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Techniques for monitoring and administering import contracts.

Techniques for monitoring and administering import contracts

The process of import procurement is a long one that begins with the buyer's identification of a need and of the product to meet that need and ends with the receipt of the goods from the foreign supplier in conformity with the agreed terms and conditions. This process has three distinct stages: the pre-contract stage, the contract stage and the post-contract stage. Each of these stages requires many management decisions and follow-up actions that are important for ensuring that procurement objectives are fully achieved.

The pre-contract stage consists of identifying the specific product that will best meet the importer's requirements, assessing the market situation, identifying potential suppliers, inviting bids and evaluating offers submitted. The contract stage establishes a relationship between the importer, who agrees to buy a given product or service, and the foreign seller, who agrees to supply the specific product or service. The contract stage is important for the next phase, the post-contract stage, because it lays down the rights and obligations of the two parties. The post-contract stage is concerned with implementing the duties assumed by the importer and the exporter under the contract. It is during this period that the important functions of contract monitoring and administration must be exercised.

Managerial functions

The successful implementation of an import contract involves two types of managerial functions: monitoring and administration. Contract monitoring refers to the activities that the importer carries out to ensure that he discharges his obligations on time and also that the supplier is carrying out his part of the responsibilities under the contract.

Contract administration goes a step further and is involved with overcoming problems that arise during the course of contract implementation not foreseen when the contract was drawn up.

Contract monitoring, the simpler of the two functions, is largely routine in nature and can usually be handled by junior managers or clerical staff. Contract administration, on the other hand, should be the responsibility of managers at a higher level, usually those originally involved in drawing up the contract. For especially complex contracts, such as imports of projects, machinery, plant and equipment, outside expertise may be needed for both monitoring and administration purposes.

Monitoring actions

Monitoring duties have to be performed by the importer at different points in time over the contract implementation period. Unless the importer institutes a system that reminds him at the appropriate time of his contractual obligations, he may either forget to take the required actions or be late in doing so. Equally important for the importer is to be alerted early when the supplier is not discharging his obligations in accordance with the schedule of the contract.

The types of monitoring activities that the importer should be concerned with will depend on the terms and conditions in the contract as well as the nature of the product. For example, his monitoring activities associated with a contract on "ex-works" terms will differ from those under "delivered duty paid" terms. For products bought repetitively, contract terms and conditions tend to be standardized, and monitoring activities become routine over time. For items purchased to meet a special need, however, which must be manufactured to particular specifications, the terms and conditions may be drawn up specifically for that situation and necessitate close surveillance of the production process.

Examples of activities that the importer should monitor include arranging for in-process inspection with the supplier (in the case of complex goods), "nominating" the ship (i.e. notifying the supplier of the name of the ship), choosing the agency for pre-shipment inspection, examining the goods for any loss or damage at the place of discharge, lodging claims if necessary, clearing goods through customs, checking them for defects and nonconformance to the specifications, and making payments when due. The importer also has to monitor that the supplier is fulfilling his obligations such as making the consignment ready for shipment, carrying out pre-shipment inspection, arranging for carriage of the goods, arranging for insurance (depending on the sales terms), sending the shipment advice and the required shipping documents to the importer, and settling any claims.

The sequence of these events depends on what has been agreed between the importer and the seller in the contract. For example, payment for supplies may have to be made towards the end of the contract, on receipt of shipping documents as evidence that the supplier has dispatched the goods. Alternatively, payment may be scheduled at different points during the contract period, for instance the first installment when the contract is signed, a second sometime thereafter and the balance upon the importer's receipt of the shipping documents.

Monitoring lead times: The advisability of organizing monitoring activities around the terms and conditions in the contract lies in the fact that each of these provisions specifies or implies not only the actions to be taken by one party or the other but also indicates the dates by which the actions should be completed.

