Contract Negotiation Handbook: Getting the Most Out of Commercial Deals

Introduction

This book will help you get the most out of your commercial deals and contracts.

The commercial world can be a cold, hard place. There are hundreds of thousands of intelligent, hungry and astute people doing deals every day in Australia. Very few of them are suckers. Most know their business and what they want to get out of it on every level — profit, growth and expansion.

When you are in such a competitive environment it is critical that you are prepared. This book will help you prepare for contract negotiations and to do the best possible deal you can.

As a lawyer who has been involved in negotiating many commercial contracts over the years, I have seen a kaleidoscope of behaviour from the incredibly astute to the widely speculative.

Some of those who have negotiated best are those without any ‘formal’ education. Their insight, intuition and ability to manage the other parties has been educative to watch. At the other end of the spectrum have been those who have MBA or doctoral qualifications but proceeded through the deal with clumsiness and a lack of smarts. This reinforced a maxim I was given by a client when I was a junior lawyer: What you know is important, but whether you win or lose today depends on how you use it.

I have also assisted clients with my fair share of disputes over the years. What has ultimately compelled me to write this book is seeing too many people fall into traps that are easily avoided — concentrating on the sexier or more cosmetically important parts of the deal to the detriment of the ‘stuff drafted by the lawyers for the lawyers’, as one client once told me.

If some of the lessons in this book had been employed at the outset, millions of dollars could have been saved and been better spent on business expansion and improving the bottom line rather than on lawyers in disputes neither party wanted to have.

In a slightly melancholy way, I suppose the other theme of this book is never to openly trust in the negotiation and performance of contracts. My view of contracts is that they are essentially a competition where both parties are seeking to obtain the maximum advantage for themselves. While there may not be winners and losers as there are in a sporting contest, often one party comes off second best. A contract negotiation is not a place for a group hug or to blindly rely on the word of your counterparties.

In my experience trust is directly related to leverage — he or she with most leverage can be the most trusting. However, there are not that many contracts that I’ve seen where the leverage is so one-sided as to give the more powerful or stronger party the right to be complacent.

Bearing in mind the general parallel of competition will help. Just as the person marking you in football or on the other side of the tennis court net is a competitor, so is your counterparty in a negotiation.

It is important not to mistake or merge competition with enmity. The best contractual negotiations, and ironically the best contracts as far as performance are concerned, tend to be between parties who negotiate hard for the strongest deal for themselves and both sides mutually recognise this. It develops a sense of respect. That respect in turn is the basis for performance of the contract.

This book is targeted at all people who negotiate contracts, from a junior procurement officer or small businessperson to a senior corporate executive.

From my observation, people at all levels in the commercial hierarchy can fall into similar types of traps and create problems for themselves and their businesses that could be avoided by more focus and preparation.

It is critical that what they want and need out of the deal is clearly known.

This book is in essentially three parts. They are:

The contractual environment — a user-friendly précis of the law and the legal elements of a contract. I have placed an emphasis here on removing the jargon and unnecessary verbosity lawyers speak with in the hope of making what seem complex and strange ideas easily graspable concepts.

Doing the deal — from the first stage or baby steps to the final negotiation of the contract. I provide practical tips and assistance in this process.

The end of the relationship — the third part of the book addresses termination. In particular I deal with the situation where things end badly and a dispute arises.

The key word is preparation. I have often been surprised in the past by the confidence contract negotiators have had in doing a deal that meets all their needs and wants when in fact they are unprepared. They have not fully articulated those needs and wants to themselves — let alone been in a position to negotiate the contract in a dynamic environment with a counterparty who wants as much as they can get in their own best interests.

If there is one message I would like contract negotiators to take away from this book, it is that there is no limit to the amount of preparation you can do at every level for the negotiation. A badly negotiated contract is like a two-storey brick house built on a foundation of sand. It may look good for a period of time but the sand shifts and the walls collapse. A negotiation that has been properly and completely prepared will generally see a house that lasts for as long as the owners want it to.

