Approach Every Contract Like a Construction Project

It struck me recently as I worked on a multi-million dollar construction project that parties would be well served if they approached each contract (at least initially) like a construction contract. So, why do I say that, and what does it mean?

A construction contract is the beginning of a project and a process – one that requires (a) careful planning, (b) trust and cooperation by multiple parties, (c) segregation of duties, (d) faithful performance and execution, and (e) recognition that circumstances will arise that may be beyond the parties’ control and will require flexibility, problem-solving and often change. These factors are actually present in most projects and transactions – not just construction projects – which is why I think the construction approach makes sense.

Here are the most basic elements of a construction project/contract that I believe should be considered and addressed in most contracts.

• Scope/Nature of the Project – what are we doing here? This should be defined as clearly as possible (even where, as in the construction process, this will change and develop as the project progresses)?
• Responsibilities – what is each party required to do, how and when? Again, this should be defined as specifically as possible.
• Standard of Care/Performance – is there an objective or subjective standard which a party must meet (e.g., codes, industry standards, the best or accepted practices in the relevant geography, the other party’s discretion)?
• Legal Compliance – who’s responsible?
• Subcontractors – who will actually perform the work, and can it be subcontracted?
• Communication/Authority – who has authority to bind each party, and how do we ensure constant communication to avoid misunderstandings?
• Foreseeable Risks – if they’re foreseeable, define them, how they will be addressed, and who bears the risk.
• Unforeseen Risks – since they’re unforeseen, they likely can’t be defined, but you can still do your best to allocate responsibility.
• Changes/Change Orders – how will we handle changes? The best answer – see Communication/Authority above. If your deal has to be changed, communicate and make the change in writing as promptly as possible.
• Disputes – how will we (hopefully) avoid, and in any case deal with disputes?
• Insurance/Bonds, Indemnification and Guarantees – how do we protect against the downside?
• Completion – how do we know, and who determines, when a party has completed its task satisfactorily?

There are other elements of a construction contract, but hopefully you see my point – think construction.

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Subtlety Has Its Place

As the title to this post indicates, subtlety has its place – just not in business negotiations or contracts.  This is not to say that people shouldn’t be tactful, courteous and professional in these contexts – of course, they should be.  I’m not talking about manners; I’m talking about clarity, precision, directness and transparency – i.e., the things that avoid uncertainty and minimize the risk of disagreement (and litigation).

Occasionally, clients will ask me to word a provision in a contract so that it isn’t as clear or explicit as it might be, so that it’s “less conspicuous,” or in a way so that “later, we can take the position that it meant X. . . .”  This is almost always a bad idea.  After all, a contract is meant to be a clear and complete expression of the parties’ mutual intent and agreement – trying to “finalize” the deal while simultaneously avoiding clarity and completeness in order to avoid points of disagreement is NOT a recipe for success; to the contrary, it is a recipe for future disputes.

So, what does this mean for your negotiations and contracts?  Quite simply, items of potential disagreement should be identified and discussed (and hopefully resolved) early on, just as items on which the parties agree should be discussed.  Dispute resolution at the point of negotiation/deal-making and as part of the contractual process is healthy and productive.  It generally leads to one of 2 outcomes – either the parties ultimately reach agreement through compromise, concessions, etc., and they move ahead with the deal; or they don’t, and the deal doesn’t get done.  Either result is far better than signing a contract or entering into a relationship only to end up in the other kind of dispute resolution – the kind that comes after the contract is signed and involves 2 teams of lawyers, a judge, jury or arbitrator, and words like injunction, breach of contract, damages, and legal fees.  Don’t be subtle . . .

Nice to Meet You – Let’s Get Married

Only fools rush in.  We’ve all heard that expression many times and probably think we’re far too wise and experienced to be such a fool.  However, you’d be amazed at how often businesses and individuals rush headlong into business relationships or contracts only to find out they should have used more discretion, patience and judgment.  Remember, before you date someone, you usually want to know at least a little bit about them; before you go steady, you want to know a little more; and before you get married, you really want to know them well.

Consider applying some of these dating lessons and clichés to your business and legal relationships and contracts, and you may find you have fewer emotional breakups or (more importantly) fewer bad marriages that end in messy divorces:

  • Ask around (a/k/a, do your due diligence) – learn all you can about a person or company before you engage them, become partners or enter into a long term binding contract.
  • Trust your instincts (a/k/a, if it doesn’t feel right, don’t do it) – unless there’s some compelling reason you have to work with a specific person or company or you have to jump into a deal with both feet, if you’re getting a bad vibe, don’t proceed.
  • Go slowly (a/k/a, – start small) – whenever possible, start with a smaller project or a short term relationship and see how it goes. There’s usually time and there will almost always be more opportunities to work together if the first one goes      well.
  • Build in an escape hatch (a/k/a, don’t put all of your eggs in one basket) – even if you’re ready to hire someone or enter into a contract, make sure you have the ability to terminate or get out of the relationship.
  • See other people (a/k/a, avoid exclusivity) – exclusive relationships are serious commitments and have high risk (and potentially, high reward); take your time.
  • There are more fish in the sea (a/k/a, know when to say when) – ending a bad relationship is always hard – whether personal or business – but when your gut tells you it’s not right, then it probably isn’t. Cut your losses and end the relationship (in the right way, of course).

The bottom line is, business and legal relationships resemble personal relationships – with the same types of risks and rewards.  Look before you leap.

Be Careful When Contracting With Related Parties

Ever heard the expression, “Good fences make good neighbors.”?  I have a similar opinion as to contracts between related parties.  I’m talking about business contracts between parties who know and trust each other and may even be in related or competitive businesses.  Even in those circumstances, a clear and specific contract is important to avoid misunderstandings and effectuate the parties’ agreement.

Let me give you a recent real life scenario.  My “Client” is in a competitive and sophisticated commodity based business where a few pennies on the input or output side can mean millions of dollars and the difference between profitability and failure.  The Client is owned by a group of individuals that are also owners and operators of competitive businesses (the “Competitors”) in the same industry – this means the owners are both partners and competitors.  To further complicate things, a subset of the owners has a related company (the “Management Company”) that manages the commodity-based businesses (both the Client and the Competitors) for a fee.

So, the Client wants to enter into a contract under which the Management Company would manage the Client’s facilities – in addition to managing its own facilities and the Competitor’s facilities.  This arrangement is filled with conflicts of interest and competitive risks/concerns – in other words, this is a situation where the contract is critical.

I can’t discuss all of the key issues here, so I’ll focus on just a few.  The parties’ proposed contract said the Management Company:  (i) had complete discretion and authority to make decisions and enter into contracts binding on the Client; (ii) could use and share the Client’s confidential information with and for the Competitors’ and the Management Company’s own purposes; (iii) had no limits on competition, solicitation or the allocation of business opportunities; and (iv) had no stated standard of care.  In other words, the proposed contact was A RECIPE FOR DISASTER FOR THE CLIENT.

Now, as it turns out, none of the above provisions accurately reflected the parties’ intentions.  However, because they know each other well and trust each other, they thought they could cobble together any document labeled “Management Agreement,” and they’d just work things out as they went along.  When presented with a series of “what-if” questions, the parties quickly realized that this contract needed a lot of work, and we included provisions addressing the above issues and several others.  The result is a contract that clearly sets forth the parties’ rights and obligations and anticipates and addresses the circumstances that might otherwise result in disputes.  In other words, a contract that facilitates and builds their business relationship rather than threatening it.

Keep in mind that contracts between related parties often present the same (and sometimes even more) risks as other contracts.  Make sure you take care when entering into them – for everyone’s benefit.