The preparation period, or lead time before the action, varies from one contract to another. Effective monitoring therefore requires identifying the date by which the decision or operation should be completed according to the contract and the time when management action should be initiated to be completed in time. (The identification of the second of these two dates is important for those responsible for administering the contract.)

Sequence: While the sequence of events and the associated activities may differ from contract to contract, depending on the particular terms and conditions, receipt of the following should be carefully monitored: the supplier's advice of readiness to ship the goods, the shipping advice, shipping and other documents, and the goods arrival notice.

The receipt of each of these requires a series of actions by the importer.

In some cases the importer will not fully achieve his procurement objectives if he does not take certain decisions in time. For example, if the contract provides for him to exercise a quantity option by a given date, the supplier may refuse to deliver the increased amount if the option is not notified to him in the period foreseen.

Likewise if, under an FOB contract, the importer fails to conclude a contract of affreightment with a shipping company well before the expected date of receipt of the shipping advice, the shipment of the goods will be delayed.

Preventive monitoring: The contract terms and conditions may, among other things, require the supplier to keep the importer informed of the implementation status of his own obligations. Rather than wait for a report from the supplier, the importer should take the initiative and make a routine inquiry with the supplier well ahead of the action concerned. Preventive monitoring of this type reassures the importer that he will receive the goods on schedule if this is the case, or, alternatively, inform him of a late delivery in time to take required action.

Contract administration

Contract implementation rarely, if ever, proceeds smoothly. Problems usually arise that have to be resolved and may require modifications in the terms and conditions of the contract. Contract administration is concerned with overcoming these problems. The complexity of administration depends on the type of contract and the nature of the product.

The problems that arise in contract administration may include: interpreting the terms and conditions of the contract, ensuring product quality, selecting quantity options, changing the delivery schedule, responding to price adjustment requests, terminating the contract, handling disputes and claims, following payment provisions and evaluating supplier performance. The contract administration staff also have responsibilities in relation to the contract of affreightment, the contract of insurance and financial guarantees connected with a contract.

Interpreting contract terms: The need often arises under an import contract to interpret the precise rights and obligations of the importer or the foreign supplier, despite good will on both sides.

For example, in an FOB contract the supplier is obliged to deliver goods on board the ship. Having done so, he may assume that he has discharged his contractual responsibilities. This in only partially true, as he must also ensure that he has delivered the goods of the quality specified in the contract. Under contract law the supplier has not in fact discharged his primary obligation until the importer has had a reasonable chance to examine the goods to determine their adherence to quality requirements. In the event of goods not conforming to specifications contract administration staff will have to interpret the scope of the supplier's obligations to include that of his supplying the right goods.

Conformance to specifications: The problems in contract administration associated with the conformance of products to the specifications may relate to changes made in the specifications (in the design, performance requirements or material inputs) or to difficulties in connection with inspection methods and procedures and to deviations in quality.

1. Specifications: Contract specifications may be changed during the course of contract implementation for different reasons. While developing a design to the importer's technical specifications, for example, a supplier may discover that the product will not be able to perform to the importer's performance requirements. The supplier may then seek the importer's approval for changes in the design specifications. Contract administration in such a situation involves checking with the end-user on the suggested changes and, if those are agreed to, informing the supplier of the approval. As a result of the changes some provisions in the contract may have to be altered as well.

An importer may himself suggest changes in performance specifications. Changes of this type occur most frequently for machinery used to manufacture other products. For example, the importer may discover that demand for the product to be manufactured has gone up and may want the machinery on order to be able to achieve higher output than originally foreseen. This is a major change and may involve renegotiation of some of the key provisions in the contract, such as price and delivery schedule.

Material input specifications may also be the subject of post-contractual changes. For example, a supplier may find that one or more of the essential components for the product to be manufactured are in short supply. He may either suggest staggering deliveries of the finished product over a longer period or offer to use a substitute. The importer's contract administration staff will have to evaluate these alternatives, considering technical, marketing and financial factors.

