Contract Drafting to Prevent Loss of Profit

Contract drafting for highly complex, high-value, high-tech, and high-risk industries is one of the most challenging activities in business.

Especially in aerospace, aviation defense, and other high-tech industries.

This post will provide you with a high-level guide to contract drafting.

I will show which role contract drafting plays in maximizing your profit and preventing future value leakage.

Define the needs and right contract form before drafting the contract

Before starting writing the contract or agreement, you need first to understand what contract form you will need to use for the product or service you are proposing or have proposed.

Questions you must try to answer are:

• Do I (still) have a clear picture of the business context of your transaction?
• What am I trying to achieve with this business? You should already have thought about that in the preparation & proposal phase.
• Do I still know clearly what the customer requirements are and what the customer is trying to achieve?
• What commitments have I already made in the proposal phase, which now have to be repeated?
• Have I already contracted for a similar good or service with this customer, and can I use that contract form?  
• Will this transaction require any other documents in addition to the main contract?
• In the case of an existing product (including ‘off-the-shelf’ software) or standard service, or when you already included it in your proposal, you often may already have a technical specification or description of activities or “statement of work.“

It is better to have separate annexes, especially if it will take more than one page to describe the works to be done or payment schedules, or other length texts.

In the ‘scope of work’ – or ‘subject matter of sale’ article – you can then add a reference to the statement of work annex.

Often the technical specification in the proposal is a high-level description further to be detailed in the contract drafting phase.

Especially if it is a non-standard product or bespoke software development, you need to be more specific in the specification when drafting the contract.

Battle of the forms

You can find yourself in a situation where you are not so much negotiating the contract itself but actually are fighting with the other party about which set of terms and conditions and which contact form to use. This is called the ‘battle of the forms’!

The ‘battle of the forms’ happens when one party wants to sell goods to the other party on its own standard terms, and the other party insists on using its own standard terms.

The best thing to do is to be the last party to send its terms and conditions. You have a big chance you’ll win if and when the other party does not explicitly reject your terms.

This is why I often not only send the proposal requested by a customer. I also send the draft contract with the full set of detailed terms & conditions.

If you already have your own set of general and standard terms and conditions, review it to ensure it does not need amending to meet specific needs related to this contract.

In many cases, the customer is happy because they don’t have to draft the contract themselves. Especially if your terms & conditions are fair, reasonable, and well-balanced, taking into account the interests of both parties.

Other customers send back their general terms & conditions. Too often, I see procurement departments sending totally unacceptable, one-sided sets of terms & conditions. As if there is some benefit to starting on the wrong footing.

In those cases, I completely rewrite the contract. To keep things simple, I may use my customer’s outline and format. I will also include the acceptable clauses. But I will, as much as possible where needed, insert my own terms & conditions.

Determining the total contract value at start of the lifecycle

Most probably, you first will send out a proposal. So you should know the maximum achievable contract value and profit margin over time (the ‘top line’) already then.

If there are no negotiations on price and other terms and conditions, that can decrease your margins. If there are no delays or other issues with delivering the products or services on time and within budget, etc., and no cross-sells and upsells, this is what you earn at close-out.

You should already have a clear picture of the costs involved ‘(‘bottom line’). And therefore, the margin you will be able to make. You probably already know how far you can go ‘down’ in negotiating with the other party and still achieve a nice deal.

All this needs to be ‘protected’ by inserting the right terms and conditions while drafting the contract.

Most important clauses to ensure ‘value-proofing’ your contracts

So, one of the most important aspects that will determine the future value of a contract is the robustness and completeness of your terms and conditions.

The terms and conditions determine the circumstances under which the parties fulfill their obligations under the contract. This goes up to and including the rights and obligations for both parties and actions needed after the contract ends.

In the following paragraphs, I will focus on the most important clauses. You need to pay attention to each one of them when drafting contracts. Or when you are reviewing the terms and conditions proposed by your customer.

1. Scope, statement of work, goals and requirements

• Scope
• Requirements

This is the most important clause since it defines what you are selling (sometimes called ‘subject matter of sales’).

Here you find the description of the types and quantities of goods and services and activities sold through this contract.

In the case of complex products and services, you will describe the technical specification or statement of work, the needs of your customer, and the requirements for the product, service, or project you want to propose.

You describe in detail the statement of work what you are proposing to do, how you will address your customer’s needs, requirements, and what will be included and what will be excluded in this proposal.

Pricing, payment schedules, delivery, acceptance procedures, warranties other terms and conditions I always include in the main part of your proposal. I again put the details in separate annexes if they take more than one page and reference them from the clause in the main body (‘the technical specification as specified in Annex A’).

