What is a Procurement Contract?
How do you legally define it?
What are the different types of procurement contracts you should know!
In this article, we will break down the legal definition of a Procurement Contract so you know all there is to know about it!
Keep reading as we have gathered exactly the information that you need!
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A procurement contract (or procurement agreement) is a type of contract used to “procure” or purchase goods or services in exchange for payment.
Businesses operate in complex commercial environments.
There are many products and services out there, lots of choices and many options for businesses to choose from.
For that reason, the procurement process can vary in complexity.
If your business is looking to handle a small project, you may not spend a lot of time on the procurement process or the contract.
On the other hand, if your company is working on an important project involving a high level of risk or costly purchases, the procurement process becomes critical.
Let’s start with the basics and define a procurement contract.
Procurement Contract definition
A procurement contract is a type of contract used to purchase goods or services by a company in exchange for cash.
The contract for procurement can be with regards to a purchase of equipment, tangible goods or products, or it can also involve a project and the purchase of services.
You can consider a procurement contract to reflect an agreement between a buyer and a seller regarding the acquisition of goods, services or work by one company from an external source.
Importance of procurement contracts
What are the stakes of procurement contracts?
In essence, a contract for procurement is a legally binding contract setting out the framework of the goods and services purchased by a buyer from a seller.
Depending on the type of project or bid, it’s crucial to use the proper procurement framework to ensure that the project remains profitable and successful for all parties.
In procurement agreements, the parties will generally lay out the foundation of their relationship and share the risk and liabilities of a project.
It’s common to see contracts define elements such as:
- Who will assume additional expenses or liabilities
- What happens if additional resources are needed
- What happens if a party does not respect the milestones or project timelines
- What happens if there are cost overruns due to the client or vendor
- What happens if the cost of material goes up during the project
For clients, obtaining quality goods and services underpins any procurement project and activity.
Clients look to find the best possible price for the best possible good or service.
On the flip side, vendors look to maximize profits and minimize time and effort spent on projects to maintain higher profitability.
Procurement managers with a solid understanding of procurement and contracts can:
- Define the best possible procurement strategies to produce predictable and reliable procurement results
- Identify key roles and responsibilities of various stakeholders in a project on the contractor side, client side or third parties
- Leverage relationships and contracts to find ways to reduce costs and overhead
- Reorganize the supply chain management to improve project profitability
- Define the right incentives for the vendors to ensure their interest remains aligned with that of the client
Types of contract in procurement
There are different types of contracts in procurement.
Procurement managers and professionals should know the different types of procurement agreements possible to better understand each type of contract’s legal ramifications.
Here are the most common types of procurement contract:
- Fixed price contracts
- Cost reimbursable contracts
- Time and material contracts
Let’s look at each briefly.
Fixed price contracts
Fixed price contracts in procurement are a type of procurement agreement where the scope of the work or services are clear and the fees associated with the services are known and fixed.
For instance, a service provider may provide a fixed price contract to handle a specific project with defined deliverables and gets paid a specific amount (fixed cost) for the work performed.
Within the fixed price contract category, the contracts can get broken down into sub-categories like:
- Fixed firm price (FFP)
- Fixed Price Incentive Fee (FPIF)
- Fixed Price with Economic Price Adjustment (FP-EPA)
Cost reimbursable contracts
Cost reimbursable contracts (also known as cost dispersible contracts or cost-reimbursement contracts) are generally signed when the service provider or the supplier cannot assess the work or project’s full scope.
With this type of contract, the objective is to ensure that the service provider or vendor remains on schedule and within the defined budget.
Typically, the seller will be paid a fee for the services rendered (the project) and the reimbursement of the costs when the project is completed.
Also, depending on how well the vendor was able to achieve the timeline targets or budgets, there may be additional incentives paid out.
Within this category, you can find sub-categories of cost reimbursable contracts such as:
- Cost Plus Fixed Fee (CPFF)
- Cost Plus Incentive Fee (CPIF)
- Cost Plus Award Fee (CPAF)
- Cost Plus Percentage of Cost (CPPC)
Time and material contracts
Time and material contracts (also known as T&M contracts) represent a procurement contract type where the seller charges the client both time and material.
In this type of relationship, the buyer agrees on an hourly rate offered by the seller’s resources.
Then, the seller’s time will be billed according to the seller’s hourly, daily, weekly or monthly fee.
Purchase orders represent one of the most common types of documents found or referred to in the procurement process.
Although it is not a procurement contract in itself, it’s a document that sets out certain terms and conditions (most often financial terms) related to a company’s approval of procurement and contracts.
In many cases, clients will send a Purchase Order or PO to vendors to outline details of the order.
When the vendor accepts the client’s PO, it creates a legally binding contract or obligation just like any other contract.
Having looked at different types of procurement contracts, its definition and why it’s important, our review would not be complete if we don’t cover some of the key procurement terms you may come across in the contract.
Here are the most common procurement contractual terms:
- Description of goods or services
- Price and payment
- Confidentiality provisions
- Intellectual property rights
- Limitation of liability
- Indemnification clause
- Breach of contract
No matter the type of procurement, types of vendor contracts or nature of project, clients and vendors enter into a contractual agreement where they agree on key terms governing their relationship and allocating risk between them.
The buyer is generally concerned to ensure that the vendor provides quality services, on time and within budget.
Vendors are generally concerned to ensure that projects remain profitable, reduce scope creep, ensure clients provide all the necessary information to ensure they can be successful in their job.
So what is the legal definition of a Procurement Contract?
Let’s look at a summary of our findings.
If you enjoyed this article on Procurement Contracts, we recommend you look into the following legal and business terms and concepts. Enjoy!
Related legal terms
Cost Plus Fixed Fee Contract
Fixed Price contract
Project management contracts
Supplier Relationship Management
Supply chain management
Time and material contract
Types of contracts