If your company has bought or sold assets, appointed or became a distributor or engaged in any other business transaction, chances are you signed a contract. Many sophisticated business owners, however, rarely read or fully understand those pieces of papers that evidence the rights and duties of their deal. But, observing the following seven rules can help you extract benefits of your contract. Adding these rules into your business practice will weaponize your contracts, turning them into assets rather than a mere expense item.
- Develop A Contract Checklist. Each contract will contain a list of deliveries that each party is to make before the contract becomes effective and, perhaps, throughout the contract term and even after the contract has ended. Ask your lawyer to prepare and share with you a checklist of the items. A checklist will make sure that you can make sure that small yet important details are completed, like the delivery of evidence that your counterparty secured the agreed upon insurance coverage and that your company is named as the insured. A checklist will also help you keep track of key documents that may be needed later to enforce your deal.
- Relate the Contract to Your Company’s Financial Statements. Share the contract with your company’s accountant to determine what, if anything, should be reflected on the company’s balance sheet or income statement. Contracts allocate costs and expenses between the counterparties. If you agree to indemnify your counterparty, depending on the circumstances, your accountant may determine that the exposure should appear as a liability on your balance sheet. That may be your que to include a reserve charge (or premium for insurance coverage) in your income statement and your pricing formula. This exercise will also let you know when you need to negotiate the parameters of your exposure like capping the overall liability and limiting the duration of such exposure.
- Look for Hidden Transaction Costs. In an attempt to save costs, you may ask your lawyer to use a “standard contract.” Yet, no matter how small or frequent, no deal is standard and the contract form the parties select may have been addressing circumstances that are inapplicable to your deal. And, those “standard” terms may carry hidden costs. For example, many contracts may require one party to submit to the other annual audited financial statements. Having an audit performed can be expensive and time consuming. While there are times that the counterparty may require an audit for its comfort, it may be that the provision of unaudited financial statements, a review or a compilation will satisfy the counterparty’s needs. Another standard term that can carry unnecessary expenses is the insurance coverage required to be carried by your company. Make sure the insurance coverage amounts and the rating of the insurers from which you can select coverage are appropriate for your deal. If your counterparty insists on higher coverage, you might insist that they pay the additional premium or, at least split a portion of the additional premium. As noted above, relating this item back to your income statement may result in adjusting your pricing formula to preserve your net margins.
- Enlist Silent Partners for Your Deal. Your contracts should reflect the inter-relatedness of today’s marketplace. A typical contract will provide a list of representations and warranties from your counterparty as to how they run their business and perform their obligations under the contract. An unforgiving marketplace makes you responsible (both from a legal and reputation perspective) for anyone in your supply chain as to quality of your product or service. When on-going supplier quality checks are not possible or are prohibitively expensive, you may want to recruit silent partners like trade groups. Requiring your counterparty to belong to and remain in good standing with reputable trade groups that assure their members are compliant with industry standards shifts some or a considerable portion of due diligence and enforcement mechanisms to a third party.
- Think Through Simple and Practical Enforcement Mechanisms. Differences of opinion and disputes between counterparties are not unusual, especially as time passes and the circumstances in the market change. Focusing solely on whether or where disputes are to be litigated or arbitrated are common mistakes. Litigation or arbitration should be a last resort. Focusing on how to ensure that problems are identified and routed to responsible decision-makers on each side while keeping products, services and payments flowing is more important. Taking time to discuss real life scenarios with your counterparty as the contract is being negotiated will also help build the relationship and lessen the likelihood that the last resort becomes the first, and costly, resort. And, know when something is so important that you need to force the counterparty to immediately comply, either by its own decision or under the order of a Court or other legal authority. Make sure that your company understands how long it will take to obtain judicial relief and the costs, and how those costs will be recovered.
- Create a Post-Closing Checklist and Deal Docket. Back to the deal checklist. Rarely is everything that is required to be done prior to a deal closing actually done and completed by closing. Once the deal is done, have your lawyer send you a post-closing checklist, assigning responsibility for each item that has to be completed and a timetable for completion. And, remember to calendar important dates. Microsoft Outlook and other calendar programs allow you to set alerts that will remind you in advance of an important date. For instance, you can program your calendar to remind you sixty days in advance of the expiration of the period in which you can file claims against your counterparty for its breach of representations and warranties made under the contract. Failure to file the claim by the date specified in the contract could compromise your ability to recover on that claim.
- Create A Transaction Bible. Ask your lawyer to provide you with hard or electronic copies of the final signed contract, together with all exhibits, schedules and all other ancillary agreements and undertakings related to, or executed in connection with, the deal. This collection is frequently called the transaction bible or notebook and should contain all of the documentation you will need to evidence, and enforce, your deal. Check with your lawyer regarding the enforceability of electronic signatures in the jurisdiction that governs your contract.
Follow these simple rules and your contracts will be transformed from mere piles of paper to useful and valuable assets of your business.