I was recently reminded of the popular Ted Talk by Simon Sinek, called Starting With Why. It’s worth a watch. Sinek describes how, very often, organisations fall into the trap of focusing on what they do and how they do it but forget to ask the question ‘Why?’.
As a commercial lawyer, I spend a lot of time drafting and negotiating contracts. In this world, there is a lot of excitement about how technology is transforming the way in which contracts are created, negotiated and managed. There are established tools for automating the way contracts are created, as well as more advanced technologies that can ‘intelligently’ analyse the content of vast quantities of text. Steps are also being taken to develop ‘smart contracts’, which could enable contracts to be ‘agreed’ automatically, with little or no human intervention.
In all this excitement, I wonder how many people are asking the question ‘Why?’.
I don’t mean “Why automate?”. I’m sure everyone understands the benefits of ‘faster and cheaper’. What I have in mind is a much more fundamental question: “Why do we write contracts at all?”.
This may seem like an odd question for a contract lawyer to ask, but I think it’s an important one to consider if we want to implement technology in a way that genuinely improves how we currently do things. I also think it’s a question too often neglected, even outside of the technology debate.
So with that in mind, here are some thoughts on why we put so much effort into (written) contracts.
Ground Zero: dispute prevention and resolution
For me, the core purpose of contracts is to prevent disputes and help resolve them where necessary. We may have drifted away from this (something I’ll come to later), but for me it is the ‘Ground Zero’ of why we put so much effort into agreeing contracts.
Writing a deal down helps prevent arguments about what was agreed. The process flushes out misunderstandings and the result provides evidence of the outcome. If needs be, contracts can also help others — like an arbitrator or a judge — settle a dispute between the parties.
If there was no risk of a future dispute between the parties, then there would be little need for a contract at all. A statement of the obvious I’m sure, but one worth reflecting on.
It reminds us that, at heart, contracts are about human relationships that are fragile and unpredictable. And in that volatile sea, contracts are an important tool for maintaining some level of order.
Also, the value of contracts is not limited to, and shouldn’t be defined by, the contract you happen to be working on. Each contract contributes to a wider, macro-benefit that can be taken for granted. There is a web of a billion contracts stopping a million disputes get out of hand. Imagine a world without contracts and you quickly realise the stabilising effect they offer us all.
So, when reflecting on our modern contracts and processes, it’s worth asking whether they help or hinder the core purpose of dispute prevention and resolution — or are they increasingly trying to achieve something else entirely?
The five functions of a contract
Beyond this highfalutin talk of dispute prevention and social order, I see five key things for which we use contracts in our modern world. Five ‘functions’ if you like. You might be able to think of more (or different) functions, but this is my best attempt so far.
I think we use contracts to:
1. create Clarity
2. manage Risk
3. define Rights
4. ensure Compliance
5. provide Guidance
Let me explain each in a little more detail.
Clarity
The Clarity function is about making sure that contracts capture what has been agreed and do so in a way that is clearly understood by the parties and understandable by others.
There’s lots to say about the Clarity function, but for now I’ll limit myself to a few observations, some of which are a little trite, but worth repeating.
1. Making a contract clearer is not the same as making it longer. The opposite is often true.
2. Making a contract clearer does not (necessarily) require a lawyer. Lawyers are good at spotting and avoiding ambiguity, but collectively, they are also guilty of making contracts longer and longer in a way that buries a lot of wood amongst many trees (see point 1).
3. Just because a contract is clear to one party doesn’t mean it’s clear to the other. Therefore, it’s useful to ask to what extent a contract achieves mutual clarity.
An obvious example of non-mutual clarity is where businesses sell products on standard terms that are non-negotiable — especially when selling to consumers online. In this scenario, one party to the contract may have little or no idea what the contract says (aside from the headline price).
4. What is meant by clarity, and whether it has been achieved, might look quite different depending on your circumstances. If you are a business entering into lots of similar contracts, you may achieve a certain kind of clarity by maintaining consistency across your whole portfolio, even if you sacrifice a measure of clarity on individual deals. I think of this as ‘portfolio’ clarity. On the other hand, if you are buying a business-critical and highly bespoke product, you are likely to require much more tailored contract terms.
5. Lastly — but certainly not least — the process of negotiating and drafting a contract is very often just as important for achieving clarity and eliminating misunderstandings as the contract itself (if not more so).
