Negotiating the terms of a contract can be difficult, and when the parties are not able to reach an agreement because of something that may happen in the future, they may decide to use a contingent contract to form an agreement. A contingent contract may sound like an oxymoron, as the finality of contracts is often emphasized, but the flexibility of a contingent contract can help keep a contract intact, even if there’s a change in the position of the parties. Contingent contracts can be a powerful negotiating tool to keep a contract on the table when the parties are having difficulties creating the terms. Yet some parties will be hesitant to agree to a contingent contract because there may be risks associated with the contingent portion of the parties may not fully understand the implications of a contingent contract. This article will examine contingent contracts and look at how they are formed, what types they may take on, how to present one, and the effectiveness of contingent terms. The goal of this article is to ensure that readers feel confident in their contracts moving forward, whether contingent or not.
Contingent Contract Defined:
A contingent contract is simply a contract where one or more of the terms are contingent on a fact or condition happening or not happening. Contingent means that the terms will only take effect or will lose their effect if the condition occurs. It is the opposite of absolute, which means that there are no conditions that can affect the occurrence of the terms in the contract. Instead, the terms will only take effect if an unknown event occurs. In negotiations for contracts, there will always be predictions about how the events following the agreement will play out, but a contingent contract gives the parties a chance to change or alter the contract based on the unknown event. They are most commonly used to create a motivation to comply with the contract or to punish a party for failing to comply. However, there are a variety of types of contingent contracts, which will be discussed below.
Elements of a Contingent Contract:
To better understand a contingent contract, it is important to understand the necessary elements to create a contingent contract. Including these elements in a contract will give the contract the flexibility that a contingent contract needs. To ensure that the contract is contingent, it needs to include:
- Event: The contract must refer to an event or condition that will either happen or not happen in the future. There must be this reference in the contract, or it will not be a contingent contract.
- Collateral: The event in the contract must be collateral to the contract. This means that is not part of the performance required by the contract. If one of the parties is required to complete the event for the other party to be required to complete their task, this is part of the performance and is essential to the contract, not collateral.
- Conditional: The performance of the contract must be dependent on an event that is both future and uncertain. If an event is sure to happen, it is not a contingent contract, because the only condition is the passage of time. A truly contingent contract requires dependence on an event that may or may not happen.
- Independent: Another important aspect of the event that triggers the action is that the event cannot be under the control of the promisor. This means that the parties to the contract cannot be responsible for the event happening or not. If a contract involves a contingency based on the actions of one of the parties, those actions are likely part of the performance of the contract.
If attempting to create a contingent contract, these elements are necessary. Looking for these elements may also help identify if a contract or contract offer is contingent and help the parties make informed decisions about the contract negotiations.
Examples of a Contingent Contract:
Another way to learn to identify contingent contracts is to look at examples of agreements that would be considered contingent contracts, and those that may look like contingent contracts but are not. To begin, let’s consider the following facts. Aly owns a soap and candle-making company. She’s recently expanded her business nationwide and would like to ship through ShipCo, Sandi’s shipping company. The two of them have a meeting to iron out their contract. Because Aly’s business, Aly’s Candles, is new, Sandi is looking at a possible contingent contract to protect any interest that they have. They are considering the following contract options.
- Option 1: Aly has a potential investor interested in her company. Sandi offers Aly a discounted shipping rate for one year if the investor backs Aly’s business by next month. This is a contingent contract because Sandi’s performance is conditioned on the investment of the outside investor in Aly’s business, which is a collateral event that is outside of Sandi’s control.
- Option 2: Aly offers Sandi a contract that says as long as Aly sends at least 50 packages through ShipCo a month, she will receive the discounted rate. This is not a contingent contract, because Aly is in control of the number of packages she sends and the discounted rate is the consideration Sandi will give for the number of boxes.
- Option 3: Sandi’s company ShipCo specializes in international shipping as well. Sandi offers Aly the national rate at a barely discounted rate, but there is a clause where Aly can fulfill international orders at a deeply discounted rate. This is a contingent contract in part because the deep discount offered is contingent on Aly’s Candles getting an international order, which is an independent event that is collateral to the contract.
- Option 4: Sandi offers another contract where she will send packages for six months. If Aly’s Candles does not receive a valid one-star review during that time, the contract will extend with ShipCo’s trusted vendor rate. This is also contingent, at least in the extension because the extension is based on Aly’s Candles not getting a low review online.
There are plenty of other contract examples that could be discussed; however, the important thing to look for when identifying or creating a contingent contract is performance dependent on an independent collateral event.
