Contract Negotiation Basics
Negotiating the business and legal terms of a contract.
Contract negotiation is the process of give and take the parties go through to reach an agreement. Or, as they often say in business, "you don't get what you deserve; you get what you negotiate." This article takes a look at the basics of contract negotiation. For practical tips on tactics at the negotiating table, check out Nolo's article Contract Negotiation: 11 Strategies.
Negotiation Comes Down to Risks and Revenues
In a typical contract negotiation, each party compromises on some issues in order to get what it really wants. Although there are always lots of details to work out, most contract negotiations boil down to two essential factors: risks and revenues.
Here's an example. A landlord in a residential lease negotiation wants to obtain a profitable rental income (revenue) while also guaranteeing the right to swiftly remove the tenant and protect the property if something goes wrong (risks). Sam, the landlord, is aware that his risks may be lower if he rents to Camille, a qualified tenant with strong recommendations and who stayed at her previous rental for fourteen years. Sam considers Camille's offer to sign a one-year lease for a lower rental price. Sam knows that a bad tenant can cost him many months of lost revenue (not to mention lost time and legal fees). He agrees to Camille's lower offer because the lower risk she presents is worth accepting lower revenue.
The Business Side vs. the Legal Side of Negotiations
Often, contract negotiations have two distinct stages: negotiation of the basic business terms followed by negotiation of the legal terms.
Let's look back at the landlord-tenant example, when Sam agrees to rent his residential property to Camille. At a walk-through at the rental home, Camille negotiates for a one-year lease at $1,500 a month. She agrees to pay first and last month's rent up front, along with a security deposit. She will move into the house in one month. Sam and Camille shake hands and Sam promises to send along a "standard" lease agreement.
A week later Camille obtains the written lease. It includes all of the basic terms she and Sam negotiated at the house, but it also includes several objectionable provisions, including an attorney fee provision and a requirement that she obtain insurance. She calls Sam and the two of them negotiate these issues. Eventually, Sam agrees to take out the attorney fee provision, and Camille agrees to get renter's insurance. Sam revises the lease and Camille signs it. (Learn more about different contract clauses in Nolo's article Common Boilerplate Provisions in Contracts.)
When Is There an Enforceable Contract?
Is it when the parties agree on the business terms or when the legal terms are finalized? Under contract law, there is no contract until all of the material elements of the deal have been negotiated and agreed upon. So, a legal dispute over whether and when a contract exists will boil down to whether any of the outstanding legal issues are material elements of the deal.
Back to Sam the landlord and Camille the prospective tenant. Let's say that Sam refuses to budge on any of the terms of his standard lease, but Camille has already given notice at her current apartment because she believed her handshake with Sam created a contract. Whether she has a legal right to force Sam to go through with the agreement or pay her damages depends on whether the attorney fee and insurance provisions are material elements of the deal.
If the parties have agreed to the business terms of the deal and want to proceed before hammering out the legal details, they can use an escrow account or condition the release of funds on the execution of a written agreement. This avoids the problem of having to chase after money you laid out if the deal never materializes. If the negotiations fall apart, everyone gets back what they put in and moves on.
Lawyers and Negotiation
If you own or run a business, you may have experienced the following situation. Your company believes it has reached an agreement with another company on the business terms of a deal. Both sides bring in their lawyers to hammer out the details -- and as soon as the lawyers get involved, everything goes down the tubes. That could be because lawyers have three potentially conflicting factors at work when they're negotiating. They want to:
- protect their clients by minimizing risks and maximizing revenue
- act professionally so they won't be vulnerable to malpractice claims or disappoint clients (who can always find another lawyer), and
- earn money (this last factor creates the perverse incentive that the more time it takes to hammer out a deal, the more money the attorney makes. In other words, it is profitable if either or both sides drag out the negotiation).
Although most attorneys focus primarily on the first and second factors, some attorneys are happy to let negotiations drag on as the meter runs. To some extent, the client can control this stage of negotiation by learning which issues are still in play, prioritizing the risks that matter, and instructing the attorney accordingly.
What's Your Negotiating Style?
As you are probably aware from watching TV shows such as The Apprentice, there are a variety of negotiating styles. The two most common styles are adversarial ("I will dominate you") or collaborative ("Together we will prosper"). The various negotiating styles are of course employed by real people, who bring their temperaments, emotions, and personalities to the table along with their list of terms. One negotiator might raise a voice and threaten to storm out of the room, while another might make points in a cool, dispassionate tone.
The modern approach to contract negotiation was pioneered at Harvard University by Roger Fisher and William Ury, authors of the classic, Getting to Yes. These authors say that a collaborative negotiation without big emotional displays is most likely to achieve the optimum results. Anger and similar emotions tend to cloud judgment, create competition, discourage mutually beneficial outcomes, and sometimes result in a retaliatory approach to problem-solving.
For more practical tips on negotiation tactics, check out Nolo's article Contract Negotiation: 11 Strategies.
Bargaining Position: The "Take It or Leave It" Situation
One key to the outcome of contract negotiation is the relative bargaining positions of the parties. A party with vastly superior bargaining power -- for example, a landlord operating during a housing shortage or an employer that is hiring during a recession -- doesn't have to negotiate. Instead, these heavy hitters often present a contract and tell the weaker party to "take it or leave it." In cases of contracts of adhesion -- form contracts that can't be negotiated -- this can sometimes backfire, because the less-advantaged party may later argue that a provision is unfair or unconscionable.
If you are in the superior bargaining position, it is not always in your best interest to dictate all of the terms. As J. Paul Getty's father once told him, "You must never try to make all the money that's in a deal. Let the other fellow make some money too, because if you have a reputation for always making all the money, you won't have many deals."
For tips on getting your agreement in writing, read Nolo's article Contracts 101: Make a Legally Valid Contract. If you're looking for an A to Z guide to everything you need to know about contracts, get Nolo's new book Contracts: The Essential Business Desk Reference, by attorney Rich Stim.