Increasing activity in international markets and increasing use of outsourced or contract labor are two of the current trends in business. So what happens when these two trends converge?
Many corporations want to expand into new markets, but they want to conduct thorough tests before they commit to major expense. Indeed, in some cases the nature of their business or the potential volume make it unlikely they will ever formally register a local company. At the same time, they need feet on the ground and sending staff on occasional visits may not be enough to build local credibility. So what are the options?
For some, the preferred route may be to appoint a local agent or distributor / reseller. However, this is often risky because many countries have onerous laws protecting the interests of these local representatives. Such appointments can be difficult and expensive to terminate. Therefore an increasingly popular approach is to hire local staff as independent contractors. For corporations based in the countries like the US and the UK, this seems a logical extension to the types of local arrangements they often follow. And indeed, in countries with liberal labor laws, it may be a fine approach. But unfortunately there are not many countries as liberal as the US and the UK.
I write about this partly because it is an interesting topic, but also because I encounter a growing number of situations where companies win an international contract and then need to hire local staff for its fulfilment. Therefore anyone involved in international contracting needs to be aware of the potential challenges associated with contract performance.
Many will be aware already of the issues associated with sending your own staff from an overseas location. Potentially they will be working illegally (no work permit) and in addition may fall foul of local tax authorities at both a personal and corporate level (for the company, it could be deemed that they have created ‘permanent establishment’). So hiring independent contractors seems an attractive option. They are arm’s length; they are personally responsible for reporting income and paying tax. It seems simple. But it is not; and getting it wrong can be costly in terms of compensation, penalties and taxes levied.
There are several things you must consider in this situation. While specific rules vary across jurisdictions, the basic principles tend to be similar. The tests applied to determine whether this is really a contractor or a de-facto employee include whether or not they market services to others; the duration of their appointment; whether they determine their own work schedule and workload management; whether their independence is evident to external parties; whether they receive benefits from the principal, such as vacation entitlement or health cover; whether they carry business risk and in particular the potential for profit and loss.
If you need to know more on this subject, law firm K&L Gates has produced an invaluable guide.
The UK government’s announcement of a new ‘Commissioner for Small Business’ is just the latest in a series of initiatives by administrations around the world to encourage economic growth.
One area of concern is the belief that large companies tend to bully their suppliers, using their size to impose unfair and unbalanced terms and conditions. The most obvious example is payment terms, where the period for payment continues to grow and getting paid can be difficult and time-consuming. IACCM recently issued a report on this topic.
These initiatives have to be seen in the context of two distinct, but related, concerns. One is to support the growth of domestic small / medium businesses. Another is the challenge of holding global enterprises to account, whether it be through anti-competitive behavior or creative schemes to avoid tax.
On the former issue, governments are introducing a variety of schemes through local content requirements (note IACCM ran a webinar on this topic last week) and use of public procurement to favor small businesses. Often these depend on large businesses for implementation. They also challenge the commercial skills of the small businesses – their relative immaturity is part of the problem.
On the issue of holding big business to account, we must expect a growing wave of intervention and regulation. The UK initiative is one example; recent legislation on human trafficking and slavery is another; the focus of national tax departments on commercial models and practices is a third.
‘Fairness’ is not easy to mandate and is best achieved through the sort of ethical standards and policies that some corporations clearly follow. It is my belief that the contracts and commercial function must sit at the heart of ensuring terms, conditions and business practices reflect favorably on corporate reputation and brand image.
My blog earlier this week drew an interesting response from Ken Adams and his co-author in a recent article offering “Top Ten Tips in Drafting & Negotiating International Contracts“. The ensuing debate seems to me to encapsulate the dilemma facing the legal community today. Essentially, are they narrow (but important) specialists in law, or should they be applying their knowledge of law within a much broader remit of ‘business advisor’?
The former role can be problematic – and I was pointing to those problems in my commentary on the original article. Essentially, good drafting or negotiation is driven by overall context. If you do not consider the broader purpose of the contract, it is probable that the resulting terms will either be inappropriate or inadequate. My view is that the suggested ‘top tips’ run into precisely this issue because they are being made without reference to context – and the context will in many cases change the priorities or choices of what or how to draft and negotiate.
Much of the work undertaken at IACCM aims to provide an increasingly factual base for decision making. We seek to reduce the extent of ‘mystery’ and ‘opinion’ and move towards positions that are based on solid research data, experience and judgment. It is in that context that I produced my counter-view of the ‘top tips’ for any lawyer drafting and negotiating an international contract. Essentially, their work must begin by understanding the context and establishing the risks. Only then can they decide the issues around use of language, use of local counsel, choice of law etc.