Risk
The Risk function describes how contracts are used to manage the potential fallout from entering into a deal, particularly the financial consequences of breaching the contract.
The most obvious example is the use of limitation of liability clauses. These cap the parties’ liability to a certain sum, even if the actual losses arising from a breach of the contract might far exceed the value of the agreed cap.
You could make a case that, in modern business, this has become the primary function of many contracts, especially for suppliers. No one wants to bring their business down because one or two contracts go badly, so it becomes critical to manage this risk. And in a rushed world where reviewing and negotiating contracts takes time, some may take the view that, for certain agreements, if the caps on liability are reasonable enough, they won’t worry too much about what the rest of the contract says (within reason).
It’s worth noting that the drive to eliminate risk can sometimes find itself in tension with the Clarity function. The temptation to cover every conceivable issue leads contracts to grow and grow, which in turn, brings us back to the problem of length becoming the enemy of genuine understanding.
Rights
The Rights function captures how contracts are used to grant one party a right to do something that they wouldn’t otherwise be permitted to do. It can also cover situations where a party agrees not to do something that they might otherwise have a right to do (such as in a non-disclosure agreement).
An obvious example is a software licence, which will grant the licensee a right to use intellectual property rights in software, provided they do so within agreed parameters. Another area where the Rights function is especially relevant is in the world of real estate and lease agreements.
Whilst it is possible to grant (or restrict) some rights verbally — i.e. without a written contract — this is an area where evidence and precision are all important. It’s for this reason that the law specifically requires some contracts of this sort to be made in writing, such as those involving the sale or leasing of property. It is also an area where the input of a lawyer can be especially valuable, as their training and expertise is particularly suited to considering whether the issues are dealt with properly.
Compliance
An increasingly important — and relatively new — function of many contracts is to drive compliance and impose positive behaviour on others. Businesses and organisations are subject to evermore regulation that puts the onus on them to regulate the performance of their own supply chain through contractual obligations — particularly in areas such as anti-corruption, modern slavery and data protection law. Many also want to be seen to be dealing with these issues.
The General Data Protection Regulation (GDPR) is a good example. It requires data controllers to have a written contract in place with parties that process personal data on their behalf. Not only that, it prescribes specific obligations that must be included in those contracts.
There is a debate to be had about whether this trend of imposing compliance obligations creates a distraction from the underlying concern they are really trying to address. Does it generate a kind of moral hazard, where focus is diverted towards putting contract clauses in place (‘ticking a box’), rather than putting effective systems and processes in place to monitor and stop unacceptable behaviour on the ground?
Of course, it needn’t (and shouldn’t) be an either-or situation. There is a strong argument that requiring contracts to deal with compliance forces wider attention on issues that might otherwise be glossed over. However, it’s crucial to remember that, if we want to stop things like modern slavery or the misuse of data, a contract clause is not an end in itself; in fact, it’s barely even a ‘means’. When it comes to compliance, no one should think their job is done when a contract is signed, and no regulator should think their job is done because they made them sign it. We don’t want to compound the impression, both within organisations and society at large, that responsibility for these types of issue sits with the contract department.
Guidance
Some contracts place particular emphasis on how the parties should work together day-to-day. This is especially true of, say, large outsourcing arrangements or IT service agreements, where there will be an ongoing relationship that may go on for years. In these scenarios, the contract can act like an operating manual or handbook. Done well, it becomes a ‘living’ document that does not sit in a draw but is a practical reference guide for those involved.
Arguably, the Guidance function has become more relevant in our tech-driven world. This is particularly true in the delivery of IT projects, where it is now very common to adopt Agile development methods. These projects often place a stronger emphasis on process and managing constant change — through collaboration, regular feedback and evolving requirements — rather than starting from the assumption that there will always be fixed outputs.
Agile projects have long posed a challenge for traditional contracting models. But they also demonstrate how, by talking more explicitly about what we want our contracts to achieve, we can start to have more conscious conversations about what ‘good’ looks like in different settings.
For some deals, it might be useful openly to acknowledge that the Clarity or Risk functions are harder to achieve (or at least, we may need a more nuanced discussion about what they mean). And where this is the case, it may be appropriate to intentionally shift focus towards the Guidance function as a method of keeping relationships on track — and ultimately, to achieve the overarching purpose of dispute prevention and resolution.
