The Power and the Peril of the Privilege Clause

by Lindsay Parcells LLM, LLB, MBA

As procurement professionals know, Canadian courts have established a clear duty on the part of owners and respondents to respect the terms of ‘Contract A,’ which includes a duty by owners to reject non-compliant bids and proposals. This included duty is based on the notion that it would make little sense for bidders and proponents to expose themselves to the risks associated with the competitive process if the owner was allowed to then ignore that process and accept a non-compliant response. Failing to reject a non-compliant response and subsequently awarding ‘Contract B’ to a non-compliant respondent may result in a claim for damages by an unsuccessful respondent who submitted a compliant bid or proposal. If that claim is successful, damages will be awarded both for the unsuccessful respondent’s lost profit and, usually, for at least a portion of their legal costs. Owners that fail to reject non-compliant bids and proposals may therefore end up paying twice for the same goods or services that were procured – once to the company they awarded it to, and once to compensate the company they should have awarded it to, had they followed their own rules.

To protect against liability, owners will often include privilege clauses in their procurement documents. A privilege clause is a provision in the RFX that gives the owner a specific right or ‘privilege’ in the procurement process, typically the right to accept or reject any response in its discretion or the right to waive defects. Privilege clauses may also give the owner the right to negotiate with respondents, to communicate for clarification purposes, or to rectify ‘minor deficiencies.’ As litigation escalates and challenges become more frequent, we see a corresponding increase in the number and variety of privilege clauses owners choose to insert.

Privilege clauses are useful tools that give owners flexibility and discretion in the procurement process, and they can be particularly beneficial for owners in more complex procurements where there are uncertainties that may be difficult to predict. For example, in a procurement where an owner is seeking proposals for a project that requires complex technology, it may be beneficial to retain the flexibility to allow for further discussions with proponents after initial proposals are reviewed, leading perhaps to a final BAFO stage based on revised specifications.

Generally speaking, the more complexities and uncertainties in the procurement, the more likely it is that privilege clauses need to be included. Owners should, however, remember the benefits of moderation in using privilege clauses. Notwithstanding the advantages of the flexibility provided by privilege clauses, owners should also remember that, in general, there is a direct correlation between the prices received and the number of privilege clauses, as respondents factor in the uncertainties created by privilege clauses and include a ‘risk premium’ in their pricing. Worse still, they may even decline to participate if the opportunity is too uncertain.

Owners should therefore include only those privileges necessary for dealing with the specific uncertainties and complexities of the procurement under consideration, remaining mindful of the impact this may have on the competitive tension. An owner should decide whether a privilege clause is “nice” or “necessary” to have, and include only the latter.

Privilege clauses, in common with all other aspects of issuing and administering procurement processes, should be exercised fairly and in good faith. Remember that discretion is a double-edged sword: it leaves room for flexibility, but owners should expect to be challenged on why they did or did not exercise the discretion in any given case.

Joining NECI’s Instructor Team in 2016, Lindsay Parcells practices local government law with Lidstone & Company, Barristers & Solicitors, a firm specializing in local government law with offices in Calgary and Vancouver. Lindsay has been practicing law since 1991 in Alberta and British Columbia. He completed a Masters’ degree in Municipal Law from Osgoode Hall Law School in 2009 and a combined Bachelors of Laws and Masters of Business Administration degree from Dalhousie University in 1991. In addition to his practice in procurement law, Lindsay also advises clients in municipal law, land use, real property and corporate and commercial matters. Lindsay is a past Chair of the Municipal Law Section of the BC Branch of the Canadian Bar Association and currently serves as vice-chair of the National Municipal Law Section of the Canadian Bar Association. He can be reached at [email protected].

Readers are cautioned not to rely upon this article as legal advice nor as an exhaustive discussion of the topic or case. For any particular legal problem, seek advice directly from your lawyer or in-house counsel. All dates, contact information and website addresses were current at the time of original publication.

National Education Consulting Inc.

Phone: (250) 370-0041     Toll Free: (888) 990-7267

[email protected]

“Smart Contracts”: Magic, Myth or Misnormer?

by Paul Humbert

The potential to use blockchain technology to create so-called “smart contracts” for a variety of commercial transactions has been much in the news lately. Some see the objective as using the self-executing code of a blockchain to automatically create and implement a transaction, thereby increasing efficiency by avoiding the time, effort, expense, and burdens of negotiating and implementing “paper” contracts.

I am no expert on blockchain technology. My understanding is that a blockchain is essentially a database that keeps records in “blocks”. Each block is timestamped and linked to a previous block and once recorded are designed to be secure. They act as a shared distributed digital ledger (on either a private or public peer-to-peer network) that can record and update transactions chronologically and publicly. It could also be used to trigger transactions automatically, i.e., if some event occurs, then some action is triggered.

Blockchain is the technology underlying cryptocurrencies such as Bitcoin and one of its major attributes is the security of the transaction. As expected, this nascent technology has attracted a lot of attention in many industries seeking to apply blockchain in a variety of contexts including as a means to save time, reduce costs, increase security, and track the ownership of assets.

There is huge potential for the application of this technology including in the fields of finance, manufacturing, and supply chain management. For example, blockchain technology could ensure a chain of custody to guarantee that goods being sold are not counterfeit or that produce is in fact organic. There is also the potential to have machines interact in what might seem like a very contractual manner, e.g., machinery could authorize and pay for its own maintenance, repair or recharging as the need arose. It’s all very new and, like any new application of a developing technology, challenges and uncertainties remain.

Against this background, the term “smart contract” has entered the picture. As Confucius so wisely stated, “The beginning of wisdom is to call things by their proper name.” The term “smart contract” doesn’t help and is the beginning of confusion, not wisdom.