There are many examples to illustrate the importance of lawyers engaging with the business issues. For instance, in my blog, I highlight the challenge of getting paid. This is fundamental to an organization’s survival and is frequently an issue in international contracts. If the lawyer does not understand the practices and norms of their counter-party, they will struggle to draft and negotiate terms that bring security in this area – and potentially the rest of the contract becomes pretty much irrelevant. Similarly, anyone preparing an international contract must be aware of the regulatory environment in the country or countries involved. Ideally, they have developed personal expertise in key areas such as data protection, competition law and export regulations – but if not, they need to be aware of their ignorance and find a way to fill the gaps. Finally, what is the time-line for getting this contract completed and what is the budget available for its production? Understanding factors such as this are critical to the lawyer operating in the real world – and again will influence the way they set about their work, the terms they draft and the priorities they establish.
Without knowing these things, how can you begin to draft or negotiate anything?
As I highlighted in my original comments, the ‘top tips’ article raises important considerations, but practical experience and research suggests that other items must come first. If lawyers are going to maintain status, they must become more effective in offering business advice. This is not a personal opinion; it reflects discussion with many lawyers – in-house, within law firms and at law schools. Indeed, it is a challenge that is common to all professional groups.
Ken Adams is a respected expert on the topic of contract style. I do not always agree with his pronouncements on this topic, but I defer to his expertise and fully expect him to challenge my rare ventures into this aspect of contracting. On this occasion, Ken went beyond style and into substance – an area where opinions start to give way to facts and processes, where what you are writing takes precedence over how you write it. Because this area of substance is where so much of my work is done, I feel it is appropriate to suggest alternative priorities – and in doing so, have inevitably ventured into the debate I mentioned at the outset – ‘what is the role of a lawyer today?’
In a recent article, the Association of Corporate Counsel offers its ‘Top Ten Tips In Drafting & Negotiating International Contracts’.
While the items listed are worthy considerations, they miss the most critical issues and in some instances, fly in the face of good practice.
So what is wrong? Essentially, the article displays an absence of appreciation for the key risks associated with doing business internationally and the role the contract can and should play in avoiding failure. For example, many experts would suggest that the number one issue in any contract (but especially in an international agreement) is around the financials – ensuring you get paid or you get what you paid for. This puts overall payment terms and the related security provisions in the first two places – though they are missing completely from the ACC list.
Today, the regulatory environment is critical to any contract and its negotiation. Awareness of relevant regulation and appreciation of its consequences is a fundamental issue that your legal team must address, whether on competition law, data security, environment or the myriad of other local and global regulatory requirements. So I am placing this at number 3.
Closely tied to this is the whole issue of reputation risk and sustainability. Gone are the days when ‘out of sight, out of mind’ seemed to prevail for many negotiators. The networked world means that mistakes in international contracts quickly make global headlines. High performing lawyers are strongly focused on reputational issues and ensuring that the deal and the counter-party are ethical, that the business relationship is sustainable and that local customs or practices will not threaten integrity.
Competent lawyers also appreciate the challenges of speed, cost and communication when transacting internationally and consider ways to tackle these. On speed, IACCM data reveals a remarkable diversity in the cycle times required to close international business. Not only does it take on average roughly 50% more time than an equivalent domestic deal, but also top quartile performers operate roughly 4 times faster than those using the method of contracting implied in the ACC article. The smart lawyer understands that cycle times are sensitive and that failure to address this issue will damage their credibility and lead either to loss of business or to the rest of the organization working around them.
On cost, it is simply unaffordable to engage local counsel in every country or to have local in-house resources. Modern business is finding ways to address this, sometimes through use of low-cost LPOs, but more often through use of alternative dispute resolution. ADR has the effect not only of slashing the legal costs of deal-making, but it also typically cuts cycle times by more than 50%. By following this route, several of the ‘ten tips’ become redundant.
Communication is a challenging field for the jurisdictionally-trained lawyer. Especially for those from a Common Law background, they feel comfortable using specific terms and wordings which will often be alien to their counter-party. Of course it is always far easier to operate in our native language. But attempting to impose our methods and approach on an international trading partner, with limited effort to ensure common understanding to respect their way of doing things, is frequently a recipe for disaster. At best, they do not really understand what has been agreed; at worst, they view the process and the agreement as unbalanced and feel no real commitment towards it. Good contracts are increasingly designed as communication instruments, not as legal weapons.
The ACC list is interesting and certainly reflects items that should be considered by the parties. However, they focus primarily on the lawyer’s role in dealing with the consequences of failure (that old security blanket that makes us indispensable) and presume adversarial behaviours. If this reflects the aspiration of the average lawyer, it explains the challenge they face in establishing business relevance and value. In reality, top lawyers aim much higher; they want to provide legal advice in the context of business realities.
