Over the last few years, software providers have increasingly offered so-called “obligation management” tools to contracting parties to:
- more effectively manage their own obligations under a contract (or specific group of contracts); and
- more importantly, measure the performance of their contract counterparties.
The expansion of these tools in the marketplace is based on the very real risk that a company may be losing money or increasing risk by over managing, under managing or, worst of all, inaccurately managing its portfolio of supply contracts. In considering whether to adopt an “obligation management” software tool to address this very real risk, focus first on the basic underpinnings of “obligation management” in your existing supply chain contracts and negotiations of future supply chain contracts. Conducting that evaluation of your existing contracts will allow you to identify risks and opportunities for negotiation of new contracts and allow you to better marry any potential technical obligation management tools to your contract environment, potentially turning in-house teams from SG&A on the income statement into their own profit center.
With that goal in mind, this article focuses on one key component of obligation management – increasing obligation tracking and traceability.
Reporting and Recordkeeping
In order to track and trace your counterparties’ obligations, you must have a data set from which to work. In the context of a commercial contract, the mechanism by which you create this data set – or, at least, the possibility of having a data set – is via reporting and recordkeeping obligations.
With respect to reporting, as part of the negotiation process, your side must have a clear understanding of the type of information that you will be able to aggregate on your own versus information that you will need to obtain from your counterparty. With respect to this latter category, key considerations include:
- Frequency of reporting. This is often a balance between not overburdening your in-house legal and compliance teams (and your counterparty’s) and creating meaningful, periodic information flows. Regardless, reports should be tendered on a frequency that will enable your company to manage its other supply chain obligations and also enable your company to make timely determinations with respect to renewal periods, payment of any service level credits, and other potential remedies.
- Method of reporting. Information format is as important as the actual information that’s conveyed. Consider the local mayor who, in response to a public information request from local media, made the thousands of hard copy documents available for inspection at city hall rather than providing the documents electronically as the media had hoped. The mayor complied with the legal request but the media did not get the searchable record they wanted. Supply chain contracts should expressly set out the format for conveying the required information to ensure it can be aggregated and/or machine analyzed in the future
- Detail of reporting. Reporting obligations should expressly include all information your company requires. However, reporting obligations should also allow your company to reasonably request additional information, particularly from a long-term partner. Such rights give your company the flexibility to maintain all flow-through information it may need to satisfy vendors, suppliers, and/or shipping partners that are on-boarded at a later date.
Information audit rights function as not only information management tools, but they also provide powerful incentives for contract counterparties to honor their informational obligations, particularly if coupled with cost recoupment remedies. Key audit provision considerations include:
- Scope of audit. Don’t limit your audit right to your counterparty’s payment obligation. Instead, make sure you are entitled to all information respecting the counterparty’s performance under the contract. Making sure you can audit all contractual obligations will give your team the ammunition needed to enforce obligations on your counterparty. Also, when dealing with counterparties with complicated corporate structures, your audit rights should extend to affiliates of your contract counterparty, especially if affiliates will be providing any direct or indirect services.
- Flexibility to choose your auditor. Oftentimes, the party being audited will contractually require that the auditor be “reasonably acceptable” to it, or the parties might expressly require a “Big 4” audit firm. However, as obligation management tools become more commonplace, I suspect so will contingency fee auditors. As a party subject to an audit, would you view an auditor on a contingency fee engagement as “reasonably acceptable” to you? Look for this to become a hotly negotiated topic in the coming years.