Billion Dollar Documents Back in Court

What's the price of an ambiguous insurance contract? About a billion dollars in the case of Larry Silverstein's policy over the World Trade Center's Twin Towers. That's a billion good reasons to get the fine print right.


One or two events that changed the world

Silverstein, the holder of a 99 year lease over the Twin Towers, and a syndicate of insurers that agreed to cover the property, were back in court this week, with both sides continuing their fight over the question whether the September 11 attack on the buildings was one event or two. If the two planes were a single incident, the insurers pay one amount. If the two planes were two separate incidents, the insurers pay a larger amount. The difference? Over a billion US dollars.

The problem? At the time of the attack, the parties had not clearly agreed which policy wording should apply.

In 2004, one jury decided that insurers who had agreed the Wilprop form could rely on wording that defined the attack as a single event. Another jury decided that insurers who didn't agree the Wilprop form were required to pay out on two events.

Now, both side are appealing.

It pays to get the fine print right.

Cronyism on Steroids?

When it was discovered that only four out of sixty contracts signed with a pair of external consultants went out to tender, New Zealand MP Murray McCully accused the Health Ministry of "cronyism on steroids". Now he reckons the Auditor-General's report on the matter portrays a saga of "incompetence on a monumental scale".


Tell us what you really think, Murray.

The Report doesn't paint a pretty picture of procurement policy compliance within the Ministry. Amongst Auditor-General Kevin Brady's many findings are these gems:

• Most officials did not have a copy of the procurement policy.
• Most officials were somewhat vague as to where they might locate a copy.
• There was a general lack of awareness among officials as to what the policy actually required.

What conclusions can we draw from all this? Perhaps the obvious one is that producing a nice fat policy on something is no guarantee that anyone will follow it.

So how do you get people to follow procurement policy?

Despite making 17 recommendations for improvement, the Auditor-General missed one obvious point. That making people aware of a policy is still no guarantee they will follow it. This is particularly true when the policy is long and complex, and the time available to learn and understand it is limited. Another approach, and one which some government agencies are starting to adopt, is to develop procurement systems that guide users naturally toward compliant outcomes.

The Case of the Disappearing Contracts

Apparently 75% of US companies can't find 90% of their contracts. Gone. Missing. Lost. This is one of the more sensational stats to be found in a recent article on post-contract management at SupplyManagement.com. It's an interesting look at who's doing what when it comes to managing contracts once the ink is dry.


At last... the missing contracts

A common theme seems to be the disconnect between procurement experts who negotiate the contract, and the technical people who manage its performance. Contracts are signed, put in the bottom drawer, and never looked at again. The article cites one example where a London based financial services company was overcharged £15 million over 12 months because it failed to reconcile invoices against the negotiated terms of the contract.

With quotes and examples from o2, British Airways, Novell, Eli Lilly, Adecco, HM Prison Service and University College London, there's an interesting mix of ideas for improving contract management.

Technical Breach OK?

According to a report in today's Australian Financial Review (In breach but in with a shot, 24/2/2006, p12) sometimes it's OK for a vendor to employ a serving Defence Force employee to assist with a tender for a multi-million dollar defence contract. It might be a breach of departmental regulations, and presumably the conditions of tender, but according to the Inspector-General of Defence, it's only a "technical" breach. Apparently they're OK.

Since the officer had no connection to or involvement in the project for which tenders were called, the vendor received no improper or unfair advantage.

So, what did the vendor get for its $48,000 fee? Two months help with the bid. That's all.

Wanna buy some SOX?

Talk about over-used and abused. SOX compliance is one of those buzz words that just about eveyone has a "solution" for. Google "Sarbanes-Oxley" and you get over 27 million hits. Google "SOX compliance" and you get just under 5 million hits. That's a lot of hits. But what does it mean for your contracts? Or more specifically, what does it mean for your purchasing contracts?


Have I got an Act for you...

A recent article from SAP INFO got me thinking about these questions. Time to get a handle on what the Sarbanes-Oxley Act means for those who create and manage contracts on a daily basis.

If I'm buying a load of sox, do I need to worry about SOX?

For large US companies (and international companies who list in the US), the answer is yes, you do need to worry. In particular, it seems, you need to worry about section 404. Or if you don't, then your boss does.

Section 404 is all about internal controls for financial reporting:

• management must establish and maintain internal controls;
• management must assess whether they're working;
• management must report on all this in the company's annual report;
• the auditors must report on management's report.

So, when you go buying sox (or anything else for that matter), the executive suite needs to be able to say that there are adequate controls in place to ensure that your contracts don't mess up the company's financials. They need to know that you can't just go and buy sox worth $100 million when the company only needs $100 worth. Or that if you buy sox that turn out to be a fire hazard, the contract passes that risk on to the company responsible. If there are no such controls, and they have no idea what risks and liabilities are buried in your purchasing contracts, then they need to report on those weaknesses and have the auditors tick off that report.

