An ounce of prevention--contracting for project success and problem prevention
Projects take place in an increasingly complex, global, networked and regulated environment. In large projects with multiple suppliers and subcontractors, the interfaces among the various providers must be managed well. Required actions must be taken at the right time and in the right place, by one's own organization and by the other parties. Coordination, communication and control become crucial. So do contracts. In today's business environment, contracts can play a determining role in the success of a project, both on the sell-side and on the buy-side. Regardless of the skills of those who craft the contracts, it is up to the project team to fully understand and successfully implement them.
The old truth, an ounce of prevention is better than a pound of cure, is true even when it comes to contracting. Unnecessary problems should be prevented at source, and many can be. Contracts can help eliminate causes of problems and provide procedures and resolution mechanisms if changes, delays, or disturbances occur, or if a conflict situation arises. Contracts can work as risk mitigation tools. In the following, we view contracting as a puzzle requiring knowledge of the project's technical, business, legal and implementation elements, all of which must be capably coordinated and managed. A contractually literate, well-managed team can merge good project, contract, quality, legal and risk management practices and benefit from the effective use and understanding of contracts as tools for 1) managing business, projects and risk, and for 2) proactively preventing problems and avoiding disputes.
Few aspects of project business are unrelated to contracts. Selling, procurement, finance, invoicing, change control, claims, and many other fields operate within the framework of contracts. Major business decisions often crystallize into a contract. Projects ranging from construction and equipment supply to IT acquisition and outsourcing all involve contracts, both on the sell-side and on the buy-side. Why then has so little attention been devoted to the role of contracts in projects and project business?
While many project, contract and legal professionals deal with similar aspects of business, there seems to have been relatively little cross-professional collaboration. One of the reasons may be the lack of common understanding of each other's roles – and of the roles and functions of contracts. Another reason may be the fact that contracting crosses the boundaries of several academic disciplines. To fully understand how contracting works, an interdisciplinary approach is necessary.
Much of the discussion about contracts is being carried out in a framework of the seller versus the buyer, or the contractor versus the employer. When lawyers are mentioned in the discussion, many people think of a dispute and lawyers as “fighters” or “hired guns”. These views are no longer accurate. There is a growing breed of lawyers who practice what is known in Scandinavia as Proactive Law and in North America as Preventive Law. In introducing and merging these two approaches, this paper seeks to establish common ground for different professions involved in projects and contracting. The goal: joining our forces to take full advantage of the opportunities that the proactive use of contracts and contracting can provide.
What is Proactive Preventive Law and Why Should You Care?
Traditionally, the steps in providing legal care have resembled those of medical care: diagnosis, treatment, and referral – all steps that happen after a client or a patient has a problem. Care has been reactive. You get sick, you seek treatment. You encounter a dispute, you turn to a lawyer. In project contracting, we need to move away from that model. Expensive disputes endanger relationships and consume time and resources which could be used for productive work. Businesses do not succeed by winning disputes or court cases, or by looking for parties to blame and claim damages from. Their reputation, their workplaces, and their ability to continue and prosper may have been destroyed long before they collect on any judgment. Emphasis must be put on dispute avoidance. “An ounce of prevention…” is true even when it comes to legal care.
Experienced project lawyers know that their clients do not want damages or remedies. They want successful relationships and the performance they expected. Each day, hundreds of lawyers still spend hours on drafting and negotiating clauses dealing with the settlement of disputes, (limitations of) liabilities and (limitations of) remedies – many more hours than they spend on drafting and negotiating clauses that enhance communication, clarify tasks, and help secure successful performance.
The good news: a growing number of lawyers involved in project business represent the proactive approach: one seeking to do what is best for the project. They strongly believe that legal knowledge is at its best when applied before things go wrong. They are concerned about how to promote better performance and sound business practices. They want to aid in the prevention and prompt resolution of issues that can adversely impact a project. Whether working on the sell-side or on the buy-side, they care about a commercially justifiable allocation of risks. They seek to secure successful project completion through incentives for good performance and arrangements where rights, responsibilities, risks and remedies are effectively identified, assessed and managed.
