Contract Provisions for Troubled Times: Part 2 Making Sure the Other Party Performs
In addition to getting paid, in troubled times, you also want to monitor and manage the other activities of the parties to your contracts.
Here’s how to put that approach to work in your contracts:
- Try to perform your part of the deal only if and as the other party performs its part of the deal. Some contracts are opportunistic, one-sided or poorly written, so you won’t always be able to do this. But strive for it in high-risk or significant relationships. One example is “pay for performance.” Another example is making sure that you have the right to test and accept the goods and services delivered to you, and perhaps obtain a warranty for a reasonable period. Think of the two parties on a see-saw. Ideally, you would want a constant, balanced back and forth in performance by the parties. For a sustainable, win-win, long-term relationship, one party should not be “down” and the other “up” and hanging in the air, for a lengthy period.
- Tightly monitor and manage deliveries, payments, reporting and other contract activities. This is obvious, but very often ignored. Don’t let your risks get out of hand. Even if you have the legal rights to demand performance under a contract, if you don’t manage them closely you may end up with a “right without a remedy.” Don’t let a problem (such as an overdue receivable) grow and grow while you keep performing your end of the bargain. It’s less expensive and distracting to deal with a small problem, rather than let it grow large and have to go to court. Don’t allow yourself or the other party to get too deep “in the hole” on the transaction.
- Watch out for possible modifications to your contracts by the parties’ actions via a “course of performance” in a single transaction or “course of dealing” across several transactions. For example, a “course of performance” can be created by a sequence of conduct “if the agreement of the parties with respect to the transaction involves repeated occasions for performance by a party; and the other party, with knowledge of the nature of the performance and opportunity for objection to it, accepts the performance or acquiesces in it without objection.” (California Commercial Code, Section 1301, http://caselaw.lp.findlaw.com/cacodes/com/1301-1310.html) Well-written contracts include a provision to prevent this issue. This is another good reason not to ignore problems as they mount higher and higher.
- Try to secure the performance in other ways. As I mentioned in the previous issue of this newsletter (Issue No. 1), if you are expecting to receive a payment, then try to get paid up front, or have the payment made into escrow. You can apply this principle to other types of performance. For example, in licenses of proprietary software, the buyer may require the developer to place the source code of the software into a “source code escrow.” Some companies try to secure the other party’s performance by means of onerous legal provisions, such as exclusivity and the threat of obtaining an injunction (court order prohibiting specified behavior).
- Always have a “Plan B.” You should be prepared for non-performance, apart from thinking, “I’ll just take it to court.” Even if you think one outcome is almost certain to occur, consider a range of alternatives, including some that may be unlikely. For example, as a buyer, hedge your risks by having a second source (or even several sources). Be alert for attempts at “vendor lock-in” (http://tinyurl.com/2ro9yf). Open source software and open business models provide a new type of “Plan B” for many businesses. Open source software can reduce your risk of being locked into a particular vendor or contract relationship, since the code base and changes are public (no need for an escrow), and other vendors can be hired to step in and fix a problem with the code. (Nothing is perfect, and open source software raises its own practical and legal issues, which I discuss elsewhere on my blog, www.BoadweeLaw.com/blog.) Similarly, an “open” business approach in other areas of your business can offer similar benefits. See the book, Wikinomics: How Mass Collaboration Changes Everything by Don Tapscott and Anthony D. Williams, for examples.
In the next issue, I’ll discuss the ways to use third parties to assure contract performance.