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Negotiating Performance Based Contracts

When hiring a contractor, we often put all the responsibility on them for completing what they are being hired to do, without any harm to our businesses. This is a fair notion, but there are some circumstances where we have to assume some responsibility to allow the contractor to do what we need them to do. This is the concept behind performance-based contracting.

In a past episode of Negotiations Ninja, I spoke with Jeanette Nyden, a commercial contracting coach, lawyer, and contract expert. One of Jeanette’s passions is performance-based contracting.

Performance-based contracts are all about ensuring each party is accountable for their business and the things that should be their responsibility. For example, if a large company on a property that has a gate, which needs a pass to get through, hires a contractor to do work in the building, and the hiring company forgets to give them passes for the gate, the hiring company is wasting the time of the contracted company and potentially slowing down the project. If this project goes longer than promised, is that at the fault of the hiring company or the contracted company? This question is why we use performance-based contracts.

In a performance-based contract for this scenario, we could outline that the hiring company needs to ensure the contracted company can enter the facility at the stated start time of the project for the promised work to be completed. Adding this to a contract not only ensures the contracted company will have reassurance that they can start on time and not be penalized for something out of their control, it also ensures that when you do hand over the passes so the contracted company can start on time, they can’t come back with that as an excuse as to why they were late in finishing the project.

When each party’s responsibilities are outlined in a contract, there will be no questions about performance in the end.

This is especially crucial when the risks are higher than wasted time. It’s important to consider all the risks they are putting on contractors before hiring them and take on that responsibility if the responsibility is theirs.

“I want to allocate risk to the party who can most control the risk. That’s really radical,” says Jeanette. “Who can best address and mitigate or control the risk? If it’s the customer, then the customer needs to own that risk. Or if it’s the supplier, then the supplier needs to own it.”

“One of the biggest erosions of value comes from misplaced risk,” Jeanette says.

Disclaimer: I’m not a lawyer, so don’t take my opinion on this issue as the gospel. As with all matters regarding contracting, make sure you hire competent and experienced legal counsel to help you develop an agreement that makes sense for your organization.

To learn more from Jeanette Nyden about performance-based contracts and how to determine where to place risk, subscribe to Negotiations Ninja podcast, and head over to my Linkedin.