Contract Renegotiation in a Time of Crisis

Amid the current economic downturn, many individuals and organizations need to engage in contract renegotiation. Here’s advice on how to approach this challenging task.

By — on / Business Negotiations

contract renegotiation

The COVID-19 pandemic has left many of us negotiating circumstances we never envisioned just months ago, from health crises to lost jobs to plummeting sales. Businesses of all sizes, in particular, are faced with the difficult task of contract renegotiation as a result of parties’ inability to meet current deal terms.

Unfortunately, contract renegotiation is much more likely to be rancorous and competitive than when we first negotiate business contracts, potentially leading to the need for contract dispute resolution. Because negative events affect people much more strongly than positive events, negotiations over costs and losses are likely to be more competitive and challenging than negotiations over benefits and assets.

In addition, parties to a contract renegotiation probably will be less willing to compromise and less likely to reach agreement than they were initially. Negotiators who focus on losses achieve less overall profitability than those who focus on gains, Margaret Neale of Stanford University, Max H. Bazerman of Harvard Business School, and the late Thomas Magliozzi found in one study.

Contract renegotiation also tends to create less mutual benefit. Negotiators are less capable of reaching agreements that trade off differences to create value when allocating burdens, such as monetary losses, than when allocating benefits, a study by Neale and University of Utah professor Harris Sondak found. The tendency for negotiators to view gains and losses differently helps to explain why we often reach less efficient agreements when discussing losses—and need tailored contract negotiation strategies to do better.

Making the Best of Contract Renegotiation

Contract renegotiation during an economic downturn is daunting, but there are steps we can take to make it at least a bit easier. During the 2008 recession, negotiation expert John S. Hammond offered guidelines on how to renegotiate a contract that are just as relevant today:

1. Feel the other side’s pain. As negotiators, we tend to get so absorbed in our own problems that we forget our counterpart has problems, too. If your company can’t fulfill an order, your customer may be in serious trouble regarding her own finances and commitments to other parties, for instance. The customer may be willing to renegotiate price with you if she needs the product badly enough and sees value in maintaining a relationship with you and your organization.

Take some time to make a list of what your counterpart’s pains might be. Then think about how you might be able to alleviate some of them in ways not specified in your contract. Maybe you can make useful introductions to others in your network, for example. Understanding that your counterpart is motivated to work with you to solve their problems can bring you a sense of power and help you collaborate to avoid worst-case scenarios, such as bankruptcy and lawsuits.

2. Change the players. When a deal sours during implementation, there are advantages to having the same individuals who negotiated the original terms negotiate the revised contract. They know the situation well and may have developed a level of trust with the other side that can help the parties revise their agreement.

But from management’s perspective, the deal that results from this contract renegotiation may not be in the organization’s best interest. Those involved in the original relationship are sometimes too committed to it to recognize that it should end. For example, Hammond found that commercial bankers who originated loans that turned into problems tended to be too slow to recognize signs of trouble and too willing to advance more money to help the borrower recover. Hammond’s recommendation: Turn problem loans over to people who can look at the situation with fresh eyes and who are skilled at dealing with such loans.

Similarly, you and your organization might benefit from asking whether keeping the same people in charge of mounting losses will lead to inappropriate additional investments of time and money. In such cases, a change of guard may be the best approach.

3. Reframe the problem. One reason contract renegotiation during a crisis is so psychologically daunting is that we tend to compare looming losses to the lofty expectations we had when the original deal was signed. Hammond’s suggestion: Focus on the realities of the new status quo, not what used to be. In the case of a mortgage default, for example, the new status quo becomes foreclosure. This means the lender will sell the house at a loss, and the buyer will lose his equity and have to move. When parties begin to look at the problem this way, they become capable of viewing any deal that realistically avoids this outcome as a gain for both parties—a mindset that is likely to lead to greater cooperation and creativity.

What advice do you have for effective contract renegotiation during an economic downturn?

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