Contracting as a Political Subdivision: Contracts for Services
Ohio’s political subdivisions - such as townships, counties, and municipalities - are authorized to enter into contracts under the Revised Code. Although political subdivisions have the power of local self-government, exercises of their contracting power can only be exerted to the extent authority is granted to them by statute. Restrictions and conditions apply depending on the type of transaction at issue – such as construction, real estate transactions, or the purchase of supplies or materials. Service contracts are one type of contract entered into frequently. Although they can appear to be fairly straightforward transactions, service contracts may be voidable or deemed unenforceable if they exceed the entity’s granted statutory authority. As a result, all terms and conditions of service contracts should be carefully reviewed and negotiated to specifically fit the type of industry and political subdivision involved.
Service contracts can take many forms, including software service agreements, temporary agreements, or contracts for professional services. These contracts ordinarily contain industry-specific terms standard in the world of the service that are rarely amended by the service provider. What vendors often fail to recognize is that, due to the statutory nature of political subdivisions, these terms must be negotiated to match the authority of the specific contracting subdivision. This will necessitate additional negotiation discussions and may even require communications with the legal department of the service provider so that the contracting parties can achieve a clear understanding of how the contract will operate and what provisions it can (and cannot) contain.
An example of terms that are not generally negotiable in a service provider’s eyes but are almost universally prohibited for political subdivisions are indemnification provisions. An indemnification clause is a contractual provision that imposes a financial obligation upon one party to a contract for the benefit of another party to the contract. It essentially means that one party promises to reimburse another party for any loss it may suffer because of a contract default or third-party act related to the contract. The Ohio Constitution, Article XII Section 11 prohibits the state and its political subdivisions from incurring a debt without first formally appropriating sufficient funds to pay that debt. Since an indemnification clause is essentially a promise to secure an open-ended debt which may arise from some unknown act that might occur at some point during the contract term, its presence in a public sector contract is problematic from the start.
Some indemnification obligations are disguised as less noticeable “hold harmless” language. The Ohio Attorney General has interpreted a promise to hold another party harmless from a loss as the equivalent to an agreement to indemnify that party. 1999 Op. Att’y Gen. No. 99-049. As a result, hold harmless clauses should be closely scrutinized as well.
Indemnification provisions are standard in private-sector contracts, so the fact that a political subdivision cannot generally indemnify a vendor is unwelcome news to most vendors. These indemnification provisions will usually need to be removed unless the public entity is able (and willing) to appropriate and certify specific monies for indemnity purposes and the vendor is able (and willing) to provide sufficient consideration to support the indemnification obligation assumed by the public entity. Public entities should be aware that the Ohio Constitution restricts governmental appropriations to a maximum period of two years. As a result, where a governmental indemnification obligation ends up remaining in a contract, it must be framed as a two-year (or less) promise to reimburse the other party up to a specified maximum dollar amount.
There are, however, alternatives to indemnification provisions available to contracting parties that can address the concerns of the service provider, such as insurance requirements and liability limitations specific to the service industry. Such alternate language can be included to move the contract forward without the presence of an indemnification clause that has the potential to render the contract void as a matter of law.
Other standard-looking contract terms, such as autorenewals and payment terms, should also be revised to fit the particular needs of the public entity. Although political subdivisions are statutorily-immune from many claims, they can still be held liable for a breach of contract. Therefore, all contract terms should be negotiated to avoid circumstances that can lead to an unintended breach. For example, political subdivisions are typically required to appropriate all expenditures, including expenditures for service contracts. In situations where a change of government or a change of the subdivision’s needs impacts the prior appropriation of funds in subsequent fiscal years, it becomes necessary to be able to terminate a contract without being in breach of that contract. Including terms such as a termination for convenience clause and specific early termination penalty costs can diminish the risk of a breach of contract claim – and the resulting monetary damages - in these scenarios.
In addition to appropriating expenditures and negotiating contract terms to match statutory authority, a contract entered into by a political subdivision must be executed by the properly-authorized representative of the public entity. Failure to ensure this could also render the contract invalid.
Service contracts are necessary to a political subdivisions’ daily operations. As explained above, they can also be tricky. For that reason, service contracts should be carefully reviewed to ensure they are valid and enforceable from the start and then revised to cure any potential problems before they are signed.
