-Wurgler & Trossen, 2009). 2.b. Negotiated contract. This contract refers to an agreement of parties for a consideration which often came in as direct agreement with the contractor free from the necessary aggressive bidding process. This kind of contract free a contractor from significant problems that may arise from tedious and often manipulative bidding process which may reduce the chances of company to win in case there are other dominant companies of similar offered services (Ndekugri, Smith & Hughes, 2007). In a construction for instance, the bidding process requires completion of architect’s plans and details about the building to be built with accurate specifications on estimates (Fenn, Lowe & Speck, 1997). For contractors, such force them to make free estimates at the cost of construction company. Such is disadvantageous for the company because it can create conflicting relationship among architect, contractor and business manager because their services necessitate payment of services (Fenn, Lowe & Speck, 1997). As such, if project being bid about is to remodel, renovate and make modern-design facility, then such needs distinct capacities to meet architectural complexity. In relation thereof, estimates is expensive and cannot be just solicited by the company as part of the bidding process because estimating is both a science and an art. Artist would even want intellectual patent as distinction of their designs. Their services deserved to be paid fully and therefore, cannot be an object of solicitation. The bidding, moreover, perceived as mechanism to control construction costs and lowering the prices discredit the quality, value and service. For them, it disregard the best values of engineers, architect and construction experts’ capacities since bidder would prefer those who can offer the lowest cost offered as against competence, but require workers to deliver the same quality of product regardless of price (Rameezdeen & Chamil Rajapakse, 2007). 2.c. Problems & Risks of these Contracts 2.c.1. Problems Inherent in Standard Form of Contract. Legal luminaries argue that standard form of contracts extol economic proficiency and lessen the cost of transactions because it excluded buyers’ right to negotiate for consideration on products sold at the market. There were also those who argued that there are legal terms perceived to be unfair or unjust because it exonerate sellers some liabilities or has option to terminate it to protect its interests depending on stipulations (Bakos, Marotta-Wurgler & Trossen, 2009). These are often illustrated with the limitation clauses such as disallowing forum shopping, foreclosure of a party to avail remedy from court, or by limitations of damages that can be sought for recovery. Legal luminaries pointed that in standard form of contract there is difficulty to seek for remedy in case of defective products, or unsatisfactory delivery of insurance policy, and in case of contractual terms because it does not meet expectations (Bakos, et. al, 2009). Standard forms of contracts are moreover, described as lengthy documents written with complicated terms criticized by linguists as superfluous and inconsequential. Those who are not legally learned or are lacking legal knowledge will not understand what was written. Since the substance of the contract is basically favorable to the seller, the contract create an unfair and exploitative power relations because the other party is deprived of negotiating rights and are forced to accept the terms (Bakos, et. al, 2009). 2.c.2. Problems Inherent in Negotiated Contract – While negotiated contract allow direct agreement with the contractor free from the necessary aggressive bidding process, it rest greater responsibility and accountability to a contracted party to deliver the project in a state of par excellence. Contracting party will bear higher responsibility and liabilities to perform at higher standard and to take all necessary actions to potential risks that may confront the company. Solutions & Alternatives to Mitigate Risks As there are risks, there are also solutions. These are the following measures that can be adopted to mitigate risk in accordance to law and some alternatives for the organizations to improve the performance management of the company (Mendoza, 1993; Bakos, et. al, 2009; Ndekugri, et. Al., 2007): Under the law, the remedies are as follows: a. when the contract lacks essential requisites mandated under the law, it can be rescinded; b. when proved grossly unfair to any of the party of the contract, it can be revoked any time before its completely accepted, but the same can’t be done when acceptance is already completed; c. contract can be rescinded when its done with undue influence, by fraud, misrepresentation, when there is mistake of fact, mistake of law, and if the consideration is unlawful. d. The contract can be voided if the terms are against public policy; e. It is essential that parties are able to make contingent contracts to determine on what to do or not to do in case an event, collateral to the contract, will occur; f. Contract can be terminated when by nature, the terms are impossible and by operation of law in case of death of any party, insolvency, merger and unauthorized alteration of terms of written document; g. In case of breach, any of the party can rescind the contract and institute a legal action for damages and/or the affected party may not rescind the contract but sustain the operations, wait for performance and hold the other party obliged to non-performance; and, h. In case of ordinary, special, exemplary or punitive damages, and nominal damages, a party may rescind the contract and sue for damages (Mendoza, 1993; Bakos, et. al, 2009; Ndekugri, et. Al., 2007): Organizationally, the company may consider all alternatives before entering into a contract, to wit: a. Strategic