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At the IACCM’s 2018 Americas conference, sourcing and legal department representatives from some of the top companies in the world met to discover more about the future of contracting.  The hot topics were:

  • smart contracts,
  • relational contracting and
  • the newly launched IACCM Contracting Principles.

Many legal departments have been pursuing all of these initiatives in one way or another but almost always as separate and distinct efforts.

By combining the three initiatives, legal professionals can elevate their stature within the business by reducing costs and optimizing the value of their services.  In a world where agility is valued and delay is not an option, every general counsel is looking to streamline contracting processes and help clients more quickly recognize revenue.  This is where the combined initiatives really show their value.

Smart contracts are essentially self-executing code utilizing Blockchain technology.  Blockchain (of Bitcoin fame) acts as a ledger for smart contracts by keeping all information in an unalterable form in a decentralized locale. 

In the traditional centralized contracting systems, one person maintains the data. In Blockchain, records are maintained and accessed by everyone on the network.  If a document is altered by one network member, the other network members can quickly verify the accuracy of the change or transaction.  Blockchain also uses cryptography to make the system more secure, cheaper, and faster than traditional contracting.  Smart contracts provide for universal knowledge and agreement of the contract details without additional human interaction.

An example:  Assume I promise to pay you $100 if it snows tomorrow in Florida.  By some form of divine intervention, it does snow tomorrow in Florida – but, I decide that I want to welch on my obligation.  With traditional contracting, you would be forced to track me down and take legal action. 

But if we use smart contracting, our agreement would be connected to a weather API and the $100 automatically would be withdrawn from my account without any other actions.  So, to intelligently leverage the efficiencies made available by smart contracting, inputs or contracting provisions should be in the form of “if-then statements” based on widely distributed and verifiable data.

One of the key elements of smart contracts is determining the specific contractual inputs the parties agree upon.  The developer of the smart contract would then code these inputs into the Blockchain platform.  As almost any contract professional can attest, it is time consuming and often arduous to get all to agree on the proper inputs in traditional contract negotiations. To use smart contracts on a wide scale operation, the initial developer’s inputs create the best benefit when they are likely to be widely accepted by all contracting parties. 

This is where the benefits of relational contracting and the IACCM Contracting Principles1 are best leveraged with smart contracts.  Using the three initiatives together maximizes efficiencies which in turn allow companies to offer greater and better products to their customers, ultimately leading to happier customers and improved company performance.

The use of relational contracting and smart contracting may seem contradictory, at first blush.  But, in fact, relational contracting fits well with smart contracting. 

In relational contracting, which has been around since the 1960s, the focus shifts from legal terms and conditions to the parties relationship of trust.  This in turn encourages the parties to behave morally and ethically, further strengthening their relationship.  Also in relational contracting, the singular contract is viewed as just one part of an evolving relationship, rather than the sum total of a discrete transaction (as is the case with traditional contracting). 

Consequently, because parties to a relationship have a deeper understanding of each other’s goals and interests, the contract vehicle more closely resembles an outline of explicit terms.  This is true, because the parties’ behaviors are driven by implicit terms and understandings developed in the course of their relationship; past dealings; and social and economic norms. 

The smart contract would be able to input the agreed explicit terms, as well as the implicit terms (or series of alternative implicit terms each of which would trigger a different supportable action). 

Relational contracting fell into disfavor in the 1970s with the rise of all-encompassing contracts resembling telephone books intended to address every eventuality in place of informal moral norms based on typical business practices (the so-called transactional or discrete type of contract).  In recent years, more companies have enjoyed success with relational contracting and it is once again rising in popularity. 

As described by Kate Vitasek, in her Forbes 2016 article2, one of the most famous successes in relational contracting is the Australian Navy’s 2014 use of a very simple but effective charter which sat atop three performance-based contracts among the Navy, their sourcing company and defense companies.  This FFG Enterprise Charter called for delivery of seaworthy guided missile warships “on-time, every-time”.    

The Charter provided guidance on the parties’ cooperation and collaboration.  The performance-based contracts sitting underneath the Charter matched this intent to collaborate and incorporated specific performance measures that aligned with the Charter’s relational attributes. 

The results were spectacular.  After 18 months of this approach, the Navy “achieved a significant reduction in sustainment costs, and a marked increase in the availability of Australia’s primary naval air warfare asset to conduct operations.”  These improvements were so significant that the Navy reported results included a 44% decrease in labor costs per hour, a 38% decrease in defect incidence, and 100% on-time delivery!    This model is also being used by numerous US and international private sector companies, and by all areas of Australian government contracting.

