Saturday, July 30, 2011

Beginning Work Without a Contract in Place

While it’s not something that I would recommend as a standard practice, there will always be times when the work needs to start while the terms get negotiated. There are several issues when you do this.

The first issue I call “point of no return” that I borrow from aviation. In aviation the “point of no return” is when you have consumed enough fuel so that you can no longer return to your place of departure. In contracts the point of no return is when you allow a supplier to proceed so far with the work that your options at that point are limited to only bad ones. You could stop with them, and go back to the beginning and start over with a new supplier. You could still attempt to close the contract.

A second issue is risk. An employee that is performing the work could be injured. The work could be damaged or the work could damage the premises where the work is being performed, etc. Since there is no contract in place, the normal contract protections to manage against the risks also are not in place.

A third issue is the impact the delay would have on the terms you are able to negotiate. With the reduced leverage you have at that point, you probably won’t get you the same terms that you would have achieved if you negotiated it earlier. I’ve had suppliers that I would swear had the strategy to delay coming to agreement as a way to lock the buyer into using them and provide more unfavorable terms in the agreement.

A final issue is while no contract may be in place, since you knew the work was being performed without the contract, you would be prevented or “estopped” from making that claim to avoid paying for the work that the Supplier could claim under the law of equity for “unjust enrichment”.

Since there may be times when you need to start the work without the contract being in place, there are two approaches to managing this. The first is to provide an authorization to start the work with two requirements. The agreement must be completed by a specific date (usually no more than thirty (30) days in the future). The second requirement would be a statement similar to “In commencing the work supplier represents that they have the insurances that are required by buyer’s proposed agreement. An approach such as this eliminated the point of no return issue. The authorization constitutes an offer and the commencement of the work would be an acceptance subject to its terms so in starting the work the supplier is representing that they have the insurances to protect against the risk. If they didn’t you could sue the supplier for damages for breach of their representation. The impact on the negotiation should be minimal as you could start over with another supplier since little time had passed. Your financial exposure would also be limited to only the work performed within that thirty-day period.

Another approach would be to have a simple agreement that says something to the effect that all work performed prior to the execution of the contract will be at each party’s own cost and risk. With that approach the Supplier knows that it’s not in their best interest to delay closing the contract. The more work they perform, the more they are at risk financially. Any claim under equity for unjust enrichment would probably not be successful as they agreed that costs would be at their cost. Any risks are their risks. Lastly, the longer it takes the less leverage they would have in negotiating terms.
In negotiating a clause like this the biggest concern that a Supplier would have is the
buyer could be abusing it and delaying coming to agreement to get more leverage. My response would be that if you have that concern, stop performing the work. There is no contract so there would be no breach if you stop performing. Use that to force the completion of the contract.

I’m sure that there are other alternatives or variations to both of these. All should be structured to drive prompt completion of the contract and the ability of either party to walk away with the least amount of impact and cost if the contract cannot be agreed.

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