Stacking the Odds in Your Favor

Contract negotiations require that the terms be spelled out and thoroughly understood

• By John P. Bachner
• Jan 01, 2007

A contract comprises a set of promises -- set out in writing and enforceable by law -- usually made by two parties, each to the other.

Generations of fledgling project managers have groaned their dislike of contracts and learning about them. While most begrudgingly acknowledge that contracts are essential, many fail to realize how vital they really are.

Imagine what would happen if the parties to contracts were unable to enforce reasonable, legal terms. A promise would only be as good as its maker's willingness to live up to it, thus converting the rule of law to the law of the jungle. In fact, it's not overstating the case to say that contracts are the linchpin not only of the United States' economic system, but of the world's system -- and not just economic systems -- think about marriage contracts, international treaties, and other related contracts.

At its root, a written contract serves to memorialize mutual understandings. Realistically, there is no reason for a contract to be anything but fair. Unfortunately, all too many of them are unfair, leading to a variety of unfortunate outcomes.

Essential Contract Elements
I'm most familiar with contracts between an owner, such as a water authority, and a consultant retained to design a new facility or expand or update an existing one. In an ideal world, such contracts comprise six elements:

• a project description comprehensive enough to make assumptions and guesses unnecessary,
• definitions of the more significant words and phrases used,
• a scope of service that identifies what the consultant will and will not do,
• terms and conditions that (principally) set forth what each or either party will do in the event certain events transpire,
• a schedule indicating when certain events will occur, and
• payment terms.

Although people often roll their eyes whenever a contract exceeds two or three pages (explaining why long contracts tend to be written in a type size even an ant would need "cheaters" to read), longer contracts almost always are better, because they provide more explanations and definitions, especially when they're written (as they should be) in "plain" (nonlegalese) English.

Attorneys should be called on to review contracts to ensure that their clients understand exactly what a contract means, especially when it comes to terms and conditions, where attorneys can expound with examples -- hypothetical and otherwise -- about what would happen "if." And they also can provide guidance on the legality of the actions required under the contract terms, because courts will not enforce a contract provision that requires either party to do something illegal. Neither party would want to inadvertently use wording that could be construed to create an illegal purpose, thus jeopardizing its ability to achieve a legitimate intent. And again: Each provision of an agreement should be mutually acceptable. It should not be either party's intent to use a contract to pull the wool over the other party's eyes in order to gain an unfair advantage.

Regrettably, not all lawyers do a top-flight job handling their role as contract advisers. This problem occurs because of legal training.

The Protection Advantage/Disadvantage
Lawyers are ethically bound to achieve the best possible legal result for those on whose behalf they are retained. When presented with an agreement that might seem fair, they may look for means to create an advantage for their clients, thus converting what should be a "win/win" document into a "win/lose" document, under the assumption that the only thing changed is the amount of protection their clients receive. But that's an extraordinarily naive outlook when the clients are owners, given the three principal types of consultant organizations that could be involved:

Astute, successful consulting organizations that often have an extensive "book of business." These firms are leaders in the field, creating great demand for their services on the part of jurisdictions, agencies, and other public or private owners with common sense or experience enough to realize that "the bitterness of low quality lingers long after the sweetness of low price is forgot." Given the growing demand for these firms' services, and the scarcity of qualified professional personnel, these firms can afford to be highly selective about the clients and projects they accept.

Few are about to kowtow to an owner's unfair, one-sided contractual terms requiring that, in addition to providing high-quality professional services (whose adequacy is backed by professional liability insurance PLI), they provide an uninsurable, "paid-for-out-of-our-own-pocket" indemnity in the event the jurisdiction or agency is damaged by parties other than the consulting firm; even when the other party is the jurisdiction itself.

Somewhat astute consulting firms that are not yet as successful as some of their brethren. Some of these firms may crave additional experience to demonstrate their capabilities in order to obtain more and more challenging commissions as well as fairer terms and conditions. Firms that accept advocacy-inspired, one-sided terms generally do so with their eyes wide open. They will take prudent steps -- at the client's expense -- to help minimize the potential for uninsurable things going wrong. This is epitomized by the facetious example of the consultant who recommends that a "two-hole" outhouse be supported by piles driven to bedrock "just in case."

Consulting firms that accept just about any onerous term or condition a lawyer can conceive. These firms are ignorant of the risks involved (which usually means they lack the assets needed to mount a competent defense let alone pay damages) or so sly as to have made themselves judgment-proof by shifting their assets to a hidden or otherwise unassailable stronghold, such as a parent corporation.

Given the three types of firms "out there," a client's insistence that a firm accept onerous, one-sided, uninsurable conditions translates into that client braying to the world:

"In order to protect the best interests of the public, we need to retain a consultant that's so stupid or so devious it's willing to accept terms that would require it to mortgage its very existence on our behalf should the least little thing go wrong, even though it probably has no resources to do this, because it's too incompetent to accumulate any or so devious it's been able to squirrel them away beyond our reach."