2. Quality conformance: Inspection to ensure the supplier's conformance to the importer's specifications can be undertaken either by the importer or an outside agency. Procurement contracts usually give details on the methods, tests and instruments to be used for inspection, as well as the place of inspection. Problems may nevertheless arise in regard to the inspection methods themselves. Some product qualities cannot be measured by instruments, but only by individual judgment, such as the quality of a surface finish, so opinions may differ on whether specifications have been complied with. Even for product attributes that are measurable, a supplier's acceptable tolerance range may differ from the importer's. Furthermore, the test reports submitted by a supplier and those obtained by the importer's inspection office could vary.

If the goods supplied do not conform to the importer's specifications, the contract administration staff must decide whether the goods should be accepted, and if so, on what terms, or, alternatively, rejected, and if so, how to deal with the matter (for instance requesting a price reduction, returning the goods, altering the goods at the supplier's cost or disposing of them, and negotiating compensation for the option chosen).

Variation in order quantity: As mentioned above, it is not uncommon for an importer to experience an increase (or decrease) in his requirements during the course of contract implementation. A prudent buyer always insures himself against a variation in his requirements by including a provision in the contract for a quantity option (for instance [+ or -] 10%) to be exercised within a specified period before the delivery date, at the agreed price. The contract administration staff are responsible for reviewing the requirements and if necessary exercising the option within the stipulated time. If the contract does not provide for this possibility, but the importer would like to alter the order, it is the job of the contract administration office to raise the question with the supplier and be prepared to discuss the price for the additional quantity (or possibly compensate the supplier in case of a quantity reduction).

Delivery schedule: The importer (or the supplier) may wish to alter the delivery schedule agreed to in the contract. For instance, if demand for the imported product decreases, the importer may prefer to delay delivery so that no unnecessary stocks accumulate, while if demand rises, he may want the delivery schedule to be moved forward. Or, because of port congestion, the importer may wish to defer the shipment or divert it to another port. The contract administration staff must negotiate such changes with the supplier including any additional freight charges that may be involved.

Price adjustment: The need to review contract prices may arise either because of a change in the supplier's obligations under the contract or a specific provision for price adjustment in the contract.

The supplier's contractual obligations may be revised during contract implementation for reasons such as revisions in contract quantities, product specifications or in delivery terms, as discussed above. Such changes may require adjustments in the contract price, which is part of contract administration.

Some contracts include a price adjustment provision that makes it necessary for the importer to negotiate prices with the supplier or make price adjustments in accordance with methods outlined in the contract. Examples of such provisions are those concerning open-end pricing, price variations and cost-plus fixed fees.

In open-end pricing contracts, no specific price is mentioned in the contract. Instead the price is the market price prevailing on the day of delivery. This pricing system is usually applicable to products traded on commodity markets. A variation of this system is for the price to be the average of X number of days preceding delivery date. The task of contract administration in this case is to collect market prices for the relevant dates and take the average agreed upon.

In the case of a price-variation clause, under high-value contracts in which fabrication, installation and commissioning extend over a long period, a supplier may wish to protect himself from cost increases. In the same way, an importer may wish to take advantage of reduced prices in the future, in the case of a falling market. If the basis of the price-variation clause is well defined, the administration of the clause is relatively easy, entailing the collection of the necessary data from agreed sources.

The system of a cost-plus fixed fee is more difficult to administer than the two adjustable pricing methods mentioned above. The major disadvantage of this system is that the supplier has no incentive to control his costs. The task of contract administration is to constantly monitor costs and try to convince the contractor to hold costs down.

Contract termination: A procurement contract generally comes to an end when the goods are delivered satisfactorily and payment is made. It may, however, terminate in an unexpected manner, because of external circumstances, by mutual agreement, for convenience or by default.

If the supplier is able to carry out his contract obligations only partially due to unforeseen circumstances and through no fault of his own, the contract is considered to have been terminated "by performance," and the importer has to pay for that portion of the obligations that the supplier was able to carry out.

