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  • Paul Swegle

Business Tip: Sign Better Contracts

Updated: Sep 7, 2020


Many mistakes involving commercial agreements are caused by simple errors in due diligence, judgment and drafting, and giving up too easily on important issues.


Here are several contract mistakes that I cover in my book, Contract Drafting and Negotiation for Entrepreneurs and Business Professionals.


Performance before Agreement


One of the worst mistakes is having one or both parties begin performance before a final agreement is in place.


Starting performance prior to having an agreement often takes organizations backward from where they started, or at least sideways. This is because, by the time the mistake is realized, the organization may have to first dig out of a mess before it can start over.


Walking away from a failed relationship might involve more than just walking away from already incurred sunken costs and critically delayed opportunities - the other party may also have valid claims for additional compensation.


Additionally, rights to any jointly created intellectual property may need to be sorted out between the parties, through amicable means or otherwise.


Impatience is the most common factor in proceeding without a final agreement. The decision to charge ahead before an agreement is in place often comes under tight deadlines, and sometimes when a difficult issue or two remain unresolved after two or more turns of a draft agreement.


Eventually, though, these very issues may bring about the relationship’s undoing. Putting off difficult issues does not make them easier to resolve.


Failing to Shop and Compare


Depending on the size, importance and complexity of an expected relationship, it is generally wise to look at more than one option before entering into serious negotiations. At the conservative end of the spectrum, significant relationships are often preceded by a “Request for Proposals” or “RFP.”


This is a document sent to prospective providers of a needed good or service that describes in detail the requested good or service, specifying exactly how interested parties are to respond and by when.


If a full RFP is too burdensome, it is still wise to follow the traditional rule of getting two or three bids for any commercial procurement of goods or services. At a minimum, going through either process will help an organization assess its objectives and expectations and prepare it for incorporating those in a final agreement.


Answers to RFPs are often carefully written. They should be carefully studied and follow-up information should be requested where answers seem incomplete, evasive or otherwise miss the mark.


Depending on the nature of the proposed arrangement and your level of certainty or uncertainty about the abilities, facilities and reputation of the parties involved, you may want to perform additional due diligence by visiting and inspecting facilities, talking with customer and creditor references, and pulling reports on financial condition, judgments and the like.


Lastly, consider adding a party’s finalized RFP response as an exhibit to any agreement entered into with them, along with language in the agreement making the RFP response part of the agreement.


An added benefit of scrutinizing and engaging with more than one prospect is that, if contract negotiations do not go well, you may have a viable fallback option. Even if you do not resort to that option, the knowledge that you have an option will make you a better negotiator.


Inadequate Performance Obligations


Performance shortcomings are surprisingly common in business. Sellers of goods and services can disappoint for any number of reasons, including over-promising, corner-cutting, staffing problems, phasing out a product line or service, selling a product line or service to another company, and simple incompetence or lack of diligence.


As a result, performance concerns are possibly the top source of commercial disputes. As discussed in Chapter Five under “Obligations of the Parties,” every contract should clearly and completely describe each party’s performance obligations.


These descriptions should include all of the details that the parties have discussed, and particularly all of the representations the other party has made, either directly or indirectly through representations of their staff members or through their advertising or marketing materials.


As noted above, if the other party provided a written RFP response, consider attaching it to the agreement if it contains the best description of the other party’s obligations and possibly also specific representations and warranties.


It is much easier to make another party perform as you expect if those expectations have been clearly written into the contract. In the end, it does not matter what the sales or “business development” person told you if it is not in the agreement.


Another party’s refusal to add detailed performance obligations to an agreement is always a red flag. Take it as a clue that the other party does not intend to perform as you are hoping or expecting. Rarely does a party’s performance exceed their written commitments.


The mistake of failing to detail performance obligations causes some of the worst contractual nightmares. If proper performance is not clearly defined, poor performance likely will not constitute a breach of the agreement, making remedies such as offsets, price reductions or termination unavailable. Paying full price for the wrong product or service is a bad outcome. If the agreement is for an extended term, the only recourse may be to negotiate a large termination fee just so you can walk away and pay a new provider all over.


Weak or Nonexistent Remedies


As noted above, poorly drafted performance obligations are possibly the top source of commercial disputes; weak or non-existent remedies could be a close second.


