A solid small business can be destroyed by a single bad deal. A customer who didn’t pay a huge bill. A service provider who took the money but didn’t provide a critical service. A business that over promised or didn’t foresee certain pricing changes.
Many people view written contracts as the way to avoid such problems. Yes, a written contract can be a great tool for a substantial deal. But a well-thought-out written contract is only part of the solution. I emphasize “well-thought-out” because I have seen situations where having no written contract would have been preferable to the one created. Here are a few general guidelines for avoiding problems in deals.
- UNDERSTAND THAT CONTRACTS AREN’T MAGICAL.
As my friend Mike Schirger says, “Lawyers don’t have time machines.” Even if you eventually get some money by enforcing a contract, you won’t get back the time and productivity you lost by not having the project done, the item you were trying to buy, the payment you were owed or whatever the subject of the contract is.
Even in the best of cases, getting enough money to cover all of your damages can be challenging. In the worst of cases, you may not get any remedy, despite having a written contract. Even if you prevail in court, which isn’t always as simple or quick as you might think, you still have a judgment to collect. Bankruptcy or no assets could result in a zero-dollar outcome, despite the judgment. Meanwhile, you will have gone through all the frustration, expense and effort of a lawsuit. This is a good reason to ask your lawyer to figure out the likely net remedy (which should include likelihood of recovery as a consideration) at the front end of a problem.
- DO YOUR RESEARCH AND PICK THE RIGHT
PERSON TO DO BUSINESS WITH.
The most important part of any substantial deal is working with someone you can trust. Yes, see your lawyer and get a written contract for your deal. But even the strongest contract is no substitute for dealing with a good person or business. Ask for references and check them. Ask around in the industry. Research the person on the other side. Bring in colleagues and your attorney or other trusted professionals to help assess the person on the other side. This is a case of “an ounce of prevention is worth a pound of cure.” Probably even 10 or 100 pounds.
Here’s a caveat to this guideline: Bad situations can occur to even the best of people. You could be dealing with someone who has great integrity and fully intends to keep his promises, yet circumstances leave him unable to keep his end of the deal. That’s why the other guidelines here are important, even if you have a solid transactional partner.
- BUILD PROGRESS PAYMENTS INTO THE
CONTRACT TO KEEP PAYMENT IN PROPORTION
TO THE GOODS OR WORK PROVIDED.
As a buyer of goods or services, you should want to make payments upon final delivery or, at least, delivery of substantial portions of the goods or services. That is, you don’t want to pay in advance for goods or services to be delivered far in the future. Sure, a seller might want some money down for custom goods or projects that have front-loaded expenses. Work with the seller to figure out a reasonable amount down — and how you can be sure that he doesn’t just take off to a tropical island with it.
Suppose you are adding on to your building. Rather than giving the contractor $25,000 so he can buy materials to get started, you pay directly for the materials and have them delivered to your facility. And then pay as work is completed.
What about a seller who is being unclear about what work is or isn’t done? Don’t be shy — ask for proof. One time, a client of mine had contracted and prepaid for some fabricated items that would reasonably have taken a month to produce. When an extra month passed with still no product and unclear answers on timelines, my client and I visited the seller’s facility to see what had actually been done. That was informative. Likewise, you shouldn’t hesitate to request clear proof of deliverables.
The same goes for sellers whose projects take longer to fulfill. You’ll want to structure progress payments in a fair manner. And be sure you’re getting paid on time for all services and goods.
- WHEN CREATING THE AGREEMENT AND
WRITTEN CONTRACT, FIGURE OUT WHAT
YOUR UNDERLYING ASSUMPTIONS ARE
AND OPEN YOUR MIND TO WHAT-IFS.
Suppose you are going to provide steel widgets at a fixed price, to be built and delivered at your expense over the next five years. What assumptions have gone into your fixed pricing? The price of widget components? Labor? Delivery? You’ve probably made some estimates about typical increases in those and built them into your fixed pricing. But have you considered unusual changes that could occur in those costs? How much can your estimates be off before you have no profit? Worse yet, before you lose money?
Apart from the cost inputs for these items, other considerations include volume, duration, distance or whatever measure applies to your situation. For example, if gas prices triple and you’re paying for delivery, the problem is a lot worse if your customer is across the country rather than across the street.
And if the price of steel used in your widgets increases dramatically, that is a problem in direct proportion to the amount of steel used and the number of widgets to be produced.
As a possible countermeasure, consider contractual provisions that allow price adjustment in case of extreme increases in some cost input, or set pricing closer-to rather than farther-from delivery dates. I understand that everyone loves the idea of long-term contracts. Buyers are excited that they have fixed pricing for a set time and sellers are thrilled to have a big deal in place. But in the real world of market fluctuations, tariffs and regulatory changes, setting pricing very far out can be challenging.
In a nutshell, contracts and court can be expensive and unrewarding, don’t deal with snakes, and set up mechanisms to limit your exposure on longer-term deals.
Jeff Orduno is an Illinois attorney. Find out more about him at