10 Practical Tips for Preparing and Negotiating Commercial Contracts
I recently helped a client negotiate a contract for a transaction that was very important to both parties. Both sides worked hard to put together a win-win business deal and were very enthusiastic and confident about closing the transaction.
The other party’s counsel was tasked with preparing the initial draft of the contract. Several weeks later (and after repeated requests to see a contract), we received a one-sided and excessively complicated contract that did not reflect the terms agreed to by the business teams. As a result, my client’s trust in the other party took a major blow, and the momentum both sides had at the outset was stalled as we tried to negotiate a poorly thought out contract. Although I was ultimately able to help our client close the transaction, the poorly prepared contract resulted in a significant delay and the incurrence of unnecessary expenses for both sides.
Unfortunately, I’ve seen this scenario play out many times during my legal career. Legal contracts should be implements, and not impediments, to getting business done. However, all too often, contract negotiations become inefficient, frustrating, and a distraction from operating your business. Here are 10 practical tips for helping you prepare and negotiate commercial contracts. By following these tips, you can hopefully avoid the issues discussed above and spend more time on what matters most to you… your business.
1. Write it Down. Make sure that the agreed business terms – price, scope, quantities, deliverables, timing, etc. – are written down before a contract is prepared in either a quote, proposal, term sheet, letter of intent, or, at the very least, an e-mail. Writing down the key business terms will ensure both parties are clear on what the business deal is, and the initial writing will also serve as a reference point to ensure the key terms of the agreement are properly memorialized.
2. Invest in Good Forms. If you have a need for your own contract forms, or find that you are consistently negotiating the same types of contracts provided by others, make the investment in developing good forms of those contracts for your business. Good contract forms should be organized, clearly written, and easy to fill out. Your forms should properly address the subject matter in a way that is typical for your industry and the transaction. Consider structuring your forms so that business terms can be included as an exhibit or schedule to the contract for ease of completion. The time and expense of developing good forms can be recouped over time by achieving efficiencies in your contract processes.
3. Leverage the Work of Industry/Trade Groups. If your business is in an industry that has a strong industry group, trade group, or professional organization, you may find that those groups or organizations provide their members with forms, best practices, and other resources for contracts that are commonly used in that industry, trade, or profession. If so, save yourself a little money on legal fees and purchase a membership.
4. Focus on the Key Risks to Your Business. In the course of developing and negotiating contracts, be aware of the key risks for your business. Try to allocate those risks between the parties appropriately in the contract, and understand when and how you are willing to give and take with respect to the allocation of those risks. You may choose to give on other contract points in order to protect against certain risks that could have a significant impact on your business.
5. Be the First Mover. Wherever appropriate, and assuming you have done the legwork to create good contract forms and processes, propose that the parties use your form of contract for the transaction. This will allow you to set the tone for the legal relationship and also gives you a better chance to fairly allocate risks.
6. Set the Right Tone. Contracts and contract negotiations can impact the relationship of the parties for better or for worse. If the party preparing a contract presents a contract that is one-sided, poorly drafted, or doesn’t accurately reflect the business deal, it can come across as unprofessional, or worse, dishonest or deceitful. There is certainly a degree of strategy involved here. In some cases, depending on your relationship to the other party, it may make sense to start with a contract that is aggressively favorable to your business. However, generally speaking, a contract that is easy to understand, fairly allocates risks, and accurately reflects the business deal is less likely to receive pushback.
7. Contracts Should Accurately Reflect the Business Deal. A contract should accurately reflect the business deal between the parties. If not, fix it yourself or ask for it to be fixed before you sign it. You should not rely on a verbal representation from the other party that they will honor the business deal despite contradictory terms in the contract. Again, make sure that the business terms are memorialized in writing before the contract is prepared. The business terms should be clearly communicated to the attorney or contract administrator who is preparing the contract, and both sides should confirm that the contract accurately reflects the written business terms before signing.
8. The Best Contract is a Signed Contract. Assuming a contract doesn’t unfairly disadvantage your business, a signed contract is better than an unsigned one. We often see parties move forward without a signed agreement when bad contracts or poor contract processes are introduced into a business deal. Certainly, there are business transactions where a contract is not necessary, but there are also many where a contract is highly advisable. In the case of the latter, you will be in a much better position when issues arise if you can point to a contract that accurately reflects the business deal.
9. Build a Good Contracts Team and Contracts Process. Your contract drafting and review process may require the input of several members of your internal and external team. Designate internal team members with the right technical, operational, or finance skills to assist in developing and reviewing contracts. Select external service professionals who understand your business to provide their expertise in developing and reviewing contracts. Clearly communicate timelines and the business objectives to the team. Also, designate one person to coordinate and facilitate input and feedback from the various team members and make sure that someone is in charge of collecting and saving fully executed copies of your contracts in an organized manner.
10. Don’t Forget About Insurance. Contracts often allocate risks among the parties through the use of indemnification obligations and requirements that a party maintain insurance naming the other party as an additional insured. Work with a knowledgeable commercial insurance broker who understands your business and has resources available to help you review contractual indemnity and insurance requirements. A competent broker will be able to issue spot the indemnity and insurance requirements in a contract and let you know if you have the required coverage. If you do not have the coverage required by a contract, consider if the required coverage is appropriate for the transaction. If not, revise the contract to match the coverages and limits you have in place. Also, ask your broker whether your current coverage includes “contractual liability” coverage for the indemnity obligations you are assuming under the contract. Finally, consider what coverage you should expect from the other party and address that coverage in the contract.
At Baker Heath, we believe that helping you develop good contract forms and processes will make your business more professional, efficient, and profitable, and will ultimately reduce your legal fees. If you have any questions about developing contract forms or processes for your business, please feel free to contact us here and we will be happy to help.
