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Hypocrisy In Contracting

March 2, 2011

We all know that most large companies would never sign their own contracts. The terms and policies they offer when selling are diametrically different from those they demand when buying.

As our understanding of the impact that terms and conditions have on business outcomes increases, more and more suppliers are advocating more collaborative and risk-sharing contract models. They point out to customers (especially those in the public sector) that creativity and innovation are closely linked with greater mutuality in key terms and that there is a joint responsibility to ensure success. All the research – from IACCM and a growing body of academics – continues to point to the validity of this conclusion.

But unfortunately, most suppliers continue to undermine the sincerity of their position because if more balanced contracts indeed result in better outcomes, why are they not applying this principle to their own procurement contracts? Why do they continue to impose burdensome terms on their supply base?

This is an important question for executives, lawyers and contracts professionals to answer. And it is something that any negotiator should be exploring as they seek to improve contract terms with their trading partners, or to understand the sincerity of their corporate culture. Addressing this hypocrisy would represent an important break-through for the integrity and quality of contracting – and a few market leaders have started to understand this point. For example, I was talking with a major service provider that is looking to eliminate the flow-through of burdensome terms from its customers, because it truly believes that this will be an important market statement and will generate new and higher levels of collaboration within and from its supply network. In the product world, SKF is a company that has similarly embarked on harmonizing its buy-side and sell-side contract principles because they are convinced that better balance results in the creation of greater value.

These are encouraging signs; but are they just aberrations? I hope that more of us will at least start asking the question. In these days where management is increasingly concerned about business integrity, reputation and value creation, should we not at least be reviewing the hypocrisy that underlies our own contracting practices?

And if you know examples of organizations that have already addressed this issue, then let’s share their names and celebrate this progress in corporate thinking.

 

18 Comments
  1. haward permalink

    This is a very good point and one I have wrestled with on both sides of the equation , buying and selling. On one hand it makes sense to leave some room for negotiation but on the other one should appreciate that sometimes one’s suppliers may be one’s customers tomorrow.

    The most egregious areas I experience are

    one way confidentiality requirements

    one way compliance with the law and ethical requirements

    I have no idea why companies believe that such requirements are defensible. Or , actually , even why they believe that they work.

    • First, there is no particular evidnce to show that ‘room for negotiation’ is a good thing. For example, 100% of suppliers have a limitation of liability clause. Most standard Procurement contracts do not. Each side knows that this is something that will therefore have to be negotiated – and hence it is the most commonly negotiated clause. What is the point of such diametrically different start points? What purpose or value does it serve?

      • haward permalink

        I don’t think I meant that diametrically opposed views was the same as room for negotiation. I tjhink that is pretty clear from my post.

        For example if a company decides that they would like to levy liquidated damages for delay at 1% per week to a maximum of 15% that would not be abnormal nor , in my opinion , unfair. The supplier may believe that a more acceptable rate and cap would be 0.5% to a maximum of 5%. What is wrong with that?

  2. Florante C. Abaya permalink

    The veracity of your observation is beyond refute, gigantic companies in the corporate world especially in the EPC business do not practice what they preach, they are still living in the maxim that “he who has the money, calls the shots” and still imposing onerous or exculpatory clauses that they themselves would never agree into.

    The only way, that I can think of, in getting rid of this contracting culture is though the operation of universal law, compelling these companies and public sector clients through the creation of a universal regulatory (contracting) body such as but not limited to the United Nations, where member countries are signatories and are obliged to adhere to the terms and conditions enacted for the sole purpose of regulating and leveling the field in the Contracting business with emphasis on EPC Contracts.

    A minority move in advocating a more collaborative and risk-sharing contract models are doomed to fail because gigantic companies and the public sector customers will never give up their undue and unfair advantage, even sometimes, it is proven, that they are just protection against phantom risks. It will take a radical approach in order to prove the balance results and inherent benefits of a collaborative and risk sharing contract models.

    If the world can formulate a law prohibiting unfair competition, such as those implemented against Microsoft in Europe, then the possibility of creating a universal terms and conditions in Contracting, in order to deter the insidious machinations by the elite and gigantic companies to monopolize the benefit of the Contracting industry, in particularly in the EPC world,is an uphill battle but not impossible.