In the context of practicing law, the idea of prevention was first introduced by Louis M. Brown, a Law Professor and legal practitioner. In an effort to help people minimize the risk of legal trouble and maximize legal benefits, he published Preventive Law in 1950 (Brown, 1950), followed by numerous other books and articles on the topic. What he stated then is as true today as it was more than fifty years ago: “It usually costs less to avoid getting into trouble than to pay for getting out of trouble” (Brown, 1950) Proactive Law is a Scandinavian approach built on Preventive Law. Both approaches have similarities with preventive medicine, a branch of medical science dealing with methods of preventing the occurrence of disease – here, the “disease” of legal trouble, disputes, and litigation.
Proactive Preventive Law helps to identify legal opportunities in time to take advantage of them, and provides tools and techniques for the early detection and prevention of potential problems. If problems do arise, the approach offers mechanisms to resolve them quickly, before they develop into disputes. Still the focus is not just on preventing problems or “legal ill-health”. The goal is to promote “legal well-being”: embed legal knowledge and skills in project and company culture, strategy and everyday actions to actively promote success, ensure desired outcomes, and balance risk with reward.
What Exactly Do We Mean by “Contract” and “Contracting Puzzle”?
When hearing the word “contract”, many people have a tendency to think solely of signed, formal, legal documents. Traditional project management literature seems to have a rather legalistic view of contracts also, with an emphasis on their legally binding function and their being subject to remedy in the courts. Often, what people think is a contract and what it actually is are two different things.
The word “contract” has two basic meanings: an agreement (a bargain, a deal); and the document recording the agreement. In many jurisdictions, no writing is required in order for a legally binding contract to exist. Bids, purchase (or change) orders, confirmations, memoranda, letters of intent and the like, even email messages, can create (or change) contracts. Project documentation, such as project plans, schedules, work scope definitions, technical specifications, and drawings, are often parts of contracts. The project team must be aware of the applicable contractual requirements when administering or changing them.
It is useful to view contracts and contracting through the analogy of a jigsaw puzzle. With a complex project in mind, Exhibit 1 shows contracting as a puzzle of technical, implementation, business and legal parts, all of which must be consistent and coordinated. If correctly assembled, the pieces of the puzzle form a complete, synchronized picture. The ideal contract matches the parties’ business needs and reflects their true goals. It is capable of being implemented within the allotted time, with the resources that have been allocated, and within budget. The designed solution matches the priced solution, which in turn matches the solution that is described – and will be implemented (Garrett & Kipke, 2003, pp. 106–108). The supplied solution will meet the customer's requirements, while the project will satisfy the supplier's needs in respect of profitability and risk management. The parts of the puzzle fit together and create a successful business deal and relationship.
Exhibit 1 – The Contracting Puzzle
When making and implementing contracts, a balance needs to be struck between many different (and often conflicting) requirements, such as the need for clear rules and certainty on one hand, and flexibility on the other. Contracts must be commercially acceptable – even attractive, so that they generate new business and revenue and help maintain good relationships. At the same time, they must be legally permissible, and secure compliance with pre-existing commitments, applicable laws, and governance regulations. Contracts must be financially sound, improve supply-chain performance, provide adequate protection, and balance risks against benefits.
Why Contracts? The Missing Link between Contracts and Projects
The Many Elements and Functions of Contracts
Contracts are probably best known as legal documents providing rights, responsibilities and remedies. Only recently have they started to draw the attention of practitioners and scholars outside the legal field. Proactive project lawyers have recognized a long time ago that courts, arbitrators, and lawyers are not the primary readership for contracts – the people applying the contracts are. People involved in procurement, design, engineering, production, and projects need business and technical information contained in contracts to implement the project, to manage the budget, scope, schedule, quality, and resources, and to coordinate different in-house and outsourced functions, sub-suppliers, etc. Contracts are made to guide and support them so that the tasks and obligations are properly fulfilled and the contracting parties reach their goals.
