International arbitration
ONE way to achieve a satisfactory result is for the parties to agree to submit any future disputes between them to a neutral decision maker. This, in fact, is what is done in the vast majority of international transactions. It takes the form of international commercial arbitration.
Arbitration, an age-old method of solving disputes, is found in most of the world’s cultures. While it has many variations, basically it is a process whereby two people agree to submit a present or future dispute to a third person and further agree that they will carry out the third person’s decisions.
Arbitration is of two types: institutional and ad hoc. In institutional arbitration, the parties select a specific institution to administer their arbitration proceeding. Many institutions exist around the world to handle arbitration. The best known include the International Chamber of Commerce, the American Arbitration Association, the London Court of Arbitration, the Stockholm Chamber of Commerce, and the Zurich Chamber of Commerce. Each has its own rules and procedures.
In an ad hoc arbitration, the parties administer the arbitration themselves according to rules they have agreed upon.
Rejection and renegotiation
When one side feels that it is tied to a contract that has become unfair or unreasonable on account of changed circumstances, it usually attempts at renegotiation before outright rejection. Attempts have been seen to redo many existing deals.
Third World borrowers have been engaged in a constant process of renegotiating loans when they have been unable to repay, an exercise commonly known as debt rescheduling.
The dramatic fall in the price of oil and gas from the heights of the early 1980s and 1990s forced purchasers in that decade to try to renegotiate long-term supply agreements that once seemed profitable but had become ruinous.
Three types of renegotiation
TO handle the problem, negotiators must understand precisely the kind of renegotiation that they are facing. The term “renegotiation” covers three fundamentally different situations, and it is important to distinguish each of them at the outset. Each raises different problems and demands different solutions. The situations are (1) post-deal renegotiation, (2) intra-deal renegotiation, and (3) extra-deal renegotiations.
Post-deal renegotiations. In this situation, negotiations take place at the expiration of a contract, when the two sides, though, legally free to go their own ways, nonetheless try to renew their relationship. Here the renegotiation process may be very much like the negotiation of their original deal, but there are also some notable differences.
The willingness of the participants to reach agreement is influenced by their tangible and intangible investments in their first relationship and the extent to which those investments may be used advantageously in their second contract. The foreign distributor will have trained its employees and organized itself to handle the US manufacturer’s products.
In general, the success of post-deal renegotiations depends on the strength of the relationship built by the two sides during the original contract. If that relationship is strong, the atmosphere at the table will be one of two partners trying to solve a problem. If the relationship is weak, the prevailing mood will be that of two cautious adversaries who know each other only too well.
Intra-deal renegotiations. A second type of renegotiation occurs when an agreement provides that, during its life at specified times, the two sides may renegotiate or at least review certain provisions. Here, renegotiation is anticipated as a legitimate activity in which both parties are to engage in good faith.
In a long-term supply contract, the two sides may agree to meet periodically to determine raw material prices. Rather than leave the matter entirely open to bargaining by the parties, the contract may put limits on renegotiation by specifying a formula or criteria to be used in setting new terms. In this case, the renegotiation will focus on the interpretation and application of the formula.
Extra-deal renegotiation. The most difficult and emotional renegotiations are those undertaken in apparent violation of an agreement, or at least in the absence of a specific clause for redoing the deal. These renegotiations take place “extra-deal,” for they occur outside the framework of the existing agreement.
Beyond mere disillusionment, extra-deal renegotiations, by their very nature, can create bad feeling and mistrust. One side believes it is being asked to give up something to which it has a legal and moral right.
Justifying extra-deal renegotiations
Respect for agreements is a basic norm in virtually every culture. How, then, can attempt to renegotiate a valid contract be anything more than an unprincipled power play? After all, a deal is a deal, isn’t it?
Respect for agreements is, indeed, the rule in virtually all societies. It may even rise to the level of a universal principle of law. But in exceptional circumstances most cultures also provide relief, in varying degrees, from the binding force of a contract. “A deal is a deal” certainly expresses a fundamental rule of human relations, but so does the statement: “Things have changed.”
A deal is not forever
While praising the sanctity of contract, every experienced negotiator knows that no deal is forever. Accordingly, before you arrive at the negotiating table, calculate the risks of change in any eventual deal and take account of them in developing your negotiating plans and strategies.
Throughout the negotiations, remember the following principles: when the costs to the other side of rejecting a deal are less than respecting it, the risk of repudiation and renegotiation increases. Your basic strategy to give stability to your deal is to assure that the other side derives sufficient benefits from keeping the agreement or incurs sufficient costs from breaking it.
To apply this strategy for a stable agreement, a negotiator should remember the following steps:
Step 1: Embody the deal in a carefully written agreement with detailed provisions and guarantees to ensure regard for the contract to the maximum extent possible. This means that you should try to anticipate possible changes in circumstances and provide them in the contract. At the same time, you should calculate the realistic possibility of extra-deal renegotiations and include that calculation in your plans.
Consequently, prices, rate of return and other essential terms should reflect a hard-headed assessment of the actual duration of the initial agreement, rather than the duration stated on the contract document.
The other side should fully understand the contract, particularly its inherent risks. If you try to hide those risks, you inevitably open yourself to charges of bad faith and demands for renegotiation later on.
The agreement itself should identify those risks and clearly allocate them to one or both sides. International contracts often include a force majeure clause, a provision that suspends or excuses performance of specified contractual obligations on the occurrence of stated events like war, strikes or civil unrest.
A wise negotiator should build into an agreement mechanism to reduce the likelihood of rejection and renegotiation. The thrust of these mechanisms is either to raise the cost to the other side for not respecting the deal or, alternatively, compensate the side that has lost the benefit of the deal it made. Two common mechanisms are a performance bond and linkage.
Step 2: Create a balanced agreement. If the agreement is mutually beneficial, both sides have an incentive to maintain it. Neither side will consider rejection or repudiation as an attractive alternative.
A balanced agreement might be one that allocates specific risks in a venture to the party best able to bear that risk, rather than merely on the basis of raw bargaining power. It might also provide that unexpected windfalls or losses be shared by both parties, rather accrue to one side or the other.
Step 3: Provide specifically in the agreement intra-deal renegotiations at defined intervals on specific issues that are particularly susceptible to changing circumstances. A variation of this approach is to provide for a series of linked short-term contracts that together will extend over the life of the contemplated business relationship. Each of the specific agreements will be renegotiated as the relationship evolves.
Rather than dismiss the possibility of renegotiation and then be forced to consider review of the entire contract at a later time, it is better to recognize the possibility of renegotiation at the outset and set down a clear framework with which to conduct the process. In short, recognize the possibility of redoing the deal, but control the process.
To be continued
To reach the writer, e-mail cecilio.arillo@gmail.com.