Renegotiating a Contract During an Economic Downturn

November 4, 2020by Brandon Banks

Usually both parties to a contract want it to succeed. However, unforeseen economic downturns and changing circumstances can make it hard to impossible for a contract to be fully performed. You could go to court to enforce the contract. And you may win. But at what cost? You could irrevocably damage a long-lasting business relationship. That could cost you far more than the nonperformance.

Many times, business owners consider a contract an all or nothing situation. Either you deliver or you’re in breach. They often do not consider renegotiating the terms to be more suitable for the current economic environment as an alternative to resolving the dispute in court. Renegotiating a contract often provides a superior outcome. An outcome that not only saves the deal but could also maintain and solidify a valuable business relationship.

The economic impact of the Covid-19 pandemic has forced companies to significantly lower controllable costs by employee reductions in force (RIFs), reduced capital expenditures, and shuttering of plants and facilities.

According to the Wall Street Journal, business and personal bankruptcies rose 52% in July 2020 from a year earlier.

Companies including the Brooks Brothers Group, Inc., California Pizza Kitchen Inc., and Remington Outdoor Co. are increasingly turning to the courts to deleverage and restructure.

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Many see the increased filings as a portent of even higher numbers of business failures, despite the government’s efforts through the CARES Act and other relief funds, as the virus continues to spread across the country with growing unemployment and reduced spending.

Long-established relationships between companies and their customers, suppliers, landlords, and lenders are strained as old contractual agreements, negotiated in a more prosperous environment, burden partners with excess costs, and obligations increasingly challenging to meet. Adverse economic conditions threaten previous successful partnerships, and their agreements signed during good times.

Legal Abandonment of
Contractual Responsibilities

The pandemics’ effects exposed the deficiencies in previously negotiated contracts when the parties failed to consider that the future business environment might change. Having omitted renegotiation clauses in their contracts, companies hope that the inclusion of standard boilerplate relief clauses – “force majeure” or “Acts of God” – or the legal doctrine of frustration will relieve them of their contractual obligations:

  • Force majeure clauses. Contract lawyers often include the catch-all clause, force majeure. These clauses offer various relief from contractual obligations – suspension, delay, termination – in the event of a particular event. Whether Covid-19 will be covered as a pandemic as one of those events will likely be determined in court cases.
  • Doctrine of frustration. This common law doctrine allows non-performance of contract terms due to a supervening event not caused by either party. Historically, courts have been reluctant to rule that circumstances that cause performance to be difficult or expensive meet the standard required to offset contract performance responsibilities.

The effect of a force majeure provision or the application of the doctrine of frustrations depends on the wording of the contract and is determined on a case-by-case basis.

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Renegotiation - A Better Alternative

During difficult times, frustration levels and stress escalate and aggravate the human tendency to scapegoat, to find a cause for discomfort. Many confuse the effect with the perpetrator, blaming the other contracting party for the situation. As a result, they often forget years of harmony when each party honored their respective contractual obligations without complaint.

Opposing or Common Interests

The tendency to assume that each contracting party has antithetical objectives creates a toxic relationship, often making dispute resolution almost impossible outside a courtroom. There are often no clear winners in litigation. Yes, one party may win in court. But frequently the expense of settling a contract dispute in court and the potential damage to long lasting business relationships can muddy the waters of a clear victory.

It is far better to approach a request to renegotiate a contract as an opportunity to improve the situation for both sides, to turn a certain loss by both into potentially a win-win, new beginning. Every attorney worth their salt recommends an attempt at renegotiating a contract before litigation.

“The dynamics of renegotiating an existing agreement are quite different from hammering out a deal from scratch.” Jeswald Salacuse, Real Leaders Negotiate!

The situation in which the two parties find themselves may be the result of a Covid-19 –like event but also reflects the omission in the initial contract to establish a process for regular review and adjustment. Whether good times or bad, circumstances and conditions for all people and organizations continuously change. What worked yesterday may be inconsequential tomorrow and debilitating the following year.

Attitudes and Experience

Seeking and engaging in renegotiation is not an innate skill, but outcomes are typically affected by the negotiators’ attitudes. Social scientists Kathleen O’Connor of Cornell University and Josh Arnold of California State University found that those who view negotiation as a challenge (a win-win solution) achieve better results than those who view the process as a threat (one-winner-take-all).