Empirical research conducted by strategy, management, and organizational economics scholars indicates that contracts have many functions, the core of which can be summarized as illustrated in Exhibit 2.
Exhibit 2 – Functions of Contracts
While the legal and risk management functions of contracts matter, they are not the primary goals of contracts. According to the International Association for Contract and Commercial Management (IACCM), on average nearly 80 % of the terms in business-to-business contracts are not areas of significant legal concern, but rather business and financial terms, such as Statements of Work, Specifications, and Service Level Agreements. (Cummins, 2003)
In recent conceptual and empirical studies on the organization of inter-firm relationships, contracts and contracting processes have proven to work as a means of communication, coordination, collaboration, and control. The studies emphasize that contracts communicate crucial information inside and between organizations; define and formalize relationships; establish organizational structures; create shared meaning; motivate; bring organizational learning; support the discovery of better outcomes; create, allocate and protect value, whether tangible or intangible (such as intellectual property rights); and allocate decision and control rights. (Argyres & Mayer, 2005; Vlaar, 2006)
Contracts and the contracting process can also be used for aligning expectations, building incentives for success, and for managing performance, uncertainty, and risk. One way to look at contracts is to see them as visible scripts for collaboration. (Haapio & Haavisto, 2005) Contracts can then be used as tools for planning and managing projects. However, not all contracts are being used so. Something seems to be missing.
A too narrow view on contracts as merely legal instruments may have prohibited many projects from making full use of the various functions of contracts. On the other hand, lack of cross-professional collaboration may have prevented contract professionals and lawyers from benefiting fully from the vast experience of project managers on what works well at the implementations stage and what does not. It seems that contract, project and legal professionals could all benefit from closer collaboration.
When properly implemented, the Proactive Preventive Law approach translates into proactive contractual care for projects. It involves helping project teams reach their goals and balance risk with reward. Where possible, it also involves helping to put in place protective systems that make projects strong and resistant so that they stay in good legal health. The goals: first, to promote successful performance and relationships and to eliminate causes of potential problems; second, to minimize the risk, problems and harmful effects when problems do arise; and third, to manage conflict, avoid litigation and minimize costs and losses where they are unavoidable. A pyramid figure (Exhibit 3) adapted from preventive medicine can be used to illustrate the approach:
Exhibit 3 – Proactive Contractual Care for Projects
Why Do Contracts (and Projects) Fail – and How to Prevent It?
Contracts and projects fail for many complex reasons. People make risky deals. Sometimes they do so eyes wide open, but not always. Sometimes people make promises they can't keep, sign a contract without first reading it, or sign a contract they do not understand. Sometimes people make risky assumptions without noticing it, or make or accept unreasonable demands without knowing it. Not everybody is capable of recognising cultural or legal landmines.
In litigation related to tech project failure, one recurring theme seems to be communication failure, which easily occurs when there are people representing different professions in one room, “pretending to speak the same language. Techies understand what they can build. Business people know what they want for their customers. Bean counters want it to be close to free, and the lawyers – what exactly is it that we do and why are we in the room anyway? The lawyer is there to foster communication. You write a contract to prevent litigation.” (Grossman, 2000)
Most people do not intentionally neglect or breach contracts, or do other things that add to their company's liability exposure. They just “do their job” and what they think is expected of them. Legal risks are most often created by people's ordinary, well-meaning, everyday behaviours. We can reduce legal risk by predicting and then shaping these behaviours. (Dauer, 2006, p. 95)
While a good contract can help eliminate causes of problems and misunderstandings and reduce risk, not everybody is enthusiastic about contracts. In fact, most people are reluctant to read contracts. They may suffer from contract phobia. They may trust that Legal – or somebody else – is in charge of contracts and handles any issues that may come up. That attitude needs to be changed.