Given the competitive context of contractual negotiations, I cannot guarantee that after reading this book that you will necessarily have the upper hand in every negotiation and do deals that every time meet your heart’s desire. Sometimes the bitter truth is that you will need to do deals with people who have more power, money and leverage. You are not in the position to get the deal you necessarily want.

However, if you still use the tips set out you will be on much stronger ground and are likely to have negotiated a better position than might otherwise have been the case.

What this book is not

You will be unsurprised to know that, like any lawyer, I like to get my disclaimer in early!

This book is a general guide to negotiating contracts and the law of contract. It is not a textbook. It contains a summary of often complex and arcane legal principles.

There is no substitute for getting specific legal advice. If you have an issue in relation to entering into a contract or, alternatively, a dispute arising from the performance of one, talk to a lawyer who is experienced in the field.

Like people, each contract is different. The nature of the issues you have in relation to the contract will depend on factors such as:

the subject matter of the contract

the amount of money under the contract

who your counterparty is

the respective resources the parties under the contract have

the importance of the contract to the parties in their business

the access either party has to legal advice

the personalities involved.

As a matter of law, your lawyer has specific duties to you as a client. These duties are important and taken seriously by lawyers.

While I hope you can use this book as a general reference and as a guide to understanding the concepts and issues in relation to negotiation of contracts, it cannot replace tailored and precise legal advice!

Part I

The contractual environment

Chapter 1

Springboard and safety net

A good commercial contract has the characteristic of being both a springboard and a safety net. It is both a sword and a shield. It provides an opportunity to expand and grow your business yet must have within it protections so as to ensure that if things go wrong, your position is guarded and preserved to the fullest extent possible.

Optimism is a good thing in a negotiation

There is a natural tendency in negotiating and then entering into a contract to believe that because of your personal experience, skills and attributes, you will be able to negotiate a contract that is watertight.

Rarely does the entrepreneurial businessperson believe there will be any problems under the contract. They think if there are, they will be able to fix them. While commercial braggadocio of this kind has probably got them where they are, I would also bet it’s bought them more than a few problems in their commercial lives. This is because in all likelihood they have seen the contract as a springboard and ignored the safety net that should be incorporated in it.

Bear in mind both dimensions of the terms of a contract. Give them equal importance in both your preparation and negotiation of the deal. If you make sure of this you will do your absolute best to guarantee that all possible problems at both the front and back ends have been dealt with prior to signing on the dotted line.

How the contract will give your business bounce

Obviously any person in the commercial world entering into a contract wants to obtain the best possible financial and commercial position for themselves. For a provider of a good or service they want to be able to charge the highest price the market will bear giving them the highest positive profile and a platform to developing a longstanding and loyal relationship with their customer. The purchaser in all likelihood would like to pay the lowest possible rate for a good or service of the highest calibre with an honourable counterparty who will work with them to ensure the contract gives them all the benefits they hope and desire from it.

In this context, both parties are looking to the best deal in their own interests. They want to enhance themselves in a commercial sense. The springboard component of a contract negotiation is the easy part. If you have undertaken proper preparation and you know your business environment, knowing what you want is relatively unchallenging.

It is the pessimistic and caution-driven safety net that provides more of a problem.

Sometimes even the most skilled of highwire artists slip!

Generally, the safety net is the part of the contract that allows you to address what will happen if there are problems in the relationship with your counterparty. If one party or the other does not perform the contract, you will want to know what the implications will be.

As mentioned in the introduction, one of the big themes in this book is preparation. There is almost no limit to the amount of thinking and consideration you can give to:

where you want to be during the course of the contract on a macro level

precisely what you want to get out of the contract on a micro level

what it will take for you to perform the contract

what it will take for your counterparty to perform their parts of the contract

the danger areas (or identifying what are) the potential issues that may arise during the course of the contract

assessing the possible permutations and combinations of problems and whether at any stage or time a particular type of breach can be remedied by a patch or a fix

what happens if your counterparty falls over and can’t perform the contract at all — how important is this contract to the continuation of your business?

The vices of not properly considering the safety net are illustrated by the example overleaf.

Example

Persuasive Advertising Agency is a medium-sized agency that prepares print media advertisements for clients. Virtually all its work is by computer. Advertisements are prepared on tailored software programs and almost all written communication with clients is by way of email or other electronic means.

