What is a Contingent Contract?
Negotiators often try to overcome their differences of opinion through persuasion techniques. A more fruitful approach might be to “bet” on your differing views with a contingent contract.
Negotiators often reach impasse because of their different predictions of how the future will unfold. By negotiating a contingent contract, they can eliminate the need to reconcile those differences.
Additionally, a contingent contract can be a highly useful, though widely overlooked, tool for creating value in negotiation.
What is a contingent contract? In virtually any negotiation, parties must make forecasts and assumptions about the future. Will materials arrive on time for the contractor to meet his deadlines? Will fuel-oil prices remain stable or rise suddenly?
In terms of deal design, a contingent contract often creates incentives for compliance and/or penalties for noncompliance, but also can take the form of insurance, bonds, and other tools designed to reduce risk.
For example, you could ask a contractor to accept a substantial discount if he doesn’t finish the work on time. If his time estimate is honest, he should be willing to take the bet.
In addition to spreading risk and surfacing deceptive claims, contingent contracts have numerous other benefits for negotiators:
- A contingent contract makes commitments self-enforcing by eliminating the need to reconvene or renegotiate when a surprise crops up.
- A contingent contract eliminates the need to come to an agreement. By allowing parties to bet on their predictions, a contingent contract enables parties to “live with” their differences.
Contingent contracts allow parties to reach agreement by managing uncertainty about the future. Just make sure that the penalties (or rewards) you propose are prohibitive (or enticing) enough that they’ll motivate the other party to stay on target.
To find out more and discover how to boost your power at the bargaining table, download this FREE special report, Business Negotiation Strategies: How to Negotiate Better Business Deals, from Harvard Law School.
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