Making It Work: Secrets of Successful Contracts and Implementation
Contracts do not make things happen – people do. After the negotiation and signing of the contract, the parties must follow their agreement. The contract documentation becomes the blueprint for the project.
Successful implementation is what contracts are made for. Contracts must translate into desired performance. Here, the role of the project manager is central. The way in which he or she is involved depends on the company, the industry, the project, and the contract type. In many organizations, the project manager manages performance – and the contract. While much of project management literature deals with buy-side contracts, many project managers work on the sell-side. When managing the project they manage not only the sell-side contract but a portfolio of buy-side contracts, which need to effectively pass on to subcontractors the applicable terms (and risks) of the main contract. So project managers need a good grasp of both sell-side and buy-side contracts, and of how to manage the interfaces.
Those in charge of contract implementation must be aware of their responsibilities and do what is required of them – and avoid doing what their company has agreed not to do. Project managers must orient their organization and suppliers to the project, make sure they are on schedule, review deliverables and invoices, work with changes and notifications, make price adjustments, agree on time extensions, and settle claims – all based on contracts. In a contractual setting, many of these activities need to be documented, and often there are strict requirements in the contract as to form and timing.
Project managers must read and understand what is agreed. There are two principal aspects to Contractual Literacy: being willing and able to read and understand what the contract says (the express, “visible” terms), and – often the more demanding task: to read and understand what the contract does not say, but still becomes part of or affects the deal (the “invisible” terms). (Haapio, 2003; 2004) Understanding the express terms requires a good grasp of the language of the contract. Even native speakers sometimes have trouble with contract terminology and concepts, and take unnecessary risks by omitting to pay attention to what seems self-evident to them. Understanding the invisible terms requires a basic understanding of the interplay of contracts and the law, which contains both default and mandatory rules. With a little help from a proactive lawyer, the project team will know how to take into account not only what the contract says, but also what it does not say but probably should – particularly if they do not want to leave room for “invisible” terms and negative surprises.
Contractual Literacy involves contract reading skills, but it is not limited to these: contracts and commitments must be recognised and properly dealt with even when there is no piece of paper with the word “contract” written on it. Appropriate attention must be paid to bids, purchase orders, order confirmations, work scope definitions and other documents as well as to changes made to existing contracts and their attachments.
In managing issues related to scope, whether certain work is included or not, there is also a need to interpret the contract. The project manager may need to work as a “judge” and determine, for example, whether contract language wins over an appendix or a subsequent memo, or whether contract terms and conditions win over scope of work.
Contractual Literacy is needed in order to identify opportunities in time to take advantage of them – and to spot potential problems while proactive preventive action is still possible. The project manager is instrumental in the early recognition and resolution of issues that might lead to a difference of opinion, disagreement and conflict. In this process, disputes will occur – or be prevented.
The entire project team needs a basic understanding of contracts and the interrelationship between contracts and projects. They need to understand that not all contracts (or terms and conditions) are the same: one really must read the contract in order to know how to establish and maintain required documentation and handle change orders, variations, claims, and notifications under the specific contract at hand. Some project professionals seem to think that the only relevant part of a contract is the scope of work. However, mastering the scope of work alone is not sufficient, nor is working with and reading only bits and pieces of the contract.
In order to know what is required, project managers on both the buy-side and the sell-side need to have access to and understand the contract(s) they work with. If they do not, how can they perform or control the work, ensure or track compliance, and do what is required?
Tools and techniques exist that can make the task easier. Resources are available to help improve contracts and contracting processes so that they serve the best interests of the project. Experience shows that it is even possible to cure people's contract phobia.
