Negotiation and Vendor Contracts

The following is an article reprinted with permission from the Summer 2007 edition of Corporate Counsel

Negotiation and Vendor Contracts 

By: Robert Rutkowski, Esquire

Managers frequently negotiate with their vendors, employees, and even other competitors on a variety of issues.  It’s really a two-step process that includes the negotiation itself and the reduction of the deal to a written contract.

It’s important to understand basic negotiation theory before sitting down with the vendor.  Think carefully about what you really want and remember that money is often a means not an end.  Set an optimistic but justifiable target.  Be specific in your goals and become committed to them.  Write down your goals and share them with someone else so that you carry your goals with you into the negotiation.  Try to anticipate the arguments the other side will make in the negotiation process.  At the same time, anticipate the counter arguments the other side will make to your points. 

Try to build a working relationship across the table with the other negotiator.  Avoid reciprocity and relationship traps such as trusting too quickly or letting others make you feel guilty.  Be reliable, trustworthy and fair to those who are fair to you but when treated unfairly, let the other side know about it.  Always negotiate with the person who will make the ultimate decision, not an agent of that person.  If you can identify the other parties’ interest, you will be that much further along in realizing your goals. 

Identify your leverage early on.  Who has the most to lose from the deal?  For whom is time a factor?  If you improve your alternatives or make the other parties’ alternatives worse, or gain control over something the other party needs, you will have leverage and can be tougher in making your case. 

Find your own bargaining style, whether it be competitive, problem-solving, compromising, accommodating or a combination thereof.  Do not try to effect a style; do what comes naturally.  No matter what approach you take, it is important to keep your emotional distance.  Pause before making a concession and pause when the other side puts you under pressure.  Deal with discouragement by being patient and always stay in control during a meeting. 

Active listening during the negotiation process is as important as your arguments themselves.  If you can avoid preconceptions and understand the perspective of the person negotiating with you, then you will be able to bring your issues to bear much more effectively.  Plan your questions for the other side in advance and ask them with a purpose.  Tailor the questions to your listener and keep the questions short and clear.  Do not interrupt the other negotiator when they are responding to your questions as they may give you valuable information. 

Avoid using threats in negotiation, raising your voice or omitting details.  Maintaining good eye contact, smiling and displaying an obvious interest in the discussion is far more effective.  You can, however, walk away from a deal that is not good for you.  Avoid committing to positions that restrict further movement in the negotiation.  Set your limits and stick to them.  Develop a specific alternative as a fallback if the negotiation fails.  People will try to put pressure on you by emphasizing the time element of the negotiation or encouraging you to split the difference when you have more to lose than they do. 

The final goal in closing the deal is to get an enforceable contract.  The contract should identify, among other things, what you’re getting, what you’re paying for, that which you are purchasing, how long the contract will be in effect and who the parties are to the contract.  Along with the contract, however, you want to gain commitment from the other side that they will do everything that they have said they will do.  Publicly announce your deal if it is newsworthy.  Have a closing where there is a simultaneous exchange. 

Negotiation is a situation where the person with the most information gets the best deal.  Preparation for a negotiation is work and you must allow time for interviewing, fact-finding and strategic thinking.  By treating the negotiation process seriously, you will become an effective dealmaker. 

After you have made your deal, the vendor may present you with a written contract.  There are many other important issues involved in reviewing such a contract.  As a rule of thumb, you want to avoid contracts where the vendor can change terms unilaterally, change fees without your consent and completely and utterly disclaim liability.  Another red flag is when a contract references a document you don’t have or a third party document that you haven’t reviewed.  Of course, price is an issue.  Yet, getting the most favorable pricing is only the beginning.  You will want to be familiar with the pricing structures of at least three vendors in the particular market. 

Along with price comes vendor performance standards.  This needs to be spelled out.  Often this is done in the form of an addendum or an exhibit to the contract.  These could include the amount of time a particular system is available or the functionality of a product.  There needs to be real teeth attached to these.  Having standards where there is no penalty to the vendor for violating them accomplishes nothing.  Penalties can come in the form of per day credits, fines or other reductions in the amount of remuneration the vendor receives.  Other penalties may include your right to terminate the contract without penalty to you.

