Businesses hire third-parties such as vendors, contractors, consultants, etc. to assist with its operation by way of an agreement.  Both contracts and purchase orders are two ways of entering into a form of agreement.  But, under what circumstances should a business issue a contract v. a purchase order?

The key difference between contracts and purchase orders is that a contract is an agreement between two or more parties that creates an obligation to do (or not do) a particular task whereas a purchase order is an offer issued by a buyer to a seller, to purchase goods for an agreed price.  It should also be understood that contracts have greater legal value so they should be used in deals with greater risk.

Purchase orders are more appropriate for commodity-style purchases when you can easily identify the exact specifications and quantity needed, as well as costs, and where services are not rendered  Some examples of situations where a purchase order might be appropriate include: ordering office supplies, purchasing IT equipment, or purchasing building material (without installation).

There are times, though, when a purchase order simply isn’t enough. A good example is when you need to procure services (possibly in addition to products) from a vendor. When you procure services, you are naturally exposed to a higher level of risk as well as a greater need to detail exactly what the vendor is being hired to provide. Without a clear description of the deliverables, project timeline and responsibilities of the parties, enforcing the contract and tracking contract performance becomes increasingly difficult.

Some common terms and conditions that you should expect to see in a formal, lengthier contract but you may not find in a standard purchase order term and termination, indemnification, insurance, safety, and scope of work.

Purchase Order v Contract?

Generally, the riskier the business transaction, the better it is to use a contract. Why? Because the contract holds more legal value than a purchase order. In situations where there is a significant risk, contracts are better because they clearly spell out the responsibilities of each party along with performance standards. This reduces risk exposure.

Top 5 Takeaways:

  • Is your relationship with the third-party only for goods? A purchase order might be appropriate.
  • Does the relationship with the third-party involve services? A contract is more appropriate.
  • Is the relationship with the third-party for goods and services. A contract is more appropriate.
  • Always outline the terms and expectations between you and the third-party in both purchase orders and contracts. This will assist in reducing exposure for liability.
  • If you are uncertain which agreement is more appropriate for a situation, consult with an attorney.

For more information, contact a member of our team.

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