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The risks of outsourced procurement

In Canadian business, more and more companies and governments are outsourcing procurement functions to agents. As with all situations where a function formerly done by in-house employees is contracted to outside workers, there are both risks and rewards.


April 25, 2011
by Robert Worthington

PURCHASINGB2B MAGAZINE: MARCH/APRIL 2011

In Canadian business, more and more companies and governments are outsourcing procurement functions to agents. As with all situations where a function formerly done by in-house employees is contracted to outside workers, there are both risks and rewards.

The rewards usually are found in cost savings or in the greater experience and expertise of the outside consultant.

There are several aspects essential to controlling the actions of an outside service provider. These include which consultant an organization chooses, having a robust contract with that consultant, as well as having a knowledgeable and careful contract administrator to manage the work and the contract.

There are several risks that go with hiring any outside consultant to do work for an organization. Besides the obvious risks of consultant breach of contract, there are a variety of potential issues involving how a consultant’s negligence could cause harm to the hirer or the public. Such risks can largely be controlled through effective contracts.

These risks pale in comparison, however, to the risks that arise when the hirer of a consultant also makes that consultant their agent, or authorized representative.

Making an outside agent into an authorized representative to act on your company’s behalf is very risky. The agent can bind their principal in a variety of ways; not just to contracts, but also to courses of action, mistakes and negligence. The principal will then be legally liable for what the agent has done.

As well, it’s unlikely a principal will recover any money lost as a result of an agent’s actions. First, an agent who acted wrongfully must have the financial resources to indemnify (compensate for damages) the principal. Second, that agent must be willing to compensate the principal—without a costly court battle.

Agency is about trust. The principal gives the agent a great deal of power which the agent can then use or abuse. The law recognizes this—and the attendant risks of that relationship—by making the agent a so-called fiduciary of the principal, meaning the agent has been entrusted with property or power.

To hold an agent to the utmost duty of care required from a fiduciary, a principal must create a detailed agency contract. This contract includes a comprehensive scope of work, as well as clauses requiring the agent to act within their authority and to take reasonable care.

The principal must also maintain careful control through powerful contract clauses such as indemnity, suspension of work and withholding of payment clauses. Only through such a robust agency contract can the principal control both what its agent can do and what that agent can be liable for.

It is important to realize, however, that there are two types of agents in law: independent contractor-agents and employee-agents. These are two very different roles.

When a principal appoints an employee as their agent, the principal has a great deal of unilateral power due to the nature of employment law. Employer-principals can give their employee-agents unilateral, daily direction, or they can remove parts of an employee-agent’s authority summarily. They can even remove the employee-agent’s authority altogether, without much legal consequence, because the employment contract is still in existence.

When a principal appoints an independent contractor or consultant as their agent, however, the legal situation is quite different. The independent contractor-agent is only bound to the agency contract. Simply put, hirer-principals cannot treat independent contractor-agents the same as employee-agents. Closely managing and directing how an employee-agent does the work is expected and allowed under the law. The employer-principal will be 100-percent liable for almost everything an employee-agent does and, as a result, the employer-principal has a lot of control. As well, employees will only be liable, personally or jointly with the employer, if they exceed their authority, act on “an adventure of their own” or are negligent.

Closely managing and directing the work of an independent contractor-agent, however, can only lawfully be done if the agency contract expressly allows the hirer to do so. And the degree to which the hirer directs the performance of the independent contractor-agent is the degree to which the hirer can be liable.

In fact and in law, an independent contractor is only liable for what they have personal control over. If they are not “independent” in fact, then they are not liable—the person who instructed them is. To remain an independent contractor, a contractor must be able to control the “method and manner of performance of the work”. The contract tells them what to do, but how they do it is their choice.

Should hirers outsource their procurement functions to independent contractors? The answer is yes, absolutely. But only if the hirer puts careful planning into the outsourcing and there is an understanding of agency law. Otherwise, it could be a recipe for disaster.

Robert Worthington, LLB, (www.purchasinglaw.com) specializes in the laws of contract, competitive bidding and procurement.