At the same time, negotiation is a skill that improves with experience. In another study, O’Connor and Arnold found that experience and successful outcomes are positively related. Less experienced negotiators are more likely to reach impasse or agreements of low value for their party.

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It is negotiation, not mortal combat! Done poorly, renegotiating a contract is likely to escalate bad feelings and mistrust.

8 Steps to Successfully
Renegotiating a Contract

Renegotiating existing contracts is like other company projects. Success requires management, planning, preparation, resource allocation, schedules, and defined outcomes. Proceeding ad hoc is more likely to end in an impasse, hard feelings, and entrenched positions. Implementing the following steps is the optimum method to achieve a satisfactory outcome and a foundation for building a cooperative relationship in the future.

  1. Know what you want. Understanding the cause of the problems necessitating a restart is critical. To the extent possible, the impact of the situation should be quantified and documented. Possible solutions and their effects, if implemented, should be analyzed, and ranked in order of preference. Differentiating between critical, desirable, inconsequential, or harmful concessions is necessary, especially if trade-offs might be required. Work for a win-win solution, so the other side has a reason to renegotiate the contract.
  2. Do not procrastinate. “Instill a sense of urgency,” recommends EquaTerra’s Mark Robinson. Clearly communicate the problem and your objectives (the changes you would like in the contract). Emphasize that if accommodation cannot be reached within the desired timeframe, you will pursue other alternatives.
  3. Agree on the “rules of engagement.” Renegotiating a contract provides an invaluable second chance to restart and forge a working partnership with an alienated partner, setting a precedent for the rest of your working relationship if renegotiation occurs. Do not be coy or duplicitous. Jill Stabler, a Managing Consultant at Alsbridge, advises, “Mistrust and tactical games on the other hand will only serve to delay or derail the process.”
  4. Bring the right team to negotiate. During the process of renegotiation, other issues or solutions might arise. While one team member typically leads discussions, having those who understand, and can quickly project consequences of any proposed changes, will avoid lengthy delays in discussions when information or expertise is needed. There is no substitute for hard data.
  5. Style matters. The perils of abrasive or aggressive actions are evident. Still, the consequences of being mealy-mouthed or too conciliatory will encourage the other side to push for unrealistic concessions. Finding the right tone – mutual respect – is essential, especially if you feel that they are responsible for the situation.
  6. Understand the status quo and know your options. Likely, concessions from your side will be asked for and expected. If possible, avoid getting into a tit-for-tat negotiation. In cases where the concessions conflict with your objectives, detailing your other alternatives – mediation or litigation – is appropriate and will strengthen your position.
  7. Aim for success, plan for failure. Experienced negotiators suggest that discussions begin with a clear expectation for a favorable result and the consequences if an agreement is not reached. Specifically, negotiators should be prepared to detail their Best Alternative to Negotiated Agreement (BATNA) in the case of an impasse. Steve Koutros, MD at Delta Management Advisors, claims, “By understanding the BATNA, both parties understand the floor and the ceiling boundaries [of the renegotiation].”
  8. Amend contract to include regular reviews. A revised agreement is not a guarantee that further problems will not arise in the future. Change in circumstances might inhibit performance or reduce its benefits to a side. Establishing specific dates or time frames to review an agreement might avoid unpleasant situations that may arise from new market conditions.

Litigators as Negotiators

Good litigators are not always good negotiators, especially in situations that require compromise and a delicate touch. Litigation is usually adversarial, requiring a “take no prisoners” mindset. On the other hand, a business attorney’s practice requires regular periods and cases of negotiation, a benefit as O’Connor and Arnold found. Whether your attorney should be your principal negotiator depends on the situation, including the other side’s representative. Most companies include their attorney as a member of the negotiation team to ensure that every responsibility, required performance, and cure remedies are fully understood before a renegotiated agreement is accepted.

Final Thoughts

Parties to a contract should never conclude that an agreement is inviolable or eternal. Even though the pandemic has forced companies to consider breaching or abandoning their contracts due to economic necessity, circumstances occur each day that should trigger a review of all contract obligations and their impact on the company’s present and future health. While no party of a contract wants to make concessions in an agreement, the alternative of litigation and losing a customer is costly and unpleasant. Most would agree that outcomes are far better when facing the other side across a negotiation table than a courtroom.

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