Balancing the Outsource Contract Scales

The old adage that the more things change the more they stay the same probably should be revised when it comes to contract terms: the more things stay the same the worse they get.

Tim Cummins, CEO of the International Association for Contract & Commercial Management (IACCM), expressed that thought in a recent Commitment Matters blog post about the need for a rebalancing of contract terms, especially in the area of risk allocation.

“The unfairness of risk allocation in contracts is one I have encountered many times during discussions in recent weeks,” he writes. “There is a feeling that large corporations and major public sector bodies have become more risk averse and have used current economic conditions to exert their strength – liabilities, indemnities, IP rights, termination provisions, performance criteria and (in the corporate sector) payment terms have been areas of focus.”

These same organizations “think nothing of using their power to force unilateral renegotiation when conditions change,” Tim continues. “Overall, I think things have become worse.”

There’s a persistent belief that harsh, muscular terms will drive performance. For complicated or long-term relationships, “all the evidence points the other way … unfairness undermines loyalty and commitment, leading to poorer outcomes and therefore added risk.”

Recognition of this problem goes back more than 40 years. In 1968 the legal scholar Ian R. Macneil observed that most contracts are ill-equipped to address the reality of business needs. In Contracts: Instruments for Social Cooperation, he wrote that contracts are rooted in the classical approach to contract law and thus crafted to address transactions and legal protections such as pricing and price changes, service levels, limitation of liability, indemnification and liquidated damages.

Macneil was instrumental in developing a wider view of the contract, called relational contract theory. He contended that business-to-business contracts should be “instruments for social cooperation,” adding that contracts can be “governed efficiently only if the parties adopt a consciously cooperative attitude.” He said that contracts are rooted in relationships and activities that have a large context, rather than as the discrete transactions prescribed in a contract.

Macneil challenged lawyers to rethink their approach to business-to-business agreements and criticized the classic approaches to contract law.

That rethinking really has not occurred in a comprehensive way. An April 2010 study by the IACCM concluded that contract terms remain mired in the classical legal approach of contract law, focusing almost exclusively and hierarchically on pricing, limiting liability, indemnification, service and transaction levels, risk mitigation, and liquidated damages.

Though Tim says things are worse he also sees some light end of the tunnel. “I have the impression that an increasing number of organizations are starting to question their approach. This is leading to a number who have renounced liquidated damages; some who are questioning how they can be more intelligent in protecting (and exploiting IP); others who are looking for shared approaches to governance through better change provisions, escalation procedures and added flexibility through mechanisms such as ‘hardship clauses’. I believe the door is opening for those suppliers who engage early and demonstrate their capabilities and commitment to deliver.”

The Vested Outsourcing Manual addresses this longstanding contracting problem by changing the way companies and service providers interact. Job one is collaboration and a non-adversarial mindset in which the parties sit with each other at the conference table and jointly discuss their intentions, objectives and Desired Outcomes before they think about final contract terms.

I heartily agree with Tim that “relationships that extend beyond a few transactions will always depend on trust and cooperation. Failure to establish and sustain these characteristics will always result in degraded performance and missed opportunities.”

A Vested Outsourcing partnership is based on trust, cooperation and contracts that are real, sustainable and aligned for the long-term win-win.

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