We’ve all been there. We’re negotiating a contract for an employer or client—deep in the weeds on things like pricing, warranties, and logistics. Our boss then turns to us and asks, “Can we sign it?” We’re taken aback, as there are so many moving parts, unknown unknowns, and things we’d prefer to be a little better. We don’t have a succinct answer that will hold the boss’s attention.
This post provides a few questions that help us answer the inevitable “Can we sign it?”:
- What happens if performance goes wrong?
- How do we get out?
- What is the worst-case scenario?
We look at each of these below:
- What happens if performance goes wrong? Contracts are tools for allocating risk. The most obvious risk is non-performance by one of the parties. It is crucial to be able to point to what happens if either party fails to perform. Are there clear remedies—interest, liquidated damages, indemnity, or termination rights? Knowing the answers greatly reduces uncertainty about whether it is safe to enter a contract.
- How do we get out? Even a good contract can become bad if you’re stuck in it. You may get a great price for a SaaS subscription, but then never use it. Being stuck with something you never use is a net loss. Many contracts feature unilateral termination rights or only allow termination for uncured breaches. Other contracts may have “breakup fees” (check your lease agreement). Being able to get out—ideally with minimal penalty—makes signing a contract much more palatable.
- What is the worst-case scenario? Recouping losses and getting out of bad deals helps. But what happens when things go truly wrong? Knowing your downside risk is critical to answering whether you can sign an agreement. Worst-case exposure is usually covered via a limitation of liability (LoL) clause. Are the caps mutual? Are key categories carved out? The LoL clause caps damages—either at a fixed dollar amount or as a percentage of sales volume—and excludes non-direct damages. A good LoL clause allows you to get a better handle on downside risk uncertainty.
One caveat is that worst-case exposure can be difficult to quantify. Well-drafted LoL clauses feature carve-outs for high-risk damage categories (IP infringement, confidentiality breaches, death, serious bodily injury, etc.). In addition to being uncapped, these damage types are often difficult to quantify (how much is confidential information actually worth?). Insurance and indemnification may mitigate risk, but both are slow and uncertain remedies. If a counterparty tells you that they need a hard number for downside exposure, you should be cautious.
Putting It All Together
The next time you are presented with a “can we sign it?” question, you will have a handy framework for getting to yes or no. First, if there is clear recourse if the other party doesn’t perform, that is a vote in favor of signing. If not, you may want to reconsider. Second, ask yourself whether you can get out if plans change. If you are stuck or there are heavy penalties for seeking to get out, you may want to hit the brakes. Third, ask yourself about worst-case exposure. If your liabilities are uncapped or you are on the hook for massive penalties, you should be skeptical about signing. If you can’t insure against contractual risk, you should think twice.
While there is no formulaic yes/no light switch, good answers to these three questions can help point you in the right direction.
Disclaimer: This blog is for informational purposes only and does not constitute legal advice. Reading or interacting with this content does not create an attorney–client relationship. You should consult a qualified attorney for advice regarding your specific situation. Mehaffy, PLLC disclaims all liability for actions taken or not taken based on this blog.