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Contract
Types
Introduction Contracts are the basis of many of our daily activities They provide the means for individuals and businesses to sell and otherwise transfer property, services, and other rights Without enforceable contracts, commerce would collapse. A contract is a legally binding agreement between two or more persons for a particular purpose.
In general, contracts are always formed on the same pattern. A person offers to give another person something (for example: to deliver an item in return for a certain price); to provide a service (to work for a certain salary); or to refrain from doing something (not to compete for a period of time in return for compensation). If the offer is accepted, the contract is then valid in principle. A contract is, above all, an instrument for the economic exchange of goods and services.
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Conditions
To be valid and therefore legally binding, five conditions must be met. First there must be the mutual consent of both parties. No one can be held to a promise involuntarily made. When consent is given by error, under physical or moral duress, or as a result of fraudulent practises, the contract may be declared null and void at the request of the aggrieved party. In certain types of contractual relationship, the law demands that the consent of the party be both free and informed. This is the case, for instance, with contracts involving medical treatment.
The second is contractual capacity – the mental ability to keep the promise one has made. A young child, a person suffering from a serious mental disorder and sometimes even a minor are all considered incapable of contracting. The third condition is that the contract should have an object or a purpose; it must concern a specific and agreed-upon good or service. The fourth condition is "lawful cause" in civil law or a "valuable consideration" in common law.
In this area, important technical differences exist between the two legal systems. Briefly, according to this fourth condition, the promise made must be serious and each obligation assumed by one of the parties must find a corresponding, but not necessarily equivalent or equal, promise made by the other party. A person may thus legally sell goods at a price that does not represent their actual market value. The contract would still be a valid one.
The fifth condition, which is not required in all cases, is the compliance in certain circumstances to formalities provided by law such as, for instance, a valid written instrument. In general, this condition holds for contracts that may have serious consequences for the parties, or those for which certain measures of publicity are required.
Parties to a Contract
•Offeror – The party who makes an offer to enter into a contract
•Offeree – The party to whom an offer to enter into a contract is made
In an offer and acceptance, the party who initiates, or makes the offer, is known as the offeror; the party to whom the offer is made is known as the offeree.
• In valid contract offers, there must be serious intent on the part of the offeror.
• When a company or business encourages the purchase of a product or service through advertising, this is an invitation to treat. A contract occurs when the product or service has actually been purchased.
• The offer must also contain definite terms, or details. Some terms are clearly defined while others are impli
Elements of a Contract And above all this an offer and acceptance Offer, Acceptance, Consideration
• In every valid contract, offer, acceptance and consideration are vital aspects.
First: An offer is made that contains all of the important and relevant terms of the contract. Second: Another party agrees to, or accepts, the offer.
Third: After the offer is accepted, something of value (an item or service) is exchanged between the parties involved in the contract. This is called consideration.
Capacity, Consent, Lawful Purpose
• In every valid contract, both parties must have the ability, or capacity, to understand the terms and nature of the contract.
• Each party involved in the contract must also freely consent, or agree, to the terms in the agreement.
• Finally, every contract that is negotiated in Canada must have a lawful purpose or objective; in other words, no contract can violate any law.
Consideration
• After an offer is accepted, something of value must be exchanged between the parties who are involved in the contract.
• The actual value or amount exchanged between the two parties (consideration) does not matter to the courts. A contract can appear to clearly favour one side over the other.
• A court simply wants to see that there is some degree of exchange or consideration involved in the contract.
Capacity
• A contract will only be considered valid in court if the offeror and offeree had the capacity to understand what they were agreeing to. Anyone with a developmental disability, impaired judgment,
or who is under the age of majority in capacity to enter into a valid contract. A minor may enter into a valid contract if it is considered necessary to ensure his or her health and welfare (e.g. an employment contract). If a contract is not considered to be in the minor’s best interests, it is declared void. may also be revoked, or cancelled, by the offeror before it can be accepted.
Consent
• In general, each party in a contract must freely agree, or consent, to the contract.
• An offeree must completely understand the terms of the contract.
• There are some situations that may prevent consent from occurring: – misrepresentation
– mistake
– undue influence – duress
Lawful Purpose
• No contract can violate any provision of the Criminal Code in Canada, as well as any provincial law or municipal bylaw. Any contract that is found to break the law will be declared void immediately. Each contract must have a lawful objective or purpose.
• Certain contracts require special rules or restrictions, as well as government intervention (e.g. betting, gaming, and gambling).
Acceptance
Similarly, the offeree has a responsibility to clearly communicate its acceptance of the proposed agreement. Offers may be accepted using the same methods of communication (e.g. mail, courier). An acceptance must occur before a specified time limit on the offer expires. The offeree may decide to make a counteroffer, which is a new offer, or amendment to the original offer. Any counteroffer ends the original offer.
Communicating & Terminating
Part of an offer includes communicating the proposed contract to the offeree. Common methods include communicating in person, by mail, courier, fax, and e-mail. Communication is not successful unless it is received by the offeree. An offer can be terminated, or cancelled, for various reasons.
A lapse occurs when an offer is not accepted within a period of time and the offer ends.
Sanctions
Parties to a valid contract are always bound by law to carry out their promise. Should they fail to, the other party is free to go to court to force them to comply. At times, the court may order the defaulting party to do exactly what he has promised (specified promise). In that respect, civil law provides more readily for the forced execution of promises than common law, for which specific performance appears to be still an exception to the rule Courts may also award financial compensation in the form of damages equal in value to the loss suffered and profits lost as a result of the breach of contract, but this loss and profit must be directly related to the non-fulfillment of promise
Furthermore, courts award only damages equivalent to those benefits that the parties might reasonably have expected to receive at the time the agreement was entered into. The rapid increase of class actions both in contractual and delictual fields has had a significant impact on the amount of damages awarded by courts which can in certain circumstances reach millions of dollars.
