Contract Balance Sheet

This post proposes a quantitative and behavioral model to measure the value of legal agreements using a contract balance sheet approach in order to address one of the hardest questions: “is this a good agreement?”

Prior posts have observed that the negotiation process in complex agreements is frequently separated into two phases. In the first stage, business people set the core terms of the bargain and in subsequent stages, contract experts–frequently lawyers–settle the non-core or legal terms.

Additionally, the core business terms are more quantifiable in terms of market value and divisible into discrete units. For example, the scope and term of a warranty can be sensitively adjusted to price. The legal terms are less quantifiable in monetary terms or easily divisible into discrete components. The terms can, however, be adjusted in terms of favorability to one side or the other.

Finally, the negotiation of the business terms tend to be in the nature of a back-and-forth exchange, fine tuning price and deliverables until the parties reach consensus. The negotiation of non-core terms may be more characteristized as a barter (since price cannot be revisited), ultimately presenting the parties with a a “take-it-or-leave-it” proposition.

Characteristics of the Contract Balance Sheet

• Each party constructs their own balance sheet. The balance sheets between the parties are not combined into a single sheet.
• Each party seeks positive contract value and will enter into agreement only if they see contractual benefits (or least equivalence in the value of the consideration given and received).
• The balance sheet separate business and legal terms.
• The core, business terms can be measured by the market value consideration given and received. However, the parties will rarely tabulate and quantify each element of the bargain given and received. Instead, it more likely that the parties assess an overall value and judge agreement by ranges from a very good bargain to one that has minimal value.
• The non-core, legal terms are assessed in terms of favorability. Typically, the parties will assess each of the terms having significant impact on the transaction and make an overall assessment of the risks.
• The core and non-core terms interact with each other. Where the parties see greater value in the business terms, the more likely they are to accept less favourable legal terms. Commensurately, where the business terms have less value, the parties threshold of acceptable legal terms narrows.

Example Balance Sheet

Below is a sample balance sheet for an employment agreement. Each principal legal term has an indication (using single and double arrows) of favorability (with single arrows indicating favorability and double arrows indication strong favorability). Based on the overall weighting, we can determine that the contract is favorable to the employee because the at-will status (employer favored) is more than offset by the lack of IP assignment and non-compete obligations. Of course, each person can make their own assessments and come to different conclusions. The purpose of the balance sheet is to offer a consistent framework for discussion.