Whether you are a start-up or an established business, contract negotiation tips can always come in handy. Taking advice and giving contract negotiation appropriate time and resources can help solidify a successful business relationship and reduce the risk of contract disputes.
Our commercial law solicitors are not just here to assist with drafting your business contracts, but can provide front loaded proactive commercial law advice at each stage of a contract’s lifecycle, from contract negotiation to review to termination.
Here, we share our best practice tips for negotiating a business contract.
Contents:
Before you start negotiations
It feels trite to say ‘be prepared’ but successful contract negotiation should start with behind the scenes preparation. If you are a start-up entrepreneur it can be tempting to just ‘get on with it’ and get a deal done and signed off but, using the lesson from the hare and tortoise, speed does not always get the best results. Alternatively, if you are a procurement officer in a listed company, it can be easy to fall into the trap of thinking that preparation is not necessary but be wary as many high profile commercial litigation disputes end up in court because the basics were not covered.
Do you have authority?
If you are a founder, it may be obvious that you have authority to negotiate a contract. If you are a director in a company, in partnership or you are an employee, consultant or an agent, your authority may not be as clear cut. For example, your authority may be limited to negotiating contracts of a certain type or value. The larger the organisation the more important it is that your business has a contract workflow document or policy setting out who is responsible for each aspect of contract negotiation and the limits of their authority.
Ongoing refresher training on contract workflow and authority is equally important, as once you get caught up in an exchange of email it can be easy to exceed your authority and end up with a contract that binds your business. This point is just as important for founders as it is for scale-ups or well established businesses, whatever your sector. Although you may be the founding entrepreneur and genius behind the business idea, it does not mean that you are best placed person to enter into contract negotiations when you have employed specialist staff or instructed agents for that purpose.
You may think that contract authority is straightforward and getting the basics wrong could not happen in your business. The salutary case of Athena Brands Ltd v Superdrug Stores Plc [2019] EWHC 3503 (Comm) is a lesson for all businesses. Superdrug said their employee did not have the authority to enter into a specific contract with Athena Brands Ltd. The court held that the employee of Superdrug had been presented as having a job role of discussing trade terms and as the other party had not been advised of the limits of the employee’s contract authority there was a binding contract.
Commercial contract solicitors say it is better to have a clear contract workflow document so everyone understands their roles, and limits on authority and authority limits are clearly relayed to the other negotiating party. For example, if the Superdrug employee had an email footer indicating that they were not entering into a contract but engaged in preliminary negotiations that would not form a binding contract without formal contract documentation might have avoided costly litigation.
Do they have authority?
It is natural to assume that the other party to a negotiation has authority to contract but that may not be the case, or their authority may be limited. For example, they may be an agent or an employee with very specific limited authority. It is best to know the extent of that authority at the outset of negotiations, so you know when the next phase of contract negotiation has been reached.
Contract authority is a source of potential conflict, so it is important to understand the basics to avoid the pitfalls. For a more in-depth look at contract authority take a look at our article Contract formation: authority.
Have you done due diligence?
It can be tempting to jump straight into contract negotiation thinking time is of the essence. Alternatively, you may think that due diligence is only for corporate lawyers involved in multi-million merger and acquisition deals. It is not. There should be some form of due diligence before every commercial contract is negotiated. Otherwise, you may be wasting both time and money in pointless negotiations or even worse end up with a contract that is not in the best interests of your business.
Due diligence should not be limited to an assessment of the financial performance of the other party and the risk of their insolvency. Due diligence should be a broad exercise and should encompass an assessment of whether your company wants to be associated with the other company. Do you know where the company sources its goods from or whether it has been accused of using overseas child labour or paying less than the UK national minimum wage? Has a director of the company been the subject of sanctions or has the company had its sponsor licence revoked or been the subject of a health and safety investigation? Due diligence can reveal that association with a third party could result in brand or reputational damage to your company. For example, a luxury retail brand wouldn’t want to be associated with a company that is not compliant with environmental regulations because of guilt by association.
Due diligence should not just be focussed on the other contracting party but also involve some market research, so you know what alternative options are available and what your competitors are doing. This can be particularly important in the tech sector where the pace of change is fast and furious.