Given its size, and for other commercial reasons, Persuasive enters into a maintenance agreement over both software and hardware with Total Computer Maintenance Solutions. Total is a small enterprise that has five technicians. Three of those technicians are owners of the business and the other two are employees. The significant appeal for Persuasive was that each of the Total representatives they met came across as professional and personable and that they guarantee high levels of responsiveness. On this basis and just before entering into the maintenance agreement Persuasive retrenches its two internal IT staff.

Soon after the contract with Persuasive, Total enters into a separate agreement with Mega Merchant Bank. It is for further computer maintenance. It was an attractive offer and one they couldn’t refuse.

In the interests of maximising profitability and with the hope of not sacrificing service, Total do not employ any further technicians and retain the five staff in the business to provide client-related services. They think they can deal with both clients with current resources.

On a deadline for a major blitz of pre-Christmas advertising for another client, a large department store chain, the Persuasive computer system crashes. Contact is made with the representatives from Total. Each of the five technicians is working at the bank. No-one can be spared to assist Persuasive. This means that deadlines are missed for publishing print advertisements for the department store. This means Persuasive is in breach of its contract and loses the client on the basis that it could not deliver what it said it could.

Persuasive’s desire to enter into a contract based on price (the springboard) and optimistically believing that nothing will go wrong (and therefore the absence of a safety net) has led to a catastrophic problem. There is no clear and easy solution for it. It may have rights for damages against Total for breach of the agreement; however, depending on how precise the performance measures are in the agreement, this claim may be speculative and therefore problematic to assert. Either way, it will mean time-consuming and potentially expensive court proceedings.

Working out the difference between springboard and safety net terms

The distinction between springboard and safety net terms is quite clear.

It is almost as simple as discerning the front end of the contract from the back end; that is, the entrepreneurial attractive part from the insulation against things going wrong.

The springboard terms will tend to be those that everyone wants to focus on. They will be the terms like:

What is the good or service to be delivered under the contract?

When is the good or service to be delivered?

How much is the provider of the good or service going to be paid?

By what means are the goods or services to be delivered?

When will the provider invoice for the goods or services?

What are the terms of payment (such as 30 days after invoice)?

Is there any exclusivity in the contract for providing the goods or services?

Is the contract of limited or unlimited scope?

These are the interesting parts of the contract for both parties.

On the one hand for the provider of the good or service, these parts deal with the big issues like:

What have I got to deliver?

When do I have to deliver it?

How much am I going to be paid?

When am I going to be paid?

On the flip side, the issues for the purchaser will be:

What am I going to get?

When am I going to get it?

What will it cost?

When do I have to pay?

How much of the product do I currently need?

Is there scope for an uplift?

The safety net clauses will look immediately less interesting. That is because they tend to be more in standard form and do not deal with the sexy parts of the contract — what you are getting or what you are paying for it.

They will tend to deal with matters like:

indemnities

whether the agreement is an entire agreement or is a mix of different types of terms

whether there are any warranties

the variation provisions

how the respective parties can terminate the contract and on what basis

any agreed damages liability for one party to the other if the contract is breached

what happens in the event the contract is rendered impossible to be performed by one party or the other

how GST is to be dealt with.

These provisions look generally unappetising to read. They appear to have been drafted by a lawyer who thinks the sky is about to fall on his or her head! They are, for want of a better term, the boring parts of the contract.

However, the importance of the relatively less glamorous part of the agreement should not be underestimated. These clauses are critical. They are as enforceable as any of the more immediately business focussed ‘front-end’ clauses in the contract. A failure to properly consider where your best interests lie and how the contract should pan out in practice may cause untold difficulties if there are problems in the contractual relationship.

So what does this mean?

A successfully negotiated contract should have attention paid to both the springboard and the safety net. It should not sacrifice one at the expense of the other.

As previously suggested, a key theme in this book is planning before you start talking. The more you think about these issues, and in particular anticipating what might go wrong and what the implications of this will be for you, the better armed you will be in the negotiation to deal deftly, quickly and efficiently with all issues.