Company Management. - Company must therefore maintain strategic competence, exceptional management abilities, reputation and financial integrity to meet all possible risks (Zeqiri, 2010). Construction company must adopt risk management is at earliest stages of project analysis to ascertain and determine whether project is befitting of the company’s capability. It must also craft measures that will not make the project fall in misfortune at the wayside. In major projects, risks in contractor relationships are evident and thus, beef its capability with specialist skills. Experts posit that project implementation necessitate comprehensive and accurate project plan that is sensitive to possible factor that may be detrimental or may hinder to its completion, such as the risks imbedded in a contract. While it’s affirmed that there are inherent uncertainties in project management, executives or managers need to administer project strategically. Such meant that with comprehensive plans, project managers should be clear on its goals; detailed and proficient in its project implementation and budget management; imbued with the capacity to forecast eventualities; capable of documenting what are achieved and its pitfalls; capable to manage resolution from arising problems and conflicts; able to maintain integrity of leadership; and responsive to manage changes as projects are often influenced by developing circumstances (Zeqiri, 2010). It is therefore important for stakeholders of the contract to conduct formal risk management program to eradicate project’s vagueness, recognize the possible impact of potential events and to plan for suitable response. With risk management, project implementers are able to accept calculated risks when placing their bets rather than gambling finances and assets on undetermined perilous factors (Zeqiri, 2010). b. Venture into Partnership. Managers may also delegate some responsibilities or risk exposure by sharing the work possible partner. Since contractors presume some risk, it is necessary to resolve the degree of risk being transferred and to evaluate how much new risk would be absolved by taking up new sub-contractor. The contractor could assuage a critical resource limitation, but if the required work cannot be finished to a precise quality level, the advantage of transferring the work is lessened by additional burden of managing for quality ((Kvaløy & Olsen, 2004) c. Plurality of Support Sources. For standard form contracts often subscribed by commercial, insurance, banking and in sales, business enthusiasts posit that the problem can be solved by encouraging more suppliers or sellers who can sell goods at more acceptable terms. They argued that the presence of similar companies offering similar goods or services can give rise to competition and may consequentially soften the terms and stipulations of contracts to serve more to the interest of clients or buyers. d. Consult lawyers and be consumer-right educated. Legal luminaries, who are usually tasked to craft standard contracts, following directives of companies or firms, should uphold fairness in vendor-vendee relations as part of mitigating the risks (Bakos, et. al, 2009). This researcher however advocate that people should be educated first of their rights as consumers to enable them to protect their interests in the market. Education remained the most potent tool to be freed from the clutches of commercial and contractual injustice for consumers, as potential party to contractual obligation. e. Learn Financial Management and nurture community relations to perfect project successfully. Contract exact expectations from the company to comply all terms. Financing and development of huge projects, like roads, water supply, schools, jails, information networks and dams could be done in a longer period and that would engage multiple of monetary and political participants. Construction would often depend for investments and participation for the project to be accomplished. Hence, risk assessment of projects should not be separated from contracting terms recognized between the parties. This risk should not be considered as purely exogenous. As such it must be assessed before contracting. Endogenous risks, those that are nuanced by the contracting terms, must also be considered thoroughly so evade pitfalls (Kvaløy & Olsen, 2004). A bridge for example, should be constructed with excellence so that to can stay for many years and withstand disasters. f. Maintain open communications. Guarantors of the project, the oversight committees, the constructor, and project operator usually have disagreeing preferences about the desired superiority to be achieved about and of the costs to be allocated for the project (Faure & Luth, 2011; Azizan & Hamimah, 2011). The constructor may wants to reduce the cost of building to also meet the needed operational cost. Meanwhile, the guarantor of the construction project may approve the budgetary approval but demands best quality of finished project while to minimize costs. Due to exogenous risk or flawed monitoring, the outcome of the actions done by divergent parties may not be completely validated. Second, with the complexities of machineries and technologies involved and the possible problem to audit, participants will make their respective private information about contractual variables. They may not be able to determine the possible contingencies to effect timely completion of the project; the operational cost defrayed and the actual cost of building in operating it. Thus, contracting parties must thoroughly consider all exogenous and endogenous risks as part of managing the economics of building construction and maintain open communications to resolve potential disagreements (Hansmann & Kraakman, 2000). Some experts would use tools for resolution, such as adopting Oracle’s Primavera Risk