We tend to enter new business partnerships and ventures with a great deal of optimism and excitement. Yet ventures that held so much promise often end up dissolving into costly legal disputes and contract dispute resolution efforts.
Formal contracts offer a method for reducing the risks of new partnerships and clarifying commitment in negotiation, but negotiators are often unsure about how detailed their written contract should be and what types of negotiation to use.
To understand how organizations can craft contracts that reduce the risk of a serious rift and manage conflict through contract dispute resolution, professors Deepak Malhotra of Harvard Business School and Fabrice Lumineau of the University of Technology in Sydney conducted an exhaustive analysis of 102 interfirm contract disputes handled by a corporate law firm in Western Europe from 1991 to 2005.
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Contract Quantity and Quality
What qualities of a contract help a business partnership survive a serious dispute? In a 2011 article in the Academy of Management Journal, Malhotra and Lumineau theorize that the quantity and quality of contractual provisions can influence trust between the parties, which in turn influences the decision to continue the relationship or not.
The researchers note that contracts between organizations include two main types of provisions: (1) control provisions designed to prevent cheating and reneging through the threat of sanctions, and (2) coordination provisions that attempt to clarify each party’s responsibilities with the goal of reducing future misunderstandings.
Malhotra and Lumineau also identify two types of trust that exist between business partners: (1) goodwill-based trust, or our perceptions of the other side’s intentions to behave in a trustworthy manner, and (2) competence-based trust, or our beliefs regarding the other side’s ability to meet our expectations.
In their analysis of the 102 disputes, the researchers found that the presence of control provisions in a contract can erode goodwill-based trust, making partners less willing to rebuild their relationship through contract dispute resolution. By contrast, the more control and coordination provisions there were in a contract, the greater the competence-based trust between parties after a breach; competence-based trust also motivates parties to continue their collaboration.
The results suggest that when it’s time to negotiate a deal, we would be wise to distinguish between control and coordination provisions. In particular, you may be able to enhance mutual perceptions of competence and goodwill, thereby making partnerships more resilient in times of conflict, by focusing more on coordination provisions and, to the extent possible, limiting control provisions. This may be especially important when you are attempting to build a long-term relationship and when future conflict seems quite possible, as in cross-cultural deals.
Hammering Out the Details
In a second study, published in the Strategic Management Journal, Lumineau and Malhotra looked at whether the level of detail in a contract affects the approach parties take to contract dispute resolution in the event of a conflict, as well as the costs of these approaches.
As any experienced negotiator knows, contracts vary widely in their complexity, particularly in the number and percentage of control and coordination provisions they include. Meanwhile, approaches to contract dispute resolution also vary: they can be cooperative (as in mediation) or competitive (as in a court trial), or somewhere in between.
In their analysis of the same data set of 102 contract disputes, Lumineau and Malhotra found that the higher the level of contractual detail, the more likely parties were to use a competitive approach to contract disputes resolution. However, when even highly detailed contracts focused more on coordination than control, parties were more likely to use a cooperative approach. In addition, disputants incurred higher legal costs in more competitive contract dispute resolution efforts than in more cooperative ones. Finally, a cooperative approach was most effective at reducing costs when one party was much more powerful than the other; when parties are more evenly matched, the discrepancy may fuel greater competition in contract dispute resolution.
In this study, contract clauses aimed at coordination—clarifying roles, responsibilities, and so on—promoted deal-making techniques that were more interest-based, constructive, cost-effective contract dispute resolution processes than control clauses, such as specifying noncompliance penalties. Overall, Malhotra and Lumineau’s research shows that in negotiating and deal making, it’s important to stay involved in contract drafting rather than leaving the details to your attorneys.
What advice would you offer those facing contract dispute resolution based on your own experiences?