Perils and pitfalls in negotiating commercial contracts

A big contract can be a make or break moment for a growth business – but they are not without their risks, explains Simon Portman, managing associate at Marks & Clerk Solicitors.

Many businesses make significant mistakes when negotiating contracts with business partners – whether they be customers, suppliers, licensees or collaborators.

These can mean the company does not get as much out of the relationship as it might have, or, worse, they can become a significant disadvantage if the parties end up in dispute.

Even if the relationship doesn’t turn sour, defective contracts can deter potential buyers and investors.

These problems can arise for a variety of reasons. Inexperienced negotiators (particularly in young businesses) may not be aware of all the potential issues or might be easily outmaneuvered or steam-rollered by the other side. Particularly for companies with cash flow problems or investor milestones to meet, it might be tempting to get the deal done at all costs, making any concession to secure signature.

The result can be a hideously one-sided contract, which sometimes turns out to be worse than not getting the contract at all. Finally, out of a desire to control costs, companies may not involve legal advisors in contract drafting and negotiation when perhaps their input would have been valuable, or even crucial.

These are some common contractual pitfalls and associated risks:

Not having any contract at all

Many key contractual relationships are based on a verbal understanding and a handshake. ‘Everyone knows what’s meant to happen and we’re not going to fall out…’

But, if the parties do fall out and end up in litigation, there will be no written agreement to refer to as objective evidence of who was meant to do what. Without that, determining what (if any) contractual breach has occurred may be difficult.

Even without a dispute, if key personnel involved in the contract leave, without a written document to refer to, their successors may not know what is meant to happen.

Minimalist contracts

Parties sometimes make do with one page of bullet points for the purpose of cost effectiveness or expedition but this can be almost as dangerous as having no contract at all.

Key provisions may be left out and what is in there may be ambiguous or truncated. This can lead to misunderstandings, which may themselves escalate to full-blown disputes. Beware of contractual loopholes, which the other side may be able exploit to the company’s detriment.

Agreeing to obligations that can’t be met or assuming liability beyond what can be paid

Companies may be tempted to make such concessions if under pressure from a party with superior bargaining power or because of internal pressure to secure that flagship contract. However, getting the deal signed will be of little comfort if the company ends up getting sued for breach of contract because it can’t actually do what it agreed to do.

Having no clear remedies if the other side is in breach

If a party’s obligations are only summarised in vague terms, it may be difficult even to prove that it is in breach. There should therefore be absolute clarity over what each party is meant to do and when.

What is more, the contract should be clear on what the other side’s remedies should be if that party fails in any regard, whether in terms of requiring the defaulting party to re-perform the obligation in question, receiving compensation or terminating.

On the practical front, any party paying for goods or services should avoid paying upfront if at all possible, or at least divide payments up into installments. It is easier to withhold money from a defaulting supplier than to claw it back. 

More on contracts in business:

Contracts with overseas parties

If a contract is subject to the law and jurisdiction of the other side’s country, in the event of a dispute, a business could find itself litigating in a foreign legal system, half way across the world, in another language and at the mercy of a biased judiciary. Take care.

Here are some useful ways to minimise the risk of making these mistakes:

Use the right staff

If contracts are negotiated in-house, only use trained and experienced personnel who know when to seek guidance from their line manager or legal advisor. Relying on sales staff with other interests, like commission, can often lead to significant concessions being made during the negotiation process.

Know when to involve your lawyers

They may be involved at every stage or only at key intervals. Either way, it is important to ensure that their involvement plugs any gaps in the experience of non-legal personnel involved in the negotiation.

Know when to walk away

Quite apart from any difficulty in finding common ground on contractual terms, if the relationship with the other side isn’t working pre-signature, it is unlikely to get any better once the contract is under way.

Of course, the commercial reality is that, even following this rule of thumb, companies may still have to sign up to contracts which are not one hundred per cent ideal. However, at least with this approach they will know what the potential risks are.

Hunter Ruthven

Hunter Ruthven

Hunter was the Editor for GrowthBusiness.co.uk from 2012 to 2014, before moving on to Caspian Media Ltd to be Editor of Real Business.

Related Topics

Contracts
Negotiation