The focus on indemnities and limits of liability in the IACCM Most Negotiated Terms1 survey, year after year, suggests that for many of us the primary role of the contract remains as a weapon (enabling us to punish the guilty) or an insurance policy (limiting our exposure if we make mistakes).
Are those two objectives in line with creating business value? If they are, can we (realistically) achieve them through our current contracting focus?
To ask a wider question, given the time, money and emotional energy invested in creating and negotiating agreements, isn't it about time our organizations started to get their money's worth?
What is your contract for?
To assess the value delivered by our contracts and contracting process, we first need to identify why we have them in the first place.
In many organizations, the necessity of a written contract to underpin each commercial relationship is taken for granted. When asked, businesses and public sector organizations will cite risk management and value maximization as key drivers for the contracting process.
When it comes to how we manage risk and maximize value, however, there are many divergent approaches. IACCM's research1 illustrates in Figure 1 that our negotiation focus does not necessarily line up with our objectives.
How the contract can underpin constructive working relationships
(in decreasing order of importance)
Focus of negotiations (in decreasing order of time spent)
Defining clear, mutually understood, objectives
Limitation of liability
Appropriate risk allocation based on common understanding
Price, charges, price changes
Enshrining common performance measurement
Linking the contract to desired behaviors
Enabling application of contractual remedies
Figure 1 – Our objectives compared with focus of negotiations
This indicates a widely spread and deeply entrenched disparity in the business community as a whole: we negotiate based on legal rights and liabilities, but we determine success based on business outcomes. To examine this in more detail, let's examine a recent high-profile example of a contract that failed in its business objectives to such an extent that the legal protections it attempted to provide were rendered worthless.
Case study: “The dog with the degree”
BSkyB v EDS2 is affectionately known as “the case of the dog with the degree”.
This dispute came to court after EDS had consistently failed to perform in accordance with its contract with BSkyB. As well as seeking damages for breach of contract, BSkyB alleged that EDS had fraudulently misrepresented its ability to deliver in the first place.
The prosecuting QC demonstrated the lack of integrity of EDS' salesman, Joe Galloway, by procuring an MBA for his dog, Lulu, from the same online “college” that had awarded Mr Galloway's own degree. As part of BSkyB's (ultimately successful) efforts to demonstrate that EDS had fraudulently misrepresented its confidence in the project timescales, the revelation that Mr Galloway was demonstrably capable of lying to his own advantage were as damaging to EDS as they were amusing to the rest of the court.
The contract itself contained many of the provisions that most of us are accustomed to seeing in every deal, including two upon which the case eventually turned:
- A limit of liability clause, capping EDS' liability at £30 million
- An “entire agreement” clause, excluding pre-contractual negotiations and other correspondence from the contract.
IACCM's Top Negotiated Terms survey shows that limits of liability occupy more negotiation time than any other contractual provision. So we can safely assume that the £30 million cap on EDS' contractual liability was the result of a significant amount of legal, commercial and management effort on both sides.
In the event, Mr Galloway's untrue assertion that EDS had analyzed the project in detail and concluded that the proposed timescales were reasonable and achievable, rendered the limit of liability irrelevant.
Why? Because by over-stating his case in order to close the deal, the salesman was deemed to have induced BSkyB to enter into the original contract by deliberately misrepresenting its capabilities. Because of this fraudulent misrepresentation, the court denied EDS the right to rely on its carefully negotiated limit of liability and put it in the position of having completely unlimited liability.
So was the time and money spent by EDS in negotiating this contract wasted? Did the commercial and legal team fail in its essential purpose of helping the business manage its legal and commercial risk, and maximize value delivered?
Not just a legal problem
On a deeper examination of the facts, this case illustrates many of the common failings of contracts large and small, most of which never hit the headlines. It shows that relying on the limit of liability to act as an ”insurance policy” is a fundamentally flawed approach to contracting. And it demonstrates how essential it is that a good understanding of how contracts work is shared beyond the commercial team, into sales, project management and delivery.
Things started to go wrong in this deal very quickly after signature, when it became clear to BSkyB that EDS had neither the resources nor the expertise to deliver the project successfully and in accordance with the contract.
As with other high-profile cases (such as British Gas v Accenture3), the attention that had been paid to managing legal risk in the contract was not underpinned with sufficient focus on managing the operational and technical risk of the project. After all, had the project gone well and BSkyB felt that EDS was delivering what it expected, neither the limit of liability or fraudulent misrepresentation issues would have come up for scrutiny.
Looking back at Figure 1, we can see that if EDS had focused more on defining clear, mutually understood objectives together with BSkyB, and allocating risks between the parties based on a common understanding of the issues, things would have gone rather differently.
How can the contracting process help?
Many of us have come to a commercial role from other business areas. My own career spans engineering, software development, project management, bid management and sales, as well as law, commercial and contract management.
