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Contract Terms: A Re-balancing

November 7, 2011

“In the last couple of years, things seem to have got worse.”

 That sentiment about the unfairness of risk allocation in contracts is one I have encountered many times during discussions in recent weeks. There is a feeling that large corporations and major public sector bodies have become more risk averse and have used current economic conditions to exert their strength – liabilities, indemnities, IP rights, termination provisions, performance criteria and (in the corporate sector) payment terms have been areas of focus. And despite their insistence on ‘the integrity of contract’, these same organizations think nothing of using their power to force unilateral renegotiation when conditions change.

 Overall, I think things have become worse. Ironically, on one hand economic conditions have forced many corporations to take added risk (new markets, more rapid product development, supplier consolidation are examples), but at the same time they have sought to clamp down further on their established suppliers, without much regard to the business consequences.

 Some legal and procurement staff stick to the belief that harsh terms drive performance. Short-term and for commodity acquisitions, that may be right. But for any more complicated or long-term acquisition, all the evidence points the other way – that unfairness undermines loyalty and commitment, leading to poorer outcomes and therefore added risk.

 However, while things may have become worse, I see growing light at the end of the tunnel. I have the impression that an increasing number of organizations are starting to question their approach. This is leading to a number who have renounced liquidated damages; some who are questioning how they can be more intelligent in protecting (and exploiting IP); others who are looking for shared approaches to governance through better change provisions, escalation procedures and added flexibility through mechanisms such as ‘hardship clauses’. I believe the door is opening for those suppliers who engage early and demonstrate their capabilities and commitment to deliver.

 Relationships that extend beyond a few transactions will always depend on trust and cooperation. Failure to establish and sustain these characteristics will always result in degraded performance and missed opportunities. This truth is dawning on a growing number of those responsible for contracts and they are influencing their management and colleagues to think differently – to distinguish between risk allocation and risk management.

 

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  1. Balancing the Outsource Contract Scales

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