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Top Tips For Negotiating and Preparing Commercial Contracts

In today’s fast-paced and inter-connected business environment, negotiating and preparing comprehensive commercial contracts has never been more critical. As businesses strive for growth, sustainability, and competitive advantage, the role of well-crafted contracts as foundational tools for establishing and managing business relationships goes hand in hand with the successful execution of corporate strategy.

Whether raising capital, establishing a mutually beneficial business relationship, accessing new markets, or providing or receiving goods or services, below are 5 practical tips to help your business negotiate and prepare commercial contracts more effectively.

Tip 1: Establish your parameters

The cornerstone of any successful commercial contract negotiation is a clear understanding of your business objectives and the boundaries within which you are willing to operate. This clarity requires a thorough analysis of what the parties aim to achieve through the contract.

 To establish your parameters:

  1. Define objectives: Clearly define what you want to achieve from the negotiation. This could range from financial terms to timelines, deliverables, or the scope of work.
  2. Define non-negotiables: Identify the aspects of the deal where compromise is either undesirable or impossible due to legal, operational, or strategic consequences. This dual awareness acts as both a compass and a boundary, guiding your negotiation strategy and ensuring you make decisions aligned with the core business values and goals.
  3. Know the other party: Understand the other party’s needs, pressures, and objectives to anticipate their strategy and respond appropriately. This also allows you to tailor your proposals in a way that aligns with their interests while still meeting your parameters.
  4. Focus on mutual benefits: The most enduring and productive commercial relationships are those built on mutual benefit, where each party feels they are receiving value commensurate with what they provide. Approaching negotiations with a zero-sum mentality can be short-sighted and counterproductive. Instead, strive to understand the other party’s needs, pressures, and objectives.

Tip 2: Conduct thorough due diligence

Although not every contract gives rise to a business relationship, a contractual relationship which is formed upon entering into a contract together requires the parties to be able to rely on each other to perform its obligations under the contract, and where a party may fail to do so, their counterpart should be able to rely on the individual director or guarantor (where a guarantee is given) to remedy the breach or be held liable for the act or omission of the wrongdoer.

Due diligence goes beyond mere background checks; it is a comprehensive assessment of the other party’s business health, market reputation, legal standings, and operational strengths and weaknesses. To properly understand the other party, research and information collection are key. To the extent possible, businesses should conduct research and ask questions to understand the market conditions, the other party’s business operations, the directors, the standard practices within the relative industry in which they operate.

Taking a proactive approach with due diligence helps to identify any potential red flags or areas of concern that could impact the contract’s success and empowers you to make informed decisions and proposals. It also provides leverage in negotiations, as knowledge of the other party’s position enables more strategic discussions and better-informed decisions. Engaging commercial lawyers early in the due diligence process ensures that due diligence enquiries are effective to assess the risk involved with the contractual relationship and expose potential detriment.

Tip 3: Consider contracting parties

When preparing a commercial contract, a critical decision is determining the entities or individuals that will be parties to the contract. Below are 5 keys to navigating this aspect of the contract preparation.

  1. Tax considerations: The structure of your contract and the parties involved can significantly impact your tax liabilities. Different entities are subject to varying tax rates, deductions, and obligations. It is important to consider how the entity type and financial position of the contracting parties will affect the tax treatment under the contract.
  2. Liability exposure: The choice of contracting party also affects liability. Corporations and limited liability companies provide their owners with protection against personal liability, where, in the case of legal disputes or debt, the personal assets of the owners are generally protected. In contrast, sole proprietors and general partners in partnerships may have unlimited personal liability. Therefore, engaging in contracts through alternate entities that offer liability protection where possible are a prudent risk management strategy.
  3. Mitigating exposure to risk: The selected contracting party can also impact exposure to operational and financial risks. Contracts should be structured to allocate risks in a manner that aligns with the parties’ ability to effectively manage or absorb those risks. For example, a party with extensive insurance coverage or capital reserves may be better positioned to assume certain risks than an entity without these attributes.
  4. Consider the use of subsidiaries or Special Purpose Vehicle (SPVs): In some cases, it may be worth your while to restructure the company group or create a new subsidiary or an SPV to act as the contracting party. SPVs are entities established as separate companies with their own assets and liabilities, legally distinct from the parent company to isolate risks and protect assets. However, it is important to ensure that the use of such entities complies with all legal requirements, that the alternative entity entering into the contract can comply with its contractual obligations.
  5. Regularly review and update contracting strategies: The legal and tax landscapes are continually evolving, as are the operations and structures of businesses. Regularly review and update your strategies for selecting contract parties and discuss with your tax advisor or accountant to ensure they remain aligned with current laws, tax regulations, and your business objectives.

