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Third-Party Contracts Can Cost You Money and Reputation

08.03.2016

Whether it is a billion-dollar construction project oAs Seen in BizTalk in the St. Louis Business Journalr a ten-thousand dollar cleaning contract, every contract for outsourced services has risks that need to be managed to protect your organization. Most organizations rely on outside third-parties to provide the goods and services they need to operate effectively. However, once you have signed a contract, do you understand the risks involved? Do you actively and effectively manage them, taking into consideration the associated costs, performance of the vendors and compliance of the vendor against the contract terms and conditions?

Don’t Pay the Price

Contracting with an outside third-party exposes organizations of all types and sizes to significant risks of financial and reputational harm. There have been several instances recently when organizations that did not understand and manage their third-party contract risks have paid a huge price.

  • Freight Shipper: The company inflated charges to the government by $13 million for shipping military freight throughout the United States. The freight shipper submitted false claims for air shipments when the freight was actually shipped by truck, inflated charges for air fuel instead of ground fuel and charged for oversized freight when the freight did not qualify as oversized.
  • Payroll Services: Instead of paying their clients’ federal taxes in appropriate amounts and by the regulatory deadlines, the company diverted the funds to pay their own salaries and expenses. They defrauded their payroll clients of more than $2 million.
  • Construction Sub-Contractor: While on a project to build a water treatment plant, the sub-contractor prepared and submitted inflated invoices and false change orders for labor and materials provided to the project, which resulted in $4.8 million in overbilling.
  • Fire Safety Company: The company contracted with a municipal government to annually inspect and re-size firefighter safety equipment, but failed to perform this critical function, putting the safety of firefighters in jeopardy.

Other Harmful Risks

Every organization should be aware of and actively manage some of the most common risks of a contract review:

  • Reputation – Third-party contractor through their actions, or lack thereof, damages the reputation of the organization.
  • Performance – Third-party contractor fails to meet timelines and/or fails to perform in accordance with the terms of the contract.
  • Compliance – Third-party contractor fails to comply with laws and regulations governing the performance of the contract.
  • Non-Conforming Goods or Services – Third-party contractor delivers goods or services that do not conform to the contract specifications.
  • Change Order Abuse – Third-party contractor increases the price or extends and expands the contract scope through the use of multiple change orders.
  • Cost Mischarging – Third-party contractor charges the organization for costs (material or labor) that are not allowable, reasonable, nor allocable to the contract.
  • Data Breaches – Third-party contractor, either intentionally or through the ineffectiveness of its information technology security and controls, mismanages critical organization or customer data.

Many organizations do not have the necessary processes or controls in place to address the risks of contracting with outside third-parties. The above risks are likely to be exposed in a contract review. A contract review provides a cost-effective avenue for identifying and mitigating risk to your organization.

Ronald P. Steinkamp, CPA, CIA, CFE,CRMA, CGMATo start mitigating these risks, click here to request our guide, "5 Steps to Managing Third-Party Contract Relationships."

If you have questions or would like to discuss how to identify and mitigate risk through a contract review, contact Ron Steinkamp, Partner, Advisory Services, at rsteinkamp@bswllc.com or 314.983.1238.

STAY TUNED: Every other week our subject matter experts share thought leadership and strategic business advice on the St. Louis Business Journal business blog, BizTalk.

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