Contracts in all forms are embedded in virtually all parts of University operations and represent a vital and integral support mechanism in furthering Harvard's mission. They come in many styles but most often take the form of a consulting services agreements, licenses, memoranda of understanding, real estate leases, equipment or fixed asset leases, purchase orders, partnership agreements, research grant applications and associated award and/or sub-award agreements. They are used to arrange for the delivery of every day supplies, basic services, and for the performance of specialized services in the areas such as publishing, architectural/engineering and design, financial advisory, cloud based IT infrastructure and applications, and research data analytics. Given the wide spectrum such activities entail, it is incumbent on all who are involved with the negotiation and execution of contracts to understand the risks involved and employ prudent control strategies to mitigate them.
Contracts can be verbal or written and are used to create or expand the relationship between two or more parties and define the conditions of how each will interact within a given set of circumstances. To be valid and enforceable in the US(1), all contracts must have the following basic components:
- Consideration - each party to the contract must be providing something of value to the other, such as a product, service, or payment.
- Offer and acceptance - an offer made by one party, such as to provide a good or service, is accepted by the other, often for payment
- Intention to create legal relations - the parties to the contract must intend for the contract to be legally binding, and if such intent is not the case, it should be clearly stated within the document
- Legal purpose - in order to be legally enforceable, the contract must be for legal purposes
- Competent parties - the parties entering into the contract must be capable of making the contract and understanding what they are doing
While contracts can include any number of parties, the most common type of contract is between two-parties with one acting as the supplier, provider or lessor and the other party as the purchaser, buyer or lessee. Each time a member of the Harvard community enters into an enforceable contract, they could be obligating the University to perform whatever commitments are prescribed in the agreement, however costly or difficult. Individuals authorized to execute contracts on behalf of Harvard, therefore, have a duty to act in the best interest of the University without assuming unreasonable risk. Consistent with the role Harvard holds in a particular contract situation and PRIOR to undertaking negotiations with the other participant(s), it's important to ascertain the business objectives (opportunities) behind the contractual relationship, the business risks created by entering into the relationship, and whether the proposed compensation is equitable given the services to be performed/delivered when weighed against the allocation of those risks.
During negotiations and PRIOR to contract execution, one must conclude whether the risks inherent to the relationship are satisfactorily addressed by specific language in the agreement, via representation, warranty, default, and allocation of risk clauses. This is best accomplished by having the final draft version reviewed by a knowledgeable person (e.g. a representative from Strategic Procurement or the Office of the General Counsel) not directly responsible for ratifying the deal. Such contract reviews typically entail: 1) estimating the magnitude of identified risks associated with the desired business venture, 2) deciding whether the projected impact of those risks exceeds the buyer's risk appetite, and 3) evaluating and implementing appropriate transfer and/or financing mechanisms for losses that are beyond the declared risk tolerances of which the underlying economics do not support assumption.
Proper and consistent treatment of contract risk (via transfer and/or financing mechanisms) is a significant lever for controlling the overall cost of risk for the University. It is not the role Risk Financing and Insurance to mandate universal contract formats and content be used across the organization but to offer guidance on the choices available to Harvard associates in aligning their risk appetite with the particular aspects of the deal at hand. While the Department maintains some limited financial resources for supporting legal liability risk assumed by TUBS, mainly in the form of the master insurance program, the policies have certain limitations in size and scope. Therefore contracting parties should consider themselves as the primary holder and financially responsible party for contractually assumed risk unless otherwise transferred via written agreement.
Allocation of Risk
Contractual risk transfers are intended to assign responsibility (financial or otherwise) for associated risk exposures to one party or the other. Contractual risk transfer can relieve the person or organization originally responsible for the risk (the "transferer") by assigning it to one or more of the contract's counterparties (the "transferees"). Within a contract, risk transfer is primarily accomplished through a combination of indemnification/hold harmless, limitation of liability, and waiver of subrogation clauses. Unless specific circumstances dictate a Harvard procurement manager fully accept the financial consequences for a negative event, it is highly recommended that contracts be structured to allocate responsibility for risk to the party that creates it and/or is best positioned to mitigate its impact.
Indemnification/Hold Harmless. An indemnification clause obligates one party (the "indemnitor") to compensate the other party (the "indemnitee") for losses or damages (physical injury or monetary) caused by that other party. In its purest form, indemnity is intended to save a party from the legal consequences or from the outlay of money for defense costs, damages, etc. thus shifting all or partial responsibility for payment to the party who caused the damages. Indemnification clauses are often closely tied to representations or warranties, which are promises that specific things are a certain way.