There are technology tools already in the market that can convert project and contract documents to an easier-to-read format (McNair, 2005). An enterprise contract management solution can simplify document creation as well as information sharing, collaboration, and real-time reporting. Tools and technology exist that can integrate and link complex documentation and make it easily accessible, searchable and navigable to those who need to know, whether they are located in the office or on site. Easy access to project and contract documentation is needed not only for the success of projects, but also for risk management and good governance.
Training helps, and it does not need to be boring. Workshops and materials exist that are interesting and thought-provoking, yet convey the critical ideas. Even low-tech training tools may be useful. The “hand tool” illustrated in the following figure (Exhibit 4) offers an example. It is designed to help recognize and avoid unwanted gaps in deals and documents. The simple set of questions can serve as the starting point when making or changing contracts. It lists the trivial-sounding but crucial questions that must be answered when creating or reviewing obligations: who/which party shall do – what – where – when – how – and, last but not least, what if / what if not. Often it is also worthwhile to ask who bears the risk and cost of doing things.
Exhibit 4 – “Hand Tool” for Better Contracts
This simple “hand tool” has proven to work in practice. If the parties remember to go through the questions and address them when creating, amending, or passing on contractual obligations, a number of potential pitfalls can be avoided. Through training and support, proactive project lawyers can provide project managers and site personnel with the ABCs of Contractual Literacy – and with easy access to tools, templates and checklists that help them read and understand their contracts and work well with them. (Haapio, 2006)
If the scope of work or allocation of tasks is unclear, everything is unclear, and problems will follow. An experienced project manager can make a valuable contribution at the contract planning stage, by sharing his or her experience and knowledge from previous projects. Clarifications can be asked for and queries can be raised during the preparation phase so that unnecessary problems can be avoided during implementation. The project manager can help tailor the contract to the needs of the project, and protect the relationship between the parties in order to protect the project. Assembling and managing the pieces of the contracting puzzle is simply too important to be left to lawyers and contracts professionals alone!
Experienced project managers and proactive lawyers have seen many projects – successes as well as failures – and can provide useful views and suggestions for future contracts. When a project is finished, it is time to go through the lessons learned: what went right and wrong, what worked well and what not so well, and what should be done differently next time. To gain most from each project, the lessons learned should be documented, shared, and result in innovations and improvements in future projects and contracting processes.
Sometimes the roles of project managers and other professionals overlap. Coordination is needed with sales managers, financial managers, legal professionals, and others. Clearly stated roles and responsibilities are called for. Each organization must make its own determination as to who is in charge. It must be clear to everybody involved.
An understanding of the contracting process is key to successful projects. A well thought-out contract and the early involvement of a proactive lawyer and an experienced project manager set the stage for successful project completion. All team members must commit to making it happen.
Contracts impact future rights, cash flows, costs, earnings, and risks. A company's contract portfolio may be subject to greater losses than one realizes. Still the greatest risk in business is not taking any risks. Contracts can and should support sound risk taking and help balance risk with reward.
In today's business environment, a growing number of organizations recognize that contracts and contracting play a critical role in ensuring that projects and commitments are implemented correctly. Many have invested in resources, tools and technologies that enable them to make and manage their contracts effectively. Many still need help in these areas. In a number of organizations, contracts could be used more effectively than they are used today, and contract failures could be prevented more often than is done today.
Good-quality contracts help establish a strong foundation for project success. They describe requirements and allocate roles, responsibilities, and risks clearly. They minimize misunderstandings, provide safeguards, and lay the foundation for long-term loyalty and trust. And a good contract is good to have if problems are encountered or if a dispute arises.
The main goal of contracts is to create and maintain successful business deals and relationships. Aligning expectations, defining desired outcomes, and allocating tasks clearly are key steps to making this happen. The contract is not the goal; successful implementation is. As contracts become increasingly complicated – and critical to projects’ success – it is no longer acceptable to believe that they can be assigned to the legal department alone.
