Vendor and contract negotiation

How I read a contract. Hieu Van Nguyen

I read a commercial contract for three things: where money can move, where risk sits, and what we can walk away from. This page uses an invented agreement. Click any clause to see what I look for, what counts as a red flag, and what it could be worth in dollars. Then test an invoice against the contract the way I would before approving payment.

What this shows

The clauses that move money: price, caps, escalation, payment terms and credits
The clauses that move risk: warranty, liability, delay and termination
A risk summary that ranks clauses by what they could cost
An invoice check that ties each charge to the clause that allows it

Sample build: reading an invented engine maintenance agreement

Twelve clauses of an agreement written for this page, each with what I look for, what counts as a red flag, what it could be worth in dollars, and the question I would put to the shop. Then an invoice to test against it.

Invented agreement for illustration. Not a real contract.

What to try

Drag the repair cap up to $600,000. The repair cap climbs to the top of the ranking and extra work approval falls away.
Raise the days late per visit to 60 and watch the delay credits clause climb the ranking.
In the invoice check, open line 2 and move the rate down to $130 an hour. The flag clears and the total at issue drops.
Open line 5 and tick written approval. The repair above the cap becomes payable.

Scenario, set the size of the contract

Annual spend with the shop$12,000,000

Shop visits a year4 visits

Yearly rate escalation4.0%

Days late per visit12 days

Repair cap per visit$250,000

The sliders set the size of the program. Each clause is then valued as the dollars a year that depend on it, using plain assumptions that are written out beside each figure.

Clause 5 of 12

Additional work approval

The clause, invented text

Additional work needs approval from the Airline's maintenance control before it starts, on a form that states the task, the price and the hours. A go-ahead may be given by phone, and the Shop confirms it in writing afterwards. Work that has no approval of either kind is not payable.

What I look for

Who can approve, in what form, and what happens to work done without approval.

What counts as a red flag high severity

Approval that can be verbal and is confirmed by the shop rather than by us, so the record of what we agreed is the shop's.

What it is worth

$1,400,000 a year at these inputs

Findings of $600,000 less the $250,000 cap leave $350,000 per visit that depends on the approval step, on 4 visits: $1,400,000.

Ranked 1st of 12 clauses by dollars at stake. Move the sliders above and this figure moves with them.

The question I would ask the shop

Who at the shop and at the airline may approve work, and can we agree that approval is only valid when our own form is signed?

Risk ranking

Dollars a year at stake. Bar color is the severity of the red flag:HighMediumLow

Clauses by dollars a year at stake. Click a clause to read it.

Rank	Red flag	A year
1	high	$1,400,000
2	high	$1,000,000
3	medium	$576,000
4	high	$480,000
5	medium	$300,000
6	medium	$288,000
7	high	$280,000
8	medium	$240,000
9	medium	$180,000
10	medium	$150,000
11	low	$36,000
12	low	$18,000

The amounts overlap, so they are not added up. The repair cap and extra work approval are two sides of the same repair spend: a higher cap moves dollars from one to the other.

An invented invoice for one shop visit in the second contract year. Click any line to see how it ties to the agreement. The check reads the agreement as written, not the sliders above, so moving them does not change it.

Flagged

Line 2 of 12

Module repair labor

Billed rate is above the agreed rate

Governing clause: 2. Pricing and rate card

Contract

$78K

$78,000

Billed

$83K

$82,800

Difference

+$5K

+$4,800

Billed at $138 an hour. The rate card is $125 plus the 4% adjustment for the second year, which is $130 (clause 2 and clause 4). 600 hours at $130 is $78,000.

To the shop: Billed at $138 an hour. The agreement allows $130 an hour (clause 2). Please reissue at $78,000, which is $4,800 less.

Try a different value

Billed rate per hour$138 an hour

Billed on the invoice

$1.03M

$1,034,742

Allowed by the agreement

$932K

$932,220

Total at issue

$103K

$102,522

Lines flagged

6 of 12

6 pass

Send back to the shop

Line 2, Module repair labor: Billed at $138 an hour. The agreement allows $130 an hour (clause 2). Please reissue at $78,000, which is $4,800 less.
Line 4, Parts and materials, second order: Marked up 20% on a cost of $75,000. The agreement allows 12% (clause 2). Please reissue at $84,000, which is $6,000 less.
Line 5, Unscheduled repair, turbine shroud: An unscheduled repair of $310,000 was billed with no written approval. The agreement lets the shop bill $250,000 per visit without approval (clause 3). Please send a written estimate for the $60,000 above the cap. We will hold that amount until we have approved it.
Line 7, Rate adjustment, 4 percent on labor: A separate rate adjustment of $7,472 was billed. The 4% adjustment is already in the labor rate of $130 an hour, and clause 4 does not allow it as its own charge. Please remove this line.
Line 8, Late payment fee on the prior invoice: A late fee of $2,250 was billed for an invoice paid on day 38. The fee can only start after day 40 (clause 7). Please remove it.
Line 9, Turnaround delay credit: The engine came back 14 days late, 11 days beyond the 3 free days, at $2,000 a day (clause 6). Please issue a credit of $22,000.

Total at issue is the net of the differences on the flagged lines. A line billed below the agreement is not flagged, because there is nothing to take back.

At these inputs the clause with the most at stake is additional work approval at $1.40M a year, then not-to-exceed cap on repairs at $1.00M a year. The invoice check finds $102,522 to take back on 6 of 12 lines.

How I use it

Preparing questions for the vendor before a negotiation
Checking an invoice against the contract rate before it is paid
Writing a short note for leadership on what the contract really commits us to