Limitation of Liability. Sometimes referred to as a damages cap, it seeks to limit the amount payable in damages on a breach, restrict the types of loss recoverable or the remedies available, or imposes a short time frame in which damages are recoverable. It is common to base the cap on a percentage of the value of the contract.
Waiver of Subrogation. An agreement between two parties in which one party agrees to waive subrogation rights against another in the event of a loss. The intent of the waiver is to prevent one party's insurer from pursuing subrogation against the other party. Subrogation occurs when an insurance company pays its insured and then sues the entity or person responsible for the loss to recover the amounts paid to their insured.
Along with the allocation of risk clauses, it is common for transferers to require transferees to carry certain types and amounts of commercial insurance as a means to assure financial resources will be available should a loss occur. Because it’s likely the typical vendor, independent contractor or landlord in Harvard’s supply chain does not have sufficient liquidity, should they be called upon, to fulfill their indemnification obligations for a major loss event, all vendors and independent contractors selling goods to Harvard, having a presence on Harvard premises, or providing services to or performing work on behalf of Harvard should be required to maintain minimal levels of commercial insurance covering claims or loss arising out of the delivery of those goods and/or services. This requirement to maintain insurance also applies to all persons and/or entities providing goods and/or services to Harvard indirectly through such vendors/contractors (e.g. "subcontractors"). [Note: Contractors providing construction services and firms providing building design or engineering services for capital projects (as defined by Harvard CAPS) should instead comply with the minimum insurance amounts specified in Harvard’s Standard Construction and Design contracts which are available on the Capital Projects (CAPS) website.
Implementing the Guidelines and Recommend Practices
The Risk Financing and Insurance department has published recommended contract risk management standards applicable to the various scenarios most procurement managers, contract specialists or leasing agents are likely to encounter. In general, the most fundamental risk management tool University buyers can and should employ when entering an agreement is to select and thoroughly vet their counterparty to verify they possess the necessary means and capabilities to supply the desired goods or deliver on the agreed upon scope of services. Beyond that, individuals drafting and/or negotiating agreements should consider these attributes as standard practice for all contracts(2):
- Agreements should not contain any limitation to, cap on, or waiver of Harvard’s right of recovery for direct or consequential losses arising out of the delivery of goods and/or services to Harvard, or which limits a provider’s liability for such losses;
- Each agreement should contain an indemnification provision conferring indemnitor status on the provider for liability (direct, indirect, and consequential including reasonable defense costs) arising out of the delivery of the goods and/or services described in the scope of work.
- The provider, including all of their subcontractors, should be required to post and maintain the minimum types and amounts of commercial insurance typical for the nature of goods being provided or work described in the scope of services.
The Office of the General Counsel and Office of Strategic Procurement both are experts in drafting and negotiating agreements governing an array of situations; both groups are also cognizant of the benefits of prudent risk assumption and the consequences of inadequate insurance coverages of a provider. Utilizing either group in finalizing contract terms and conditions has two benefits: first, the procuring TUB no longer has to consult with the Risk Financing and Insurance department seeking a review/approval of particular contract wording and therefore is likely able to expedite agreement execution. Second, each is able to, based on local business needs and risk factors, modify the standard contract risk allocation and insurance language (dealing with limitation of liability, waivers of subrogation, indemnification/hold harmless, and minimum insurance coverages) that would normally be expected to apply.
Failure of a buyer to solicit and implement guidance from either group or otherwise adhere to the contract risk management standards and practices presented herein exposes the University collectively and their individual academic or administrative unit to potentially significant financial loss. Although Harvard maintains its own programs of insurance, there are certain types and portions of losses that Harvard can’t or does not insure against. As such, for liabilities arising from a provider agreement that were magnified by allowing less stringent terms than those recommended above, the responsible TUB will absorb the increased financial consequences imposed on the University for the portion of a loss that would have been recoverable from the provider if the applicable standards and practices had been followed
While the Risk Financing and Insurance department remains available to any University department or affiliate for a consultation to assist with risk analysis efforts and advising on appropriate risk financing solutions, we strongly urge any group looking for specific guidance on contract language allocating (assumption/transfer and minimum insurance wording) risk contact OGC or Strategic Procurement for help. As of April 2015, the Risk Financing and Insurance department will no longer be evaluating these aspects of any vendor, independent contractor or consultant agreements, instead will refer all such inquires to the OGC or Strategic Procurement for incorporating of the noted risk and insurance standards.
(1) while similar requirements exist in many non-US jurisdictions, subtle differences in local laws and legal environment can create unintended impacts on contractual terms. Qualified legal counsel with a working knowledge of local conditions and business practices should always be consulted before entering into contracts outside the United States
(2) not applicable to construction agreements on capital projects; see HPPM/CAPS website for model agreements reflecting standard practices applicable to capital projects.