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.