Any business that deals with third party contractors for procurement, development, sales or distribution needs to sign a business contract to ensure a smooth and seamless operation. In the absence of these contracts, projects may often get stalled midway because of disagreements over issues such as pricing or quality. An experienced attorney can help your business draft the clauses that will come handy during disputes. There are essentially three factors that a business must account for while drafting a contract – time, quality and money.
Project Timeline and Penalty Clause
The ‘time value of money’ theory states that any amount of money is worth more when it is received sooner. When a project is delayed, it also delays the time it takes a business to make money off the project, which is theoretically a loss. Establishing a penalty clause for delay in project delivery ensures that the contractors execute the projects with a plan and complete the projects on time. When Millau Viaduct, the tallest bridge in the world today was constructed, the contractors promised to pay a massive $30,000 fine for every day of delay. This ensured that this stunning piece of engineering was completed in less than four years.
What happens when a contractor is threatened with penalty for overshooting the deadline? They try to make up for it with shoddy work that is on-time but is riddled with quality issues. Any contract with a penalty clause for delays should also inevitably include a quality clause that comprehensively documents the quality of work expected of the contractor. This should not only include the dimensions and specifications of the end product, but also other parameters that must be followed during the development phase. For example, projects involving painting, meat consumption, or casting involve an aging period that ensures a high quality end product. Your quality clause must include the tentative periods for such processes to be carried out in order to ensure that your contractor does not bypass them for quicker completion of the project.
Cost Overrun Clause
Projects that involve consumption of commodities are prone to cost overruns. Such escalations in budget are likely to hit small businesses quite significantly. Cost overrun is essentially an unexpected increase in the cost of a project, mostly due to external circumstances such as a dramatic increase in the price of a commodity (like steel, oil, etc.) that is necessary for production. There are two ways to handle cost overruns in a contract. The first option is to let the contractor quote a fixed amount for the project and in this case, the contractor takes responsibility for overruns. But since the onus is on the contractors to pay for overruns, their quotations include a buffer for overruns and could thus be expensive for the business.
An alternate model is to let the contractor only quote for their service. In this case, the client (your business in this case) incurs the cost for procurement of the commodities at the prevailing rate. This ensures competitive quotes from contractors. Businesses can however limit exposure to unexpected cost overruns by insuring themselves against such events. Many insurance providers offer policies that specifically address increased loss exposure and cost overruns. By subscribing to these policies, businesses could keep themselves immune to potential overruns while also making sure that contractors bid competitively.
Cost, delays and quality are three reasons why many projects end in disputes. By including clauses that effectively address these issues, businesses can make sure that they set the right expectations and also cover their bases while outsourcing specific components of their business to a third party.