Why Does Contract Negotiation Cost So Darn Much?

Drafting contracts can be time-consuming. Since lawyers bill by the hour (for the most part) they can also be very expensive for the client. It’s sometimes difficult to explain to a client why a contract is so costly.

From the lawyers’ perspective, she just drafts. If the other side’s lawyer gives pushback, she deals with it. She will usually spend a bunch of time with the client explaining what’s going on, helping the client understand the risk of the proposed terms and seeking instructions. Then the contract gets finished and she sends a bill.

That’s when the client’s eyes bug out at the cost, either because the client had no idea it would cost so much, or because the client is sophisticated enough to understand the contract negotiation process, and feels the lawyer went too far to get the job done (also known as “over-lawyering”).

I think it really helps to understand some key factors (we’ll call them, the “Seven Factors”) that increase or decrease the cost of negotiating and drafting a contract.  When you take the Seven Factors all together, it provides a framework for discussing the potential costs of having your lawyer get involved in contract negotiation. And, remember, every time you read the the phrase “more time”, you can substitute the phrase “more money”.

1. Bargaining Power. In general, equal bargaining power is more costly to each side. When one side has great leverage, it usually dictates the contractual terms, there is little negotiation (which takes time), and the party with no leverage generally signs the contract put in front of it, if it wants the deal.

Example of equal bargaining power:  Two big, sophisticated companies looking to enter into an agreement.  Both parties feel that getting into bed together would be beneficial, but neither party has to enter into a business arrangement with the other. In that case, the parties will only enter into an agreement if it makes sense to both, otherwise they will walk away. Neither party can force terms on the other. This often means the parties spend a bunch of time discussing what is “fair” in the circumstances.

Example of unequal bargaining power:  A small company, Company A, is attempting to enter into an agreement to supply services to big Company B.  Company A would really benefit from getting Company B’s business.  Company B, however, can choose from any number of suppliers to get the same services, and at similar prices, as Company A supplies. Thus, Company B has all the leverage to dictate contractual terms.

2. Mission Critical. In general, the more important a contract is to my client, the more it will cost to draft and negotiate.

Example of Mission Critical:  Using the Company A example, above, getting Company B’s business might be mission critical if it will provide both the revenue and the prestige/credibility to get business from other large companies like Company B. Company A, therefore, really wants Company B’s business. In that case, as its lawyer, I want to ensure Company A understands the risks, gets the best terms possible and doesn’t just jump into a contract prematurely.

3. Risk. In general, the more risk my client has, the more it will cost to draft and negotiate a contract.

Example of high risk: Perhaps Company B wants to include onerous terms in the contract that might put Company A out of business if there is a lawsuit.

4. Complexity. In general, the more complex the contract, the more it will cost to draft and negotiate a contract.

Example of Complexity:  If a company has divisions in multiple jurisdictions this could raise issues that need to be dealt with on a jurisdiction-by-jurisdiction basis.

Another example of Complexity:  A sixty page contract (they happen frequently). It might take three or four hours to read a long contract and make notes.  The lawyer will probably read that contract front to back at least three times. That’s nine to twelve hours just in reading.

5. Sophistication of the Parties. In general, the more sophisticated the parties, the less it will cost to draft and negotiate a contract.

Issues associated with less sophisticated parties:  In generally, the lawyer must spend more time educating and advising less sophisticated parties to ensure they understand the risks of entering into a contract.  As always, more lawyer time = higher expenses (obviously).

6. Timing. In general, the quicker a contract must get finished, the more expensive it will be to draft and negotiate.

Example of quick timing:  If the client needs to draft and negotiate a complex contract in a few days, it means its lawyer has to potentially say no to other files, or rearrange her schedule to accommodate the quick turnaround. Many lawyers charge a premium rate in order to compensate them for having to drop other matters to negotiate a time-sensitive agreement.