The IACCM, the University of Tennessee, and the Lindahl Law Firm published a white paper setting out five foundational tenets of relational contracting,3 as a solution to the contracting paradox, i.e., that contract professionals are deluded into writing contracts that make descriptive plans in the absence of any ability to make plans.  Contract professionals too often exacerbate the problem by developing large, unwieldy contracts that are expensive to develop and to administer. 

The fourth and fifth of these five tenets are:

  • contracting parties should “avoid and mitigate risks by alignment of interests”3, and
  • contracting parties should create a fair and flexible framework to align with the guiding principles of relational contracting (namely reciprocity, autonomy, honesty, equity, loyalty and integrity).

To achieve the benefits of relational contracting, the parties would need to lay the foundation for continuously aligning interests, beginning agreement(s) on a shared vision, and strategic objectives for the partnership specifying what joint success and value looks like.  To lay this foundation, widely accepted, fair and balanced contract terms are needed to develop the framework for the agreement and align the parties’ interests. 

The IACCM Contracting Principles1 are the perfect tool for practitioner(s) to achieve this, and to conform their contracts to the relational contracting tenets, all within the secure confines of smart contracting.

These principles are a set of fair, balanced contracting guidelines endorsed by the IACCM that, when accepted in advance by the parties and built into template agreements, can remove issues from the negotiating table by aligning interests and allow the parties to focus on collaboration.  First announced in late 2017, the principles are the first step in what will be an expanding program that leads to a more robust and collaborative contracting environment.  Under the auspices of the IACCM, a group of large technology suppliers addressed some of the more frequently contested clauses:

  • Intellectual Property Rights and Indemnification for Third Party IP Claims
  • SLA Remedies
  • Customer Audits of Suppliers
  • Liability Caps and Exclusions from Liability
  • Data Security and Privacy
  • Indemnification of Third Party Claims (Excluding IP Claims)

The IACCM Contracting Principles1 reflect a shift in the contracting paradigm away from each party attempting to get every contractual advantage relative to its bargaining power. In discrete transactions, these types of negotiations divert from the business objectives by pitting both parties into a “battle of the paper” until one party capitulates – but only after arduous, labor-intensive and expensive negotiations. 

Most negotiations result in predictable, market-drive equilibriums but they can sometimes also lead to an inequitable agreement which then handicaps the parties’ long-term relationships and prevents future collaboration that likely would have resulted in economic benefits to each party and to end-user consumers.  The worst-case scenario is that the negotiation leads to insurmountable acrimony which torpedoes the deal and the relationship.

The principles were developed to be equitable to all parties.  The initial working team, which included Verizon as well as other large technology and manufacturing companies, used learnings from both their buy-side and sell-side.  The foundational premise of the principles is that they represent a rough consensus on balanced terms, ultimately reducing negotiation cycles so the parties can focus on their relationship ideals.

The publication of these initial principles is only the first step in a long-term plan initially created to increase their adoption.  The IACCM is both endorsing and publicizing the initiative and hosting a page on its web site so that companies can note their support and participation. 

In this way, companies will know when they are dealing with others who are similarly aligned with respect to relevant contract clauses and therefore will more readily agree to terms that are consistent with the principles.  This is a definite boon to those seeking fair and distinct terms to incorporate into their relational contracts within the smart contracting regime.  The benefit to these companies will be better long-term relations with their business partners. 

In sum, smart contracting should be used as a way to develop the relational contract, driving corporate efficiencies and agility.  The final smart contract would contain the explicit contract terms as well as the various implicit terms and their reasonable alternatives, based on the parties’ relationship and social and economic norms. 

In addition to cost, resource and time savings, this relational contracting approach strengthens the parties’ business relationship and provides flexibility to handle the unknowns collaboratively.  The contract terms would be derived from the IACCM Contracting Principles as they continue to evolve.  And as their usage increases, they would then represent the terms most commonly agreed upon in commercial contracts. 

Contracting groups can and should maximize their value to the business by combining these three different initiatives into the ultimate smart relational contract.

Authors:

Lita

Lita Bollimpalli, Assistant General Counsel Verizon Business

Jerry Silber

Jerry Silber, Vice President & Deputy General Counsel, Verizon Business Group 

END NOTES

  1. Contracting Excellence Journal article Jan 2018 IACCM Contracting Principles
  2. Relational Contracting On The Rise With the Success of the Australian Navy, Forbes, Kate Vitasek, November 2016 edition.
  3. Unpacking Relational Contracts: The Practitioner’s Go-To Guide for Understanding Relational Contracts, 2016.

Lita Bollimpalli, Assistant General Counsel Verizon Business and Jerry Silber, Vice President & Deputy General Counsel, Verizon Business Group


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