Chapter 4
Negotiating — doing the deal
Every negotiation of a contract is different. This is because the subject matter, the personalities, the price and the commercial pressures are idiosyncratic. A contract negotiated for a good or service in May 2007 may proceed entirely differently when renegotiated in May 2009. If nothing else, broad market shifts in a globalised economy mean circumstances change with startling and often disorienting regularity.
The nature of the negotiation will be ordained by the size and nature of the contract. A contract to provide a fairly regular or commoditised good or service will tend to be simple. It is the price, delivery time and quality of that good or service that are the main issues.
However, larger contracts involving more money, more sophisticated assets or services and more complex rights and obligations will ordinarily have a longer negotiation period and be more detailed in nature.
Different transactions have different negotiation profiles. An acquisition of a competing business is a different negotiation from the deal you may do with your financiers to fund that acquisition. This is in turn a different negotiation from that which you do with the management employees of the business you are acquiring. This is again different from the negotiation you do with the landlord of the old premises occupied by the business you have bought in order to opt out of the lease.
Below I have set out the four regular steps that are undertaken in negotiations. They are:
1 can I do a deal?
2 the recap
3 locking them in before we are signed, sealed and delivered — do I need to?
4 negotiating the words.
The following tips assist in each stage of the negotiation. This is not intended to be prescriptive. There is no necessary reason a negotiation will follow this path. You may not need all four stages. You may go straight from stage 1 to stage 4. It is largely up to you, your counterparty and the commercial circumstances.
Can I do a deal? Drawing the big picture
The preparatory considerations to be given are generally at this stage of negotiations. This is when you are working out whether you can do the deal or not. As the negotiation progresses, more and more information is obtained and you form a view about the viability of the contract. The key messages here are precision and particularity. The more detail you can extract from the other side in every sense, the better position you are in to form a view about whether the contract is worth pursuing or not. This can take a relatively long or short time depending on the negotiating style of your opponent, how forthcoming they are and whether they are being deceptive or full and frank.
The glorious uncertainty of negotiation may mean they seem as though they are all of these things during phase 1.
At various milestone stages in the negotiation it is useful to have a recap with your counterparties. This does not need to be formalised. It can be a relatively casual summary of where the negotiations are up to. This is of assistance on three levels:
1 It forces you to be vigilant in keeping track of where the negotiations are at — an issue that does not appear important early on may become fundamentally important later. A recap regularly through the negotiation expressly causes you to think about where you are up to and what has been resolved and what hasn’t.
2 It provides a useful point to revisit matters that have been previously negotiated and tentatively resolved or left open — subsequent negotiations and other terms or conditions may cause you to rethink how you structure the deal early on. A recap allows the parties to discuss where the deal as it is at this stage and whether that sits comfortably with what was initially negotiated.
3 It allows you to make an efficient decision as to whether the negotiation is worth continuing with — if the recap means you have much less resolved than you would have hoped, the negotiation is not meeting your requirements and the vista is bleak, it may be time to assess whether the negotiation is worth it. It is a trigger point for you to assess where you are up to and can work against a general optimism that a deal can be done when that optimism is misplaced. It is particularly useful in this context in big negotiating teams.
Often stronger personalities in a negotiating team will be more influential and in my experience they are also generally more optimistic. They may pressure others into continuing a negotiation when they are trying to do a deal that can never be done. Their optimism, drive and verve can be infectious and overpowering. These attributes are generally appealing but can sometimes be misplaced. An objective assessment may make it clear that a deal cannot be done and that is best resolved sooner rather than later. A recap is a formal means by which the understandable but unwise enthusiasm of charismatic colleagues can be addressed.
Locking them in before we are signed, sealed and delivered — do I need to?
This assumes you have got to a stage where the big issues are tied off and you are ready to enter into a contract.
A heads of agreement may be a useful document at this stage. It does not purport to be the full and final contract, however it sets out what the parties intend to do subject to final documentation.
Example
Two large privately held companies talk about a merger. They skirt around and flirt with each other over a period of time about whether the merger discussions are worth pursuing. They sketch out the general terms of the merger.
A heads of agreement may be useful to set out what the agreement to that point is. The heads of agreement may bind the parties subject to subsequent conditions or events arising. It is a powerful statement of goodwill that they want to do a deal. It commercially justifies expensive consultants and professionals being brought in to finalise the agreement. It means, in general terms, the parties want to do a deal. It also may have binding legal consequences if all of the conditions precedent or subsequent necessary events fall in line.
A big question is working out whether you want the heads of agreement to be enforceable or not. It is sometimes hard to have a fully enforceable heads of agreement because, commercially speaking, both parties want to keep their options open and the final deal is still in play.
However, in important commercial negotiations you want to maintain confidentiality and exclusivity. Confidentiality is an issue you should deal with at the outset, particularly if you are buying and selling businesses. It is generally in both parties’ interest that all individuals enter into confidentiality deeds, ensuring they do not tell anyone about the negotiation taking place.
When you get to an advanced stage in seriously exploring the deal, and on a provisional basis agreeing to it, you may wish to tie in the counterparty to exclusively dealing with you and no-one else.
If you are the more eager party in doing the deal, you may want to tie in your counterparty on a limited but enforceable contract through the heads of agreement. This is also risky. By entering a heads of agreement you expressly acknowledge that you haven’t resolved all aspects of the deal. There is a practical consideration here about what a court would be asked to enforce if there was a dispute. This would depend very much on the terms of the heads of agreement and what it said.
There are also strategic issues. Often it is good not to be seen to be too eager to do the deal because it hints at loss of commercial objectivity. When a party has lost its commercial objectivity and seems to be taking an emotional or overly enthusiastic approach, it leaves it open to be manipulated by the other side.