To a very real extent then, attorneys who get the nod to "beef this up a bit" (to draft contracts that contain one-sided uninsurable terms) should advise their clients such an action could have an effect opposite from the one intended, in that the "beefed-up" result could discourage the most qualified firms from participating and encourage (or by default force) the involvement of firms that

• are incapable of performing high-quality services;
• are more likely to commit errors and omissions that cause the client to exercise its onerous conditions; and
• could care less, because they don't have the resources to make good!

Many attorneys will not provide that advice, because they're unaware of the rough-and-tumble business their clients actually are involved in. In essence, they're just too inexperienced to understand that, as air-tight as some contractual provisions may seem, when it comes right down to it, those provisions are just words.

Here's an example of the type of provision I'm talking about. If you represent an owner, it's time to change this one-sided contractual condition that is heavily weighted against the consultant (without losing any reasonable protection). And if you represent a firm that ordinarily would accept the requirement, it's time for that firm to join ASFE/The Best People on Earth! The provision in question involves use of the word "defend," as in:

CONSULTANT agrees to hold harmless, indemnify, and defend CLIENT from any losses arising from CONSULTANT's negligent performance of its services.

This provision requires the consultant to defend the client if the consultant is accused of professional negligence, even though the claim might be meritless. How could such a situation arise? Easily. Party A sues the client -- a public agency, say -- alleging that the agency has caused damage by virtue of an activity in which the consultant was involved. This causes the client to sue the consultant, alleging it was the consultant's negligence that created the situation that caused Party A to file its claim. And that being the case, the consultant would be required to defend not only itself, but its client as well.

That situation puts the consultant in a huge "one-down" position: While its PLI would cover its own defense costs (less the deductible), the insurance would not cover the cost of the client's defense if, in fact, the client's damages were not caused by the consultant's negligence, or if it were found that the client did not damage Party A.

It's All in the Wording
Now, suppose the consultant was negligent and, as a consequence of that negligence, the client had to pay money to defend itself. Am I advocating that the client should bear that expense? Not at all. One could cover that exposure with wording such as:

CONSULTANT agrees to hold harmless and indemnify CLIENT from losses arising from CONSULTANT's negligent performance of its services, such losses to include, but not be limited to, a proportionate share of CLIENT's reasonable attorney's fees and other reasonable defense costs.

This is a completely fair provision, because it requires the consultant to pay a proportionate share of defense costs if it's found negligent; that is, were the consultant adjudged to have been 70 percent at fault for a loss, it would have to pay 70 percent of the client's damages, including 70 percent of the client's reasonable defense costs. Because if those defense costs would be considered damages, they would be covered by the consultant's PLI. (It's also fair when one considers that the consultant's share of defense costs is likely to exceed the consultant's fee, and that a consultant generally needs to earn $10 in order to generate the $1 profit required to pay for an expense; that is, consultants commonly have to generate $500,000 in fees to cover a $50,000 deductible. Even when fairness prevails, acceptance of a commission exposes a consultant to a loss risk 10 or more times greater than the consultant's fee, and 100 or more times greater than the benefit profit the consultant hopes to derive from fulfilling the commission.)

To require a consultant to face such a risk even when it has performed in a wholly satisfactory manner is grossly unfair, and an astute firm is not likely to accept the bargain unless it can somehow modify the risk without being caught (which, thanks to conservative and, thus, far more costly-to-construct design, is not that difficult a trick). In the event a client insists on its "defend" language, an alternative provision might be:

To the extent of CONSULTANT's negligence, CONSULTANT agrees to hold harmless, indemnify, and defend CLIENT from losses arising from CONSULTANT's negligent performance of its services.

Unfortunately, a provision like this is not very good because it probably would be subject to differing interpretations. Clearly, the consultant would interpret it to require reimbursement of the client's legal costs to the extent of the consultant's liability. Given that, at the outset of the claim, the consultant would claim zero negligence, it would cover zero percent of the client's defense costs. If the consultant paid anything at all, the amount would/could be determined only after it was decided that negligence actually occurred. But the client would probably say the provision required the consultant to pay its defense costs "from the get-go" with the possibility -- a contestable one -- that it might have to reimburse the consultant if it's subsequently found the consultant was less than 100 percent at fault or not negligent at all.

Were I an owner's representative, I'd certainly want an attorney to offer these various alternatives to me, providing the attorney explained each and discussed the problems they could generate, in addition to the benefits. If I recognized the potential problems while fully endorsing the language for its potential (unfair) benefits, so be it. My lawyer and my consultant would be on the same side of the fence for a change: Both would have a fool for a client.

This Why Risk It? column originally appeared in the January/February 2007 issue of Water & Wastewater Products.

This article originally appeared in the 01/01/2007 issue of Environmental Protection.