The Devil is in the Details:
A review of complex agreement terms can improve cash flow.

James Edmonstone has partnered with GFAS to provide contract audit and recovery services.  In this article he discusses how this new service can benefit your firm and/or your clients.

Many corporations employ processes to identify and recover overpayments.  This process may include a series of reviews starting with an in-house examination of recent payments, supplemented by one or more secondary reviews of these same payments by third-party firms.  These third-party audit firms specialize in the identification and recovery of overpayments, and may utilize proprietary software in their process. 

In smaller organizations, the initial review may be outsourced and performed by a third-party firm from the start.  Generally, third-party auditors receive a percent of the amounts recovered, with the percentage received by the audit firm increasing for each level of review, or each “pass”.  This type of third-party compensation works for high-volume payments and straight-forward purchasing arrangements.   

Accounts payable reviews can be cost-effective in identifying and recovering overpayments of recurring charges and large recurring vendor purchases.   The types of errors that can be identified include:

• Missed payment discounts.
• Missed or incorrect application of volume purchase discounts. For example, an incentive agreement for multiple products or groups of products may not include all of the eligible products in the volume discount calculation.
• Missed vendor rebates for sales or purchases in excess of an agreed-upon base amount, measured over a specified time interval.
• Invoice terms conflict with purchase order terms. For example, the vendor may be charging a lower price than what was specified in the client’s purchase order, and the client is paying this higher price.
• Double payments.

Effective third-party audit agreements should include provisions to ensure that the third-party auditor identifies systemic errors in the payment process, and provides recommendations to minimize these errors going forward.  Providers, who are being paid a percentage of recoveries, may be reluctant to focus on this aspect of their service as it is likely to reduce their revenue stream over time.   We have seen instances where the third-party provider has spent years collecting the same vendor overcharges for the same client (and receiving their commission), because the client never changed their behavior.  We have also seen where in-house audit teams do similar things to inflate recoveries to justify their staffing levels and prevent being outsourced.  

However, many clients miss significant recovery (and compliance) opportunities which result from systematic recovery and compliance audits of:

• Contracts, change orders and corresponding payments
• Lease agreements
• Licensee agreements and associated revenue receipts
• Partnership agreements
• Insurance claim recoveries
• Professional provider payments
• Benefit administrator agreements and related transactions/payments
• Payroll administrator agreements and related transactions/payments
• Professional service agreements
• Other specialized arrangements

While third-party accounts payable auditors generally assume the risk of identification and collection of these funds, audits of more complex agreements, such as those described above, generally require a sharing of risk between the client and auditor during at least the initial phase.  For example, an auditor may charge a fixed fee or an hourly rate to provide an assessment to determine what areas may benefit from a more in-depth engagement.  The ultimate compensation agreement will be a function of the type of audit a client ultimately selects (recovery, prospective savings, etc.) and may include a credit for the initial payment.

Reviews of complex agreements can be time consuming and may require the use of professionals skilled in interpreting contract terms or having specific training or experience (i.e. healthcare terminology knowledge).  Due to the size and complexity of certain issues, the recovery process may involve negotiations between the client, the auditor, legal counsel, and the auditees.   Many audit firms may be hesitant to commit to a purely sharing of recovered funds agreement without some guarantee that the client will fully support collection of recovered amounts.

Recoveries and prospective savings from audits of complex agreements can be very significant as the audits may identify systemic problems inside the client organization or with specific providers.  For example, these audits may identify:

• Overpayments
• Inflated costs by the vendor/partner to avoid sharing profits
• Diverted revenues and customers
• Unauthorized and out-of-scope work and billings
• Billing for the same work twice. For example:
  • Including the same scope and associated payment in the original contract and then in a subsequent change order.
  • Contracts containing multiple types of measurements (i.e. fixed price original contract and change orders paid on the basis of hours incurred).
• Double payments
• In-scope work invoiced as out-of-scope
• Unreasonable rates or billing increments
• Theft of tangible or intangible property
• Contracting irregularities identified in the client’s bidding files
• Improper payments made by third parties on behalf of the client
• Collusion

Examples of actual issues which we have observed include:

• Professionals billing multiple organizations for the same time period, and using unreasonable minimum time increments.
• Licensees directing client customers to non-licensed locations.
• Licensees opening new offices within prohibited service areas.
• Licensees soliciting client’s customers by advertising their own services during customer phone holds on client lines administered by licensee.
• Insurers retained to administer client self-funded insurance programs, paying claims outside of contractual terms, impacting both employer and employees.
• Contracts being structured without considering available tax incentives or being structured improperly for tax purposes.
• Collusion between buyers and vendors/contractors.
• Vendors using client assets to compete against the client
• Partners inflating costs and inflating inter/intra company allocations to avoid profit sharing payments.

Compliance and recovery audits involve every aspect of the organization.  Many times, individual business or overhead units may resist recovery/compliance audit efforts because their goals are not aligned with their organization’s goals.  This is particularly true when auditors are looking at agreements where there are long-term relationships or where services are being provided for overhead functions.  An effective audit and recovery program must have the support of executive management and report to senior management. 

In future articles, we will discuss designing and implementing a cost-effective and whole-organization approach.  For more information about GFAS’ contract audits click here and to contact us click here.