I have to thank an IACCM member for bringing this particular article to my attention. As a General Counsel, she also made the following generous observation: “It is certainly an interesting subject addressed by great experts. Their selected focus though is precisely the reason why I personally find IACCM so enriching for lawyers when compared to other corporate lawyers associations”.
It’s not only companies that impact the ‘ease of doing business’ – it is entire countries.
When it comes to negotiating or performing contracts, there are major international variations. It isn’t just the obvious differences such as language or the rule of law. Factors such as the depth of negotiating skills or insistence on performance bonds or guarantees are equally significant.
In a current survey, IACCM is assessing nine elements that directly impact ‘ease of doing business’ and comparing them across 50 countries. The effects are quickly evident. For example, nearly 40% of respondents highlight that they have turned down opportunities to do business in Nigeria because of perceived risk or difficulty.
Perception is often key in how organizations approach international business. For example, it impacts the way that negotiations are conducted. Many hold the view that the United States is risky because of its legal and regulatory system; this causes negotiators to approach the market in defensive mode and reinforces their focus on risk allocation within the contract.
If you have any experience of international contracts, the current survey can be accessed at https://www.surveymonkey.com/r/intcontracting2015. It takes only a few minutes to complete and results will be shared with all participants later this month.
I received a request from an IACCM member who is undertaking analysis of the potential savings if his large, international corporation replaces in-house lawyers with contract managers. Research in the US has apparently led to a number of $100 per hour – presumably fully accounted cost. His question is whether the potential for cost reductions is similar in Europe.
I thought that I would share my answer to see how others might react. I am sure there will be those who applaud the idea of cutting legal headcount, while many will doubtless suggest that such a move would represent grossly irresponsible risk-taking.
Your question is really interesting and quite challenging to answer.
“In Europe – as increasingly in the US – there are many contract or commercial managers who are qualified attorneys, but not ‘of counsel’. In some instances, they may perform jobs of broad equivalence to the in-house counsel. In others, the thing that attracts them to the job is that their role is significantly broader – and hence a cost comparison may be rather misleading.
In other instances, the alternative to a lawyer may be a para-legal or even an unqualified individual who has been trained to perform many of the ‘lower-level’ legal tasks. This model can of course reduce per hour costs considerably.
A third model is where much of the legal and contract-related work is moved to an off-shore center, either captive or outsourced. This option will generally be the cheapest of all.
I think the point here is that there is wide variability between organizations in the role they perceive to be needed. By way of example, I attach recent benchmark data showing where contracts / commercial groups typically spend their time; you will see that this is a much wider remit than the typical law department. Indeed, to the extent there is a trend in Europe, it is towards the realization that legal skills and knowledge are only a component of contracting and that there needs to be a focus away from pure lawyers towards ‘commercial managers’ with a much wider understanding of deal economics, risks and value management.
Our research shows that companies with a dedicated contract / commercial function achieve significant headcount efficiencies – but only part of this is through reduced legal resources; they also drive significant efficiencies in the functions that otherwise have to prepare and manage key aspects of the contract (e.g. Statements of Work, Service Levels etc).
I suspect that the theoretical per hour savings of simply replacing in-house counsel with an equivalent ‘contract manager’ would typically be around $35 – $50 in Europe – and significantly more if the work is moved to a low-cost center. However, as indicated above, my concern is that this approach fails to ask what is the real business need and how to optimize the value achieved from contract management.
If there is interest in this wider question, IACCM has various tools to support analysis of the contracting process and extensive additional benchmarking data to indicate the business impacts of alternative models.”
Although the business environment is undergoing rapid change, the focus of term and condition negotiations seems to remain relatively constant. Is that because contracts offer a point of stability in an unstable world, or is it because those who lead negotiations are failing to adapt?
IACCM’s annual study of ‘most negotiated terms’ never fails to offer fascinating insights. Over the years, it has shown the effect of new regulation, of economic recession, of geopolitical insecurity, of shifts in technologies and business offerings. Yet it has also confirmed an underlying tendency for negotiators to focus on issues of risk consequence – and in so doing, to undermine the value that contracts can deliver.
Does this tendency suggest that most of today’s contract negotiators are pessimists, or that they see their role as protecting the business against the over-optimism or lack of precision within sales or business unit management? Certainly such an attitude has validity, but it also fails to tackle the real problems (or opportunities) that come from creative and collaborative contracting.
With today’s steady increase in executive interest and focus on contracting, are we seeing a shift in the timing and purpose of negotiations? Is this affecting the terms we negotiate? IACCM will value your opinion and experience – and also share with you the results of their global survey. You can participate by visiting https://www.surveymonkey.com/r/topterms2015