Key Contract Terms Part 2: Pricing Provisions
In our last blog, we outlined the importance for a well-defined scope of work in a business contract. This month in our Business Law Series on Key Contract Terms, we will help you understand the value of precise pricing provisions in your contacts. Do you know if you are supposed to pay a contractor or partner before or after the work has been done? Is there a payment plan that arranges for multiple payments? Do you know when YOU’RE supposed to be paid?
Pricing provisions are integral parts of any transaction. In the simplest transactions they are straight forward: You give the convenience store cashier $2 and immediately walk away with a candy bar. However, as the size of the transaction increases, the situation immediately becomes more complex. Consider the following example:
A homeowner hires a contractor to build a deck. The contractor quotes $20,000 to the homeowner and estimates that the deck will take approximately 1 month to complete. Now the parties must decide whether the homeowner should pay $20,000 up front (in which case the homeowner would pay and risk the deck not being completed or completed properly) or whether the homeowner should pay at the end (in which case the contractor would provide services and risk the owner defaulting on the payment). If they settle on a 50% down payment, should this be refundable, and if so, in what scenarios? What if lightning strikes the almost-completed deck, it burns down, and the contractor must begin again—how does this impact the overall price? What if the homeowner wants to cancel the contract? Are there any laws concerning residential contracts that the parties must consider?
As this example demonstrates, much care and consideration should go into drafting comprehensive pricing provisions. Collectively, these provisions should: 1) Ensure there is a fair trade of goods or services and compensation between the parties; 2) clearly set forth the obligations of both parties, 3) prepare for common contingencies; and 4) comply with relevant laws.
Ensuring a Fair Exchange
The overall price paid under the contract should give the provider of the goods or services a profit while remaining competitive in the relevant market. Factors to consider in establishing the price is the overall market in the relevant area where the goods or services will be provided, the experience and reputation of the service provider, and, if you’re the service provider, what amount you would need to make the transaction worth your while (of course, there may be situations where you can’t charge a fair market price that is also profitable for your business, in which case you should possibly reconsider your services or strategy).
Another consideration is how the parties will charge the price. Some projects work well with a flat fee. These tend to be straight forward projects where the provider has enough experience and data to set a fee that accounts for the typical resources the provider must dedicate to completing the project. The benefit to using a flat fee is clarity. The difficulty is that for the provider, they may fail to address atypical contingencies that cause the provider to use more resources than normal in completing the project. For the purchaser, flat fees may cause them to spend more money, if their given situation happens to use less time and resources than is normal. For example, if the flat fee was set during a period of high inflation and the price of labor and supplies dropped over the course of the project.
In order to provide a more exact, but less predictable price, contracting parties may instead utilize varied rates based on factors like time (ex. an hourly rate) or size (ex. price per square footage).
Frequently, contracting parties will attempt to form hybrids of these methods in order to reap the benefits of both and mitigate the costs.
Clearly Set forth Obligations
The selected pricing method should clearly set forth the timeline for one party’s obligation to make a payment and the other party’s obligation to provide services. For example, the purchasing party may pay an installment payment which obligates the providing party to begin phase one of the project. Then the contract may determine that the providing party has no obligation to begin phase two until the purchasing party pays the second installment payment.
However, if the parties choose to proceed, these obligations and procedures should be negotiated and established before the project begins.
Prepare for Common Contingencies
A contract’s pricing provisions should account for common contingencies that may occur and reshape the scope of the services provided under the contract. These are events like acts of God, supply chain interruptions, requests to change the scope of the project, unexpected and significant increase to the cost of supplies, refund requests, payment defaults, and other events. These are common occurrences and electing to “cross that bridge when we get there” often leads to headaches at best and costly legal battles at worst.
Legal Compliance
Finally, pricing provisions should comply with relevant laws. While freedom to contract without government interference is a right we generally enjoy in America, this lack of government interference isn’t absolute. The government often interferes and sets certain industry specific provisions intended to protect consumers and ensure fairness. These are laws like mandatory late fees on commercial clients, obligatory grace periods, or prohibitions against contract provisions the government considers “unconscionable.”
In North Carolina, the government will strike impermissible provisions rather than re-write them. For example, if a contractor sets a late fee of 50% per day and a judge deemed this to be unreasonable, rather than inserting a reasonable rate, the judge’s ruling strikes the provision wholly and there would be no late fee. Accordingly, contracting parties should strive to ensure their provisions are legal and not assume a judge will fix errors.
Takeaway
A contract’s pricing provisions have far-reaching impact. When drafted properly, they provide clarity and direction and prepare the contracting parties for success. When drafted poorly, they can lead to frustration, confusion, disputes, limited paths for recourse, and government interference. Contracting parties should give these provisions appropriate care and thought on the front end to avoid costly headaches on the back end.
If you are interested in speaking with an attorney about reviewing, revising or preparing a business contract that is sure to contain sufficiently comprehensive pricing provisions please contact the business law attorneys at Skufca Law at (704) 376-3030.
Up Next: Time for Performance
Stay tuned for our next blog in the Business Law Series: Key Contract Terms where we will discuss what you should consider and include in your performance timeline when drafting your business contracts. After signing a contract, do you know when it goes into effect? When will each stage of the agreement take place? We will address these questions and more.