Types of a Contingent Contact:
Outside of identifying a contingent contract, it may be helpful to understand the types of contingent contracts that may be helpful in bargaining and knowing options to present. The common types of contingent contracts are:
- Occurrence of an uncertain event: This type of contingent contract will have the performance of the contract if an uncertain event occurs. In the examples above, the international order would be a good example, because the international order is an uncertain event that could happen, or might not happen.
- Nonoccurrence of an Uncertain Event: This contract will be dependent on an event not happening. The example above that lists the one-star review option would be a good example of this if there was no time frame because performance on Sandi’s part is wholly dependent on no reviews being posted.
- Occurrence with a Timeframe: Similar to the first type, this contract will have performance dependent on the occurrence of a certain event within a set period of time. Option 1 above is a great example of this type because it requires an investor to back Aly’s company within a month, which is the timeframe within which the event must occur.
- Nonoccurrence with a Timeframe: Similar to the type before, a contract contingent upon the non-occurrence of an uncertain event within a timeframe will condition performance on a certain event not occurring within a timeframe. Option 4 is the perfect example of this. Sandi’s performance is contingent on Aly’s Candles not getting a valid one-star review within six months, or the nonoccurrence of a one-star review.
- Impossible: The final kind of contingent contract is one type of contingent contract that the parties should seek to avoid. This is a contract that is contingent upon the occurrence of an impossible event, or an event that is guaranteed not to happen. These contracts are void immediately and cannot be completed. An example of this type would be option one if the investor has already told Aly she will not invest in her company. Therefore, the contract would be void because it would be impossible for Sandi’s performance to occur without the investor being in the picture any longer.
Contingent contracts can only take on these forms. If you change any other aspects of the contract, it will likely shift into an absolute contract or will be excluded because the condition will be under a party’s control. Therefore, if looking to create a contingent contract, these types should be considered.
Effectiveness of Contingent Contracts:
Before looking at the situations where a contingent contract is a good option or how to bargain for a contingent contract, it is important for the parties to consider the effectiveness of a contingent contract and whether they protect the interests that they are designed to protect. Contingent contracts are often effective when crafted well, but it can be dependent on what interests are designed to be protected in the contract. Understanding what and who the contingency protects is vital to consider their effectiveness. To examine how well contingencies perform, consider the interests it seeks to protect.
The most common interest protected by contingent contracts is fear. This can come from a variety of places and will likely be an undercurrent in other interests that play into the contract. This is most commonly the interest when one of the parties is nervous about an event happening, so they build protection for themselves into the contingency if the event happens. These can be incredibly effective when a party is reluctant to commit and the event making them nervous is unlikely to happen.
Another common interest at play in. contingent contract is protection. This is also typically based on fear, but the fear is tied directly to something else that they need to protect. In our example above, Sandi is nervous about agreeing too much with Aly because Aly’s Candles is new and Sandi has a business reputation to protect. When contingencies are built into a contract based on protection, they are often successful in this protection but are somewhat hard to create consideration for.
Bargaining for a Contingent Contract:
If a party is in a situation where they would like to create and bargain for a contingent contract or contingent term, they may feel that they need to be creative with their bargaining. In some industries, contingent contracts are incredibly common, yet in many companies and negotiations, the parties are unsure or unaware of how contingent contracts work. Highlighting the advantages of contingent contracts can help demonstrate the benefits and increase the chances of achieving a contract with a contingency in it to protect interests. When looking to create a contingency in a contract, the parties have the unique opportunity to make the very issues that they are struggling to reconcile a term of the contract. Presenting contingencies as this type of value will often help encourage the other party to agree. Some common advantages of contingent contracts that can demonstrate their value include:
- Avoid Disagreement: By agreeing to make the performance on some or all of the contract contingent on an unforeseen event, the parties will avoid any large disagreements that they are having by making either option play out depending on the outcome of the event. It gives the parties the ability to bet on their predictions and receive what they need from the contract.
- Avoid Litigation: Contingent contracts also avoid litigation because the parties have the answers for the outcomes of the event without needing a court to sort through the contract. By creating options within the contract, the parties can avoid further disagreement.
- Avoid Renegotiating: When parties create an absolute contract or refuse to create a contract until an event occurs, they run the risk of needing to reconvene to renegotiate the terms of the agreement. By creating contingencies in the contract that dictate the outcome of the contract without having to renegotiate.
- Avoid Imbalance: Negotiations often involve one of the parties having more information than the other. Creating a contingent contract that has options for the party who knows less to discover more about the contract and be locked into a decision when they receive that information. In this case, contingent contracts allow the parties to even the playing field through the conditions.
By highlighting these and other advantages of a contingent contract, a party will be able to create value in the negotiations and gain ground in their contract. Finding ways to avoid disagreement by creating an agreement with options based on unforeseen events will help the parties enter into a working relationship and encourage interaction in the future.