Final thoughts
Contracts vary enormously — from international treaties to online terms and conditions; from multi-billion-pound outsourcing agreements to the one-off purchase of a house — so trying to condense all this to a few common functions is probably a fool’s errand.
These exercises are always imperfect; but it can be helpful to zoom out and ask: “What are we trying to achieve here?”. Starting with the ‘why’ brings focus to the ‘how’ and the ‘what’.
For those of us who work on contracts for a living, we live in exciting times. More and more focus is being given to how we can contract better. Whether it’s finding practical ways to realise the importance of relationships (see the IACCM’s initiative on relational contracts), ambitious plans to reimagine contracts as dynamic collections of structured data (see Clause.io) or applying design principles to drive simplicity and improve understanding (see IACCM’s resources on contract design patterns, led by Stefania Passera and Helena Haapio), there is definitely lots of positive work going on.
The challenge for all of us is to make sure that the solutions we offer — whether mind-bendingly novel or mind-numbingly familiar — are rooted in the problems our clients need us to solve. And if our focus is on improving contracts, this will inevitably need different and varied solutions, because contracts themselves are a solution to more than one problem.
Looking ahead, an interesting question is whether we can more radically reimagine what a contract is by acknowledging its core functions and achieving them in different ways.
Consciously or not, this has been happening in the online consumer space for years. It has slowly been recognised that, whilst burying bad news in (unread) terms and conditions might protect you in court, if you lose a thousand angry customers on your way to proving it, maybe your ‘contract’ didn’t do its job after all. For this reason, many companies have started to present their ‘deal’ in more user-friendly ways, perhaps through FAQs, videos and more. The boundaries of the traditional contract may become messier, but perhaps the need for one also becomes narrower.
And whilst the context can be very different in business-to-business settings, some of the same forces are at play — especially in the world of, say, cloud-based services, where the march towards standardised, non-negotiable contracts continues apace.
Whatever the contract, if you get far enough under the skin, I think the aims are broadly the same — and this means, the potential for shared learning and improvement across sectors and disciplines is vast and exciting. That’s always been the case, but perhaps the focus of new technologies and design-led approaches to contract problems is a good stimulant to speed up the process, which is a great thing, provided it always starts with: “Why?”.
Postscript
There are a couple of areas I debated including as additional ‘functions’, but ultimately decided against. My internal debate continues, so I thought I’d share why I haven’t included them.
The first is Data. There’s no doubt that contracts are a rich source of data and insight for many business. There’s also no doubt that this data can be extremely helpful for improving the shared understanding of what a contract says and for optimising contract processes. However, I don’t believe creating data, in itself, is a core function of contracts. It is a secondary effect that can (potentially) help achieve the primary functions.
To put this another way: hospitals generate vast amounts of data that can help us understand public health issues and improve health outcomes in powerful ways. But hospitals don’t exist to collect data. They exist to treat the sick. And they did so long before people started collecting health data in ways which would have blown the minds of early physicians.
The second topic is Enforcement. I have struggled much more with whether to include this one. It’s certainly true that being able to enforce a contract is massively important. In fact, in some settings it could be seen as a contract’s key function. For example, banks may only lend money if they have the comfort of a separate guarantee (contract), which can reliably be enforced to recover the money if needs be.
So why didn’t I include enforcement as a function? There are a couple of reasons.
The first is that, to some extent, the process of enforcing a contract is already inherent in the core purpose of dispute prevention and resolution. There are also overlaps with other functions; particularly the Clarity function. To be enforceable, a contract must be clear, both in terms of what it says, but also in its ability to demonstrate a genuine agreement between the parties. However, the key reason I did not include enforcement is that, whether or not a contract is enforceable in practice, will very often have more to do with factors beyond the contract itself. For example, it will depend on the availability of a functioning and accessible legal system and effective dispute resolution mechanisms.
Sadly, the lack of these things can certainly undermine the purpose of many contracts. Not only that, the emergence of effective enforcement mechanisms is typically a necessary precursor for contracts to become the trusted and powerful tools they are. Just look at international treaties — themselves contracts — which often create new dispute resolution mechanisms as a first step to ensuring that the treaty has some teeth. But despite the importance of enforcement, I still think that, on balance, it is something distinct from the contract itself.
Like a car that needs an effective road network to achieve all that it was designed for, contracts need a supporting social infrastructure to realise their full potential. But just like a car that struggles off the beaten track, a contract that is difficult to enforce may be less effective, but it can still achieve an awful lot.