7. “X-Factor”. This refers to things that are outside my client’s control. For example, I often work across from lawyers that aren’t particularly good at contract negotiation (sad to say). That, unfortunately, means I often must spend time (i.e. my client’s money) to educate the lawyer on the other side, in order to get the terms my client desires. Another example—where the lawyer on the other side has to prove to his client how smart he is (a “grandstander”). Grandstanders do this by fighting every point (small or big), looking for ways to make simple things more complex and just generally getting in the way of smart, efficient negotiation. Bullies are also expensive to deal with because they just make everything more difficult (grandstanders are often bullies and vice versa).

One thing I should mention that you probably already figured out. The Seven Factors are not completely standalone categories. They intertwine to a certain extent. Risk and complexity, for instance, are closely tied together.  I think it’s fair to say I would spend more time defining and managing risk in a more complex contract than I would in a straight forward contract. Put differently, risk is easier to spot and manage in a straight forward contract than it is in a complex one.

Now, let’s set the outer edge of contract negotiation costs:

Most expensive: Equal bargaining power, mission critical for both parties, high risk, high complexity, parties have medium sophistication (because unsophisticated parties would not likely get into this type of arrangement), contract needs to be signed quickly and one of the lawyers is a grandstander.

Least expensive:  One party has strong bargaining power, the contract is fairly routine and in the ordinary course of business (i.e. not mission critical), the risk to each party is low (perhaps because the dollar amount of the contract is small), the contract is relatively simple, the parties are sophisticated, there is no rush to get the deal done immediately, and the lawyers for both sides understand all the above factors and, therefore, do not “over-lawyer” the agreement.

Most contracts are going to sit somewhere between the most expensive and the least expensive examples. But now you have a framework against which to gauge the potential legal expenses of contract negotiation and with which you can have a fruitful discussion with your lawyer so your eyes don’t bug out when you get the bill.


Where is the law business going?

Bruce Stachenfeld, partner at Duval & Stachenfeld LLP, has written another terrific article for Above the Law. This is the first in a series of articles that look into the future of the business.  Part one deals with the future of “branded” law firms.

Bruce is my favourite legal industry writer.  Why is he so good?  He’s not a pontificating consultant trying to drum up business. He runs a boutique law firm.  He thinks about the business of law every day from the inside. He thinks about branding, competition, marketing, employee happiness, law firm growth, etc. The decisions he makes have a real world impact on his firm. And, he’s gracious, and confident, enough to share what he’s learned with others (including his competition).

Additionally, he’s a comparative writer.  He doesn’t just write about the inner workings of his firm. You can tell he spends a lot of time thinking about what his firm is not, and what that means.  Duval & Stachenfeld is not, for example, a Super-Mega Big Verein (as he terms it). Because he studies other types of law firms, he doesn’t get caught in the trap of trying to make his firm into something it’s not (or can’t be).  He can also write intelligently about the strengths and weaknesses of other business models.

Here’s Bruce’s column. Well worth reading.


Find Your Kumbaya

Here’s a link to my latest Above the Law column about finding balance and harmony in your life.


Hey Shareholders, Should You Get a Shareholders Agreement?

Shareholders agreements are amongst the most important contracts for private company owners. I highly recommend them. When drafted well, they can provide a framework for operating a business with minimal conflict between owners. Additionally, if the shareholders do have a serious conflict, the provisions of the shareholders agreement may help resolve the conflict before things get really expensive and messy (i.e. one shareholder serving a lawsuit on another).

Having said all that, they are expensive contracts to draft because: (a) they require a lot of shareholder input (i.e. it takes time); and (b) they are long, complex documents with variety of provisions that can be included or excluded based on the parties’ negotiations.

No two shareholders agreements are, or should be, alike. They should be drafted specifically to deal with the realities of your business and your fellow owners.

