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Negotiating a Contractual Agreement with the Selected Supplier

Posted By Robert Shumate, Thursday, May 14, 2015

This is the seventh of an eight-part series on procurement practices in information technology. This series is authored by Bob Shumate, a Member Emeritus of the IJIS Institute and the chair of the IJIS Institute’s Procurement Innovation Task Force. The material in these articles covers the findings of the Procurement Innovation Task Force and offers some insight into the problems and solutions in procurement evident in today’s information technology markets.

If you have included the contract terms in the procurement document and have provided the opportunity for feedback from the RFP responders, you are probably in a position to reduce the time required to reach agreement as to legal terms and conditions. The selected provider(s) either already knows the terms that will be required or has negotiated acceptable changes and can be presumed to be ready to agree to them.

The contract is an important part of the procurement process and can absorb anywhere from a month to a year to reach final agreement depending upon the size and complexity of the work to be performed and whether or not there has been pre agreement to the terms as part of the RFP. Negotiating the contract involves reaching agreement as to the level of risk each party will accept in respect to performance of the service. The development of the contract agreement ideally should involve the professional procurement officials who are likely to understand the practical requirements and the jurisdiction’s legal representatives who can ascertain and advise as to the legal requirements of the desired terms.

Contract negotiations by their very nature are adversarial. Keep in mind that you will be entering into a relationship that will function best as a partnership rather than two adversaries seeing who can outpoint the other in working with the agreement. Attempt to keep negotiations civil, rational, objective, and as non-controversial as possible. Keep in mind that collaborative partnerships produce better results than the adversarial relationships that can easily develop during negotiations of the contractual agreement.

Contracts between the buyer and the solution provider need to be fair and balance the risks associated with the effort equitably between the two parties. Traditional approached to public contracting have, in the past, tended to place an undue risk burden on the solution provider. While this does reduce the buyer’s risk, it can also eliminate some of the best-qualified companies who are unwilling to accept the level of risk being demanded and result in the buyer having to accept less qualified providers.

No two contracts are exactly alike and circumstances will dictate many of the terms and conditions that are included in the final agreement. Further, many states, as well as counties and cities, have laws or administrative requirements specifying terms that must be included in a contract. However best practices advocated by numerous groups involved in procurement innovation suggest that the following areas deserve consideration.

Limitations on Liability

Solution providers should be prepared to accept liability for failure to deliver the solutions that they have offered and any direct damages resulting from contract breach. Few reliable companies are, however, prepared to accept unlimited liability including special and consequential damages, incidental damages, and third-party claims arising out of indirect damages. Contracts should contain caps on the amount of liability the provider may incur. This is usually either the amount of the contractor or some percentage multiplier of the contract amount. NASCIO’s 2010 survey found that the average state cap for liability limitations (in states that allow them) was between 150% and 200% of the contract value with the absolute floor being 100% of contract value. Generally speaking, you should balance the limitation of liability with the risk involved subject to whatever limitations may apply by law in your jurisdiction.

Intellectual Property Rights

As more RFP’s turn to COTS or SaaS approaches, intellectual property (IP) rights become less of an issue since license agreements contain specific provisions regarding IP and frequently include copyright or patent rights of the provider. However, procurements that require extensive modifications to a COTS product may involve serious IP issues. Contract terms that require that any work performed under the agreement become the property of the Buyer also tend to limit competition or result in using a less qualified provider due to the reluctance of a qualified supplier to relinquish IP rights to the work to be performed.

  1. The solution provider retains ownership of the IP and grants the buyer an unlimited, irrevocable, worldwide, perpetual, royalty-free, non-exclusive right and license to use modify, reproduce, perform, release, display, and create derivative works for, any State government purpose.
  2. An alternative approach is to reverse the process with the buyer having ownership of the intellectual property produced under the agreement and then granting the solution provider an unlimited, irrevocable, worldwide, perpetual, royalty-free, non-exclusive right and license to use modify, reproduce, perform, release, display, and create derivative works for any purpose.

There are of course numerous variations of language found in specific contracts but in principle these represent the two principal approaches to IP.


Performance Bonds

Generally speaking, the use of performance bonds in IT contracts should be avoided wherever possible since the requirement tends to discourage competition. Surety companies that issue such bonds do not know how to evaluate the risk of contract failure in IT contracts, thus, they are reluctant to issue such bonds to small- and medium-sized companies, making it impossible for them to compete. In the case of larger companies, to minimize their perceived risk, surety companies charge high premiums that will be passed on to the buyer. Further, current accounting practices require that such bonds appear on company balance sheets as a liability, which discourages even large companies from bidding on procurements that require such bonding.

There are numerous other ways in which the buyer can minimize the risk of failure including such practices as: payment holdbacks until defined tasks are completed and validated; project termination with damages, warranty remedies, and liquidated damages.


An excellent paper discussing the pros and cons of Performance Bonds in IT procurements is Leaving Performance Bonds at the Door for Improved IT Procurement prepared by NASCIO in collaboration with TechAmerica and NASPO.


Indemnification and Warranty

Warranties should guaranty substantial conformance to the contract requirements and freedom from material defects. Contracts that have terms stating that the results shall be free from defects are rarely acceptable to the solution provider because of the lack of limitations. The preferred approach is to warrant substantial conformance to contract requirements and freedom from material defects. Indemnity against claims of infringement should provide for the buyer to use the alleged infringing property while the provider defends such claim or replaces the infringing portion with a non-infringing solution.


Mutuality of Responsibility

If a contract is to have a successful conclusion, both parties must assume certain responsibilities. Agreements that attempt to place all of the responsibility for contract performance on the solution provider are likely to lead to problems during the implementation. Successful implementation of any IT contract requires that the buyer provide certain services including access to facilities, data, and people as well as timely reviews and approvals all of which can leads to project delays. Further, the buyer must provide a project manager with the authority to make decisions and meet the buyer’s responsibilities in a timely fashion. The contract should provide terms that provide contractual and financial relief to the solution provider that mirrors the penalties that would be assessed if the solution provider fails to meet their obligations. Mutuality provisions in the contract should be aimed at encouraging responsible actions on both parties to the contract by providing comparable penalties for failure to meet those responsibilities.

The above items by no means cover the entire range of contract issues. Further, the emergence of COTS solutions as a preferred means of addressing IT requirements require new terms and conditions to satisfy the requirements of this approach. The emergence of cloud computing is also generating a completely new set of requirements that have to be addressed as part of the contract negotiations. A recent collaboration between the private sector and the California Department of General Services resulted in a contract template for terms and conditions entitled General Provisions Information Technology that is a major step towards finding common ground between buyers and sellers on a number of controversial contract terms including those discussed above.

Next: Contract Oversight and Management

For further reading: http://www.ijis.org/?page=Procurement_Resource

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