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Imprecise terms and the balance of risk

January 24, 2012
I was asked recently for my opinion on the use of  such vague terms as  ´unforeseen circumstances´ or ‘reasonable efforts’ and the beleif by most lawyers (and some economists) that such language will be a cause of litigation. My correspondent observed: “I try to argue that business people actually resort to such vague terms on purpose and often think that balance of risk allocation is important to prevent conflicts”.
 
I thought I would share my initial response and see what opinions readers of this blog might have.
I think that business people recognise that not every situation can be foreseen and that any attempt to do so would create severe counter-risks – such as inability to ever reach agreement or unacceptable and costly delays.
 
Businesses don’t enter contracts to litigate. They enter contracts to make money. There are always risks and lawyers will always argue – that is what they are trained to do, as one senior IACCM member pointed out to me yesterday. So business people are looking for practical vehicles through which their financial goals can be met and which – as far as possible – limit the risk that they will not be met. They don’t fall out and litigate because of the words on the contract; they fall out and litigate because the money they hoped for (revenue, savings) did not materialize. In reality, business people are frustrated by the delays caused by lawyers or contracts staff arguing over what they see as petty details.
 
Now the lawyer will say (quite rightly) that this is just fine unless and until something goes wrong; and then the executives will turn round and ask why they were not better protected. But this is where lawyers must think of different approaches because many of these ‘vague’ terms are in practice unavoidable. A good example of a practical response is agile contracting. In circumstances where the scope and requirements are unclear, the parties phase the agreement in such a way that milestones are funded and there is a deliberate intent to then agree – and potentially re-negotiate – the next phase. It is the recognition that attempts to be precise will actually cause risks that has led to this approach to major development projects (originally software, today much wider).
 
Lawyers and contracts professionals believe that the main purpose of a contract is to manage risk (IACCM research April 2011). Business people believe the main purpose is to drive financial returns. It is this gap that frequently causes lawyers to be seen as frustrating business intent. Business people want practical measures through which to handle risk. This might be through contract structure, or increasingly is through more thoughtful governance terms – for example, change management mechanisms, communications and reporting, incentives to jointly manage unexpected incidents or disruptions.
 
Final points: how many lawyers and contracts staff take time to discover what the primary sources of claim and dispute actually are? I am sure there are many court cases that have revolved around word interpretation, but how common is that relative to the overall issues that create risk in contracts? (The answer of course is that it is very rare). These issues of wording only become issues when the business relationship has collapsed. If those charged with contract negotiation really care about risk, they would be thinking about how to tackle the real, rather than theoretical, risks and considering what terms and principles assist in establishing and maintaining good relationships (and lengthy battles over the use of words is a very good way to erode trust and get relationships off to a bad start).
 
And in conclusion, most of this debate has relevance primarily in the context of common law. Yet a growing proportion of trade is not under common law and even most US corporations now depend extensively on foreign relationships. The challenges of litigating are growing so entering contracts with this assumption is foolhardy. Many top corporations now use arbitration / mediation because they know litigation is not practical. We are moving rapidly to a world where judgments are more based on intent than on precise words. So it is time for lawyers to emerge from theory and deal with the world as it really is!
3 Comments
  1. Alan Roach permalink

    I agree with your comments but contracts personnel and legal staff can only formulate language to cover what they know about. Often I work on agreements or bid documents that the requesting party hasn’t clearly thought through or recognized all of the issues/concerns for the project. That’s where good contracting skills help lead them to find those issues.
    On a second point, many companies are trying to use master agreements to cover multiple orders with a vendor or group of vendors. Once a master is in place there is little control over what/how or when work is ordered. So often the original intent of the master may change over time requiring that vague language to cover all of the “unseen” uses.

  2. Arian Alexander Danilovic permalink

    Excellent article! The idea that ‘issues of wording only become issues when the business relationship has broken down’ is indeed spot on. It seems obvious that contracts should allow both parties to complete a business related task with a level of security assured by a contract. However, over and over again we build contracts that take us towards litigation, or disputes in general, from day one. The end result is always increased costs and expensive delays.

    Arian-Alexander

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  1. Vagueness in Contract Terms (Continued) « Commitment Matters

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