Another advantage will be that, as often as not, your counterparty will not be focussed on these apparently more mundane and less interesting aspects of the contract. By having a greater awareness and understanding of all aspects of contracts you may be able to get the jump on the other party to your advantage.

As suggested above, there is a natural tendency to focus on the front-end issues. This is at the entire expense of looking at the back end. This means a person who has given holistic consideration to the contract will be forearmed with views as to what is likely to happen to the contract and what their position will be if things go badly.

The two levels of the safety net

There are two broad levels of thought you should work on when considering your position and negotiating the contract with regard to the safety net. They are:

1 What clauses do I need to include in the contract to ensure that my position is protected if my counterparty breaches or does not perform their obligations under it?

2 What will be the implications for my business if this contracting party either is not willing to, or is unable to, perform their obligations under the contract?

The first of these has a more direct relationship to the precise terms and clauses of the agreement. The types of safety net clauses set out above are internal mechanisms in the contract that can assist you to maximise your position under it. In particular, warranties, indemnities and liquidated damages clauses can be really important aspects in maximising your position.

The second level goes to the viability of the contract. If the contracting party with whom you have entered into an agreement does not perform their obligations, do you have another supplier of the relevant good or service to step into their shoes at short notice so as to ensure minimum business disruption?

This is more a general commercial risk management issue and is often difficult to cater for. Again, liquidated damages clauses and termination clauses drafted in the appropriate and precise ways may be important.

Clauses like this will allow you firstly to exit the contract on the default and claim back any damage you have suffered that is agreed under the contract. Of course you have no legal necessity to agree what the damage will be and you have your rights at general law if there is a breach of the contract irrespective as to whether there is a damages clause in the contract or otherwise.

Later in the book there is a more precise outline of contractual terms and their effect.

Two sides of the coin

Two parties negotiating a contract tend to have different perspectives on what they will and will not do and what they want to get out of the deal.

At various times in this book the perspectives of a seller or a purchaser are adopted.

It is not intended as a manual for either sellers or purchasers. The premise is to set out general principles and guidelines in relation to negotiating contracts for both sides of the deal.

Who can enter into a contract?

Generally speaking individuals, companies or other entities have absolute freedom to enter into contracts. Individuals, companies or other entities can enter into contracts that are good, bad or indifferent. They may agree rights and obligations in those contracts that are commercially sensible or self-evidently unwise.

There are certain categories of people who do not have freedom to enter into contracts. In broad terms they are:

children

people with a mental illness

intoxicated or drunken people

bankrupts or companies in liquidation.

The right to freely enter into a contract for these people or entities is impaired by virtue of their special difficulties derived from immaturity, compromised circumstances or practical hurdles.

Being a party to a contract — what does this mean?

Entering into a contract is serious business. It means earning certain legal rights on the one hand and committing to obligations on the other.

Example

You are a procurement manager for a public company that owns a coal mine. You acquire an expensive new dragline mechanism for the mine. You negotiate the terms and conditions of the contract over a significant period of time and satisfy all the requirements of who can enter into a contract. The contract is signed by both parties.

Your company now has a legal obligation to do for the other party what it said it would do. That would generally mean providing information to them as necessary so as to perform their obligations. It will most certainly mean making a payment or delivering goods or services to them at a milestone or a date that is agreed. It may mean making a sequence of acts at different times during the course of the contract. Subject to all of the above elements being satisfied, you have an obligation that you cannot simply abandon or avoid. The company cannot elect that it is no longer bound by the contract. The only rights you will have to terminate the contract will be for breach by the other party or on some other basis that you have negotiated.

The old cliché that a contract is ‘not worth the paper it is written on’ is a brave and possibly unwise comment for a party to it to make. A well-drafted contract that can be enforced is invaluable. You ignore it at your peril and cost. If your counterparty is sufficiently aggrieved by your conduct in not satisfying your obligations to the letter and within the spirit of the agreement, it may be able to terminate the contract and sue you for breach of it. This may have significant financial consequences.

Entering into a contract is a commitment that, subject to various conditions being satisfied, is very hard to break or ignore.

To do so will be to risk serious and decidedly