What is commercial contracting? – Part 1: Understanding the Product

29 October 2021



Commercial contracting means understanding a contract in the whole of its commercial context. A contract document can be perfectly drafted from a legal perspective but if it bears no reflection to the overall commercial deal or actual relationship between the parties, then it may have consequences for the business. Commercial contracting is the process of making sure the document reflects the deal as well as understanding and managing the risks associated with the contract.

Commercial contracting starts at the beginning of the contract lifecycle – understanding the product or service and the market into which it is sold. These key factors, which will shape the contract and its negotiation.

Firstly, in relation to the product itself, it is important to understand the key technical features of the product or service as well as the value of the intellectual property subsisting in it. Does it contain distinguishing intellectual property which sets it apart from competitors and is this reflected in the pricing?

Understanding how the product or service has been developed will also influence negotiations relating the price and payment terms.  If the product or service is newly developed, what are the development costs, and to what extent can they be recouped? If the product or service is developed on a bespoke basis, what are the likely development costs going forwards? These factors, together with an understanding of the supply chain will enable the business to negotiate payment terms to manage development costs and minimise cash flow risks.

Understanding the profit margins, overheads and expenses, together with the costs of any licences, insurance, safety certificates and delivery costs will enable businesses to identify the negotiation parameters for contract price discussions.

Finally, an understanding of how the product or service is to be used will help to identify contractual risks relating to warranty and liability.

Understanding the product lifecycle, the probability of claims and their likely cost can help the business calculate potential warranty provisions to be built into the contract price. In relation to liability, identifying the worst-case scenario can assist when negotiating liability clauses to mitigate the risks. What could go wrong and what is the likely damage? Do we have insurance in place to cover these risks? For example, if you are delivering software, what is the risk of corruption of customer data and what are the consequences? If you are delivering a mechanical product, what happens if it breaks down, what other property or equipment could it damage and what losses could be caused to the customer and any third party?

Understanding these product related factors will enable the enable the business to identify the key contractual risks relating to pricing, payment, intellectual property, warranty and liability. This is the reason that it is important in a pre-bid or pre negotiation phase to liaise with finance and development teams in order to understand the product.