Here are some other general thoughts on shareholders agreements to keep in mind when deciding on whether to put one in place:

1. Shareholders agreements contain best practice language that may not have been challenged in a court. I cannot say for certain whether a court would enforce a number of typical provisions in a shareholders agreement, but I put them in anyway because a court might enforce them and, in any event, some of these provisions can provide negotiating leverage (knowing that it won’t likely go to court). For example, a court might not enforce any provision that allows one shareholder to essentially control another upon the second shareholder’s bankruptcy. This is a typical provision put in many shareholders agreements. In a bankruptcy case, for example, a trustee in bankruptcy might ask a court to not enforce such a control provision and there’s a chance the trustee will win.

2. I draft shareholders agreements with the best information on hand at the time of drafting and with my client’s instructions on how he or she want to run the business. I can’t cover off every possibility with a shareholders agreement. There are some things I cannot contemplate. Additionally, the client makes a lot of decisions with respect to how the shareholders agreement is drafted. In hindsight (or during a dispute) these decisions may turn out to have problematic consequences for the client. We’ll talk more about that below with respect to the infamous Shotgun Clause.

3. Every contract is governed by an implied duty of good faith. I can’t boil down exactly how a court will look at the implied duty of good faith when resolving a dispute. The best advice I can give is all decisions and actions must be made in good faith. Keep in mind, if you use a shareholders agreement as sword to try and skewer the other shareholder, even if you do what is allowed under the shareholders agreement, the court might still say you acted in bad faith.

4. Most shareholders agreement contains provisions to prevent shareholders from transferring shares without consent. Usually it’s the remaining shareholders that have the right to grant or refuse consent to a transfer. A transferee might be able to get around restrictions on transfer if he or she sells the shares to a bona fide purchaser of the shares for value. This means if a third person doesn’t know there is a restriction on the transfer of shares, and the third person gives valuable consideration for the shares, the court will not interfere with the transfer. All that will be left is for the other shareholders to sue the shareholder who sells his or her shares in breach of the shareholders agreement.

5. Buy/Sell provisions (i.e. Shotgun Clauses) are a double-edged sword. In some cases they can be used effectively to resolve a situation where the parties just cannot get along. In other cases, a Shotgun Clause gives one party a sizeable advantage. Let’s look at the case of a company with two shareholders. They are not getting along. In the case where both shareholders can run the business, the shareholder with more financial resources can have a sizeable advantage when using a Shotgun Clause. Where only one of the shareholders can run the business (and the other cannot hire someone to do so), the shareholder that can run the business has a sizeable advantage if a Shotgun Clause is used.

6. I approach shareholders agreements in terms of groups. Shareholders agreements typically contain provisions that allow shareholders to sell shares to related parties (e.g. wife, kids, a family trust, etc.). In that case, I still consider the Principals the operating minds of the business (and the head of their “group”). If a Principal wants to get out of the business (or is forced out), he or she should have to transfer all of the shares of his/her group (not just the shares he or she holds personally). If I don’t draft it this way, there might be instances where, for example, a Shotgun Clause is triggered and the Principal has to give an opportunity to buy the shares to the Principal’s family trust (i.e. the Principal is forcing his own family trust to either buy his shares or sell its shares to him). This doesn’t make sense as it would frustrate the Shotgun Clause’s purpose.

7. I recommend using arbitration as the formal dispute resolution process. Arbitration is usually, but not always, faster and cheaper than the courts. It allows you to pick an expert to adjudicate, rather than a judge (who may not have much expertise in your dispute area). Also, court proceedings are all public. Arbitrations are private, meaning you keep your dispute confidential.

Welcome To My Blog

Welcome to my blog.

What are my goals for this blog? First, to be informative. Second, to keep things light—there’s enough stress in life already. I take the law very seriously, but that doesn’t mean it can’t be explained with a little humour.

I am planning to blog on lots of different legal and business issues. I want to provide you with information on how to avoid legal problems, if you can. I might blog on interesting stories that catch my eye for whatever reason.

So, to sum: I’ll try to keep it light. I’ll try to be informative. I’ll try to pass along stories that I find interesting that you might too.

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