Why do we have a problem with contracts?

Contracts are the driving force behind the economy. For many years, the practice of concluding and performing contracts remained unchanged. Now, however, a lot is changing – for better or for worse.
What are these changes?

More and more regulations – longer and longer contracts

Contracts and related transactions are the lifeblood of the economy, but the transactional costs associated with their conclusion and execution are increasing.

The increase in transaction costs is influenced by a number of factors, but one of the most significant is the increasing number of legal regulations that must be taken into account while drafting a contract. RODO should be mentioned here, as well as tax regulations on invoicing, regulations against excessive delays in commercial transactions and other provisions aimed at ensuring compliance with various legislation.

All these regulations generate the need for additional provisions to be written into the body of the contract.

At the same time, those provisions that aim to implement regulatory obligations are worded very differently – on the one hand they say more or less the same thing, but on the other hand they use different words. This requires all participants in the contracting process to spend their time analysing and negotiating them.

In my practice, I have encountered contracts in which, for example, the provisions describing the invoicing and payment process took up as many as five pages, as well as those in which half a page was sufficient.

There is therefore an important problem in practice – contracts are becoming more complex, but more and more of them are dealing with issues that are ancillary to the subject matter of the contract.

Standardisation through reduction of the number of contractual models

However, it is not only the increase in the number of regulations that has contributed to this state of affairs. The same is also true of the ‘standard’ provisions of contracts, the volume of which has definitely increased in recent years.

Those market players who create their model contracts try to include provisions for every situation, even if the situation is unlikely to arise. At the same time, they usually want to minimise the number of such templates, with the result that voluminous contracts are prepared that apply to every situation – whether a simple supply or a complex service.

Moreover the common law model of contracts became popular, in which the contract should regulate all aspects of the relationship between the parties, despite the fact that in the reality of a country with a civil code (like Poland), such an exhaustive description of all issues related to, for example, liability, is not really necessary.

As a result, a lot of time is wasted by the parties in analysing and negotiating provisions that, in practice, often have a negligible impact on the implementation of the transaction to which the contract relates.

In this context, it is also worth reviewing the reports published annually by World Commerce & Contracting, which collect information on the most frequently negotiated contractual provisions. At the same time, participants are asked about those provisions that have proven to be the most important in practice and have led to successful contract implementation.

The conclusion of these analyses should make us rethink the current approach to contracts – it appears that mainly provisions regulating liability issues are negotiated, while the source of real litigation is most often entirely different provisions – those on the scope of the contractor’s tasks or obligations related to the performance of the contract. My analysis of one such report is here: Most frequently negotiated v. most important contractual provisions (Polish only).

The contract is for the time of “war”

There is a widespread belief (in Poland at least) that contracts are concluded only for bad times, that they are primarily intended to protect the parties against non-performance. On the website of a certain law firm, one can even find the thesis that we only benefit from a signed contract if one of the parties fails to perform its contractual obligation.

Meanwhile, such one-sided approach to the contract has a number of negative consequences. The preparation of the contract is mainly carried out by lawyers who focus on issues related to securing the interests of the party they are advising. The contract then often does not regulate well the important issues related to the execution of its subject matter (as the above-mentioned reports on the most frequently negotiated provisions show well).

In addition, such an approach results in the creation of one-sided contracts, which cause a number of business problems – prolonged negotiation time, abandonment of such transactions by the other party, contracting with unreliable counterparties for whom the provisions of the contract will have little relevance in the course of the contract anyway.

The problem of unilateral contracts is particularly significant in public procurement – as there the contract is prepared by the contracting authority and the contractor has quite limited possibilities to change it (unless it is a negotiated procedure). In theory, the contracting authority is bound by the principle of proportionality, but in practice this varies (more on the principle of proportionality here: Znaj proporcjum, mocium panie… – a guide to the application of the principle of proportionality in public procurement – Polish only).

The reasons for this approach to contracts as a “war tool” are complex. An interesting voice on this issue is the publication by Jan Winczorek and Karol Muszyński ‘The access to justice gap and the rule of law crisis in Poland’. The authors put forward the thesis that Polish society has developed a system of settlement of its problems without using the legal system, treating the law (represented both by courts and contracts) as a last resort – we resort to the law only when we have to (because there is a dispute that cannot be ‘settled’ by other means). This translates into an attitude towards contracts, the way they are formulated and the management of their execution. Since problems that arise in the course of contract implementation will be resolved informally, the contract may be limited to regulating only issues that can be litigated.

NDA agreement

Perhaps the best example of an agreement that significantly inflates transaction costs out of all proportion to the value added to the transaction is the non-disclosure agreement (NDA). This is a document that, in many companies, is signed compulsorily before any form of cooperation is initiated, the initial terms of which are usually tailored to projects that are the most complex and require the greatest effort to maintain the confidentiality of information. As a result, such a document almost always generates the need to negotiate it when the parties have not yet started discussing the main subject of the planned transaction.

It often happens that the potential contractor gives up already at that point – because the ‘non-negotiable’ draft NDA agreement, which is filled with high contractual penalties, does not inspire optimism regarding the negotiation of the main contract.

This, of course, is not the only issue with NDA agreements – another is the phenomenon of ‘magic spells’ to prevent disclosure of confidential information, which I have written about here: Confidential cloud and magic spells (Polish only).

Contract automation does not always help

The problem described becomes even more apparent when an organisation attempts to automate the contracting process. The automation of elaborate, ‘Byzantine’ or one-sided contract templates results in a kind of ‘freezing’ and perpetuation of their use.

In this case, automation only exacerbates the scale of the problem, rather than solving it.

How to deal with it

Fortunately, there are many ideas on how to improve the quality of contracts and reduce their transaction costs – for each of them, I refer you to my article on the subject: