Monday, February 6, 2012

A Word to Small Business Owners: Don't Be Afraid to Negotiate Contracts

All too often small business owners readily accept the terms of a contract or are concerned about pushing back on both economic and legal terms because either they fear losing the deal or simply don't fully understand the terms.  As a business owner, you need to recognize that in most circumstances there is an opportunity to negotiate terms of an agreement, and therefore you should not be afraid to seek the best deal possible even if the other party initially seems unwilling to consider your position on key aspects of the contract.  So, here is the advice, Don't Be Afraid to Negotiate. 

Negotiation skills are one of the most important tools a business owner should have in its toolbox.  Therefore, if you receive a contract from a party, read it carefully, and then proactively respond in writing with your comments.  One negotiating trick that vendors often try is to provide a form contract, creating the impression that the terms are non-negotiable -- indeed, if I am representing the vendor, I will often suggest creating a form agreement.  Any contract, even a form, can be revised by an amendment, so do not automatically assume the agreement must be accepted "as is".  The following are among the material terms that business owners should not only fully understand, but seek to negotiate.

1.  Term.   If you want a longer or shorter contact term, then ask for it.  One alternative is to get an option to renew, which should be exercised within a certain number of days prior to expiration of the contract.  The mechanics of the option and financial terms should be clearly spelled out as well. 

2. Fees.  There are many different ways to skin this cat, and you should consider what best works for your business over the term of the agreement.  The financial terms can be based on (a) a set periodic payment, (b) an up front payment and then installments, (c) fees that scale up or even down over the life of the contract, (c) revenues, (d) milestones, or (e) a combination of several different fee structures.  If the payments are based on revenues, then it is essential that the parties clearly define not just the percentage by the term "Revenue."   For example, is it based on Gross or Net, and what is to be included in the Gross and what can be deducted as a legitimate expense when determining Net Revenues?  A Net Revenue contract may refer to overhead expenses, like a businesses' borrowing costs, which can be a killer for a party who is being paid based on Net.  Make sure you understand the definition, and if you don't ask for professional advice rather than assume the definitions are fair or standard.

3.  Financial Reports/Audit.  If the consideration under the contract is based on revenues or certain milestones, require periodic financial reports. In addition, you should have the opportunity to review and audit (i.e., challenge) such reports rather than simply accepting the information provided by the other contracting party.  In addition, provide a dispute mechanism in the event of a challenge, such as CFO's meet and try to resolve, appointing independent third party, or even arbitration -- and if the audit reveals you were in the right, include a requirement that the other party pays your costs.     

4.  Termination of the Contract/Suspension.  Of course the contract will expire at the end of its term, but include other events that will result in termination:  (a) non-payment, (b) material breach, (c) bankruptcy, (d) failure to achieve defined milestones, including financial ones, (e) assignment/sale of the business (see below), (f) departure of personnel if the business relies on certain key employees, or (g) force majeure.  Termination clauses will often allow the breaching party an opportunity to cure a default, provided it is one that can be cured.  In the case of a force majeure event, the contract can be suspended pending passage of the event or terminated if the contract becomes impossible to continue due to the event.  

5.  Assignment/Sale of the Business.  Do you want the contract to be assignable to a third party, including in the event of the sale of the business. This is an important issue for many types of agreements, such as licensing agreements or service contracts.  You can require consent for the assignment, but if you want the contract to be assignable, as an alternative you can propose that it is assignable to an assignee with financial ability to meet the contractual obligations.    

6. Warranties/Limitations on Liability.   Suppliers/service providers will often provide a lengthy provisions denying all warranties and limiting their liability -- and if you are the vendor, you generally want to push for these provisions.  If you are purchasing the the services of a large company, there may be no room to push back on any of the limitations, but whether the other contracting party is a small or large company, there is no harm in trying -- even if they send you the form or the "Master Service Agreement."  For either party, it is all about the bargaining power, and how much the other party wants your business versus how much you need the agreement.  Even if you cannot get the other party to budge, ask at least for an exception for gross negligence, and regardless a court may negate the limitation based on intentional misconduct or even gross negligence.               

7. Dispute Resolution.   Avoid an issues as to how disputes are to be resolved by negotiating the applicable (a) governing law, (b) venue for the dispute (meaning both the tribunal that will handle the matter, such as a court or arbitration/mediation, and the geographic location), (c) if there is to be mediation or arbitration, the procedures, and (d) will the parties impose legal fees and costs on the losing party.

8. Remedies.  Among the remedies you can include are (a) specific performance, which is important if money cannot cure a default, (b) liquidated damages, if you prefer to define the damages to avoid disputes as to proof the proper compensation for a breach, and (c) equitable remedies (other than specific performance), like an injunction.    

9. Non-Compete/Non-Solicitation.  Simple vendor/supplier agreements generally won't include these terms, but many other contracts will, including licensing agreements, consulting/employment, certain service agreements, or more major transactions (like sale of a business) to name a few.  Enforcement, especially as to non-competes, is a key legal issue, and it is highly advisable to have the provisions reviewed by counsel that understands the law in the applicable jurisdiction as it can vary greatly from state-to-state.

10.  Other Terms/Conclusion.   If there are other terms included or, for that matter, missing from the agreement, then make these part of the punch list of issues to be addressed with the other party.  The reality is that the worse response you can receive is "no", and then you can decide how important the provision is from your perspective.  A bad contract is NOT better than no contract.  In a competitive economy, even larger/established businesses are often willing to negotiate and "the last and final", "take it or leave it" or "as is" response may be just a bargaining tactic.

The Lesson: Read the Contract, Understand Each Provisions and Don't Be Afraid to Negotiate the Terms.

Disclaimer:  The discussions in this blog do not constitute legal advise nor create any attorney-client relationship.  You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.


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