Because a contract is a mutual agreement between the importer and the seller, the same parties may terminate it at any stage of its implementation, if they mutually agree.

Termination for convenience sake is sometimes provided for in a contract clause to enable either party to cancel the contract if they consider such an action to be in their best interests or to reflect changes in circumstances. For example a new product may be developed that is more efficient than the one specified in the contract, or the importer himself may in the meantime develop a new design for his manufactured product, making the goods under contract unsuitable as inputs. In such cases those responsible for contract administration must carefully weigh the benefits against the costs of cancellation, as the importer will have to compensate the supplier in accordance with the contract terms.

Under contract termination by default, one of the parties fails to carry out his obligations under the contract and a breach of contract occurs. The other party then has a right to terminate the contract. The defaulting party must subsequently compensate the aggrieved party, either on the basis of negotiations or specific provisions in the contract spelling out the extent of compensation, arranged through contract administration staff.

Disputes and claims: Although a well written contract specifies the rights and obligations of the two parties, claims nevertheless often arise in the course of contract implementation. A number of intermediaries are usually involved in the purchase of imported goods, and when damage occurs, it is important for the importer to determine where it happened, before filing claims. It is thus important in contract administration to be aware of the obligations of each party.

Payment provisions: Administration of payment provisions is relatively simple in a fixed-price contract and when payment is to be made on receipt of either the goods or a clean set of documents of title to the goods. It may become complex, however, in the case of progress payments, as payment is linked to progress of implementation, according to the time schedule and the specifications agreed in the contract. In a cost-reimbursement contract an important task of contract administration is assessing the correctness of cost claims submitted by the supplier before releasing the payments.

Contract of affreightment: When the terms and conditions of the contract provide that the importer has to arrange transport for the goods, the importer has to conclude a contract of affreightment and to administer it in accordance with the terms established under it. Effective contract administration is particularly important when the goods are unloaded from the ship, as a means to establish the responsibility for any damage to the goods while they were in the custody of the shipowner.

Contract of insurance: Contract administration in regard to insurance also depends on the terms of the contract. In a CIF contract, the foreign supplier is responsible for taking out insurance, while in an FOB or a C&F contract the importer has this task.

In the event of damage or loss, those responsible for contract administration must notify the insurance company; make a written claim against the carrier, port authorities or other parties; apply for a survey at the docks by the carrier's representative, port authority or other parties and file a claim against any of them when their responsibility has been established; give written notice to the carrier's representative within three days of delivery if the loss or damage was not apparent earlier; in case of nondelivery, obtain from the carrier's representative a nondelivery certificate; and obtain, when appropriate, a copy of a "master's protest," certifying any unusual conditions of the voyage that may have contributed to the damage or loss. As soon as these actions have been taken, the contract administration office should file a claim with the insurance company.

Guarantees: To protect himself against supplier default, an importer may require the supplier to provide financial guarantees at the time of concluding a contract. Such guarantees are made by a third party, usually a bank. The most common types are bid bonds or tender guarantees and securities; performance bonds, guarantees and securities; and advance payment guarantees. One of the responsibilities of contract administration is to release payment under such guarantees as soon as requirements have been completed.

Project procurement

Import procurement of industrial and infrastructure projects is of a different nature than that of products. Project imports usually involve the purchase of an entire range of products--some in primary form, some semiprocessed and some manufactured--as well as of services, process knowhow and technology. The supplier's contractual obligations may also include the assembly and installation of plant and equipment, plant operations and maintenance, and the training of operators. Projects can be grouped into different categories depending on the degree of the importer's own involvement in managing, installing and commissioning the protect. In a complete turnkey project, in which the supplier hands over a fully operational plant to the importer, the importer's responsibility in project management (that is, coordination of different activities) is negligible. In other cases of project imports, however, the importer may be responsible for a wide range of monitoring and administrative functions.