Consider confidentiality
There are many reasons why your business may want to keep information or contract negotiations confidential. In contract negotiations there is normally an exchange of information. Whilst that information may not appear confidential to the negotiator it may be highly sensitive in nature. For example, your business may not want technical information about the proposed goods, pricing information, financial forecasts or other information to be shared in the public domain.
Similarly, the leaking of information could seriously damage your business plans as they rely on an element of surprise and the fanfare of a market launch of a new product. If the manufacturer you are dealing with has leaked news of the contract negotiations this could ruin your plans. The other party may not realise the significance of confidentiality to the success of contract negotiations but a non-disclosure agreement, entered into at the very outset, will emphasise the need for confidentiality and protect your business interests.
For additional information on confidentiality agreements read our article on Non-disclosure agreements: your questions answered.
Be clear
Whilst contract negotiation is not about upfront demands it is important to be clear from the start of contract negotiations to avoid misunderstandings and delay.
On the details of the transaction
There is no point being unclear about what you want out of the contract negotiation, because if you are poles apart in terms of pricing or the availability of supply it is best to know rather than waste time on negotiations that are doomed to failure. Likewise, if it is critical to you that a supplier is able to meet specific manufacturing requirements or to retain membership of a professional body or organisation, then the negotiations will go nowhere unless you are clear from the outset about what you need.
On your objectives – what is negotiable?
Once you start negotiations, or when you take over negotiations, it can be very easy to lose sight of what is important.
Price and delivery times may be negotiable but other points may not be, such as product specification or the ethical sourcing of materials required for the product manufacture. If you are negotiating for the supply of professional services, it can be easy to get side tracked on price without realising that the price negotiation has ended up with service standards that fall below your minimum acceptable requirements. That is why it is essential not to take your eye of email exchanges that have come a long way from what you originally set out to achieve.
A contract should never be at any price but be on your terms. However, it is also important to be realistic. If you are entering a franchise agreement with a national franchisor or a contract with a digital services provider there may not be much scope for negotiation.
On the potential risks
No contract comes without risks and so you need to be alive to them so you can manage the risks in a way that is acceptable to your business. The first step is for the risks to be assessed and to determine if they are something that your business is willing to accept responsibility for or if they are non-negotiable.
Minimising risk is always a key objective. You may want to achieve risk management by imposing a condition precedent on a contract. Alternatively, a combination of pre-contract negotiation due diligence and alertness during contract negotiations could address risk.
Contract negotiation risk management strategies include:
- Use of a contract negotiation checklist
- Use of a due diligence pro forma
- Work management and contract formation and authority policies
- Risk management allocation such as a requirement for the contracting party to take out and maintain insurance
- Negotiation of limitation of liability clauses, indemnity clauses, late penalty clauses, Force majeure clauses, business interruption or disaster recovery clauses, monitoring of contract performance by including a right to audit, or termination clauses.
This is the sort of detail that can, in the long term, make a contract a success as through contract negotiation you (working with your commercial solicitor) can manage and minimise the risk.
Do you need to use heads of terms?
Many businesses do not use heads of terms thinking that they are an unnecessary extra step in contract negotiation that are best avoided. However, many commercial contract solicitors welcome the use of heads of terms as a single page document as they can help focus minds on the crux of the deal. They are a highly useful start point to negotiate and finalise the detail of a contract. From a practical point of view, for negotiators a heads of terms document can be a helpful aide memoir as to what is actually agreed, especially in fast paced or complex negotiations. If you want to know more about heads of terms, take a look at our article Heads of terms and letters of intent.
Reviewing contracts
If you have successfully negotiated a contract the job should not end there as all commercial contracts need to be monitored and reviewed and, if necessary, tweaked and revised as the business relationship, supply and demand needs and the economic climate changes. The success of a business can be down to not how well it negotiates its commercial contracts but how well it nurtures them and reviews them. The ability to review a commercial contract may come down to the review and termination clauses that were negotiated at the start of the contract. That is why it is important not to simply add in boiler plate clauses without first assessing whether clauses require reconsideration to meet demanding economic or financial times or the vagaries of the market.
For more reading on contract life cycles take a look at:
- Why you should regularly update your commercial contracts
- Contract lifecycle management: what you should be doing
- Terminating a commercial contract
