In recent months I have been involved in a number of Performance Based Contracting (PBC) discussions between buyers and sellers. One consistent point of heated discussion is around the application of a reduction in seller payment as part of the Performance Management Framework (PMF) that, as those familiar with this blog, is 1 of the 5 key characteristics of a PBC. Specifically:

5. Range of monetary and non-monetary consequences, either rewards or sanctions for the contractor, based on performance

So why am I bringing this up since it is a core part of a PBC?  The main reason is around language; specifically with the use of “penalty” to represent this reduction in seller payment.

Firstly, in Australia, where I am from, a penalty under Australian Law refers to a fine imposed when a person or organisation breaches a statute law (e.g. driving without a licence). Given a contract is not a statute a “penalty” cannot be applied to a seller in the circumstances of a failure to deliver contractual obligations.

Secondly, and my opinion more important, is the emotional use of “penalty” by many sellers. While some of you will disagree with this perspective, I ask whether applying monetary / non-monetary consequences to a seller based on their performance is a penalty? Similarly, am I applying a penalty to my local take-away restaurant when I won’t pay for all 3 dishes I ordered when they have only given me 2 of the 3 dishes? I am penalising them?

The reason we are very careful about using “penalty” is that, as one of my colleagues Matt McDonald puts it, the use of “penalty” is a cultural cancer. By using “penalty” it creates the impression that the sanctions (remedies) imposed in the PBC for a seller’s failure to perform is somehow unjust and unfair. Clearly, this is at odds with the intent of a PBC; that is sellers are accountable for their performance. However, whether these organisations use it intentionally as part of a negotiation strategy, or whether simply because it is a handy word, I will leave you to decide.

So I ask my fellow PBC practitioners, regardless of whether buyer or seller, to carefully consider whether the sanctions (remedies) being applied is truly a “penalty”. Or whether it is a performance abatement (or reduction in the performance fee) due to the seller’s failure to deliver.

I will let you be the umpire.