Unlike some areas of contract negotiation, Remedies is a difficult topic to reduce to simple, actionable pearls of wisdom. There are many types of remedies; there are also an infinite number of ways to draft them, disclaim them, and limit them. And while the law generously provides for all kinds of damages for contract breaches, the almost universal tendency of sellers is to vigorously resist detailed remedies provisions and to disclaim and limit liabilities.


The typical seller negotiating position is essentially, “Why should we agree to damages that could greatly exceed the value of the agreement?” Such sellers are often unmoved by typical buyers’ responses such as, “If the losses were foreseeable and you caused them, why not?” Well-coached sellers often come back with comments like, “We simply cannot agree to unknown and potentially ruinous liabilities; we cannot be your insurer.”


The correct response to this type of rebuttal is often “Maybe not, but your insurer can and should be our insurer for any liabilities caused by your performance.”


Despite these negotiating and drafting challenges, it is a mistake to give up too quickly. Pushing sellers for the right remedies is worth the effort and the inevitable friction.


Even though the law theoretically provides damages for breach whether specifically agreed to or not, contractual breach remedies can make the difference between success or failure in a commercial relationship. Contracts with clear and meaningful remedies provide (i) incentives for better performance, (ii) leverage for forcing faster performance corrections, and (iii) greater certainty regarding the outcome of potential litigation or other dispute resolution processes, all of which reduce the likelihood of disputes in the first place.


Poor Vetting of Vendors and Suppliers


Selecting companies and persons to do business with requires good judgment. A tightly drafted contract does not provide absolute protection from business, legal, financial, regulatory, or third-party liability risk. Contractual protections from such risks usually depend on the strength and solvency of the other party and, less frequently, any available insurance.


Consequently, success in forming business relationships requires great care. Be on guard to identify and avoid con artists, blustering sales persons, and others who may mean well, but who simply lack the integrity or intellectual capacity to avoid making promises they cannot honor.


Whatever the titles of the individual or individuals with whom you are dealing – CEO, founder, head of business development - there are certain signs of trouble that should not be ignored. Too slick or too friendly? Disinterested in details? Pressure to sign quickly and/or pay up front? Unwilling to put promises made orally in writing? Trust your eyes, your ears, your brain, and your gut.


Blindly Accepting “Standard Contracts”


Unless you are looking at a “click-wrap” software agreement or the standard terms and conditions for a credit card, always assume that you can propose edits! When necessary, insist on doing so. Unfortunately too many non-lawyers give up very easily in the face of resistance over making changes to “form” or “standard” agreements.


Reputable companies that are serious about providing value and growing their businesses often have acceptable standard agreements. You might need to strike the clause subjecting you to the courts of Cedar Rapids and boost the remedies section a bit, but that may be all. Other times, substantial revisions are required. You may need to get past the other party’s insistence that the standard agreement is not negotiable.


Appealing to the other party’s fairness or sense of reason works most of the time. Credibly threatening to walk from the deal should work in just about every other situation. In any event, you should read the contract. If it is unacceptable or incomprehensible, insist on changes or find a new provider of the particular product or service.


Duration Too Long or Too Short


Do not make the mistake of accepting the first “term” or “termination date” drafted into an agreement dictating its duration.


Contracts can often be for as long or as short as you need them to be. If you have doubts about a person or company, set up an agreement as a 90 day test with an option to extend. If you need to lock in a critical supplier for several years, do so.


But keep in mind the increasing pace of change when signing contracts for longer than one year, particularly contracts that involve technologies, goods or services that may soon be obsolete or a lot cheaper.


One year contracts that renew annually if neither party opts out with proper notice work well for many types of relationships, provided it is okay if both parties have the ability to terminate each year rather than renew. Always make sure processes and systems are in place to allow for timely evaluation of contracts with upcoming automatic renewal notice deadlines.


For more tips and strategies on making the most of every commercial agreement, pick up the #1 new release, Contract Drafting and Negotiation for Entrepreneurs and Business Professionals.



Paul Swegle has served as general counsel to numerous tech companies and advises a dozen others as outside counsel. He has completed $12+ billion of financings and M&A deals, including growing and selling startups to public companies ING, Capital One, Nortek, and Abbott.


Paul has authored two authoritative and practical business law books, available for preview and purchase here:


"Contract Drafting and Negotiation"

&

"Startup Law and Fundraising"




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