The problem with the term “smart contract” in the context of blockchain technology starts with the word “smart”. To me, being “smart” means applying learning and experience to make good business or personal decisions or choices. For example, I like to think that my students get smart (or at least smarter) about how to structure and manage commercial transactions as a result of taking my course on contract management.

Using blockchain technology to create “smart” contracts, would require a very substantial exercise in putting into code all the nuances of language and the law, including statutes, treaties, conventions and court decisions. There is an old saying among attorneys that “No matter how flat you make the pancake, there are always two sides.” Some people see this as unavoidable ambiguity due to the nature of language. I see it as necessary flexibility given the complex ways in which people need to interact and communicate. And if an ambiguity does present itself or if some scenario occurs that was not anticipated by the parties to a contract, the general intent and objective of the contract can be ascertained by the parties through negotiation (or if need be by the courts or some other dispute resolution mechanism) by applying legal principles and precedent in the context of what is reasonable under the facts and circumstances. Will taking language and the law and translating it into computer code make it easier to address complex issues? Aside from the challenge of doing so, there is the very real risk that “bugs” in the code could yield unintended consequences. I think most would agree that bugs in such a complex coding effort would be inevitable. “Garbage in garbage out” as the saying goes. And what about a scenario where certain information is not provided in the blockchain, i.e. an error of omission? How would code address that?

I have yet to discover a “smart” machine despite the efforts of skilled programmers and code writers. Moreover, despite being called “smart” most machines (e.g. smart TVs, smart cars, smart phones, etc…) are not really “smart” at all. You may be born with a certain level of innate measurable “intelligence”, but you get “smart” as a result of learning, making mistakes, and then adapting your experience to future behavior. Most machines or appliances labeled as “smart” are simply connected to the internet. To me that does not make them smart. Will blockchain technology breathe the ability to think into the code that will create “smart” contracts?

Despite warnings from Bill Gates, Stephen Hawking, and Elon Musk on the dangers of artificial intelligence (“summoning the demon”), we can sleep peacefully secure in the knowledge that for the time at least machines are safely dumb. Perhaps a few machines (smart bombs?) are capable of making adjustments that resemble human decisions, but we are a long way from autonomous machines or technology taking over the world.

Putting the word “contract” after the word “smart” doesn’t help. The definition of a “contract” is deceptively simple, namely: “An agreement between two or more parties creating obligations that are enforceable by law.” Black’s Law Dictionary. This small group of words is simultaneously clear yet complex; obvious but nuanced. In fact, it is simply not possible to completely define the term “contract” in a sentence or two. Any short definition requires further explanation of the underlying principles and facts under which a contract can be created, changed or ended.

So, what is really meant by the term “smart contract”? There is room for both confusion and competing definitions. It would appear that many people use the term “smart contract” to mean essentially blockchain technology that uses code to create and administer a legally enforceable agreement. By the press of a button, could we eliminate the time, treasure and headache of the hard work of negotiating contracts, not to mention putting all those boilerplate scriveners out of work? Seems unlikely. Could some savant make the “smart” contract so “flat” that controversies would never occur? Even if the code operated precisely as intended, yet a party was disappointed, could you envision a scenario whereby the disappointed party would claim not only error, but fraudulent inducement, unjust enrichment, superior undisclosed knowledge, bad faith, violation of public policy, promissory or equitable estoppel and run to the nearest friendly jurisdiction?

The law makes it easy to enter into agreements as long as the elements of offer, acceptance, consideration, indicating a meeting of the minds for some lawful purpose are met. However, there is a huge variety and different types of contracts. In addition, the importance of individual facts and circumstances pertaining to a particular transaction as well as how the parties choose to allocate risks and responsibilities cannot be overstated. That’s not to say that certain simple circumstances could not be coded to be “self-executing”. Certainly, payment could be programmed by code to occur immediately upon delivery and acceptance (after due inspection of course) of goods or services. But, rather than try to translate into code an endless variety of contractual transactions with so many permutations and combinations of outcomes, why not simply combine some simple “black and white” code-driven scenarios (like payment for conforming goods or services) with traditional legal language reflecting the rights, risks, and responsibilities according to each party’s capabilities and risk tolerance.

Moreover, a contract consists of many respective rights and responsibilities as well as the assumption of certain risks. How the parties choose to allocate those risks via the sometimes very complex contractual language used in indemnification clauses, insurance provisions, restrictions on the use of information, limitations of liability or other such language allocating risks and responsibilities between the parties varies. These and other factors may be a limitation to the application of so-called “smart contracts”.

That’s not to say that blockchain technology has no role in facilitating transactions. It can be a real game changer for many industries, including supply chain management. Tracking and recording the quantity, quality, certifications and transfer of goods as well as sharing information about products, together with the greater transparency, scalability and security are among the benefits of using blockchain technology. However, let’s avoid blockchain fever and not let the magic of blockchain trespass into fever and myth.

Readers are cautioned not to rely upon this article as legal advice nor as an exhaustive discussion of the topic or case. For any particular legal problem, seek advice directly from your lawyer or in-house counsel. All dates, contact information and website addresses were current at the time of original publication.

Paul Humbert is president of The Humbert Group, llc and provides consulting services on process improvement and transactional matters. He has co-authored several books for use in contract development and implementation, project management, and process improvement. They include: Playbook for Managing Supply Chain Transactions with Desktop Tools, References and Sample Forms; Contract and Risk Management for Supply Chain Management Professionals; and Model Contract Terms and Conditions with Annotations and Case Summaries. This article originally appeared on the European Financial Review site on December 28, 2015. It has been edited for style and is reprinted by permission of the author.

National Education Consulting Inc.

Phone: (250) 370-0041     Toll Free: (888) 990-7267

[email protected]