When might a contingency agreement be appropriate?

Sometimes both parties agree to disagree, but it can be possible for the parties to come up with a contingency agreement to memorialize perspectives and set up the parties for success in the future.  This commentary addresses this type of situation.  This may essentially be a bet on the future that both parties can live with going forward.

How about the IRS?

As an example, let’s look at the IRS and proposed regulations.  Proposed regulations are exactly that, they are proposed.  That is, proposed regulations do not become effective until after comments and testimony are received ("notice and comment"), and a final regulation is issued. Proposed Regulations may offer guidance for a specific section of the Code, and are useful in determining a taxpayer's liability for the given year, although they have limited precedent value.  This means that if the taxpayer follows the proposed regulations this will limit the possibilities of penalties, but should the final regulations differ markedly, then the IRS may challenge the taxpayer’s position. 

This means that if the taxpayer follows the proposed regulations this will limit the possibilities of penalties, but should the final regulations differ markedly, then the IRS may challenge the taxpayer’s position. 

In some cases proposed regulations may even be contrary to the Internal Revenue Code (the law) to solicit feedback from the public on what the public thinks about the proposed regulations based on public input in formulating the proposed regulations.  What should a taxpayer do if challenged on audit by the IRS when the taxpayer likes the proposed regulation, but the IRS makes a determination on audit to make an adjustment based on the code?  The taxpayer should consider filing a protective claim.  What is that?  The taxpayer agrees to pay the tax today as presented by the IRS on audit and file a protective claim. That is an agreement with the IRS that should at some point the final regulations come out in the taxpayer’s favor consistent with the current proposed regulations, then the taxpayer could file a claim to correct the return and be paid interest on the amount in question.

In this case both parties are betting on a risk in the future.  This allows both parties to move on and yet have a position to sustain their respective positions based on a future outcome.  It protects both parties against risk.

What about a contingent agreement with a  homeowner and contractor?

With a home remodeling project, the contractor clearly states that the project will be completed at some point in the future.  You both agree this is acceptable.  Is the contractor willing to put this in writing and state that should the project be completed on time and cost with the quality stated, that the homeowner may be willing to write a nice commentary regarding the work for the contractor to use for marketing purposes on the web and in other media. 

Set up each party for success with a testimonial up by the homeowner if done on time and a reduction on price by 10% if late.

However, if the contractor does not come through as promised, the contractor agrees to reduce the total payment by some percentage (say 10%). This offers the contractor an incentive for an early completion and a disincentive for work not completed on time. If others are not doing this and this homeowner makes use of this clause, whose project do you think is more likely to be completed on time? The one with the contingent agreement. This seems like a clever idea for the homeowner and this gives an incentive to the contractor.

This type of arrangement allows each party to capitalize on their differences and avoid the differences from preventing the deal from being completed.

There can be difficulties with contingent agreements. Keep this in mind too. Something unexpected may happen leading to unforeseen circumstances. Should this be the case, the legal contract may still govern, but might not mercy rather than justice be an appropriate approach?  Say there was a strike beyond the control of the contractor that was unforeseen and certain supplies were unable to be delivered timely.  Would the homeowner be willing to accept this once the contractor explained that situation?  This is something to think about. The homeowner may have the right, but is it the right thing to do? How might this impact future arrangements?

What are some other risks?

Before entering into a contingent agreement keep in mind that (1) you or the other party may not know all of the relevant information, (2) if the incentive is not thought of as being fair by both parties this could create a negative working relationship [for example the contractor might want a 10% bonus for finishing early or on time consistent with the 10% penalty for finishing late rather than simply a written recommendation], (3) the contingent agreement may set a precedent for the future that you may not want to have in the future and (4) make sure the contingent agreement is clearly stated and measurable.

Keep these ideas in mind when considering a contingent agreement as an acceptable way to address risk. You can read more on this topic from the Program on Negotiation from the Harvard Law School.

Contact me to speak to your group or consult with you. Check out my website, books and content. I am an international speaker. I speak on how to overcome conflict with collaboration by taking advantage of the collaboration effect ^TM enhancing relationships, resources and revenues. My service areas are related to helping clients resolve conflict: business to IRS, business to business and within businesses. I have written 11 books including The Servant Manager and Peaceful Resolutions. I may be contacted directly at mg@mikegreg.com and at (651) 633-5311. [Michael Gregory, NSA, ASA, CVA; MBA]

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