The Case for Contracts

Write it Down. If it is significant, affects your business and is contractual in nature, commit and follow through on negotiating it, writing it down, and signing it, not because of paranoia but rather as a sound, ongoing business strategy. The contract process serves two equally important roles: First, it memorializes (hopefully clearly and completely) the parties’ rights and duties. Second, it serves to educate and focus the parties on aspects of the arrangement they may not have otherwise considered – but which are likely to or could occur over the life of the arrangement – at a time when the relationship is prospective and everyone is levelheaded. The omitted matters most often cause the problems. Virtually every business dispute I see could have been avoided with some front-end work, but it is too late for a simple fix when the conflict arises, the dollars at issue are large, and there is either no written agreement or an agreement that is incomplete or ambiguous.

Worth the Effort. Many business owners dismiss or short-circuit the contract process because (1) it costs too much money; (2) it is not an area they know well; (3) negotiating contracts “makes waves”; (4) the other party may resist formalizing a contract; (5) the parties may be in unequal bargaining positions; or (6) it doesn’t matter what the contract says if the other side has significant resources to weasel out of its terms. While it is true that the contract process is not perfect (having a strong contract with an insolvent entity, for example), in the vast majority of cases the process will be worthwhile and beneficial, often providing some unanticipated benefits – such as recognition of otherwise unaddressed potential problem areas – in addition to the obvious ones. In my experience, a clear, well-written arrangement serves to keep both parties in line – someone is less likely to take an unsupported position if the contractual duty and the consequences for not meeting it are clearly stated. Conversely, working without a documented arrangement invites abuse, especially for smaller companies without the resources to engage larger companies in prolonged disputes over undocumented business arrangements.
Work hard to earn trust in your business, but be cautious. Have the discipline to look critically at your important relationships – do not assume you will be treated fairly or that the person or company you are dealing with today will be there tomorrow. My most successful clients deal from a position of contractual strength and operational empathy – the contract is in place for the difficult cases, but its protections can be waived in the interest of goodwill and relationship building. This is not pessimistic, it is good business.

Use Templates. Cost-conscious business owners understandably do not want to run to their lawyer at every business turn, but some owners go too far in the other direction and do not seek legal help when they should. They use outdated, incomplete contracts and forms handed down through the years that do not adequately address their operations or current laws and regulations – many times they do not even understand their own forms – and then they wonder why there are problems when a unique or even routine event occurs. Identify your few fundamental relationships – vendors, customers, service providers, employees, contractors, investors – and commit to make each of these relationships contractually sound and enforceable. At times you will be the contract drafter; in these cases, create better forms. At times you must work with the other party’s contract; in these cases, negotiate and create a short addendum that addresses the main areas of concern. Several of my clients have “master” agreements governing all transactions with their primary business suppliers and customers. Once these contract forms and addendums are in place, they can be used – after education of company personnel and with changes as appropriate – in each instance in your future operations. Not only will you be much better protected in all of your relationships, but each future use will further amortize the cost of creating better contracts.

The Upper Hand. Business owners often forfeit or actively attempt to shift initial contract-drafting to the other party, thinking that in doing so they will reduce their legal and transaction costs. This perception is usually erroneous and misses a golden opportunity to gain the upper hand, especially in sales of businesses, real estate and other unique transactions. In most cases, the party with the “power of the pen” will achieve significantly more of its objectives – assuming the starting point draft agreement is competently written. Not wanting to appear combative, the non-drafting party will pick only three or four main points to negotiate, leaving the other 15-20 provisions as written. Conversely, often we have had to clean up onerous, ambiguous, or incomplete contracts drafted by the other party, resulting in higher transaction costs than if we had simply drafted a better contract from the start.

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