While this definitely helps me to understand the contribution of the different parts of a business to successful deal outcomes, it certainly does not enable me to assess whether delivery timescales for project ABC are realistic. I am not qualified to assess whether the technical risks of development XYZ are properly understood and quantified and neither, I suspect, are you.
This means that it is essential to engage all elements of the business in the contracting process.
In creating and negotiating contracts, those of us in commercial roles have a responsibility to engage each part of the organization whose performance is critical to a successful outcome. We must translate our contractual needs into language they can understand. Similarly, we must be able to decipher their input, removing ambiguity and ensuring that the organization is truly able to commit to timescales, deliverables and pricing.
We must be realistic, and not idealistic, about the capabilities of our contract managers to keep track of changes and follow the contractual change management process. And if that process is unwieldy or unworkable, the contract managers on both sides should be empowered to change it so that it works.
A basic understanding of how contracts work is essential for all those involved, whether they are in sales, delivery, finance or support roles. Each individual must appreciate how their contribution affects the whole, and should be aware of their role in the overall success of the deal. Had Mr Galloway understood the potential risks of fraudulent misrepresentation, would he still have stretched the truth in his communications with BSkyB to win the business? One would hope not.
Similarly, had the development team been properly involved in the contracting process, would the timescales put forward for delivery have been so unrealistic? Again, we would hope not.
So are your contracts a waste of money?
What can we learn from the experience of BSkyB and EDS? What conclusions can we draw from the IACCM research which illustrates a fundamental mismatch between what we know we need from our contracts, and what we spend our time creating?
One conclusion we can draw is that the “contract as insurance policy” approach is fundamentally flawed. Having fully comprehensive motor insurance does not mean we can drive without paying attention to the road. Similarly, having an indemnity from our supplier, or a limit of liability with our client, does not mean we should charge ahead with a project without taking all possible steps to manage the technical, operational and commercial risks.
After all, in the event of a collision (contractual or otherwise), one is always worse off than one would have been had it not occurred – no matter how good the insurance, or how big the award of damages.
So while limits of liability and indemnities matter, they are not all that matter. We might consider them to be our contractual ”safety belt”, rather than a substitute for careful driving. A more holistic approach to risk and opportunity management would undoubtedly serve us well.
A second conclusion is that, in order to derive true value from our contracts, we must ensure they reflect reality. The only way to do this is to engage those who understand that reality, and have experience at the “coal face” of selling, delivering and managing similar contracts. The mechanisms created within our contracts to measure progress and monitor performance must be practical, easy to use and easy to report on. Those that manage change must not create barriers to doing business.
And finally, we can see that developing commercial and contractual competence across all areas of the business is a necessity, not a luxury. When each silo within our organization understands how their actions or inaction can impact contractual risk and opportunity, we in the commercial and contracting arena will be invited to support, engage and assist them earlier and more often. And that, in turn, will truly enable the contract, and those who are responsible for creating, negotiating and managing the contract, to add value to the organization.
This month sees the launch of IACCM's face-to-face “Fundamentals” training courses. Providing sales, procurement, finance and delivery teams with an intensive overview of the contracting process, IACCM is creating tools to help your organization address these challenges and bring about real change. Embrace them. Otherwise you might just find that your contracts are a waste of money.
- IACCM Research into Attitudes to Contracting https://www.iaccm.com/resources/?id=5074&cb=1414062410&
- BSkyB Limited v HP Enterprise Services UK Limited (formerly Electronic Data Systems Limited)  EWHC 86 (TCC)
- GB Gas Holdings Ltd ( Centrica) v Accenture (UK) Ltd & ors 
ABOUT THE AUTHOR
As founder of Devant, Ltd, UK, and a professional speaker and Fellow of the Professional Speaking Association (PSA), Tiffany encourages her audiences to engage with the contract as a valuable business tool that increases sales, improves profits, creates more positive client relationships and helps manage risk. Through her highly interactive, practical and entertaining training workshops, and through hands-on consulting and support, she provides the tools and the knowledge to put these principles into action. By taking the mystery out of legal jargon, translating contract terms into practical commercial risks and issues, and looking for solutions in the business, not just the contract, Tiffany empowers even the contract-phobic to become ace commercial negotiators!
Tiffany has authored two books:
- Deal Makers - how intelligent use of contracts can help you sell more, and deliver better! combines her extensive legal contract knowledge with her background in engineering, software development, delivery and sales to provide an immensely readable and practical perspective on how to use the contract effectively in business.
- Essential Contract Drafting Skills - A Practical Guide aims to help experienced contract managers and lawyers take a fresh look at what they are drafting, and why, to maximize the usefulness and effectiveness of the contracts they create.
ABOUT DEVANT LTD
To learn more about Devant Limited, the company Tiffany founded, click on http://devant.co.uk.