A heads of agreement can be a useful document, although only on a restricted basis. Again, the precise subject matter of the contract, who your counterparty is and the broad commercial circumstances, will be important in you determining whether a heads of agreement will hurt or help you. If it helps, what terms need to be incorporated and is it to be binding? These are the consequential questions when and if you decide on a heads of agreement.
The heads of agreement needs to be closely considered. How will it help? What does it give us? What does it oblige us to do? Does it help or hurt when objectively assessed? What happens if things turn nasty — can we be sued and if so what are the risk profiles? All these considerations are important and different in each case.
Example
A small software supplier, Softly Softly, is negotiating a multimillion-dollar contract with a bank. It suspects the bank is talking to bigger market players. The bank has never stated that Softly Softly is their only courtier. A deal is negotiated where price, development milestones and installation dates are resolved. The outstanding issues are intellectual property ownership, maintenance, resourcing and guarantees and indemnities among less negotiable matters. Softly is happy and wants to exclude competitors. It closely considers a heads of agreement. The great benefit will be that the bank will need to commit to it exclusively. On the other side, the bank will want to add a clause that says if Softly does not go ahead, it agrees to pay any damages the bank suffers.
The software that is the subject of the agreement is necessary for the rollout of a new finance product. If there are undue delays in finalising the contract or Softly causes it not to go ahead, the bank will rely on this clause. If Softly does not cause it to go ahead for any reason, liability may arise. The relative sizes of the bank and Softly may mean that a claim by the bank causes Softly to go under. Softly is potentially writing the bank a blank cheque on a damages claim.
After sleepless nights and soul searching, Softly opts for the heads of agreement on the basis of exclusivity. They form a view that this exclusivity is of greater value to them than the potential risk for the damages claim. However, they know the bank will rely on the clause and it is probably enforceable. What they don’t know is how much it may cost. However, the heads of agreement may pave the way for Softly to go from a small market player to a serious operator at warp speed. Here self-belief and optimism have won out although importantly not at the expense of rational judgement and risk management.
The key element is the balancing act Softly makes between tying the bank into an exclusive deal and the risk of time pressure. Any extended negotiation of the agreement will be a problem for the bank, and as a consequence, possibly also Softly. Softly must place a commercial emphasis on quickly negotiating the agreement. However, given the disparity in the commercial sizes of the respective entities and the fact that the bank will always have more leverage, this may be easier than it sounds.
Take for instance intellectual property rights. If Softly’s work is successful, it may wish to retain intellectual property rights in the software so that it can be marketed to other banks in Australia and around the world. However, it is fairly and squarely in the bank’s interest to take those intellectual property rights and utilise them itself. It is in the bank’s interests to either use that product to sell to other financial institutions or quarantine a great software product so it is used only by itself. This may give it a market edge.
It may be that a deal is not done because of no agreement on who is to own the intellectual property rights. This would be extremely problematic.
The deal falling over may give rise to a damages claim given the bank tied itself to exclusively negotiating with Softly and a deal was not done. The bank preserved its right to sue Softly for damages if it suffered any commercial loss as a result of any delay, under the heads of agreement, including protracted negotiations.
Again, Softly formed the view it could manage the commercial risk and that the potential opportunity outweighed the possibility of it being sued and having to pay out a lot of money to the bank.
Of course the simple way out would be if there was a sticking point in the negotiations for Softly to simply concede intellectual property rights. However, this is easier than it sounds. Softly is obviously confident of the product it is developing and, commercially speaking, its eyes light up with the prospect of selling it to other financial institutions.
This situation again illustrates the delicate and gut-wrenching matters a commercial party must consider when considering whether or not to enter a heads of agreement as a stage in doing the deal.
More than joining the dots — final wording
When preparing the full and final written agreement, leave nothing to chance or assumption. Consider every aspect of the deal and make sure the words reflected in the agreement are consistent with the deal you have done.
It is extremely dangerous to place too much faith in your counterparty or assume that because both parties are showing goodwill at the outset they will honour their representations and the deal they have done.
The value and importance of the precise words to be used in the agreement cannot be emphasised enough. Their gravity is profound. Time and incredible care must be taken to ensure you are happy with the way every clause of the agreement is expressed.
Even apparently innocuous clauses can be loaded so profoundly on one party’s side that it makes the agreement very risky to enter into.
It is also important, at the risk of being pessimistic, to consider what happens if the relationship breaks down. Termination clauses in particular are given very little heed in commercial negotiations because the understandable assumption is that ‘nothing will go wrong’ or ‘if it does, we will be able to fix it’.
Sadly, this is not always the case.
Courts are full of disputes involving breaches of contract where one of the parties could have advantaged themselves by giving close consideration to the clauses that looked to be formal or standard.
It is also important to consider whether any of the clauses in the agreement are illegal. As set out above, courts will not enforce or will render void contracts or parts of contracts that contain obligations that are illegal. A particular area of trap is the Trade Practices Act. In general terms parties cannot contract out of the Trade Practices Act. That means that they cannot engage in any anti-competitive practices by agreeing to squeeze out other market players. You also cannot agree to remove warranties that your service is fit for purpose or your good is of merchantable quality. These are implied by law. Any attempt to do so will not be accepted by the court.
It is important to acknowledge these kinds of legal principles because they may be important to you in the contract. You need to know whether there is a risk it will be unenforceable. That may materially change the commercial considerations you have in entering into the contract. In this context it is important to obtain legal advice or closely consider the relevant legal issues so as to ensure you are given maximum protection and do not have an important clause that is illegal in a contract.