In project procurement an importer often finds it necessary to seek outside technical advice for supervision and coordination of the project. Contractual arrangements for this purpose may be concluded between the importer and different outside parties, such as a consulting engineer firm, a prime contractor and subcontractor(s). The importer's responsibilities in monitoring and administering a project contract in which these outside firms are involved depend on the specific terms and conditions of the contracts drawn up with the firms. Rather than leaving all contract management and administration to the consulting engineer and/or to the (prime) contractor(s) and relying on legal recourse in case of difficulties, the importer should be closely involved in monitoring and administering the contract so that problems with the contractors are settled expeditiously and amicably.

Monitoring: Implementation of contractual obligations by different subcontractors has to be scheduled and synchronized. If the performance of any of the suppliers is affected by a lack of effective coordination by the importer, the importer will have no recourse to penalties for delays in the implementation schedule of those contractors. On the contrary, the importer may have to pay compensation to other suppliers.

Contract monitoring can therefore seldom be handled effectively by a simple sequential or chronological listing of activities. The more complex the project, the more sophisticated the method of contract monitoring must be. Various methods, including some involving computerized applications, are used to monitor project contract implementation, but for space limitations are not discussed here.

Contract administration: Some of the problems that may arise in contract administration for project imports are similar to those that importers of products have to face, discussed above. In addition, however, other problems are more specific to project imports, including latent conditions, changes in the scope of work, design faults, hardship clauses, nonavailability of supplies and changes in costs.

Latent conditions are situations that could not reasonably be foreseen at the time of contract negotiations. For example, the civil contractor may strike rock rather than clay during foundation work, necessitating rescheduling of subsequent activities including, for example, postponing the delivery of machinery. The contract administration staff must alert the supplier of the machinery and settle any claims for compensation to cover storage and/or damage risks to the machinery during the extended period.

Concerning the scope of work, it is not uncommon for changes to occur during project implementation, mostly at the importer's request, in terms of performance standards or material inputs. This again entails responsibility of the project administration staff to negotiate appropriate contract amendments with the supplier.

Faults in the design of the project sometimes come to light only during the course of implementation. In such a case the contract has to be reviewed and new negotiations undertaken with the suppliers of equipment, machinery and other inputs.

Hardship clauses are similar to "force majeure" provisions, although they are not strictly legally the same. A hardship situation is one in which fundamental changes (for instance civil conflict) take place, as a result of which the supplier has difficulties in discharging his contractual obligations without amending the contract. Such cases warrant a review and renegotiation of the original contract.

It is not uncommon for developing countries to experience periodic shortages of critical inputs such as cement or steel, which can create problems in project contracts providing for the maximum use of domestic supplies. In such a situation, the importer's administration staff may have to discuss the matter with the appropriate government agencies, either for priority allocations from domestic suppliers or the release of foreign exchange for imports. The contract may have to be amended if the supplier incurs financial losses as a result.

Changes in costs in project imports can occur for a number of reasons, for instance because of changes in import duties or a default of the importer, for example not ensuring access to the project site. Contract administration involves settling the supplier's claims for such situations.

Conclusion: Effective contract administration is essential to the success of a project import. This requires an in-depth understanding of contract terms and conditions, as well as efficient monitoring to bring problems quickly to the buyer's attention, a clear view of the options in dealing with those problems, and careful assessment of the advantages and disadvantages of each option.

PHOTO : An importer should be certain that contractual duties are implemented.

PHOTO : Preventive monitoring will reassure the importer of timely delivery.

PHOTO : Despite good will on both sides, contracts often need interpretation.

Hari K. Raina is an ITC adviser on import operations and techniques. This article is based on a new import guide that he wrote for ITC on contract monitoring and administration in import procurement.
COPYRIGHT 1991 International Trade Centre UNCTAD/GATT
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Author:Raina, Hari K.
Publication:International Trade Forum
Date:Apr 1, 1991
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