The risk shared between the buyer and seller is determined by the contract type. Although the firm-fixed-price type of contractual arrangement is typically the preferred type which is encouraged and often demanded by most organizations, there are times when another contract form may be in the best interests of the project. If a contract type other than fixed-price is intended, it is incumbent on the project team to justify its use.
The type of contract to be used and the specific contract terms and conditions fix the degree of risk being assumed by the buyer and seller. All legal contractual relationships generally fall into one of two broad families, either fixed-price or cost reimbursable. Also, there is a third hybrid-type commonly in use called the time and materials contract. The more popular of the contract types in use are discussed below as discrete types, but in practice it is not unusual to combine one or more types into a single procurement.
1. Fixed-price contracts
This category of contracts involves setting a fixed total price for a defined product or service to be provided. Fixed-price contracts may also incorporate financial incentives for achieving or exceeding selected project objectives, such as schedule delivery dates, cost and technical performance, or anything that can be quantified and subsequently measured. Sellers under fixed-price contracts are legally obligated to complete such contracts, with possible financial damages if they do not. Under the fixed-price arrangement, buyers must precisely specify the product or services being procured. Changes in scope can be accommodated, but generally at an increase in contract price.
2. Firm Fixed Price Contracts (FFP)
The most commonly used contract type is the FFP. It is favored by most buying organizations because the price for goods is set at the outset and not subject to change unless the scope of work changes. Any cost increase due to adverse performance is the responsibility of the seller, who is obligated to complete the effort. Under the FFP contract, the buyer must precisely specify the product or services to be procured, and any changes to the procurement specification can increase the costs to the buyer.
3. Fixed Price Incentive Fee Contracts (FPIF)
This fixed-price arrangement gives the buyer and seller some flexibility in that it allows for deviation from performance, with financial incentives tied to achieving agreed to metrics. Typically such financial incentives are related to cost, schedule, or technical performance of the seller. Performance targets are established at the outset, and the final contract price is determined after completion of all work based on the seller’s performance. Under FPIF contracts, a price ceiling is set, and all costs above the price ceiling are the responsibility of the seller, who is obligated to complete the work.
4. Fixed Price with Economic Price Adjustment Contracts (FP-EPA)
This contract type is used whenever the seller’s performance period spans a considerable period of years, as is desired with many long-term relationships. It is a fixed-price contract, but with a special provision allowing for pre-defined final adjustments to the contract price due to changed conditions, such as inflation changes, or cost increases (or decreases) for specific commodities. The EPA clause must relate to some reliable financial index which is used to precisely adjust the final price. The FP-EPA contract is intended to protect both buyer and seller from external conditions beyond their control.
5. Cost-reimbursable contracts.
This category of contract involves payments (cost reimbursements) to the seller for all legitimate actual costs incurred for completed work, plus a fee representing seller profit. Cost-reimbursable contracts may also include financial incentive clauses whenever the seller exceeds, or falls below, defined objectives such as costs, schedule, or technical performance targets.
Three of the more common types of cost-reimbursable contracts in use are Cost Plus Fixed Fee (CPFF), Cost Plus Incentive Fee (CPIF), and Cost Plus Award Fee (CPAF). A cost-reimbursable contract gives the project flexibility to redirect a seller whenever the scope of work cannot be precisely defined at the start and needs to be altered, or when high risks may exist in the effort.
6. Cost Plus Fixed Fee Contracts (CPFF)
The seller is reimbursed for all allowable costs for performing the contract work, and receives a fixed fee payment calculated as a percentage of the initial estimated project costs. Fee is paid only for completed work and does not change due to seller performance. Fee amounts do not change unless the project scope changes.
7. Cost Plus Incentive Fee Contracts (CPIF)
The seller is reimbursed for all allowable costs for performing the contract work and receives a predetermined incentive fee based upon achieving certain performance objectives as set forth in the contract. In CPIF contracts, if the final costs are less or greater than the original estimated costs, then both the buyer and seller share costs from the departures based upon a pre-negotiated cost sharing formula, e.g., an 80/20 split over/under target costs based on the actual performance of the seller.
8. Cost Plus Award Fee Contracts (CPAF)
The seller is reimbursed for all legitimate costs, but the majority of the fee is only earned based on the satisfaction of certain broad subjective performance criteria defined and incorporated into the contract. The determination of fee is based solely on the subjective determination of seller performance by the buyer, and is generally not subject to appeals.
Time and Material Contracts (T&M)
Time and material contracts are a hybrid type of contractual arrangement that contain aspects of both cost-reimbursable and fixed-price contracts. They are often used for staff augmentation, acquisition of experts, and any outside support when a precise statement of work cannot be quickly prescribed. These types of contracts resemble cost-reimbursable contracts in that they can be left open ended and may be subject to a cost increase for the buyer. The full value of the agreement and the exact quantity of items to be delivered may not be defined by the buyer at the time of the contract award.
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Thus, T&M contracts can increase in contract value as if they were cost-reimbursable contracts. Many organizations require not-to-exceed values and time limits placed in all T&M contracts to prevent unlimited cost growth. Conversely, T&M contracts can also resemble fixed unit price arrangements when certain parameters are specified in the contract. Unit labor or material rates can be preset by the buyer and seller, including seller profit, when both parties agree on the values for specific resource categories, such as senior engineers at specified rates per hour, or categories of materials at specified rates per unit.
The Author: Ala'a Elbeheri
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A versatile and highly accomplished senior certified IT risk management Advisor and Senior IT Lead Auditor with over 20 years of progressive experience in all domains of ICT.
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