Long Read: Contract Negotiation
Contract negotiation is at the heart of any business relationship and is an important element in the process. The art of negotiation is the process by which the parties to the contract discuss and eventually agree on the terms of the contract.
This article will walk you through the process of negotiation as well as further aspects of the initial relationship, such as understanding the parties and who has authorization to act; last minute changes and producing a heads of agreement.
The contract governs the relationship you have with your supplier and it is therefore essential that you ensure the terms are relevant to your business and are weighted in your favour as much as possible.
The negotiation process involves the initial discussions between the parties with a view to forming a contract. The art of negotiation will involve compromise from all parties in order to reach an agreement on the final terms. During this process it is important to keep track of all outstanding points; this should ideally be kept on the same document throughout. By keeping the same document, it focuses the attention on the outstanding points throughout the negotiation and provides clarity on what has been agreed. Negotiation is an art form and a process that can be split into four phases; preparation; opening; bargaining and closure.
This is a vital stage and is often one of the lengthiest aspects as it involves research and information gathering. Being well prepared generates confidence and understanding which will ultimately give you an advantage.
A key part of this stage is to know your objectives and what elements you are initially willing to concede.
This is where you present your case to the other parties, normally at a face to face meeting. It is important to set the tone of the meeting at the outset, build rapport, and make a good first impression.
It is important here to sift out the emotion and focus entirely on the commercial aspect of the deal. Each parties’ objective at this stage will be to move closer to their desired outcome. A basic strategy to adopt is to convince the other party’s that what you are asking for is justified and reasonable.
The first step is clarity; it is important that you clarify what you have agreed with the other parties. This ensures that all parties have the same understanding of what was said during the earlier phases. You may need to revisit the bargaining stage for any outstanding points that have been raised, however once this is done then you can move to the final stages of preparing the documentation.
Identifying Outstanding Issues
Identifying the outstanding issues is important as it can highlight what you haven’t agreed and also how close to agreement you are. It is important that you have a summary of the key points that have been agreed and that this is kept updated through various stages of the negotiation. You then always have a focus point to come back to should any party stray, which will help facilitate a conclusion.
There will always be points that the parties will not agree on and in order to avoid salami slicing (debating one point at a time and making concessions in order to agree the individual point) it is important to negotiate all terms before conceding as well as taking the points as whole.
It is essential that all outstanding issues that have been identified are resolved before any drafting of the documents begin. This will make the rest of the process run smoother.
Who are you dealing with?
It is an important element of the contract negotiation to know who you are dealing with and whether they have the authority as well as legal capacity to negotiate and enter into the contract. You should ensure they are able to sign off any point that you have agreed and that it does not need to be escalated to the board or for further approval.
If they do not have the authority to negotiate or approve any agreement then this may cause delay in the negotiation process. At the very least you should discuss the steps needed for authority to be given.
You will want to gather information on the other parties reputation and you may consider carrying out credit checks if you have not dealt with the other parties before.
Another element to consider is how many parties should be joined into the contract, is there only two vital parties or are there more for instance, guarantors, sub-contractors or associated companies.
If you are negotiating internationally it is also important to consider the different business cultures. There may be a strong emphasis on certain elements in one culture that could have the possibility of being wrongly interpreted.
Identifying Parties & Last Minute Changes
As mentioned above it is important that you know who you are dealing with and their authority, just as important is to ensure you have identified the parties. This is especially pertinent if you are dealing with a group of companies, as you need to be clear which company should be the party and whether the correct one is detailed. Another element to consider is whether the company that you are dealing with is the party with the assets including intangible assets. If you are dealing with a NewCo or SPV then you should obtain guarantees.
It is always good practice to confirm the agreed points as well as the parties details before the drafting commences.
Regardless of the above, there may still be some last minute changes that one party asks for including price chipping and a price hike, which can affect the whole deal including any funding that has been secured. Do not take this personally, it may still be a good deal, however you will need to reassess.
If a last minute change is made to the contracting parties such as an SPV being presented in place of a company with substance, this should immediately produce a red flag.
Parties by this stage have spent a considerable amount of time and effort as well as costs on the deal and will need to consider the next move carefully as due diligence may need to be repeated and effectively you could be starting all over again.
Heads of Agreement
Heads of agreement (also known as memorandum of understanding or term sheet) is a summary of key commercial points and is a good place to start as it enables people to see the key points.
It is a good idea to know the local laws regarding heads of agreement as although this document is not normally binding on either party, there is a possibility it can be. When drafting the heads of agreement you should always use the words “subject to contract” in any correspondence regarding them and the document itself to avoid potentially entering into a binding contract. If you inadvertently make them binding then you will have stumbled into a legal relationship by mistake from which it may be difficult to extract yourself.
A well drafted heads of agreement can set a road map for the transaction and the drafting element; it provides clarity and will help reduce the likelihood of disputes arising.