Contracts Negotiation Best Practices

Since contracts today form the basis of all business transactions and relationships, it is inevitable that every business owner or manager will be faced with negotiating contracts at one time or another.  For some businesses, contracts are drafted so regularly and in such volume that the failure to have a good contract management process can quickly lead to frustration and negative consequences.  For others, the harmful results of ad hoc contract management only become evident when it’s too late—when there is non-compliance or costly litigation.

Contract management is the process used by businesses to negotiate the terms and conditions in a contract and also to ensure compliance with those terms and conditions after execution.  A strong contract management process can be described as methodically and efficiently managing contract negotiation, execution and compliance for the purpose of maximizing financial and operational performance and minimizing strategic and operational risk to the company.  While each step in the contract management process is equally important, we thought we’d focus on step 1: contract negotiation.

We believe that having a well-managed contract negotiation system is an essential first step toward structuring contract management for any business.  All parties suffer when poorly managed contract negotiations take on a life of their own—distracting in house counsel and business owners from their core business objectives, wasting time, breaking budgets, and potentially resulting in contracts being delivered incorrectly.

By no means is this a comprehensive list of strategies, but two very powerful ways to increase the efficiency of drafting and negotiating an effective contract are as follows:

  1. Start with standard and neutral templates that you and your customers perceive as fair.
  2. Create standard, pre-determined fallback positions that require minimal revision or negotiation.

Starting with Standard and Neutral Templates

Standard and neutral templates can help to streamline negotiations and minimize the overall length and cost of the negotiation process.

Begin by identifying your most frequently used contracts and create a template for each type.  Because your business is not conducted in a vacuum, you need your contracts to be up-to-date and very savvy to industry standards. Take time to thoughtfully benchmark key provisions—especially those with the most legal significance and risk—against industry standards, industry leaders and your customers’ and competitors’ previously executed contracts. Your company’s policies, preferences and risk tolerance should always be in the forefront as you develop the key templates for your business.

Next, identify those provisions where it is acceptable and fair for your company to provide truly neutral language. Reciprocal indemnification and confidentiality provisions and balanced boilerplate are terms where neutral language should be considered.

Lastly, delete extraneous and unnecessary provisions from the contract that have no significance or are unduly onerous. For example, some may see extensive audit rights or record keeping requirements as inappropriate or overly burdensome depending on the business relationship of the parties.

Creating Standard, Pre-determined Fallback Positions

Standard, pre-determined fallback provisions also help to minimize the overall length and cost of negotiation. Perhaps more importantly, pre-determined fallback provisions can prevent ad hoc customization and time-consuming negotiation of individual contracts and ensure that the negotiated terms are always attuned to the operational or strategic risks to the company.

Fallback provisions should be based on specific risk criteria for the relevant transaction.  Any negotiator armed with a set of standard fallback provisions can produce a quick and balanced response to a counterparty’s objection to particular terms.

Here’s an example of standard, predetermined fallbacks applied to the indemnification provision of a service agreement:  A company’s standard clause may provide that the “Vendor shall indemnify Company and its Personnel for any and all damages, costs, expenses and other liabilities, including reasonable attorney’s fees and court costs, arising under this Agreement or out of Vendor’s performance of Services.”  Depending on the industry of the service provider, this may be acceptable; however, there are many ways to limit this indemnification if requested. Some standard fallback options to this provision could include:

(i)      limiting indemnification to the extent the claim is caused by vendor’s negligence;

(ii)     including the limitation in (i) above and also providing that the vendor will have no obligation if a court deems the claim to have arisen from the company’s negligence; or

(iii)    including the limitations in (i) and (ii) above and also further limiting the vendor’s indemnification obligation to a specific dollar amount.

Failure to Develop Templates or Have Fallback Positions

Failure to develop neutral templates or have standard fallback positions will increase the amount of time required for contract negotiations and can have numerous ramifications on contract management and business generally, including:

  • loss of business resulting from harm to the business reputation
  • increased legal work and expense resulting from the need to review and approve changes to non-standard terms
  • a longer overall contracting process resulting in lost productivity
  • higher commercial and legal risk resulting from ad hoc negotiations that don’t take into consideration the operational and strategic risk to the company
  • greater customization and complexity in the final contracts that often lead to inconsistency among the final terms and complicated compliance with contractual obligations and government or industry regulations

These two contract negotiation strategies are truly the tip of the iceberg in terms of possible improvements to your company’s contract management approach. Call me at (202) 973-2682 and I’ll be happy to chat with you about your particular concerns.