Tip 4: Prioritise protection

As businesses continue to navigate the complexities of the digital age, protecting your business’s intellectual property assets will remain a hallmark of prudent legal and business practice. Your commercial contract should include comprehensive provisions for the protection of intellectual property, confidentiality, and data security, tailored to the specific risks and requirements of the deal. Confidentiality and intellectual property clauses are vital safeguards that protect the core assets and competitive edge of businesses, particularly where intellectual property constitutes a significant portion of a company’s valuation.

Confidentiality clauses specify what information is considered confidential, who is privy to it, how it can be used, and the repercussions for unauthorised disclosure. Intellectual Property clauses outline the ownership, use, and protection of intellectual property rights within the scope of the contract, covering patents, trademarks, copyrights, and trade secrets.

Their importance is highlighted through several key functions:

  1. Protecting sensitive information: preventing the leakage of critical business information that could be detrimental if fallen into competitors’ hands.
  2. Trust building: building trust between parties while engaging in partnerships, negotiations, or any business relationship involving the sharing of sensitive data.
  3. Clarifying ownership: by clearly defining who owns the intellectual property created before, during, or as a result of a contract prevents disputes over intellectual property rights.
  4. Licensing rights: by outlining the scope of the use (if any), ensuring that intellectual property is used within agreed boundaries, and protected against infringement.
  5. Enforcement: by providing mechanisms for enforcement against the other party’s unauthorised use, ensuring that the rightful owners can protect and monetise their intellectual property effectively.

These protections are not just about safeguarding the business’ assets, but also about ensuring the continuity and stability of the business relationship. It is important to note that the requirements of commercial contracts are case by case and a 1-size-fits all approach will no doubt cause more damage than good. However, such clauses should consider the following:

  1. Scope and definition: Clearly define what constitutes confidential information and intellectual property within the context of the agreement to avoid interpretation disputes.
  2. Duration: Specify the duration for which confidentiality must be maintained. For intellectual property clauses specifically, detail the term of any licenses granted and the conditions under which they can be terminated or renewed.
  3. Permissions and restrictions: Outline what the receiving party can and cannot do with the confidential information and licensed intellectual property. This includes limitations on copying, sharing, and altering the information or intellectual property.
  4. Consequences of breach: Clearly articulate the consequences of violating the clauses, including potential damages, injunctions, and the requirement to bear legal costs.

Tip 5: Scrutinise and review

Once the back and forth of contract negotiation has come to an end, conducting a final comprehensive review ensures that the terms of the contract accurately reflects the business’s intentions.

  1. Understanding: Question whether you fully understand the terms of the arrangement, the business’ rights owed to it by the other party, and the business’ contractual obligations. Each term should be clear and unambiguous.
  2. Compliance: Ensure the business can fulfill its obligations and deliver on the undertakings given in the contract. In particular, any warranties or indemnities that the business may have given. If you are unsure about any of the warranties given, it is crucial you discuss these with your commercial lawyer and where necessary, the business’ accountant, to ensure that the information contained in the warranties are factually correct and can be relied upon.
  3. Scope: Ensure that the contract clearly outlines what goods, services, or results are required to be delivered, including quality standards, timelines and completion criteria to properly measure the result. Clarity is important to prevent disputes over whether obligations were fulfilled by either party. Take note of any clause which may permit a change of scope without corresponding adjustments to compensation or timelines. Any such change should typically require mutual agreement.
  4. Duration: Confirm you understand the commencement and duration of the contract. In particular, review the events which may lead to termination of the contract by either party. Conditions for termination may include notice period, grounds for termination and consequences for early termination, including penalty fees.
  5. Impact on future commercial opportunities: Review for any exclusivity clauses or non-compete agreements that might limit the ability of the business or key employees to engage in other opportunities. If included, these clauses should be reasonable in scope, duration and geographic area to not unduly restrict the business or key stakeholders.

This is not a complete list of items to be considered. Each individual term of the contract should be reviewed carefully, taking a “what-if”, risk-based approach to assess whether the application of each term in any given scenario may pose risk to the business, or otherwise counter-act the benefits provided by the contract. However, businesses and executives must ride the line between mitigating risk and capitalising on opportunity. Whilst opportunity and risk often go hand in hand, your commercial lawyer can assist with finding the sweet spot; tailoring the terms to suit your business’ individual risk appetite.

Where to from here?

Negotiating and preparing commercial contracts is a complex process that requires strategic thinking, legal experience and a holistic understanding of the business’ objectives. By adopting the above tips in the negotiation and preparation stages, you can mitigate your business’ exposure to risks, optimise financial and operational outcomes, and enhance the protection against liabilities.

Engaging with knowledgeable commercial lawyers and financial advisors is essential to navigate these complexities and ensure that each aspect of your commercial contracts support your business to achieve its broader goals and compliance requirements.

We understand the intricacies involved in commercial contracts and negotiations and are committed to providing our clients with pragmatic solutions and advice to navigate these processes with skill and care. Contact us today for a discussion with one of our experienced commercial lawyers.

This guide is intended for general informational purposes only and should not be construed as legal advice. Always consult with a commercial lawyer for advice on specific legal issues.