Contracts are not just legal documents or enforcement mechanisms, something used as evidence in court. A contract is a vehicle to achieve revenues, profit, goods, and services. When potential problems are recognized and, where possible, prevented early – and when problems do occur, they are solved in good time, before they result in a dispute – everyone's resources are saved. Even legal knowledge is at its best when applied before things go wrong.
As organizations both in the private and in the public sector continue to streamline and outsource their operations, more project and program managers need contracting skills and support. At the same time, when putting together complex business arrangements, legal and contract professionals increasingly need project management skills and support.
The time has come for project, contract and legal professionals to work more closely together. A knowledgeable, well-connected project team can create and implement contracts that set incentives for good performance and help reach desired outcomes with the minimum of cost and risk. Working together, proactive project, contract and legal professionals – along with scholars and educators in these fields – can identify the skills that are required and assess ways to practice, teach, and strengthen them. It then becomes easier to systematically secure a strong foundation for project success and problem prevention.
Argyres, Nicholas & Mayer, Kyle J. (2004, July-August). Learning to Contract: Evidence from the Personal Computer Industry. Organization Science15(4) 394–410.
Brown, Louis M. (1950). Preventive Law. New York: Prentice-Hall, Inc. Also published under the title of Manual of Preventive Law (1950). New York: Prentice-Hall, Inc.
Cummins, Tim (2003). Contracting as a Strategic Competence. International Association for Contract and Commercial Management IACCM. Retrieved on March 2, 2007 from the IACCM Web site: http://www.iaccm.com/library/nonphp/contracting.pdf.
Dauer, Edward A. (2006). The Role of Culture in Legal Risk Management. In Wahlgren, Peter & Magnusson Sjöberg, Cecilia (Eds.) (2006). A Proactive Approach. Scandinavian Studies in Law 49. Stockholm: Stockholm Institute for Scandinavian Law, 93–108.
Garrett, Gregory A. & Kipke, Reginald J. (2003). The Capture Management Life-Cycle. Winning More Business. Chicago: CCH Incorporated.
Grossman, Mark (2000, November 6th). Contract Negotiation Crucial Before Website Development. The Miami Herald. Retrieved on March 2, 2007 from the Law Offices of Mark Grossman, P.A. Web site: http://www.mgrossmanlaw.com/articles/show_article.php?article=2006_contract_negotiation_crucial_before_websit_development.
Haapio Helena (2006). Business Success and Problem Prevention through Proactive Contracting. In Wahlgren, Peter & Magnusson Sjöberg, Cecilia (Eds.) (2006). A Proactive Approach. Scandinavian Studies in Law 49. Stockholm: Stockholm Institute for Scandinavian Law, 149–194.
Haapio, Helena (2004, July). Invisible Terms in International Contracts and What to Do about Them. Contract Management 44(7) 32–35. National Contract Management Association (NCMA).
Haapio, Helena (2003). Contractual Literacy in International Business: The Fine Art that has to be mastered by Lawyers and Clients – together! Turku Law Journal 5(1) 35–57.
Haapio, Helena & Haavisto, Vaula (2005). Sopimusosaaminen: tulevaisuuden kilpailutekijä ja strateginen voimavara. [Contracting Capabilities: Emerging Source of Competitive Advantage and a Strategic Resource]. Yritystalous – Leader's Magazine 2/2005 7–15.
McNair, Damian (2005, November/December). Contractual risk identification, assessment and management system for the owner. Contract Management in Practice 2(9) 136–140.
Vlaar, Paul W.L. (2006). Making Sense of Formalization in Interorganizational Relationships: Beyond Coordination and Control. PhD Thesis. ERIM Ph.D. Series Research in Management. Erasmus Research Institute of Management (ERIM), RSM Erasmus University / Erasmus School of Economics. Retrieved on March 2, 2007 from the Erasmus University Rotterdam Web site: http://hdl.handle.net/1765/7326.
© 2007, Helena Haapio
Originally published as a part of 2007 PMI Global Congress Proceedings – Budapest, Hungary