My experience is that such clauses are too important, and have too many legal implications to be hidden away somewhere in the back or in an appendix to a statement of work.

I have often been nastily surprised to find out that people had inserted penalty clauses in contracts in appendices to the annex of the statement of work that really didn’t belong there.

2. Price and payment

• Purchase price
• Payment terms
• Guarantees

3. Delivery

• Dates of delivery
• Terms of delivery
• Ordering
• Test, inspection, and acceptance procedures and acceptance criteria
• Additional work and changes
• Transfer of title and risk in the case of goods, or licensing and related user rights in the case of software

4. Other obligations that can hurt your bottom line

• Delay in delivery
• Force majeure
• Liability
• Insurance
• Warranties
• Contract termination

• Confidentiality
• Intellectual property rights and 3rd parties’ rights
• Quality
• Subcontractors

5. Final clauses

• Applicable law
• Proposal/contract documents and order of precedence
• Contact persons
• Duration
• Contract renewal or extension
• Contract amendments
• Disputes
• Severability
• Assignment

Contract drafting process

In more complex, high-value high-tech industries, often multiple steps, approval loops, and stakeholders are involved in the proposal and contract development processes.

Commercial contract professionals and delivery managers, therefore, often have trouble in achieving due dates. Not only in cases where the service or product is new or not offered or contracted before, but even for simple products and services. Do you recognize this?

I have seen companies where approval processes alone took more than a week on average to get a proposal out or contract approved to be signed and delaying the launch of a new service or product or start of work (both contract value destroyers!).

But also companies that took ages to get relatively simple statements of work out or assumptions ‘frozen’ with customers.

As with any other company, your commercial & contract teams and legal counsels will feel the need to implement faster contract turnaround times.

This can lead to drafting contracts too quickly than reasonably possible and may lead to errors that will impact you in the future or that you must fix at a later date or cause conflicts that lead to claims.

With the proper processes and (CLM) tools in place, you can achieve effective and efficient commercial and contract management and quick turn-around times in sending out drafts. It would help if you also had effective and experienced commercial and contract managers.

The role of commercial and contract managers

Your commercial and contract managers represent your business towards the customer and work with the legal department, finance, and other stakeholders, to ensure your contracts are of high quality and represent the proposed business case.

They are essential for your organization since they are the ones steering your company through each stage of the contract lifecycle.

The commercial and contract managers provide the expertise and know-how to manage the contract lifecycle process successfully.

Ensuring that they can properly execute the contract drafting phase can save you time and resources and prevent future contract value leakage from impacting your top and bottom lines.

Collaboration before you start contract drafting

Before the official agreement writing begins, you really need to work closely with your internal stakeholders and project leaders and – if applicable – the external parties like subcontractors and vendors to understand what each party is responsible for. The same kind of collaboration needs to be done with the other contract party, your customer.

By working together on the contract and establishing the main and most important details, you can prevent critical errors that will hurt you well into the future.

Drafting and sending the contract

Once you have successfully worked together on the draft contract and have further detailed the essential ingredients of the contract, you can start drafting the actual contract and its applicable terms and conditions and send it out to the customer.

Contract negotiation

Your commercial and contract managers can lead the contract negotiation, freeing the person responsible for sales and the customer to concentrate on the business and business relationship.

The more and longer you cooperated with the customer, the less time it will take to reach an agreement on the draft contracts.

Getting approvals and signatures

As soon as both parties are satisfied with the wording in the draft contract, your contract managers and the customer can focus on contract execution:

• internal stakeholder approvals, such as the legal department and executive board of directors
• contract signature by both parties.

This will ensure everyone is informed of the contract and approves of it.

Contract drafting requires organization and discipline

In the contract drafting phase of contract lifecycle management, there are many steps you must follow to create the most comprehensive but still timely contract possible.

After the drafting and contract signature, the contract will go into the contract execution or contract management stage, which is as complex as the phases before.

Each phase requires a vast amount of organization and discipline and skilled commercial and contract professionals.

Conclusion

Contract drafting is an art and requires robust planning.

Your proposal sets the first benchmark for the maximum contract value you will achieve over the lifecycle of the contract.

Contract drafting is the second activity where the focus should be on further securing maximum contract value by including fair and equitable terms & conditions that mitigate the risk of contract value leakage after contract execution.

Contract negotiation is the next stage in the contract lifecycle in which your contract value will be under attack.

So you can better prepare by having a robust and complete set of terms and conditions in place by taking contract drafting very seriously!