Analysis (for instance) to resolve problems in a win-win state. Conclusion There cannot be definite solution that can be considered best in these contracts with variegated problems arising from contracts. But being educated about the nature, terms, effects, obligations, remedies available under the law is very helpful already. As people are active agents of contractual relations in the market, they should also be educated about consumer right so that they will not be fooled in all contractual obligations (Zhang, 2008). Rights are fundamental in all relations whether in the market, in commercial areas, in firms, in government institutions, and even in homes. Consumer access to the regular form of contracts that rule consumer transactions has been the focal of legal and policy disputes, especially on the context whether revelation of contractual terms needs to be regulated. This also relates to a policy discussion focused on the enforceability of terms and the probable need to standardize disclosure (Che, & Chung, 1996). Focal point in this issue is the consideration about the validity of the informed minority hypothesis—a precept that shoppers who are informed about standard terms help maintain proficient equilibria in the stipulation of those terms. As all contractual relations relates about generating, utilizing and maximizing it, parties to agreements should be sensitive in ensuring that they are able to observe standard cost-benefit analysis to arrest the endogenous and exogenous risks inherent in all contracts (Che & Chung, 1999). In case there are problems in the fulfillment of the obligations, the affected party may seek remedies from the court. The court will apply general principles of contract law to understand the nature of the contract and anent obligations arising from the agreements of parties (Stremitzer, 2009). Terms will be reexamined, specially its indemnity clauses to evaluate the denotation of the contract terms. The court will likewise reflect on significant aforementioned evidence to know the intention of the parties when contract was agreed by parties (Stremitzer, 2009). Legal luminaries will not, however, consider this information to contravene, contradict or change the terms of formal agreement. The law authorized the court to impose the indemnity clause against those who drafted the agreement when uncertainty creates two or more interpretations. Thus, it is important that contract should be express, clear, and unequivocal in terms (Lee, 2005). It is also necessary that a party must consult a legal adviser or a lawyer to consider all statutes and terms when negotiating a contract. In the absence thereof, the person of contractual interest may forfeit the protection to legally avail indemnity in case of loss or damages, or plans to rescind the contract. Contracting parties should also be clear of their goals. The contractor, who has obligation to perform, should conduct strategic planning in fulfilling an agreement (Cafaggi, 2006). Agreements that are conferred hastily or lacking of information is considered as detrimental and perilous to parties (Cafaggi, 2006). Parties should be comfortable with the agreement and insure that both parties enjoy fairness in term. In case, a party failed to negotiate an equitable contract, it is wise that it be critically terminated and reasons for non-acceptance should be interposed (Cafaggi, 2006). It should be reckoned that when entering a contract, parties are specific of its scope of agreements. Those that aren’t addressing the important terms and conditions may result to an inconsequential outcome. It must be noted that contracts should have legal enforceability of the contract. Those contracts that contravene public policy, national laws, or statute are unenforceable. Such need the capacity of parties to manage risks so that they are able to honor financial commitment and be able to perform obligations with integrity. REFERENCES Issaka Ndekugri & Nigel Smith & Will Hughes, 2007."The engineer under FIDIC's conditions of contract for construction," Construction Management & Economics, Taylor and Francis Journals, vol. 25(7), pages 791-799. 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Henry Hansmann & Reinier Kraakman, 2000. "The Essential Role of Organizational Law," Yale School of Management Working Papers 147, Yale School of Management, revised 01 Nov 2001. Fan Zhang, 2008. "Dynamic Contract Breach," EAG Discussions Papers 200803, Department of Justice, Antitrust Division. Che, Y.K. & Chung, Y.T., 1996. "Contract Damages and Cooperative Investments," UWO Department of Economics Working Papers 9612, University of Western Ontario, Department of Economics. Yeon-Koo Che & Tai-Yeong Chung, 1999."Contract Damages and Cooperative Investments," RAND Journal of Economics, The RAND Corporation, vol. 30(1), pages 84-105, Spring. Alexander Stremitzer, 2009. "Standard Breach Remedies, Quality Thresholds, and Cooperative Investments," Bonn Econ Discussion Papers _2009, University of Bonn, Germany. Kvaløy, Ola & Olsen, Trond E., 2004. "Endogenous Verifiability in Relational Contracting," Discussion Papers 2004/20, Department of Finance and Management Science, Norwegian School of Economics. Jihong Lee, 2005."Incomplete Information, Renegotiation, and Breach of Contract," Economics Bulletin, AccessEcon, vol. 3(5), pages 1-7. Yannis Bakos & Florencia Marotta-Wurgler & David R. Trossen, 2009. "Does Anyone Read the Fine Print? Testing a Law and Economics Approach to Standard Form Contracts," Working Papers 09-04, NET Institute. Mendoza, Quintin, (1993). Engineering Contracts, Specifications and Ethics. Rex Printing Company Inc., Florentino St., Quezon City, Philippines. Zeqiri, Izet, 2010. "A theoretical overview of the interactions between entrepreneurship and strategic management," MPRA Paper 21943, University Library of Munich, Germany. Read More