It is important for public entities to have written contracts in place whenever doing business with a third party. It is also imperative that entities have a program in place for managing these contracts. Establishment of a contract management program begins with the development of written policies and procedures that address the review and maintenance of third-party contracts. A formal contract review process can ensure a thorough analysis and understanding of each contract, helping entities to limit their contractual exposures and protect their assets. A contract maintenance plan will further help to preserve and organize these important documents.
The Importance of Contracts
When a public entity enters into an agreement with a third party, they may be assuming liabilities that would not otherwise be their responsibility. Without effective risk transfer measures in place, the public entity may be held financially liable for a claim caused by the contracted party.
Consider the following scenarios in which a public entity did not take sufficient protective measures.
Scenario 1: A water district contracted a water operator to manage the daily operations at the water treatment facility. The contracted water operator did not have insurance, and their contract with the water district did not include either a hold harmless provision, or an indemnification provision in favor of the water district. Due to the lack of risk transfer provisions in the contract, the district will likely be responsible to pay for any damage occurring from the negligent operation of the facility even if caused by the contracted water operator.
Scenario 2: A special district hired a heavy equipment operator to perform excavation on their behalf. However, the special district did not have a written contract or agreement with the operator, who also did not have any insurance. While driving across a road to reach the excavation site, the equipment operator collided with a motorcycle, seriously injuring the motorcycle driver. Because there was no contract with provisions to protect the district, and no other insurance to cover damage caused by the negligent operation of the heavy equipment, the district was ultimately responsible to pay for the motorcycle driver’s injuries.
Scenario 3: A sewer district rented their meeting hall for a private party where alcohol was served. Following the party, a partygoer was involved in an alcohol-related crash. A signed rental agreement was not obtained. A lawsuit was filed against multiple parties, including the district, even though the district did not serve the alcohol or have any other involvement with the event. The absence of a rental agreement containing sufficiently protective indemnification and hold harmless provisions forced the district to defend itself and remain in the lawsuit.
Failing to transfer liability back to the responsible party in a contract may result in significant, unintended financial loss. Obtaining risk shifting contractual provisions and proof of insurance may have greatly reduced liability to the districts involved in these incidents.
Tips for Managing Contracts
A contract management program can help entities organize the contract process. Two essential elements of a successful contract management program are contract review and contract maintenance.
When reviewing contracts, it is important to read beyond the scope of service and pricing and evaluate all of the terms and conditions. Contract review will help entities to make informed decisions whether to avoid, transfer, or accept the risks that accompany each contract. Additionally, contract review will help entities to ensure compliance with defined responsibilities.
In addition to contract review, it is important to develop a policy for maintaining contracts. When developing your contract management program include a written policy that outlines this process, including a system to schedule, and review contracts on an annual basis.
Consider the following recommendations for your contract management program.
- Use written contracts with all third parties, including entities you intend to do work for, those doing work for you and any individuals or groups renting or using the facilities of the public entity.
- Perform reference and/or background checks prior to doing business with anyone.
- Avoid standard form contracts. Contracts should be customized to meet specific business needs and jurisdictional requirements.
- Require that any changes in the contract be put in writing.
- Arrange for legal counsel to review all contracts before they are signed to ensure enforceability in consideration of jurisdictional requirements, and to confirm the appropriate loss protection and risk transfer provisions exist.
- Identify persons authorized to sign contracts on behalf of the organization.
- Require that contractors maintain insurance to protect against potential exposures posed by provision of services or failure to provide a service.
- Require that contractors maintain insurance to protect their employees with workers compensation or disability coverage, and specify that neither the contractor nor their employees are employees of the public entity.
- Require contractors to name the public entity as an additional named insured on the contractor’s policy, when appropriate.
- Identify minimum acceptable limits of liability on the contractor’s insurance.
- Require that a properly completed certificate of insurance (COI) be provided.
- Implement a systematic process for centralizing the storage of original contract documents in a secure (locked and fire resistant) file cabinet or safe.
- Implement a system to schedule and review all contracts on a periodic basis, to ensure all terms and conditions are being met, while the contract is in force.
- Confirm the renewal and termination provisions are appropriate.
- Maintain a process to obtain and store documents that must be updated periodically, such as certificates of insurance, per the terms and conditions of some contracts.
- Maintain copies of expired or terminated contracts and certificates of insurance for a defined period, in accordance with your organization’s document retention policy.
Public entities should be proactive when managing contracts. Ongoing review and maintenance will help ensure contracts are not just filed away but that they are utilized to hold third parties accountable for the terms of the contract as agreed. Review of third-party contracts will also help entities measure the performance of third-party contractors and determine possible renewal of contracts and/or alterations in their terms and conditions.
Entities can protect themselves from third-party liabilities with written contracts; however, it is important that they understand the provisions of these agreements and continue to review and evaluate the contracts as well as the performance of the contracted parties. A contract management program provides a structure for reviewing and maintaining contracts, helping entities to limit their liability when working with third parties.