Termination itself can be tricky.  Often, a vendor will ask for a fee to terminate a contract early.  Depending on the size of the contract itself, this fee can be sizable.  You, on the other hand, need as much flexibility as possible to pursue other options.

Warranties are the representation that the vendor makes with respect to the goods or services being sold.  While some disclaimer of warranties might be granted, it’s wise to pay attention to exactly what the vendor is seeking to avoid.  You need to insist that a product or service that you’re getting works when you get it.  If it doesn’t, you need recourse.  Warranties may establish your right to recourse (other factors are involved as well).  And if things really go wrong, you need to be able to sue the vendor.  The vendor of course wants to avoid this.

One of the most important provisions, and one that merits close scrutiny, is the provision limiting liability.   Typically, a vendor will seek to limit its liability for the products and/or services it offers.  A common provision of this type disclaims special, indirect, incidental or consequential damages.  Very aggressive contracts will also seek to limit direct or actual damages as well.  That is not acceptable on its face; there must be liability for direct or actual damages caused by the vendor. 

Nor should damages based on the vendor’s negligence or misconduct be eliminated or limited.  A common modification is to use “gross” negligence and “willful” misconduct as a higher standard, but some level of responsibility for this issue needs to remain in the contract.

These damages can be limited by clauses that cap overall liability.  The contract will contain a clause, for example, stating that liability is limited to the amount paid under the contract three months prior to the claim.  This can be an astoundingly small amount in the face of a serious breach of a large commercial agreement.  Certainly, one can argue that such a provision is unenforceable or unconscionable, but why not try to eliminate it before the contract is signed?  A compromise to this would be to raise the limit to three times the amount paid for the life of the contract.

More insidious yet is the effect of the damages limitation provision on other important provisions of the contract.  Typically, a fair contract will have a mutual indemnity provision.  If one party is sued by a third party because of something that the other party did, the innocent party should be indemnified.  The provisions may appear generous, but if there is a liability cap, the vendor can argue later that its duty to indemnify is also limited by that cap.  The generous indemnity provision is then effectively destroyed.  The indemnification provisions need to be outside any cap on liability or damages.

Nowadays, intellectual property litigation is more common than ever.  Perhaps the largest action in this regard pending today is the SCO v. IBM litigation.  SCO sued IBM for approximately $5 billion over ownership of the Linux operating system.  This suit has implications for every business that uses Linux.  A business that thinks it has the legal right to use the software may not after all.  This is why it is important to have an unfettered right of indemnity back to the vendor in the event of a third party challenge to that vendor’s intellectual property.

Some final considerations include privacy, venue, choice of law and a host of other miscellaneous issues.  Financial institutions require very specific language in their contracts concerning privacy.  Depending on your business, perhaps you need less, but it still needs to be in the contract along with a confidentiality provision.  These are not necessarily the same thing.  Venue describes where lawsuits must be brought under the contract if there’s a dispute.  Make it in the court closest to you.  Avoid arbitration clauses, as there’s no real right of appeal in arbitration.  If nothing else, make it non-binding.  Choice of law concerns which state’s law applies to the contract.  It’s a matter of debate as to which state has the best contract law.  People often just choose the state where they are located or that they know the best.

In short, contract negotiation can be quite challenging, but being forewarned is being forearmed.  Stay away from vendors carving out unilateral powers for themselves.  Make these provisions mutual or eliminate them.  Any limitations on liability that are agreed to must be given special attention.  If a vendor is unwilling to negotiate on these points, consider walking away from the contract.  Understanding the contract you sign in advance can help you avoid unpleasant surprises later.

Robert Rutkowski is a Partner in the Brooklyn Heights operations center of Weltman, Weinberg & Reis Co., L.P.A. He is responsible for managing the firm’s Credit Union department and Corporate & Financial Services Practice Group. He can be reached at (216) 739-5004 or rrutkowski@weltman.com.

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