    Whilst I cannot speak for my company, at least I believe that we are practicing what we preach by flowing down both the risks and benefits that we are inheriting from our Clients, as an astute and prudent EPCM company must be.

    • Excellent comment! I agree that those with the power to impose terms are unlikely to stop unless either:

      1) As you suggest, some external (and greater) power makes them; or
      2) It becomes possible to demonstrate that such behavior is contrary to their economic interests

      I suspect that the first option will never happen. Most UN efforts at more balanced approaches – such as UNCISG – have been ignored and overridden by large corporations and public sector bodies. I am more optimistic about option 2. Indeed, you mention Microsoft in your comment and they are showing leadership on this issue. As part of their support for IACCM, a senior representative from Microsoft Law Department has led a project to look at more balanced terms for the technology sector. This work in progress has already resulted in substantial revisions to Microsoft’s contract terms, in particular greater synergy between the way they sell and the way they buy. Why have they done this? Because they believe it will be positive for their brand image, as well as driving greater business efficiency, shorter negotiation times etc.

      Many companies collaborated in the research for this project and, when the final results and recommendations are released in several months, I am hopeful that we may start to see a break-through in this key industry sector – and therefore perhaps set an example for other industries to move forward.

  3. Gregg Barrett permalink

    An important issue indeed Tim. I think it is time that the community of contract and commercial managers drafted and adopted a code of ethics and a standard of professional conduct.

  4. Peter permalink

    There is as always another side.

    From a F.D. position, keeping cash in the business is obviously a positive. Reducing Debtor Days. Increasing Creditor Days.

    One the one hand, yes this could be viewed as short-sighted, as suppliers get squeezed and worse. In the UK, the Legislature recognised a related problem over a decade ago (in the construction industry), when in general, “pay when paid” clauses were rendered unenforceable, thus ameliorating the SME failure explosion of the mid 90`s.

    On the other hand, the F.D. owns a duty which directly impacts the employees of the business. The argument runs that such actions protect the Company`s interests, and hence, their interests ultimately.

    I suggest that is hard to refute?

    • Peter, it is understandable – but can you offer any specific economic analysis that shows it to be beneficial? For example, do you really believe that suppliers don’t adjust prices or change service levels in response to customer behavior? I quite understand the argument, but I have yet to find an FD who can tell me the economic costs of the cash retention policies you mention. As an example, I covered this issue in a previous blog and asked how a company might benefit by ‘thinking the opposite’. What additional discounts, or other benefits, might it negotiate with its suppliers if it offered payment terms better than those of its competitors? The chances are that the impact on the bottom line would actually be far more favorable than the one-teim benefit of extending the payment period.

  5. Charles Rear permalink

    A company may be big to its suppliers but small to its customers and have little choice than to be ‘hypocritical’.
    Any company would have to have a pretty clear view of its medium-term business to implement such collaborative processes. The commercial person conducting a negotiation has little latitude to adopt such a broad or medium-term view. Heads of department and their strategies change, resulting in an exhaustively-negotiated framework agreement – full of good intentions – being put in the bin.
    In my experience sometimes the ‘large’ company, acting as the prime, does not/cannot flow down the contractual risk/ terms to its subcontrators; the latter may be in a stronger position than the prime who has had to fight off 4 or 5 rivals to win a contract. A sub-contractor may have a product or geopgraphical USP which will mean its profit/risk profile is better than that of the prime.

    • Charles, I certainly acknowledge the points you make, but of course the underlying hypocrisy that the original blog references is the discrepancy within an organization – and this is purely a matter of choice. I certainly understand the influence of power in negotiation, but the real point is that there is absolutely no evidence that those who use that power to impose one-sided risk actually gain any benefit. In fact, the evidence increasingly points the other way. So this attack on hypocrisy is not driven by some notion of morality or fairness (though they are welcome side benefits), but is actually a matter of good economic sense.

      • Charles Rear permalink

        Tim,

        Yes I agree that companies slavishly sticking to certain terms which result in one-sided (apparent) risk can/do miss the point: the limited time available for negotiation might well be better spent on other elements of the contract (e.g. schedules containing scope, service levels…) rather than, say, core terms such as limit of liability.

