USE YOUR CONTRACTS TO PREVENT DISPUTES
Updated: Feb 11
The sixth in a series of articles on contract management.
Many people assume that disputes are an inevitable part of contracts. They view the contract as either a "sword" or a "shield" to be wielded in litigation. As a sword, the contract is used to procure rights to which a party believes it is entitled. As a shield, it is used to limit a party's responsibility for certain matters and to defend against unwarranted claims. There is a better view, however, which views the contract as a "bridge" to enable the parties to complete their business transaction successfully, without any disputes whatsoever.
The view of the contract as a "sword" is one that assumes the contract must be aggressively used to force the other party to honor its commitments. The following are some typical contract provisions designed to enforce one party's rights:
· A clause requiring the other party to pay interest if invoices are not paid precisely on time and in full.
· A requirement that the service provider transfer to the client any and all rights to the work product.
· A provision obligating the other party to pay penalties if the project is not finished on schedule.
· A guarantee that all work will be performed to the other party's satisfaction.
Here are some examples of contract provisions intended to act as a "shield":
· A clause requiring one party to indemnify the other against any and all claims arising out of the contract.
· A provision denying responsibility for any problems related to work done by other parties involved in the business transaction.
· A clause releasing one party from the obligation to pay damages if the matter is covered by the other party's insurance.
In the real world of business, the use of these types of offensive and defensive contract provisions is a reality and it is often appropriate to include them in a contract. To view the contract only as a weapon to be wielded in litigation, however, is to adopt a limited, and limiting, perspective. This attitude assumes that business relationships are adversarial by nature and that the contract is necessary to protect oneself from those who can't be trusted. If the contract is used only as a litigation tool, it will have failed to achieve its fundamental purpose. The highest and best function of a contract is not to facilitate litigation but to prevent it.
The better view is to envision the contract as a "bridge" between the parties that establishes the consensus necessary to enable them to complete their transaction amicably and that provides mechanisms to prevent any misunderstandings from degenerating into disputes that torpedo the deal. In this view, the contract is seen as a vehicle for each of the parties, at the beginning of the transaction, to engage in the intellectual discipline of asserting their respective legitimate business interests and thoroughly exploring the extent to which they differ, as well as how they might diverge during the transaction. The contract negotiation process should thus enable the parties to build the foundation for a mutually beneficial, and therefore successful, relationship.
Let's look at how the non-adversarial approach to contracts can prevent disputes. Consider the typical payment clause in a contract. The service provider will insist that it be paid on time and in full for all work performed. The client, on the other hand, will insist on its right to refuse to pay an invoice if it feels that the services have been deficient. When this situation arises, the entire payment will be withheld, the service provider will refuse to work, and the contract will self-destruct.
The better approach is to recognize that each side has a legitimate business interest in this situation and to provide a mechanism for achieving each of their objectives. The payment clause in the contract, for example, could provide that, if the client feels that the services have been deficient, it has an obligation to notify the service provider within a set period of time so that the problem can be promptly corrected. The client will be entitled to withhold payment of the disputed portion of the invoice until the deficient portion of the work has been corrected, but will be obligated to make timely payment of the balance that is not in dispute.
The contract should also provide a mechanism for promptly resolving the disputed portion of the invoice. The parties may, for example, be obligated to discuss the matter in good faith and, if this does not resolve the problem, take the matter to a mediator who is acceptable to both parties and is knowledgeable on the issues. If this is unsuccessful, the parties can then resort to binding arbitration. For matters above a certain dollar amount, the parties may, if they wish, retain the right to pursue litigation in the court system.
Consider another example: a clause involving the ownership of blueprints, documents or other work product. The client will typically insist that, since it is paying for the work product, it should have the right to own it and use it any way it chooses. The service provider, however, will normally insist that the work product is its own professional creation and that it should retain all ownership rights.
The real issue here, however, is not "ownership" so much as potential liability to the service provider caused by the improper re-use of the work product on other projects performed by someone else. For example, using blueprints created for one building, to be situated on flat terrain, to try to build another building of the same design on a hillside could have disastrous consequences. The service provider's legitimate business interest here is to be indemnified against claims arising out of such improper re-use of the documents by the client on other projects. The client's legitimate interest is to have the right to use the documents or other work product for its own internal uses, but not for other projects. An appropriate contract provision could accommodate both of these interests and avoid any dispute about "ownership."
This non-adversarial approach can be taken in regard to each of the contract's provisions. Using the contract negotiation process to probe for consensus, to identify potentially divisive issues, and to put agreed-upon mechanisms for dealing with them into the contract will prevent misunderstandings from becoming full-fledged disputes that endanger the successful completion of the business transaction. The contract will thus become a means for preventing disputes and for enabling both parties to accomplish their legitimate business objectives.