One firm that paid a heavy price for weak internal controls is Adecco, a global temp agency with about 700,000 employees and annual turnover of $20 billion. According to a report in The Economist (19 May 2005), material weaknesses in Adecco's 2003 accounts meant that the auditors refused to sign-off without first checking every single transactions worth over $100. Six months, 160 auditors, 15 law firms, and $120 million in fees later, the accounts were signed off. In the words of Adecco's John Bowmer "It was a fee fest". Ouch.

Dis-Kinnected

Contract certainty may be a major problem for the London insurance market, but Kinnect is no longer part of the solution.

Despite investing several years and many millions of pounds in its Kinnect insurance trading platform, Lloyd's has now decided to shut it down.

Breaking 300 years of face-to-face, pen-on-paper contract negotiation tradition was never going to be easy.

More on this later...

Avoiding Contract Scandals 103

When the blame game begins, ignorance is rarely a good defence. It does, however, seem to be a very popular defence. Which brings us to the third lesson in this series.

Lesson 3:

Don't stick your head in the sand when your contract prices mysteriously go up, just as market prices around you are going down.

There's another name for prices that seem too good to be true: kickbacks. And with AWB accused of kicking back around $300 million to Saddam Hussein's regime, everyone wants to know who knew.

Not me, says AWB boss Andrew Lindberg. He has no recollection of puffing up the price of wheat contracts in order to funnel cash from the UN oil-for-food program back to the former Iraqi regime. After four days of questions, and around 200 "can't recall" answers, counsel assisting the special inquiry had this to say:

"It's ridiculous to suggest that you did not know, Mr Lindberg. Are you a complete fool?"

The inquiry continues.


Lindberg can't recall

Avoiding Contract Scandals 102

As the old saying goes: It takes two to tango. Which brings us to the second lesson in our contract scandal series.

Lesson 2:

Don't offer a cushy job to the procurement official who just awarded you a contract at an inflated price.

Failure to heed this lesson cost former Boeing CFO, Michael Seers, his job. And it landed him a four month prison sentence. All because he offered Darleen Druyan a job at about the same time she awarded his company a $23 billion contract.


Sears cops 4 months

Avoiding Contract Scandals 101

When a contract scandal breaks, everyone ducks for cover. Who broke the rules? Who knew? Who should have known? Whose heads will roll? The media shines a bright light into the darkest corners of the deal, looking for someone to blame.

There are two classic targets when the blame game begins. Those who did the dodgy deal, and those who should have stopped it but didn't. The former look corrupt. The latter incompetent.

Using two recent contract scandals as a guide - the Boeing Tanker Aircraft scandal, and the AWB Wheat-for-Oil scandal - we've come up with some simple lessons for staying out of trouble.

Lesson 1:

Don't take a cushy job at the company to which you just awarded a contract at an inflated price.

Failure to heed this lesson cost Darleen Druyan 9 months in prison. The former Air Force procurement official had awarded a $23 billion tanker aircraft contract to Boeing as a "parting gift", just before she went off to work there.


Druyan in happier times

Sign Here Please...

For most people, the task of creating and negotiating contracts was transformed some ten years ago, when email "tipped" and became the preferred mode of business communication. Drafts are prepared in Word, then emailed back and forth. Most of the time, changes are marked up (although sometimes not, but that's another story), and eventually a final version emerges, ready to sign.

It's at this point that things go decidedly low-tech. Despite much e-signature talk and buzz over the years, the task of signing contracts still seems to happen with pen, paper, fedex and fax.

But where do you look when, 6 months down the road, a dispute is looming, and you want to check the final terms of the contract you signed? Do you trust the last electronic copy buried deep in your email archives, or do you go rummaging around for the signed piece of paper?

This simple problem - keeping a signed digital copy of the final contract in one central place - is what EchoSign hopes to solve with a new web-based service.

All you do is browse to EchoSign, upload your final contract, tell it who needs to sign, and the contract is emailed to all relevant parties. They print, sign, and fax it back to your EchoSign number, and the final signed versions are stored as PDFs for future reference. Easy.

FSA Reaches for the Stick

Two years sounded like a long time. Less than one year doesn't. So with 11 months to go till John Tiner's deadline for contract certainty in the London insurance market, the question is being asked: what happens if the market misses the deadline? What if the deals are being done, but the details are still missing? Does it really matter?

It's starting to sound like the answer is yes. It matters. The FSA is reaching for the stick.

Amongst other things, David Strachan, the FSA's Insurance Sector Leader, hinted that brokers and underwriters who fall down on contract certainty may be required to hold more capital. Another option will be restrictions on the drawdown of broker commissions. Ouch.

Read the full text of David Strachan's speech at the The Insurance Institute of London.

Focus on the Fine Print

Pactum is latin for contract. And contracts are the focus of this blog. From the recitals to the execution blocks, and all the fine print in between.

Whether you're a contracts manager, general counsel, risk manager or deal maker, there's no escaping the joys of contracts. A great contract makes you money and keeps you warm at night. A bad one leaves you exposed and counting the costs.

Why blog about contracts? Because there's always something useful to learn from a contract scandal, and there's lots to keep up with when it comes to drafting, negotiating, closing, signing, managing, enforcing and renewing the contracts we deal with every day.