      • haward permalink

        In a previous life I was responsible for setting the boundaries and the goals for negotiations and although my own style is to get to the core terms quickly I used to advise my people , whether we were buying or selling , to work long and hard on the grammar , the minor detail , the areas where there is little change to the risk. Then , once time is short , and assuming expertise on our part , a lack of time , that each party needs the deal , give the other side little or no time to work on what we wanted on core liability clauses. This worked fairly well as many negotiators simply cannot work on complex liability clauses at high speed. It needs all those assumptions to come together to work. It is surprising how many negotiators will spend hours on trivia and not bother to work out what the break points are.

  6. haward permalink

    I am a bit puzzled by the various assertions that a company that tries to persuade suppliers to accept terms which the company itself would not accept is somehow acting unethically or hypocritically. The company is only indulging in a form of arbitrage ; a very old form of wealth creation or risk management. Now I see that the effectiveness of such arrangements may be questioned but I imagine that most players in the EPC world would assure you that they atre effective and although it is possible that there is little empirical data the views of expert practitioners should not be jettisoned so easily

    But there is no ethical dimension to this ; absent fraud or collusion. This is just business as she is run.

    I have known companies which act in such a way , I have worked for them. In a couple of instances I have found that they are both a supplier and a customer. In those cases I have taken their terms of purchase , changed them so that we are the buyer and told them that those are now the , non-negotiable , terms on which we will now buy from them. Horrified , they usually find a way through the apparent dilemma. But that is not about exposing any hypocrisy ; it is , rather , about the judicious use of market power.

    • Peter permalink

      [M]arket power; yes. But things can change very quickly. Perhaps the point is that adopting collaborative techniques yields more in the long term.
      There is an adage in English Law: “He who comes to Equity should come with clean hands”. I worked for a business whose offices were rendered unusable and whose IT operations were devastated by a gas explosion at a neighbouring oil depot.
      The equity I mentioned consisted in said business reaching out to the community for “help” – to get up and running to meet obligations temporarily suspended by force majeure.
      They were successful in that endeavour: They had “clean hands”; they were liked. Had it not been so, they may have gone under.

      • haward permalink

        Peter ; I agree that collaboration works best in the long term. The point for many businesses is that the transaction in question is a short term , one off. In those cases I believe that the relationship still matters and that fair dealing brings rewards.

        You know , by the way , that there is another adage about Equity which goes that equity varies with the Chancellor’s conscience …….which is such an uncertain measure that it might as well vary with the length of the Chancellor’s foot

  7. Florante permalink

    Gentlemen;

    There is a fine dividing line concerning what is fraudulent or not and the fecundity of human brain in designing schemes of arguments in order to trounce the legal system including but not limited to the issue of “collusion” and “fraud” in the world of contracting is too great that even the judicial system have failed to enumerate them.

    The above is the very foundation of the argument that we are trying to advocate i.e. unless Contract professionals (as a start) find the conviction or decency to encourage collaborative contracting and cease from suggesting and/or formulating onerous and/or exculpatory clauses in their contract terms and conditions, as it is not commercially sustainable in the long term, then it is reasonably fair to conclude that we will not move forward into collaborative contracting and it will become a norm to take advantage or unjustly enrich some at the expense of others.

    In my own experience, more often than not, onerous provisions and exculpatory clauses like LD’s, Limit of Liability, No Damage for Delay, etc., are as a result of weaknesses, poor planning and preparation of the drafters of the Contract document, it is either, they don’t have the ability or time to ascertain the bona-fide effect of the exposure, in such a way that they are using the “catch all” provisions, as a fall back position due to their own inefficiencies. Therefore, condoning them is not only accepting “hypocrisy” as a norm but also encouraging inefficiencies.

    The “hypocrisy in contracting” was originated by the great minds in the Contracting world. As such, change can only be started by the same body that started it.

    Gentlemen, “Let us practice, what we preach”.

    A litmus and moral test, Can you let others, swallow what you can not even taste? It is not only “hypocrisy” but “moral corruption”.

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