Importance of Commercial Terms

I’ve recently seen a number of high value contracts go sideways, because some of the basic details of the arrangement were ignored. The parties had focussed their efforts on negotiating long and detailed legal terms, without agreeing to the commercial terms (like price and deliverables). They then assumed both parties were on the same page when they were not. By the time they realised this, they were well into the project making it very difficult to untangle what was in or out of scope when none had been agreed.

It’s generally understood that a solid contract is essential before starting a new business relationship with a supplier. Lawyers often spend months negotiating a services contract with their client, focusing mainly on the legal terms that underpin the commercial arrangement (e.g. liability, confidentiality, payment terms etc). However, all that work can be for naught if the commercial terms aren’t properly documented. This is usually the customer’s primary concern, as they want to know exactly what they’re paying for. They work with the lawyer to ensure that the mechanisms for working with the supplier are addressed.

However, sometimes the task of agreeing on the commercial details of the relationship is overlooked or assumed. The head contract might state something like, “we will pay $30,000 for the development of some software in accordance with the Statement of Work.” The parties assume this deals with the main issues they want covered, and that the details of the statement of work can be sorted out later.

There are many ways to encapsulate the commercial details (Statements of Work, Proposals, Scope of Services, even via email). But situations arise, more often than they should, where parties simply start working together, intending to sort out the details later, or they simply forget to do it altogether because they get so caught up on the project itself.

Such oversights can be detrimental to the business relationship because both parties make assumptions about the arrangement, the deliverables, and the payment. The main contract, often called a Master Services Agreement (MSA), Professional Services Agreement (PSA), Services Agreement or similar, is assumed to cover everything when it does not. These contracts are meant to apply to the entire relationship for different projects and jobs, allowing the parties to agree on commercial details as needed. This can be done through Purchase Orders (PO), Statements of Work (SOW), Scopes, etc. The process of setting out the commercial terms is something that lawyers are not equipped or allowed to advise on.

The Role of Lawyers in Commercial Contracts

The cost of a good or service and whether that good or service is required by the business is outside a lawyer’s area of expertise. There are rules prohibiting lawyers from giving this kind of commercial advice. While lawyers often review or assist in drafting statements of work, proposals, and scopes of services, they usually limit their services to describing how the deliverables and commercial details tie back to the main contract or otherwise vary the main contract with special conditions.

For repeat business, this usually means that the lawyer’s work is mostly done upfront on Statements of Work because the document they work on will generally operate as a template for the business to complete on a project-by-project basis. This means that lawyers will not review every statement of work, proposal, etc., that the business sends out, even when they have an in-house team of lawyers. It is the role of the business managers at the supplier business to ensure that Statements of Work are completed and agreed with their Customer.

Problems Arising from Unsigned Statements of Work

Problems arise when statements of work are not signed before the commencement of the services or delivery of goods. Often large amounts of work or goods will have been delivered before the parties sit down to negotiate price and scope of services or volume of goods, making it much more difficult to reach agreement. These issues often lead to disputes, requiring mediation and, in some instances, litigation. The relationship between the parties can deteriorate and break down, and in many cases, it may not be recoverable.

The Dilemma of Enforcing Contracts for Essential Services

But what happens when the supplier provides an essential service for their customer’s business operation, and the customer cannot easily switch to an alternative provider for the same service?

If an unhappy client wishes to enforce a contract for an essential service like this, it puts them in a difficult position because enforcing a claim for breach of contract requires termination of the contract altogether. Terminating the contract can lead to operational disruptions or even halt operations entirely. Finding a replacement service might not be immediate or straightforward, potentially causing further delays. This also means that the business would have to invest time and resources into on-boarding a new supplier, which could prove costly and time-consuming. Moreover, if the service is specialized or unique, finding an equivalent replacement might be nearly impossible. While the client has the right to enforce a breach of contract, the implications of terminating the contract need to be carefully weighed against the potential operational impact on the business.

Even if a customer in that situation wishes to avoid litigation, negotiating a resolution can be fraught because simply issuing a notice of dispute will generally sour the working relationship and can imperil the ongoing provision of services from the supplier.

Conclusion: Importance of Documenting Commercial Terms

The moral of the story here is that if your business has taken the time to negotiate substantive legal provisions under a head contract to govern various commercial terms to be agreed from time to time, it is crucial to ensure that those terms are documented and agreed as considered by the head agreement before the services or goods begin to be supplied. It is very difficult to shut the gate once the horse has bolted, or put the genie back in the bottle.

NB: This article was also published on Yule’s LinkedIn.