The Business Counselor Blog™

Mediation Clauses and Agreements

A mediation clause can, and often is, used in conjunction with formal procedures for negotiations and/or arbitration. For example, the parties may be obligated to engage in some period of negotiations without the assistance of a neutral before a mediator is brought in to assist. Mediation may also be a required first step before the parties can commence binding arbitration procedures or ask for relief from the courts.  This month's report describes various methods for memorializing a mediation arrangement and also includes an example of a mediation services agreement.

Minimizing Risks in Renegotiating Contracts

In a previous post I discussed some basic guidelines for attempting to restructure contracts that have turned out to be problematic in light of unforeseen events after the deal was first signed.  Obviously there are risks in attempting to informally renegotiate a contract.  The major concern is that if discussions are not successful the non-defaulting party, the customer in this case, has been given a substantial amount of information that can be used in subsequent litigation and information provided in good faith as a basis for striking a new deal can be turned into a harmful weapon in the hands of the party’s attorneys.  In many cases, however, the rewards exceed the risks and companies can resolve problems by providing the other side with sufficient information to allow them to make an informed decision and understand the benefits of a proposed compromise. 

Several safeguards should be used when entering into negotiations to restructure a troubled contract.  First of all, any documents provided to the non-defaulting party that contain sensitive information should be marked “confidential” and only disclosed after the other party has agreed to sign and return a confidentiality and non-disclosure agreement.  Second, while it is usually obvious that the reasons for the discussion are that the terms of the initial contract have become significantly unfavorable an effort should be made to avoid using language that the other party might reasonably interpret as being an admission of impending non-performance such that the other party might claim anticipatory breach.  Third, try to continue complying with the terms of the contract as they stand during a limited negotiation period even if this means incurring modest losses on the contract during that time.  If possible, start talking about restructuring a contract as soon as it appears that problems are on the horizon but before they reach a crisis level.  Fourth, try and determine if the other party has specific problems of its own that might be solved or managed in some way during the negotiation process.  For example, the other party might have an immediate need for cash that might open the door to discussing a buyout of the contract with an immediate lump sum payment that represents a substantial discount from the costs of performing for the entire term.  Finally, if litigation is a real possibility and there are legitimate concerns about misuse of information disclosed in good faith consider holding the discussions through a mediator.  A mediator is not only trained to get both parties to find common grown, and ignore emotions and anxieties, but it is also possible to have discussions with a mediator protected as confidential and privileged so that they do not later come back to cause harm in the event of litigation.

Renegotiating Contracts That Have Gone Sour

Companies often find themselves in a bind with regard to performing their obligations under a contract with a vendor, customer or other business partner.  For example, a company may have agreed to sell raw materials to a customer over a two-year period at a fixed price only to find that the deal suddenly became unprofitable because of an unforeseen rise in the company’s costs of procuring the raw materials that it was obligated to sell.  At that point the company can continue to try and perform under the contract, and risk significant financial damage to its business, or can simply cease deliveries and hope for the best when the customer begins threatening litigation.  A strategy of stopping deliveries is often accompanied by any attempt to find fault on the customer side that would allow the company to claim that the customer has breached its duties under the contract thus relieving the company from its obligations.  Unfortunately, arguing over the words of the contract at that point will only benefit the lawyers involved and the better course for the senior management of the company is to attempt to sit down with the customer and try and work out a restructuring of the contract that makes sense for all parties.

When attempting to restructure a problematic contract an attempt should be made to align the interests of both sides and offer the other party, the customer in this case, an incentive to cooperate other than the prospect of costly litigation.  In the illustration above the company might offer to substitute a new pricing formula for the fixed price arrangement which offers the customer reasonable pricing under all market conditions plus assurances that the company will not seek and obtain unfair profits from the restructured relationship.  For example, assume the fixed price was $1.00 per unit and at the time the contract was first entered into the company’s cost was $0.85 per unit.  At that time the company’s profit was $0.15 per unit.  If the market price went down to $0.50 per unit the company’s profit would increase to $0.50; however, the contract became unprofitable for the company—and advantageous for the customer—when market prices rose to $1.50 and looked like they were going to stay there for the balance of the contract term.  In that situation the company might suggest that contract price be set at the market price plus 10% which means that the customer would enjoy a price that is in line with the market and the company is entitled to a modest profit at all times during the contract term.  The customer waives the right to the attractive pricing in relation to the market that it would have received under the initial contract but is spared the costs of litigating the breach and finding a new vendor.  The company gets to keep the customer, and stay in business, but the days of 50% profit margins are gone.  The company may throw in other incentives, such as more robust customer service plans, to sweeten the deal.

Pre-Dispute Agreements to Arbitrate Come Under Fire

Since the enactment of the Federal Arbitration Act in 1925 there has been a strong federal policy in favor of arbitration absent a showing of legal or equitable grounds for revocation of the contract that includes the arbitration provisions.  Areas in which the use of arbitration provisions have often been contentious include franchise, consumer and employment contracts and franchisees, dealers, consumers and employees have often argued, largely without success, that arbitration requirements in those contracts should be avoidable on the basis of “fraud in the inducement.”  However, if the Arbitration Fairness Act of 2007, which was introduced in Congress in July 2007, becomes law, pre-dispute agreements to arbitrate statutory defined “franchise,” “consumer,” and “employment” disputes would be unenforceable.  Of note is the fact that the Arbitration Fairness Act would not only apply to agreements that went into effect after the date that the Act became effective but would also apply retroactively to contracts that had been entered into before the effective date.  The Arbitration Fairness Act would essentially re-write existing contracts and substantially alter the strategic positions of the parties in the event that a dispute covered by an arbitration clause arises.

Obviously the following definitions of the “disputes” that would be subject to the Arbitration Fairness Act are extremely important:

• "Franchise" disputes include those arising under any contract whereby (1) a franchisee is granted the right to engage in business under a marketing plan prescribed in substantial part by the franchisor, (2) the operation of the franchisee's business is substantially associated with a commercial symbol such as a trademark or logo, which designates the franchisor or an affiliate of the franchisor, and (3) the franchisee is required to pay a franchise fee, either directly or indirectly.
• "Consumer" disputes include those between a "person" (which would not include an organization) and a seller or provider of property, services, money, or credit with respect to goods or services obtained for personal, family, or household purposes.  In general, a consumer dispute would not include a transaction in which goods or services are obtained for business purposes; however, small businesses could seek to invalidate an arbitration clause in cases where the contract was between "parties of unequal bargaining power."
• "Employment" disputes include those between employees and employers using the definition of employee-employer relationship found in the Fair Labor Standards Act.  Arbitration provisions in collective bargaining agreements would not be subject to the Arbitration Fairness Act.

Another important change included in the Arbitration Fairness Act is that the courts, applying federal law, would have the authority to decide whether an arbitration provision is enforceable.  Current law generally places the issue of whether a dispute must be arbitrated in the hands of the arbitrator unless the parties have expressed a preference for a court to decide in the specific arbitration agreement.

The changes for success of the Arbitration Fairness Act are uncertain at this point; however, it is an interesting development worth watching closely.